Small Cap Value Report (Fri 12 Mar 2021) - Fundraisings, BOWL, BEG, SMRT

Good morning, it’s Paul here with the SCVR for Friday.

Timing – FYI, Jack and I are both working on some sections now, which should start to appear at about 11:30 – apologies for any inconvenience, Friday’s a slow news day, so we tend to take a more leisurely approach.

Agenda -

Paul’s comments on fundraisings, dilution, etc.

Hollywood Bowl (LON:BOWL) – fundraising

Begbies Traynor (LON:BEG) – fundraising amp; another acquisition

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We’re seeing a deluge of fresh equity fundraisings at the moment. I might focus on that today, as it’s a really important issue for investors. There are so many companies on the stock market which have stretched their creditors, and run up heavy losses over the last year. Hence it’s only a matter of time until they have to repair the balance sheet at the expense of shareholders, and often prompted by banks seeking to reduce their risk.

We’re in very buoyant markets, and institutions amp; high net worth individuals seem happy to pour money into the coffers of almost any listed company that asks. There are 2 risks though;

1. Dilution – raising equity by definition increases the number of shares in issue. Yet earnings remain roughly the same, improving a little if interest-bearing debt is reduced. Therefore EPS (and divis per share) in the future are usually going to be lower. That means the share price probably won’t recover to previous levels, and if it does, the shares would probably then be over-priced. People following momentum amp; drawing lines on the charts, could therefore be in for a rude awakening when results are published, and everyone realises that due to the higher share count, the shares are now over-valued. Therefore I think there’s a risk of price corrections occurring in some shares where the share count has risen a lot. It takes a while for dilution to feed through into broker forecasts, but it does mean that future years EPS forecasts are likely to be reduced, as the higher share count feeds through the analysts spreadsheets.
2. Discount – I don’t mind if a company gets a placing away which doesn’t dilute existing holders too much, and is at or near the current market price. However, if the company is seen as poorly performing, and/or with an uncertain outlook, then existing amp; new shareholders may not be happy to put more money into the company. What happens then is that the price negotiations ratchet down until a level is found where the broker can raise enough money. Sometimes that can be at a nasty discount, that permanently resets the share price at a lower level. In my view there should always be a decent-sized Open Offer attached to a placing, if a fundraising is at a significant discount, in order to respect the pre-emption rights of existing holders, but this isn’t always done.

This area is fraught with risk. It’s actually very easy to identify if any company needs more cash, it’s something I assess when reporting on nearly every company in the SCVRs. You look at the balance sheet, and estimate how cashflows are likely to pan out over say the next year.

I think we should get into the habit of discounting EPS, to take into account potential future dilution, at companies which have a clear need to raise fresh equity funding. That could render some shares looking too expensive.

The market seems to be ignoring this fundraising risk at the moment, which greatly perplexes me. A good example is Card Factory (LON:CARD) – this company was already in a stretched financial state before covid, paying out excessive dividends, and carrying too much bank debt. Having its stores closed on amp; off for a year, has done a lot of damage. As reported here, the company is now limping along from one month to the next, with the bank giving short term extensions to the covenants. In other words, it’s close to potentially going bust, if it’s not able to raise more equity. The company has already told the market that it’s exploring funding options, i.e. almost certainly a placing is probably underway as we speak. Yet we have no idea how many new shares are likely to be issued, nor the price. Isn’t it crazy that the shares are still trading then? It’s a false market, due to the funding uncertainty.

Shares should always be suspended when a fundraising starts, because there are too many people (hundreds) who are made insiders, and good or bad information is bound to leak out – someone somewhere tips off someone else, who then buys or sells in the market, on insider information. If they’re not formally connected parties, and there’s no paper or email trail, then nothing can be proven, even if insider dealing is suspected.

You can see clear evidence of insider dealing from the charts of some companies – inexplicable share price weakness usually, in the month before a fundraising is announced. The system’s a joke, and needs urgent reform. Fundraisings should be quick, electronic, with the minimum of paperwork amp; costs, and done in a week, with the shares suspended while it’s underway. London could gain a terrific advantage as a place to raise money for growth companies, if the system was reformed in this way.

I don’t know how Card Factory (LON:CARD) is going to end up, but there must be substantial dilution in the pipeline, and why the share price has doubled in recent weeks, when the company is financially distressed, I have no idea. Perhaps the company is telling a story that it’s going to pivot to the internet, and become the next Moonpig (LON:MOON) whilst keeping the profitable shops too ? That’s what CARD should have done years ago, but it could be a reason for the resurgence in share price, despite the precarious financial position, maybe?

Here are a few recent fundraisings, and my assessment of them -

Hollywood Bowl (LON:BOWL)

Dilution – 13.04m new shares, 8.3% enlargement of the share capital

Price – 230p, an 8% discount, although the share price had been buoyant, so 230p looks a fair price, as you can see from the chart below

Raised – £30m before costs

Costs – £0.8m (2.7% – not excessive)

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Reason given for fundraising – capex (refurbs), 9 new sites in the pipeline (£2.4m per site), and to strengthen balance sheet (improved bank facility terms are mentioned).

Broker – Investec

My opinion – this looks fine to me. I’ve read through the announcement, and it makes a lot of sense to raise a bit of fresh cash, to support the business amp; invest in existing amp; new sites. We know that trading was quite good when they were allowed to re-open last year, evidence that full re-opening this year should see strong pent-up demand.

8% dilution, and a modest price discount, don’t significantly impact the investment case for this share, in my opinion. It reduces risk, keeps the bank happy, and allows BOWL to expand further, when competitors might be struggling or even insolvent. So a good thing, this gets a thumbs up from me.

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Share price: 131.4p (+1.86%)

Shares in issue: 28,255,823

Market cap: £37.1m

Smartspace Software (LON:SMRT) is a small SaaS business that encountered issues pre-Covid but has since initiated a turnaround. The cause of the original profit warning came from its Enterprise Division, which has since been offloaded.

The group provides digital workspace technologies that ‘make real estate more efficient’. More specifically, it provides contactless check-in, visitor pre-screening, contact tracing, desk booking, and meeting room solutions. Perhaps its products are well-placed to benefit from a more flexible style of office working in future.

After a couple of false starts, Smartspace is now focused on growing annual recurring revenue (ARR) and average revenue per user (ARPU), which should drive earnings visibility, margins, and cash flows.

Shares have rerated materially so improving prospects have to a degree been priced in. The question now is whether or not this is a sustainable growth opportunity ahead.

The market cap is £36m although a net cash position brings the enterprise value down a touch to £35m. With FY revenue of £4.6m that prices Smartspace at a punchy 7.8x sales.

The group has been loss making for the past couple of years, but momentum appears to be improving after a couple of Covid-related hits.

Trading update for the year ended 31 January 2021

Key highlights:

• Full year revenues of c£4.6m (FY20: £5.1m)
• SaaS revenues of £2.3m, up by 73% year on year, and ARR up 60% to £2.9m
• Cash at year end of £4.5m
• SwipedOn now has 4,735 customers across 6,741 locations. ARPU up by 18% to NZ$91.90
• Space Connect – Evoko Naso now shipping and first revenues recognised

Recurring revenues comprising SaaS and software maintenance revenues were up 39% year-on-year in H1 and this has accelerated in H2, with full year recurring revenues expected to increase by more than 73%. That’s now £2.9m of group annual recurring revenue, or 63% of the total (up from 35% in the previous year).

Australia and New Zealand have remained strong, while the US team is up and running again and the group sees ‘the green shoots of recovery in the UK’ with a ‘flurry of Space Connect orders at the end of February’ for delayed projects.

Cash at the year end was £4.5m with a further £0.4m added in March 2021 from the sale of the enterprise software division.

SwipedOn – SwipedOn deals in contactless sign in and visitor screening. ARR was up 53% here, from £1.78m (NZ$3.64m) to £2.73m (NZ$5.22m). A total of 1,354 new customers and 2,105 new locations were added, bringing the total number of customers to 4,735 across 6,741 locations.

The average revenue per user per month (ARPU) has increased by 18% to NZ$91.90. The average number of locations per customer is up from 1.36 to 1.42.

Revenue churn has increased from 4.4% since the beginning of FY21 or 5.7% at the half year to 7.3% at the year end, primarily due to Covid-19.

Space Connect – Smartspace continues to grow its channel sales network for Space Connect. The partnership with Softcat is delivering new customers and revenue expansion from existing customers and the sales pipeline is growing strongly. Lockdowns have had an impact, however.

Evoko Naso – December 2020 saw the release of Evoko Naso, a next generation meeting room solution powered by Space Connect.

It’s still early days here but the first revenues have been invoiced and the group ‘remains of the belief that the relationship with Evoko has the potential to generate significant future revenues’.

Anders amp; Kern – Anders amp; Kern (“A+K”) is a room booking system. It has not yet returned to pre-Covid 19 levels due to ongoing office closures and non-recurring revenue has fallen 38% year-on-year.

Conclusion

Smartspace appears to have navigated Covid reasonably well although churn has increased at SwipedOn and A+K has taken a hit. The valuation looks fairly expensive though, and a good amount of growth is priced in right now.

The group has pushed through a price increase for new customers at SwipedOn which is expected to have a significant beneficial impact on ARPU in the coming year. It will be interesting to see the impact on churn – I have no personal insight into these products so that would be a useful indicator of pricing power and market demand.

It does sound like there’s a big market to go after, with ‘an exciting pipeline of opportunities for Space Connect in the UK, the Far East and Australia’.

I wouldn’t imagine trading over the past year is particularly indicative of Smartspace’s longer term prospects, so if you are bullish on the management and products then I can’t see anything to change that view in this update. In fact, if pushed to give a view, I would anticipate a boost to trade over the next year. The recent announcement of the UK roadmap out of lockdown has been a major catalyst and should help in the coming months.

That said, Smartspace remains a Speculative micro cap with limited liquidity. It has struggled to generate cash over the past few years and shares in issue have been on the up.

Given the above points and today’s valuation, I’d need to do more work into the group’s products and prospects before I’m comfortable here – but I don’t doubt the growth opportunity around flexible working.

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