Small Cap Value Report (Mon 18 Sept 2023) - SFOR, BPM, PDG, CTG, TPX

Good morning from Paul amp; Graham!

Reminder – it’s Mello Monday starting at 17:00 today. Well known fund manager Judith MacKenzie is on first, then it’s the new Director Hot Seat feature. Last week’s was really interesting, with the CEO of AFC Energy (LON:AFC) subjected to a thorough grilling from an experienced investor. I thought  he coped very well! Let’s see if tonight’s CEO will stand up to scrutiny too?

I (Paul) was starting to feel unwell on Friday, and tested positive for covid on Saturday morning – it’s spreading like wildfire in London, where I am at the moment. The good news is that the symptoms are definitely milder than the first wave in April 2020. I’ve experienced a very sore throat, mild fever, and lethargy as the main symptoms. So my top tip is for subscribers to stock up with soluble aspirin and paracetamol, because they’re a necessity for this variant. Anyway, I’m bored stiff after doing nothing for 48 hours, so will do some work here, but please bear with me if it’s not fully up to scratch.

Explanatory notes -

A quick reminder that we don’t recommend any stocks. We aim to review trading updates amp; results of the day and offer our opinions on them as possible candidates for further research if they interest you. Our opinions will sometimes turn out to be right, and sometimes wrong, because it’s anybody’s guess what direction market sentiment will take amp; nobody can predict the future with certainty. We are analysing the company fundamentals, not trying to predict market sentiment.

We stick to companies that have issued news on the day, with market caps (usually) between £10m and £1bn. We usually avoid the smallest, and most speculative companies, and also avoid a few specialist sectors (e.g. natural resources, pharma/biotech).

A key assumption is that readers DYOR (do your own research), and make your own investment decisions. Reader comments are welcomed – please be civil, rational, and include the company name/ticker, otherwise people won’t necessarily know what company you are referring to.

What does our colour-coding mean? Will it guarantee instant, easy riches? Sadly not! Share prices move up or down for many reasons, and can often detach from the company fundamentals. So we’re not making any predictions about what share prices will do.

Green (thumbs up) – means in our opinion, a company is well-financed (so low risk of dilution/insolvency), is trading well, and has a reasonably good outlook, with the shares reasonably priced.

Amber – means we don’t have a strong view either way, and can see some positives, and some negatives. Often companies like this are good, but expensive.

Red (thumbs down) – means we see significant, or serious problems, so anyone looking at the share needs to be aware of the high risk. Sometimes risky shares can produce high returns, if they survive/recover. So again, we’re not saying the share price will necessarily under-perform, we’re just flagging the high risk.

S4 Capital (LON:SFOR) – 95.5p (pre market) £556m – Interim Results – Paul – RED

As usual, a wide range of performance measures is provided, confusing us – what is reality, and what is spin? If in doubt, I look at cashflow, and SFOR doesn’t generate any! Meanwhile it has £111m in deferred consideration to pay shortly, which will increase net debt to dangerous levels I think. This group looks distinctly wobbly to me.

B.P. Marsh amp; Partners (LON:BPM) – up 2% to 372p (£138m) – Trading Statement – Graham – GREEN

A reassuring update from this investor in early-stage insurance intermediaries. Offering specialist expertise in a small niche of the financial services industry, I am a long-term fan of this investment vehicle. They intend to return £6m to shareholders in the near future.

Pendragon (LON:PDG) - Up 28% to 23.7p (£330m) – Proposed Disposal – Paul – GREEN

An interesting deal, to sell its UK car dealerships amp; leasing business to an American dealer called Lithia. Then the proposal is that PDG becomes a standalone software company, Pinewood Tech, which is buried in the existing group, and seems to have interesting potential. My only worry is whether PDG has sold its core business too cheaply – that does seem to be the case, based on numbers out from Zeus (many thanks) this morning.

Christie (LON:CTG) – down 5% to 104p (£28m) – Interim Results – Graham – AMBER

This diversified professional services group reports an H1 loss after economic conditions slowed down transactions at its small business brokerage. I expect that it will find its way towards performance recovery but still struggle to get excited about the opportunity here.

Tpximpact Holdings (LON:TPX) – up 1.5% to 41.1p (£38m) – Disposal – Paul – AMBER/RED

I’ve expressed serious concerns about the debt problems at this software contracting business. However today’s news is a lot more encouraging. It’s sold a Bulgarian subsidiary for £7.5m, and will use £5m of the proceeds to reduce debt from £17.9m at 6/2023, to forecast £11-12m at 3/2024. I imagine the bank is likely to be very relieved at this, which in turn reduces risk for shareholders. It will mean losing £13.1m revenues and £1.3m of aEBITDA though, so forecasts will have to be reduced (rather misleadingly glossed over in today’s update I thought). Current trading is in line with expectations. Some big orders have been previously announced.

Paul’s view – this strikes me as key moment, where the risk of insolvency or deep dilution have greatly receded. If TPX can improve its profit margins, which is the plan, then shares could be worth a fresh look. Although several of these IT consultancies have gone badly wrong recently, and it strikes me as being a tough, competitive space, so doesn’t really interest me. But things have clearly improved, so I’ll move up from RED to AMBER/RED. [no section below]

Down 25% to 72p (at 09:07) £417m – Interim Results – Paul – RED

This is Sir Martin Sorrell’s fast-growing (by acquisition) digital marketing group. Clearly his reputation is second to none, after what he achieved at WPP. However, I’ve never liked the figures at SFOR, and viewed it negatively, RED, on 24/7/2023 (down 20% on a profit warning), 9/6/2023, and 11/5/2023 (in line Q1 TU).

My main concerns are: weak, highly geared balance sheet, and huge adjustments needed to produce any profit, and no genuine cash generation. So major concerns!

Let’s take a look at today’s interim results, with fresh eyes.

Shares have dropped a lot, so there might be a turnaround opportunity here perhaps?

I should add that, in a bear market, it’s easy to fall into the trap of thinking a negative opinion on any share has been proven correct, because the shares are falling. Whereas in reality, it’s often just caught up in a general market downturn, and could be a bargain. Sometimes.

Hence why it’s good to keep an open mind, and change our minds if the facts change.

I’ve just looked at the share price, and seen it’s down 23% to 74p, so clearly the market isn’t impressed with the numbers/outlook today.

My first impression of these numbers is that they’re almost unintelligible! We’re even given 3 different figures for revenue! (£925m billings, £517m revenue, and £446m net revenue).

We have a range of profit measures, from adj EBITDA of £36.5m (up 21% reported, but down 30% LFL).

Adj PBT is positive, at £13.8m, down 9% on H1 LY.

Statutory loss before tax is £(23.2)m, much improved from £(85.6)m in H1 LY.

This table does a good job in demonstrating how EBITDA is a nonsense number at SFOR – because the costs it excludes are real-world cash outflows, you can’t just ignore these costs! -

Balance sheet – this is a deal-breaker for me. Marketing spending is often cut by customers in a downturn, so that makes it all the more important to have a strong balance sheet to fall back on. SFOR has a very weak balance sheet, the way I calculate the numbers.

NAV was £828m at 30 June 2023. But that included £1,095m of intangible assets, mostly related to acquisitions (goodwill amp; similar). Deleting that, gives us negative NTAV of £(267)m.

It held cash of £213m, which was exceeded by “borrowings” of £317m, that figure excludes lease liabilities.

So anyone investing here would need to focus on the terms of that debt, in particular what covenants apply? Today it says that debt maturity is long-dated, and that it has complied with covenants (so far).

The borrowings are also expensive – note that net finance charges shot up to £17.5m in H1.

There’s a timebomb on the balance sheet of £111m contingent consideration payable in the next 12 months, which will significantly increase net debt.

Cashflow statement - much as I expected, SFOR doesn’t generate any cashflow, once all real world costs are taken into account.

Outlook – oh dear, it’s another profit warning.

Following slower than expected trading over the summer months, including August and current client activity levels, full year expectations have been further revised. Like-for-like net revenue is now expected to be likely down on the prior year and operational EBITDA margins are now targeted to be in the range of 12% to 13.5%. As in recent years, we expect the full year results to be heavily Q4 weighted reflecting our seasonality and anticipated client activity9.

Our net debt7 will rise in H2 2023 reflecting payments for prior year combinations, after which virtually all of the existing contingent consideration due will have been satisfied. Our expected range for the year end is £180-220 million. We aim for financial leverage of around 1.5 times operational EBITDA over the medium term.

Paul’s opinion – for the reasons outlined above, I think this looks a mess. Why get involved? I’m struggling to understand why the equity is worth anything at all, given that SFOR doesn’t generate any cash, yet will have £180-220m net debt by the year end.

Shareholders must be hoping that it can turn things around, cut costs, and somehow increase revenues. Why would I want to gamble on that? It seems to me that Sir Martin has created a monster here, with over-rapid expansion, at the worst point of the cycle. Bulls will have to hope that his reputation can carry the day, because these numbers certainly don’t.

Up 28% to 23.7p (£330m) – Proposed Disposal – Paul – GREEN

UK car dealer Pendragon has done a deal with Lithia Motors (NYSE:LAD) – mkt cap £6.5bn per Lithia’s StockReport here (requires US subscription) and also on a low fwd PER of 7.8.

This is an unusual deal, PDG is selling to Lithia for £250m -

“the Company’s entire UK motor business and leasing business”

Cash proceeds will be paid out in a dividend of 16.5p (approx. £240m total)

Lithia will invest £30m in new equity into Pendragon, at 10.7p per new share (but no entitlement to the special divi, so it’s really 27.2p for comparison.

Pendragon’s continuing business seems to be its SaaS software subsidiary, Pinewood Tech, meaning that it will be a much smaller, and less liquid share to own (which might lead to some institutions wanting to exit maybe?) But it claims higher growth potential.

Joint Venture with Lithia to roll out Pinewood software in the US – sounds interesting.

Key details we need, are -

1. Will Pendragon shareholders support this deal? It has one major shareholder called Hedin, owning 27.6%, that I think tried to bid for Pendragon itself a while ago, but it fell through, I can’t remember any details about that. Hedin is notable for its absence from the list given today of institutions totalling 26.5% that have agreed the deal -

Schroder Investment Management Limited, Briarwood Capital Partners LP, Hosking Partners LLP, Farringdon Netherlands BV, Huntington Management LLC, and Sir Nigel Rudd.

2. We need to see pro forma accounts for Pinewood. It says today that Pinewood made £15m EBITDA in FY 12/2022, and hopes to grow that to £27m EBITDA by 2027. However, as we always point out, software companies’ EBITDA is often a fantasy number, due to capitalising of development spending.

Pinewood Technology accounts - I’ve looked these up from Companies House, and for FY 12/2022 it did revenue of £25m, of which almost all £24m was in UK amp; Europe – so the expansion into the US would be incremental sales, which I like.

Operating profit was a very impressive £11.0m, although we have to be cautious when looking at accounts for subsidiaries in a group, because numbers can be skewed by intra-group adjustments.

Pinewood’s balance sheet looks healthy, with NTAV of £17m, so the injection of a fresh £30m in new shares to be subscribed for by Lithia Motors, suggests to me that Pinewood should be very strongly capitalised as a standalone SaaS company, using Pendragon’s listing in future. If this possibly because a lot of money might be spent to launch its roll-out in America? Lithia is taking all other liabilities with the main operating business that it’s buying, so Pinewood Tech looks like it will be a clean, well-financed newly standalone business.

Paul’s opinion – I need more details, but based on the limited information available today, I think this looks an interesting situation. I’m tempted to buy a few PDG shares, at c.24p now, get the 16.5p special dividend, and then end up with a stake in an interesting software company which could increase nicely in value, if its US expansion works out (and being hand-held by a large US partner helps for that roll-out).

What could go wrong? The obvious risk is if Hedin blocks the deal. So it would be important to find out if the shareholder vote is an ordinary (50%) resolution, or a special resolution (75%), if its a special resolution then Hedin could block the deal. Could Hedin launch a renewed bid for Pendragon itself, I wonder?

So I feel that the main downside risk would come from Hedin blocking the deal, then the share price losing its (effectively) bid premium, and dropping back to say 20p. So 20% downside risk, but potentially nice upside if the deal goes ahead, and the market rerates new Pendragon (Pinewood Tech) to a tech company rating, which it might well do.

Based on incomplete information, my hunch is that this deal could be good for PDG shareholders, I like it. GREEN.

Our most recent 3 previous comments on PDG have also been GREEN.

Now when will someone come and bid for Vertu Motors (LON:VTU) ?!

One final thought – I’ve just looked at an update note from Zeus, which flags up that PDG seems to be selling its core business on a very low valuation multiple. So whilst I accept the strategic rationale for this deal, I wonder if they could have got a better price?

Share price: 372p (+2%)

Market cap: £138m

B.P. Marsh amp; Partners Plc (AIM: BPM), the specialist venture capital investor in early stage financial services businesses, is pleased to provide the market with an update on trading for the Group’s six month period ended 31 July 2023.

I covered this company’s full-year results back in June. I was positive about it due to its excellent long-term record plus the ongoing share price discount to NAV (NAV at 526p or fully diluted NAV at 516.8p, vs. share price at the time of 390p).

The BPM share price has softened a little since then, despite the company buying back its own shares.

Today brings a trading update for H1 (the period to July).

Kentro: the £51.5m disposal of BPM’s stake in this business remains “dependent on certain regulatory approvals and completion mechanics and a further announcement will be made when all conditions have been met”. Note: the disposal price matches Kentro’s balance sheet value at BPM, so I’m not expecting the deal to trigger any change in BPM’s net asset value.

I have no reason to believe that this disposal will not be going ahead.

Dividend and buyback policy: as previously announced, shareholders should get £2m in dividends each year for the next three years, plus a one-off £1m special dividend.

For buybacks, the company is planning a £6m return of capital – “the specific mechanics of how this will be achieved are still under consideration and will be announced in due course”. A tender offer might be the fairest way?

In total, that’s £13m going back to shareholders over three years, or 25% of the expected Kentro sale proceeds.

Latest NAV? We will have to wait and see. “The Group remains positive regarding its ongoing performance.” H1 results will be out on 17th October.

New investments

• Shares in the new insurance broker Pantheon, and a loan to it.

• Shares in Verve Risk Services

Ongoing investments – highlights

• Lilley Plummer Risks – performance “continues to be impressive”.

• CBC – “continues to trade significantly ahead of budget”. Achieved £7.5m of adjusted EBITDA in the first seven months of the year, versus full-year expectations of £5.5m.

Cash – it sounds like cash is currently very thin. I think they have a tendency to be fully invested in their portfolio, a policy which makes sense to me. They have no debt.

New opportunities – it remains business as usual on the investing front, although they may feel some pressure to start deploying the proceeds of the large disposal soon.

There are “a high number of potential new business opportunities” and they are “ready to take advantage of opportunities emanating from the financial services industry generally, and the insurance market specifically”.

Industry outlook – in aggregate, insurance rates continue to increase every quarter. UK rates have increased every quarter for the past year and BPM “does not anticipate the market returning to the pricing of the last soft market in the short to medium term”.

Insurance strikes me as a good industry to invest in for protection against inflation: insurers are never shy to increase rates to offset their cost increases!

Graham’s view

No reason for me to change my view on this one. It’s an excellent long-term performer, it’s trading at a significant (c. 28%) discount to NAV, and it’s buying back its own shares. I like the industry and I like the way it gives access to an insurance niche that would otherwise be difficult to invest in. So two thumbs up from me.

Stockopedia likes it, too:

It passes two stock screens, including one of my favourites – the “Neglected Firms Screen”!

Share price: 104p (-5%)

Market cap: £28m

We already had a recent profit warning from this professional services company. See my comments in August.

Christie has a particular emphasis on brokering the sale of small businesses – but low levels of activity over the summer months have weighed on the stock.

Today brings interim results. Highlights:

• Revenues down 1.6% to £33.1m

• Operating loss £1.4m (a loss was expected).

• The “Inventory Systems and Services” division books a £1m loss, about the same as the loss in H1 last year. Christie acknowledges that it will remain unprofitable at the current level of revenues.

• The “Professional and Financial Services” division books a £0.4m loss, versus a profit of over £3m in H1 last year.

Interim dividend: 0.5p (last year: 1.25p).

Outlook doesn’t promise too much:

The delays in transactional deals seen in H1 have continued into the summer period, and the full year outcome will be determined by the number of deals which can be brought to contractual exchange in the remaining four months of 2023. As vendors and buyers adjust to the changed economic environment, we anticipate more normalised levels of activity resuming.

Transactional pipelines have recovered to levels similar to a year ago…

Earlier in the statement, they say “uncertainty remains as to the timing of transactions which will exchange in 2023 as opposed to 2024”. Visibility around the 2023 result seems to be very limited indeed.

Graham’s view

I am maintaining a neutral view on this stock. On the positive side, it has a small net cash position, a very long operating history (usually profitable), and is largely owned by insiders and their relatives.

Against that, there is some uncertainty at the top with the loss of the largest shareholder Philip Gwyn from the Board (28% shareholding, and his relatives also have significant shareholdings).

More fundamentally, I don’t see any medium-term or long-term growth here that is worth writing home about. A solid and diversified professional services business, perhaps, but I’m unconvinced that it makes for an interesting investment.

Stockopedia