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Three ‘value’ plays

Three ‘value’ plays
May 19, 2015
Three ‘value’ plays

It makes sense for the board to consider all options especially as following a major product development programme, which is now substantially complete, and with the benefit of a number of product launches, there is scope to ramp up sales in the years as I noted when I initiated coverage on the shares at 124p last month ('Bug busting potential', 20 April 2015). Being part of a larger organisation offering greater international sales and marketing resources would undoubtedly accelerate this process and enable the business to capture market share and grow product-related revenues more quickly than as a standalone entity. A business combination, joint venture, a distribution deal, or a co-promotion agreement, are all being considered as is an outright sale of the company.

It's also fair to say that there is still substantial value in the shares. That's because the disposal of TRaC generated net cash proceeds of £43.9m for Bioquell, to which we can now add net funds of £4m as of the end of last month. This means Bioquell currently has net cash of £47.9m, or 113p a share, on its balance sheet, so its retained biocontamination control technology products business is only being attributed a value of £11.6m based on the company's market value of £59.5m.

This business generated revenues of £27.3m and cash profits of £3.9m last fiscal year and analysts at broking house N+1 Singer believe it will make cash profits of £4.4m and pre-tax profits of £1.4m on revenues of £36m in fiscal 2016. In other words, Bioquell's biocontamination control business is in effect in the price at only a third of its annual sales and 2.5 times cash profits. Furthermore, analyst Elizabeth Klein at N+1 Singer believes that "a purchaser could easily take out substantial costs from the business, not least £1.5m of annual central costs." This is far more than I had factored in when I initiated coverage last month. It also means that based on 42.5m of shares in issue, then the pre-tax cost savings alone could be worth 3.5p a share to a larger organisation and would double N+1 Singer's EPS estimate of 2.8p for fiscal 2016.

Or put it another way, with Bioquell's shares trading on a bid-offer spread of 147p to 148p, then after stripping out net funds of 113p a share, the retained businesses are only being priced in at 35p, or 12 times their fiscal 2016 net earnings. But they could be easily worth between 60p to 75p a share in a bid situation based on exactly the same earnings multiple once you factor in the cost savings for a larger acquirer.

Even that estimate could prove conservative because Ms Klein sees a value of between 150p to 262p for Bioquell's shares including its cash pile, the higher figure is based on a value of £67m for the retained biocontamination control technology products operations using a multiple of 2 times 2016 fiscal sales. N+1 Singer has a minimum valuation of 150p a share, but as Bioquell's board will only "engage with third parties willing to provide value to Bioquell's shareholders by recognising and supporting the company's significant growth potential", then I can see a much higher valuation materialising in a bid situation.

Of course, there is no guarantee that a larger rival will snap up Bioquell, but there is no denying that it would make an attractive bolt-on purchase given the cost savings and potential to grow revenues. In fact, I definitely see a takeover or sale of the unit as the end game here, and am very comfortable raising my original fair value estimate from 155p to a new range between 170p to 185p a share. At the upper end of that range, this implies a valuation of £30.7m for Bioquell's biodecontamination business, or 7 times cash profit forecasts for fiscal 2016. Please note that the planned capital return of a significant part of the TRaC proceeds has been deferred until the outcome of the strategic review has been completed. Buy.

 

Somero's solid performance

Aim-traded Somero Enterprises (SOM:140p), a Florida-headquartered company that specialises in the design, assembly, and sale of patented, laser-guided concrete levelling equipment for commercial floors, has issued a reassuring trading statement.

The strong momentum seen across the business last year has continued into the first 20 weeks of the new financial year. Sales from the majority of its product lines have been solid and growth broad-based across North America, Europe, Middle East, Southeast Asia and Latin America. In fact, new products have yielded "results ahead of forecasts", and activity levels for North American customers "remain high due to pent up demand and the backlog for new project starts." The healthy North American project pipeline, coupled with technology upgrades are key to the higher demand being seen for Somero equipment. The region accounts for almost two thirds of Somero's sales, so is important.

Internationally, the Middle East, Latin America, and Southeast Asia have posted growth rates ahead of last year, with Southeast Asia's performance driven by accelerated activity in Indonesia and Vietnam. Even the eurozone continues to "show signs of improvement from a variety of countries, reinforced by increased customer inquiries, a leading indicator of future sales performance". The only blip came from China, a region which accounted for 16 per cent of Somero's sales last year. Trading there started slower than expected, but momentum is now picking up and the region is still expected to post its "fifth consecutive year of growth".

Importantly, overall trading points to another year of decent growth: analysts at broker Profile predict that current year revenues and pre-tax profits will both rise by around 7 per cent to $63.8m and $13.2m, respectively, to underpin a further hike in the dividend to 6¢ a share, or 3.8p at current exchange rates. This implies a 2.8 per cent prospective dividend yield, with the payout covered 3.3 times over by adjusted EPS of 19.7¢, or 12.5p a share. On this basis, Somero's shares are rated on a modest 10.5 times current cash adjusted earnings after factoring in a current cash pile worth 7.5p a share.

But that lowly rating ignores the cash generation of the business as analysts predict Somero's net funds will more than double to $14m (£8.9m), or 16p a share, by the year-end. In other words, assuming Somero hits analysts' earnings estimates, then at the current price the shares are being valued on only 9.5 times cash adjusted likely earnings after factoring in the year-end forecast cash pile. In my book that represents solid value.

So having initiated coverage when the price was 140p ('On solid foundations', 22 April 2015), I am comfortable with my 185p year-end target price. Trading on a bid-offer spread of 137p to 140p, I continue to rate Somero's shares a buy.

 

KBC break-out imminent

I have been following with interest developments at Aim-traded KBC Advanced Technologies (KBC:109.5p), a consultancy and software provider to the global hydrocarbon processing industry.

I last updated the investment case at the time of the company's fiscal 2014 results in March when the price was 87p ('Blow-out results', 18 March 2015), having initiated coverage at 69p ('Fuelled for growth', 5 May 2013). Since my last article KBC's share price has moved up 23 per cent to 109.5p and is now on the cusp of taking out last autumn's highs at 110p. This price action should be noted because a close above 110p would signal a major share price break-out and one which, in my view, paves the way for a return to the 142p highs dating back to June last year. Moreover, with a decent operational tailwind, I expect my fair value target price of 165p to be challenged in due course.

It's easy to see the company is gathering investor interest. Firstly, at the end of last month, KBC Advanced Technologies entered into an agreement with Kongsberg Oil & Gas Technologies to develop stronger simulation software integration and more effective engineering and operations workflows for the oil and gas industry. At the same time the parties have signed a reseller agreement to enable them to cross-sell their leading software technology products together as a complete suite for simulation, optimisation and operator training across the breadth of hydrocarbon production and facilities. This can do no harm at all to earnings expectations for the year ahead.

Secondly, KBC has recently appointed a new finance director, Eric Dodds, formerly finance chief at software company Morse prior to its takeover five years ago. His appointment is a good addition as he brings in a wealth of experience in financial management of both consulting and technology companies.

Thirdly, there is an active buyer in the market, Kestrel Partners, the investment manager to Kestrel Opportunities, a Guernsey-based cell acting on behalf of wealthy private clients. In fact, in the past couple of months Kestrel has purchased more than 750,000 shares in KBC to lift its stake to 12.25m shares, or 14.89 per cent of the issued share capital. Oliver Scott, non-executive director of KBC, is a partner of, and holds a beneficial interest in, Kestrel Partners and is also a shareholder in Kestrel Opportunities. In other words, there has been indirect share buying by an insider.

Fourthly, the valuation is still attractive. That's because analysts at brokerage Cenkos Securities and research firm Equity Development predict that KBC should be able to increase underlying pre-tax profits by 10 per cent to £10.5m this year. This means that once you strip out KBC's latest net cash figure of £15m, worth around 18p a share, from the company's market capitalisation of £90m, then the shares are being rated on less than 10 times post tax earnings, a near 40 per cent discount to the small cap software average for sub-£100m market cap companies.

In the circumstances, I feel that KBC's shares are still worth buying on a bid-offer spread of 107p to 109.5p. My year-end target is 165p. Buy.

 

Inspired Capital boardroom exodus

Inspired Capital (INSC:14.25p), a company aiming to become a major force in lending to small- and medium-sized enterprises (SMEs) has announced the departure of both its chief executive Brian Cole and chairman Matt Cooper.

Clearly, there has been a boardroom rift of some nature, and there is no getting away from the fact that the track record of Mr Cooper, one of the founders of Capital One, the fifth-largest bank in the US, and Mr Cole, former head of Capital One's UK operations, were key factors in my decision to recommended buying shares at 16p in this new challenger bank in my 2015 Bargain shares portfolio. I subsequently reiterated that advice at 17p ('Bargain shares 2015 updates', 23 March 2015). The recruitment process for a new chief executive and chairman is now underway.

In the meantime, Roger McDowell, senior non-executive director and former chairman of small-cap SME lender Ultimate Finance, a company Inspired acquired in September 2013, takes over as interim chairman, and Jeremy Coombes, chief operating officer and former chief executive of Ultimate Finance, becomes interim chief executive. Jamie Brooke, an investment manager at Inspired's largest shareholder, Henderson, remains as non-executive on the board.

Expect news on an appointment of a new finance director too as David Blain departs at the end of July to take up the same position at quantum dot maker Nanoco (NANO:105p), albeit Inspired's board always intended to appoint a finance director with more financial services specific experience as the business developed.

It's pretty unusual to lose three senior board members when a company is clearly delivering. Inspired posted an adjusted pre-tax profit of £400,000 in fiscal 2014, reversing a loss of £400,000 in 2013, having increased client numbers by over a third to 1,323 and grown its loan book by 60 per cent to £66.9m. The latest loan book is £71.9m, up 53 per cent year-on-year, and the company aims to grow lending to £200m by 2016. Credit lines are in place to support this year's growth and a collaboration agreement with Aim-traded PROACTIS (PHD:81p), a global spend control and eProcurement solution provider, to develop an accelerated payment facility (APF) for UK SMEs will enable Inspired to ramp up the settlement of suppliers' pre-qualified invoices.

So having taken all facts into consideration, I would continue to hold the shares at 14.25p as both Mr Coombes and Mr McDowell successfully ran Ultimate Finance and have full support of shareholders, Inspired has a strong management team below board level, and there is every reason to expect the positive trading trends to continue.

Please note that I published an article with all the share recommendations I have made this year at the end of last month.

■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'