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OPINION

Shareholder activism works

Shareholder activism works
September 2, 2015
Shareholder activism works

As I noted in that article, I didn't recommended buying into LMS for exposure to the energy sector. If I wanted that then there are far better ways of doing so than paying a new investment team handsomely for their expertise. And it goes without saying that it would have increased the risk profile of the shares markedly, something that clearly other shareholders who bought into the orderly wind down of the company have rejected too.

So LMS will now continue to pursue the realisations of its investments with a view to returning cash to shareholders. Bearing this in mind, the company's last reported net asset value of £136m at the end of June 2015 included net cash of £35.3m, quoted securities worth £13.2m, unquoted private-equity-style investments worth £53.2m, and investments held in funds of £43.8m. More than 60 per cent of the portfolio is in the US and LMS's 10 largest investments account for 84 per cent of the portfolio by value, so it's concentrated in a small number of investments which should be easy to divest.

Indeed, LMS is currently expecting completion of two transactions in the near term. When the outcome and timing of these transactions is known the board expects to be in a position to announce a further return of capital to shareholders. Even before the proceeds from these disposals is taken into account LMS has net cash of 24p a share, or a third of the share price, so there is ample surplus funds on the balance sheet to support another tax-efficient tender offer to shareholders pitched around net asset value of 94p, or almost a third above the current share price. Please note I reckon that LMS's net asset value hasn't changed much in the past couple of months as paper losses on quoted investments have been largely offset by currency gains on US dollar denominated holdings.

However, amid the sharp stock market volatility last week investors have overlooked LMS's important announcement and the likelihood of a significant share buy-back through a tender offer process pitched at net asset value. Trading on a bid-offer spread of 71.75p to 73p, I rate the shares a buy on a 22 per cent discount to book value.

Please note that since I initiated coverage on the shares at 54.5p ('Capital returns', 11 February 2011), LMS has returned the equivalent of 77 per cent of its market value through three tender offers: a buy-back of 17.4 per cent of the share capital at 84p in December 2012; a buy-back of 17.2 per cent of the share capital at 90p in July 2013; and a buy-back of 22.5 per cent of the share capital at 95p in May 2014. So for instance if you who bought 10,000 shares at 54.5p on my original advice you will still retain a holding of 5,300 shares worth £3,800, and with a net asset value close to £5,000, and have so far received cash proceeds of £4,200.

A pensions pay day

Shares in STM (STM:53p), the Aim-traded financial services company specialising in the administration of assets for international clients in relation to retirement, estate and succession planning and wealth structuring, are well on their way to hitting my 60p target price.

I recommended buying them at 35p ('Tapping into a pensions payday', 27 April 2015), and subsequently issued a strong buy recommendation at 47p in the summer ahead of the half-year results ('Exploiting upgrades', 9 July 2015). The figures didn't disappoint either as the company's pre-tax profits increased by 40 per cent to £1.4m on revenue up 12 per cent to £8.3m, leaving the company well on track to hit analysts' full-year forecasts. Analyst Duncan Hall at brokerage finnCap predicts that STM should manage to grow fiscal 2015 pre-tax profits from £1.7m to £2.7m based on a £1.8m increase in revenue to £17.7m. On this basis, expect normalised EPS to almost double from 2p to 3.8p. But with pro-forma net cash of £6.8m on its balance sheet at the end of June 2015, a sum equivalent of 11.5p a share, STM's shares are still only being priced on 11 times cash adjusted earnings, far too low a rating in my view.

QROPS - a valuable business

That's because STM's Qualifying Recognised Overseas Pension Schemes (QROPS) business, an offshore pension scheme approved by HMRC and used by expatriates and internationally mobile employees whose tax domicile can change as a consequence of employment, is growing rapidly and now has over 8,800 clients globally, having added another 1,400 in the first six months of this year.

In terms of the geographic split, 40 per cent of new business this year has originated from the Middle East, 28 per cent from Europe, 14 per cent from the US., 10 per cent from Asia and 8 per cent from Africa. Moreover, the unit has applications from 1,500 new clients in the pipeline so is maintaining a run rate of 250 new clients a month. This underpins a 20 per cent forecast hike in divisional revenues for the full-year and, with the benefit of rising revenues on a relatively fixed cost base, a much sharper rise in profits.

Indeed, Mr Hall predicts STM's pensions business will lift cash profits by 44 per cent to £2.6m on revenues of £9.7m this year. It's a forecast I am very comfortable with as the business unit had deferred income relating to annual fees invoiced but not yet earned of £1.46m at the end of June, all of which will be booked in the second half. The company also had sizeable accruals for work performed for clients but not yet billed, thus providing additional visibility on future revenues.

Operating from centres in both Gibraltar and Malta, the platform is in place for growth rates to be maintained into next year and beyond too. That's because STM has been expanding the number of introducers with whom it works to sustain the robust sales momentum and to exploit a captive market for long-term savings products. There are around 5m UK overseas residents according to some estimates, so the "QROPS administration market is still in its infancy", according to Mr Hall at finnCap.

To tap into this lucrative market, STM opened sales offices in South Africa, South East Asia and the Middle East in the latest six-month trading period, and signed up more introducers than in the whole of 2014. The full benefits of this investment will be reaped from the second half of next year onwards, so supporting expectations that STM's pension business will turn in cash profits of £3.3m on revenues of £10.3m in fiscal 2016. finnCap forecast the company as a whole will make pre-tax profits of £3.7m on revenues of £18.6m in 2016 which looks well underpinned by me.

It's worth pointing out too that STM selected Malta and Gibraltar as its bases for QROPS schemes because both governments had gone out of their way to ensure that the jurisdictional legislation for QROPS meets all HMRC requirements, having engaged in a full dialogue with the UK tax authorities throughout the process. Malta and Gibraltar receive protection under European passporting arrangements promoting a single market for financial services. That's important given that HMRC has recently deleted some QROPS approved schemes from its website, and in particular those which breached HMRC guidelines by offering early access to lump-sum withdrawals.

Potential for disposals and dividends

Interestingly, Mr Hall values STM's legacy corporate and trust administration business, which handles personal trust and corporate secretarial functions and is expected to generate cash profits of £300,000 this year, at about £4m. During the results call yesterday, I got the impression from the company's chief executive Colin Porter that the board would not be averse to considering a sale of the unit, assuming of course the price was right.

Strategically it would make sense as management could then focus all their attention and resources on the company's pensions business and its much smaller, but fast growing life unit. The latter offers a flexible life assurance bond whereby assets can be introduced into a wrapper administered by STM. The product offering is complementary to STM's customers and is applicable to the tax jurisdictions in which the company operates in.

The bottom line is that this ongoing growth story is not yet fully priced into the valuation with STM's market capitalisation of £31.5m equating to a modest 1.3 times net asset value, and the shares being priced on less than 9 times fiscal 2016 cash adjusted earnings estimates. I would also point out that the board plans to introduce a progressive dividend policy in due course.

Trading on a bid-offer spread of 51p to 53p, I continue to rate STM's shares a decent buy and maintain what could yet prove to be a conservative target price of 60p.

Lights dim on Entu

Shares in Entu (ENTU:65p), a UK supplier and installer of windows, doors, solar panels and other energy efficient products, crashed by 30 per cent yesterday after the company announced it was withdrawing from all of its solar panel activities. The government's proposal to cut feed-in-tarrifs by upto 90 per cent from January next year, coupled with weaker demand over the summer due to a likely hike in the VAT rate applicable to solar panel products following an EU ruling, no longer makes this business a viable proposition for Entu.

As a result as many staff as possible will be retrained and redeployed into the company's other activities, but the cost of the exit, and operating losses incurred, will result in Entu's solar business making a loss in excess of £2m in the 12 months to end October 2015, against a forecast profit of £1.6m. This means that instead of generating a fiscal 2015 pre-tax profit of £11.5m, as analyst Dr Tom McColm at house broker Zeus Capital had predicted when I last updated the investment case only six weeks ago ('Cashed up for gains', 23 July 2015), Entu is now expected to only make pre-tax profits of £8.1m and EPS of 9.7p. It's a massive downgrade and means that expectations of a likely 8p a share full-year dividend have been reined back too; Entu's board now expect to declare a final payout of "not less than 2.67p", in line with the interim paid out last week.

It didn't help matters either that the profit warning was released on another dark day for equity markets, accentuating the downward move in the share price. So having recommend buying at a 5 per cent premium to the float price of 100p ('Yielding to efficiency gains', 10 November 2014), the question is whether it's worth holding on?

Decision time

I think it is because even though investors' confidence in the company's management has clearly been shaken, there are reasons to believe the sell-off has gone too far: after the savage share price decline Entu's shares trade on 6.5 times downgraded earnings estimates for the 12 months to end October 2015 and offer a prospective dividend yield of 8.2 per cent.

Furthermore, the company's order book stood at an all-time high of £30m at the end of April and since then its home improvement division has won a £10m a year contract with a national DIY retailer. This part of the business has been performing strongly and accounted for 60 per cent of Entu's first half operating profit of £3.8m, having increased operating profits by 41 per cent to £2.38m on revenue of £40m in the six months to end April 2015. Analysts expect the unit to make a similar contribution in the second half and account for over 80 per cent of Entu's revenues of £101m and 56 per cent of full-year pre-tax profits of £8.1m. That profit contribution is expected to grow to around three quarters of downgraded group pre-tax profits of £10m based on revenues of £120m in fiscal 2016 when Entu is predicted to produce EPS of 12p.

In effect, the decision to hold onto Entu's shares is dependent on assessing three key factors: the ability of management to deliver the 16 per cent revenue growth forecast by analysts in the home improvement business in fiscal 2016; the scale of the likely margin expansion materialising in this business unit as the fixed costs associated with the solar business are redeployed and start generating sales and profits; and the sustainability of the proposed 5.34p a share dividend. On all three points I am positive enough to think analyst expectations of a sharp recovery in Entu's profits in 2016 is achievable in order to support a well covered dividend, albeit one that is a third below the level when I initiated coverage on the shares at 105p last autumn.

So with the lowly rated shares offering a dividend yield greater than the PE ratio, and the 14-day relative strength indicator showing a heavily oversold reading below 20, I would recommend holding onto Entu's shares at 65p for their recovery potential.

MORE FROM SIMON THOMPSON...

I have published articles on the following companies in the past four weeks:

Non-Standard Finance: Buy at 107.5p; Software Radio Technology: Buy at 27.5p, target 40p; Character Group: Run profits at 500p; Communisis: Hold at 50p ('Value judgements', 3 Aug 2015)

Fairpoint: Buy at 138p, target 190p; Creston: Run profits at 155p; Sanderson: Buy at 71p, target 80p to 85p; Renew Holdings: Buy at 340p, target 375p ('Break-outs looming', 4 Aug 2015)

Globo: Buy at 42.75p, target 69p; Cambria Automobiles: Run profits at 72p ('Short sellers in for shock treatment', 5 Aug 2015)

Cohort: Run profits at 357p, target 375p; Cineworld: Run profits at 530p; Paragon: Buy at 412p ('Acquisitive growth drives re-ratings', 6 Aug 2015)

PROACTIS: Buy at 93p, target 117p ('Procuring growth', 10 Aug 2015)

Town Centre Securities: Buy at 310p, target 350p ('Equity market watch', 11 August 2015)

Equity market strategy ('Equity market watch', 11 August 2015)

KBC Advanced Technologies: Buy at 122p, target 165p; Getech: Buy at 59p, target 80p ('Fuelled for strong growth', 12 August 2015)

Pure Wafer: Run profits at 162p, target 178p; Inland: Run profits at 71.5p, next target 80p; Macau Property Opportunities: Take profits at 189p ('Bumper cash returns', 13 August 2015)

Inspired Capital: Accept cash offer of 21.5p; Record: Buy at 40p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('Bargain shares updates', 17 August 2015)

Equity market strategy ('Stay calm', 25 August 2015)

Capital & Regional: Run profits at 67p; Redde: Run profits at 152.5p; Cineworld: Run profits at 578p; Cohort: Run profits at 375p; H&T: Buy at 195p; Record: Buy at 33.5p; Bioquell: Buy at 137p, target range 170p to 185p ('Running bumper profits', 27 August 2015)

Equity market strategy ('A sense of perspective', 1 September 2015)

LMS Capital: Buy at 73p ahead of tender offer; STM: Buy at 53p, target 60p; Entu: Hold at 65p ('Shareholder activism works', 2 September 2015)

■ 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'