In today's column, I am focusing on another special situation that's in play, too, and one where the end game could be reached by the time the board issues a pre-close trading update in mid-January. The company is Bioquell (BQE:137p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets.
I first spotted the potential in the shares after the company announced it was selling off its specialist testing services subsidiary, TRaC ('Bug busting potential', 20 April 2015). At the time the share price was 124p. When that disposal completed in May the board said that it had decided to initiate a strategic review of its retained biocontamination control technology products business. 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. In the meantime the planned return of a large chunk of the cash proceeds back to shareholders has been put on hold. The share price has flatlined for the past few months as investors await news.
But frankly, the downside risk here looks very limited. That's because in Bioquell's half-year results in late summer the accounts showed net funds of £47.7m on its balance sheet, a sum equivalent to 112p a share. This means that the company's retained biocontamination control technology business is being attributed a value of only £10m based on its current market capitalisation of £58m. In the same interim report, the board revealed that the company's net asset value had more than doubled to £64.7m, or 152p a share, after booking a £34.2m gain on the disposal of TRaC, so the carrying value of the retained operations is actually £17m. Moreover, over 80 per cent of Bioquell's share price is backed by cash which mitigates risk.
The critical question is what is a fair value for Bioquell's biocontamination control technology business? My own view is that it's worth somewhere between £24.5m (or 58p a share) and £31m (or 73p a share). I have sound reason to think this range is achievable, too, if it's sold to a larger company.
That's because Bioquell's retained operations reported a near trebling of cash profits to £1.4m on revenues of £12.5m in the first six months of 2015, and analysts believe they should be able to generate around £4.4m of annual cash profits in 2016 based on revenues of £32.6m, implying a cash profit margin of 13.5 per cent. On this basis, my valuation range implies a reasonable exit multiple of between 5.5 times to 6.5 times cash profits to an acquirer, hardly an exacting valuation given the niche area of the healthcare market in which the company specialises in. Let me explain.
Decent trading prospects
Andover-based Bioquell generates a large chunk of its revenues by selling biocontamination control technology products, based around hydrogen peroxide vapour (HPV). These are highly efficacious at eradicating micro-organisms such as bacteria and viruses at room temperature and are principally used by bio-pharmaceutical, biotechnology and research institutions to provide sterile equipment and/or sterile facilities. It's an international business and Bioquell has operations in the US, France, Ireland, Singapore and China.
HPV-based products are also used to eradicate 'superbugs' from hospitals, a segment of the business that is seeing increased demand from the healthcare sector given the difficulties treating patients who contract bacterial infections that no longer respond to antibiotics.
Bioquell is enjoying robust demand from the defence sector too, and specifically for its specialist chemical, biological, radiological and nuclear (CBRN) filtration systems and environmental control equipment for military vehicles and fixed systems. Interest has been buoyed over the past year by conflicts in the Middle East, North Africa, instability in eastern Europe close to the Russian border, and the use of chemical weapons in Syria.
For instance, its CBRN filtration systems can be configured to provide a face mask for a range of military applications. The division also manufactures a defence shelter CBRN filtration system configured to provide clean filtered air directly into a rigid or tented shelter or through the platform air conditioning system. Given the uncertain geo-political back drop, it's hardly surprising that demand has risen sharply. In fact, divisional revenue rocketed by 175 per cent to £2.2m in the six-month period to end June 2015, to account for a sixth of Bioquell's turnover. Frankly, I wouldn't be surprised at all if the second-half performance proves just as robust in light of the heightened geo-political risk right now.
Prospects are equally encouraging in other areas of biocontamination control, a point chairman Nigel Keen rightly made in the half-year results, noting that "world hospitals and public health bodies are increasingly worried by the clinical threat and attendant financial consequences of antibiotic resistance, hospital acquired infection and the rapid spread of viruses such as MERS-CoV and Ebola". It's hard to disagree with that assessment as Bioquell's healthcare revenues increased by more than a fifth to £2.1m in the first half and forward guidance is strong, too.
Indeed, the order book is only likely to have increased following the launch earlier this year of Bioquell's new healthcare product, the BQ-50, which rapidly eradicates pathogens from surfaces in hospitals by drawing on technologies and components the company developed for a US military development programme a few years ago. It also provides a lower cost, more flexible bio-decontamination service offering to hospitals in the US and Europe.
Upside for acquirer
Given the possibility of a bid emerging for the whole company, it's worth flagging up that there is scope for a much larger rival to take significant costs out of the business. Analysts at N+1 Singer believe that annual overheads of around £1.5m could be removed without impacting the business. On this basis, my valuation range for Bioquell's biocontamination control operations (excluding cash on the balance sheet) drops to only 4 to 5 times their likely cash profits for 2016 if costs could be reduced on this scale.
Another point worth raising at this stage is that chief investment officer Christopher Mills is a member of Bioquell's major shareholder, Harwood LLP, which owns 29.6 per cent of the equity, and three other main board directors own a total of 3.8 per cent of the equity between them. In addition, chief executive Nick Adams and finance director Michael Roller have options over 800,000 shares, or just 1.9 per cent of the issued share capital, exercisable at prices between 122.5p and 146.5p. In my view, this makes it more likely for Bioquell's board to seek a sale of the company as a whole to maximise the return to shareholders and its directors, too. In addition, Liontrust Investment Partners LLP own 9.9 per cent of the shares in issue and private shareholder AJ Muir owns a further 5.2 per cent stake, so in effect just over 50 per cent of the diluted share capital is controlled by the board and these three large shareholders. Again, that makes a takeover of the company a more likely, and far easier, prospect.
The end game
Given that shareholders will either receive a substantial cash return from the TRaC disposal proceeds in the event that Bioquell remains independent, enters a joint venture, a distribution deal, or a co-promotion agreement with a third party, or a bid for the whole company will result in a significant bid premium as I have outlined in my calculations above, then whatever way I look at this there should be a positive outcome.
Trading on a bid-offer spread of 134p to 137p, and offering 24 per cent share price upside to the bottom end of my valuation range of between 170p to 185p, I rate Bioquell's shares a strong buy.
Please note that I recommend running profits if you hold bought shares in the other contamination controls specialist I actively follow, Aim-traded Tristel (TSTL:126p), a maker of infection prevention, and hygiene products. I previously upgraded my target price range to between 130p to 135p, having first advised buying the shares at 60p ('Clean up on superbugs', 6 May 2014), and previewed last month’s bumper full-year results when the price was 99p ('Cleaning up with a superbug buster', 7 October 2015). So with a further 8 per cent upside potential on offer, I would run your 100 per cent plus paper gains.
Please note that I have published two columns today, and nine in total last week, all of which are listed below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past two weeks:
■ Redde: Run profits at 178.5p; Trakm8: Run profits at 250p; 32Red: Run profits at 95p; Manx Telecom: Run profits at 208p; Burford Capital: Run profits at 189p ('Five companies that keep on delivering', 3 November 2015)
■ Getech: Sell at 38p ('Getech warns', 3 November 2015)
■ Gresham House: Buy at 345p, 12-month target price 450p ('Sowing the seeds for growth', 9 November 2015)
■ Inland: Run profits at 73p, target 80p ('Tapping into hidden value', 9 November 2015)
■ K3 Business Technology: Run profits at 361p ('In the money, 9 November 2015)
■ Fairpoint: Run profits at 190p, target range 200p to 220p ('Riding a seven year high', 10 November 2015)
■ KBC Advanced Technologies: Buy at 129p, new target range 160p to 169p ('Running oily gains', 10 November 2015)
■ Epwin: Run profit at 138p ('Decked out for further gains', 10 November 2015)
■ Plethora Solutions: Speculative buy at 5p, target 7.5p; Renewable Energy Generation: Speculative buy at 49p, target 60p ('Playing the takeover game', 11 November 2015)
■ Trifast: Buy at 116p, target 140p (‘Engineering a chart break-out’, 12 November 2015)
■ Software Radio Technology: Speculative buy at 23.5p, target 40p (‘Break-even beckons’, 12 November 2015)
■ Bioquell: Buy at 137p, target range 170p to 185p ('Bug busting potential for short-term gains', 16 November 2015)
■ Communisis: Hold at 45p ('Communisis slammed for earnings miss', 16 November 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'
