Bargain Shares updates: May 2016

It would appear that I wasn't the only one running the slide rule over private equity group Oakley Capital Investments (OCL:150p), the subject of my column last week ('Take time out to consider Oakley', 25 April 2016). Just before the markets closed ahead of the bank holiday weekend, Oakley's board announced that it was reviewing a potential sale of Time Out Group, the globally recognised brand of city-based leisure magazines. I understand that investment bank Liberum Capital has been appointed and a potential move to Aim could be on the cards for Time Out Group next month to raise £80m of fresh funds from new investors and place a market value of at least £200m on the enterprise.

To put this sum into perspective, at the end of December 2015 Time Out Group had an enterprise value of £105m, according to Oakley accounts, including net debt of £20m. Oakley's share of its interests in the private equity funds that control 70 per cent of Time Out Group's equity was £40m at the time, and Oakley also made a co-investment of £13.3m, so in aggregate the holding accounts for about 14 per cent of Oakley's net asset value of 200p a share, so is a major holding.

It doesn't take a genius to work out that if Time Out Group joins Aim with a valuation in excess of £200m, then there is going to be material upside to Oakley's investment. I would also point out that this valuation excludes the £7m co-investment Oakley made in Time Out Fly Pay, a mobile ordering and payment app (a pay-at-table concept for restaurants and bars). Nor does it include a £5.6m investment in Time Out Markets, in which Oakley has a 75 per cent equity stake. A launch on Aim for Time Out Group would bring into focus the value in these two investments, too.

So with a potential windfall on the cards, and a likely strong uplift to net asset value, I strongly believe Oakley's shares rate a buy on a 25 per cent-plus discount to historic book value. Please note that in last week's issue one of my colleagues mistakenly stated in the Aim 100 feature that Oakley had sold off its investments in Parship, Europe's leading online dating business, and also Italy's largest car insurance broker and price comparison website, Facile.it. This was incorrect. Oakley actually received a cash distribution from Facile.it after it refinanced debt and returned capital to its shareholders, and also received a distribution from Parship. Oakley's holdings in these two companies have more than doubled in value since it acquired them and now account for 17 per cent of its net asset value. Moreover, given the significant investment upside potential I outlined in last week's article, I don't expect the company to exit these two strongly performing investments for some time yet.

How Simon Thompson's 2016 Bargain Shares portfolio has fared

Bumper cash return from Bioquell

Andover-based Bioquell (BQE:168p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets, is returning £42.7m of its £47.5m cash pile to shareholders through a tender offer process whereby the company will repurchase 50 per cent of the issued share capital at 200p a share. In effect, this is equivalent to a cash return of 100p a share.

Having sold off its specialist testing services subsidiary, TRaC, the board initiated a strategic review of its retained biocontamination control technology products division. 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. To facilitate this process the board is returning the cash to shareholders now. It makes sense to do so because it highlights the value in the company's ongoing operations, which increased cash profits by £1.2m to £3.4m on revenues of £26.9m last year and reported underlying operating profit of £771,000 after accounting for a £1.6m non-cash depreciation charge on plant and equipment and almost £1m of amortisation charges.

Prospects for the company's biocontamination control technology products, based around hydrogen peroxide vapour (HPV), look sound. In last Friday's annual results, chairman Nigel Keen noted that "underlying demand for the eradication of bioburden and the provision of an aseptic environment remains strong in the Life Sciences sector. Antibiotic resistance and hospital acquired infection remain real and increasing issues for healthcare providers around the world. There remains ongoing geopolitical stress in a number of parts of the world, which is helping drive demand for our defence business".

The point being that these prospects are not in the price. In fact, after adjusting for the proposed £42.7m cash return, the company will have equity shareholders funds of £22.7m including net funds of £4.8m. Based on 21.35m shares in issue post the tender offer, the company will have a market value of £29m based on a share price of 136p.

This means that if you strip out retained net funds of £4.8m, in effect a business that has just reported annual cash profits of £3.4m is being attributed an enterprise value of only £24m post the tender offer, or seven times cash profits. Frankly, there doesn't seem much downside risk here, so having included the shares at 145p in this year's Bargain Shares portfolio, I maintain my buy advice. Please note that details of the tender offer will be sent to shareholders shortly. Buy.

Dynamic forecasts

I am starting to lose count of the number of earnings beats posted by Aim-traded AB Dynamics (ABDP:468p), a UK designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry. I included the shares in my 2015 Bargain Shares portfolio when the price was 173p, so it has proved a dream holding with the price now up 170 per cent.

And last week's half-year results to end February 2016 led to another raft of upgrades after the company reported a 50 per cent rise in pre-tax profits on revenues up a third. Analyst Richard Hickinbotham at brokerage Cantor Fitzgerald upgraded his full-year pre-tax profit forecast by 9 per cent to £4.7m (August year-end), his 2017 estimate by 17 per cent to £5.3m and his 2018 forecast by more than a third to £7m. On this basis, expect EPS of 21.6p, 24.6p and 32p, respectively.

Furthermore, I wouldn't bet against the 2016 estimates being beaten given the increased investment by the car industry in new car models with a focus on advanced safety systems, and strong sales of both track and lab testing products. This is clearly benefiting AB Dynamics as revenues from track testing systems (robots and soft crash vehicles) are now expected to rise by a third to £15.2m in the 12 months to end August 2016 to account for three-quarters of likely turnover of £20.2m. Mr Hickinbotham believes that this segment will be able to post double-digit growth in the next two financial years, too.

And the company's laboratory testing business is set to step up a gear driven by the strategic partnership with Williams Advanced Engineering, the technology and engineering services business of the Williams Group, to bring novel virtual vehicle dynamic simulators to the global automotive sector. This exciting collaboration combines Williams' expertise in F1 simulators and high-speed dynamic motion platforms, with AB Dynamics' industry knowledge, manufacturing capabilities and sales channels.

Using F1 vehicle modelling and simulation, the technology will enable engineers to test-drive conceptual vehicle designs through numerous virtual environments and scenarios, well in advance of the launch of physical prototypes. Upside from this partnership is likely to drive laboratory testing revenues up by almost half to £7.1m in the 12 months to August 2017, ramping up to £9.6m the year after, according to analysts. In other words, AB Dynamics' revenues could rise from around £20m in the current financial year to almost £30m within two years. In the circumstances, it's hardly surprising the shares are motoring.

A bumper cash flow performance also means that net funds have swollen by a quarter to over £10m, a sum worth 56p a share, so covering the cost of a new £6.5m factory that will add an additional 33,000 sq ft of space to existing capacity of 23,550 sq ft. Shareholders are benefiting from a very progressive dividend policy too and can expect mid-teens hikes in the payout per share to 3.11p, 3.57p and 4.11p, respectively, in the next three financial years.

On this basis, the shares are now rated on a cash-adjusted forward PE ratio of 16.5 and offer a prospective dividend yield of 0.7 per cent for the 2017 financial year. That's clearly a much fairer rating than when I initiated coverage 15 months ago, and the price has risen by 20 per cent since my last update ('British success stories', 29 March 2016), but with AB Dynamics in the grips of a strong earnings upgrade cycle I would recommend running profits.

Director buys at Minds + Machines

Shares in Minds + Machines (MMX:8.25p), a company that provides services in all areas of the domain name industry, ranging from registry ownership to consumer sales, and is primarily focused on the new top-level domain (TLD) space, have drifted since the company reported its 2015 full-year results last month. I feel it's unwarranted and so does Toby Hall, the company's new chief executive who snapped up 250,000 shares at 8p each last week.

I think the problem here is that some investors have the 'rear-view mirror syndrome', focusing not on the decent prospects of the business moving into sustained profitability, but on past losses incurred prior to a restructuring of the board and a change in the business model. I highlighted the new financial discipline the company's slimmed-down board are trying to instil when I updated the investment case last month ('Bargain Shares updates', 15 April 2016). Director costs of $700,000 (£479,000) are now a third of what they were and the board includes a representative from Minds + Machines' largest institutional shareholder. Mr Hall is driving marketing and business development with the aim of achieving the highest levels of operating efficiency in order to maximise value for all shareholders.

In particular, outsourcing back-end registry functions of up to 28 TLDs within Minds + Machines' portfolio and ridding itself of its lossmaking, consumer-facing www.mindsandmachines.com branded registrar operation, should transform Minds + Machines into a pure-play, high-value registry business with dramatically reduced overheads while ensuring all customers are on leading platforms. On a like-for-like basis, these outsourcing deals are forecast to deliver annual savings of $2m (£1.4m), which when combined with a better use of resources and increased revenues should in turn provide the requisite head room to invest in registry sales and marketing.

Moreover, if Mr Hall can turn the cash-rich company profitable, then there is no way the shares will be trading on a modest 1.2 times book value of 7.1p, especially as net funds account for just over 3p of the current share price and a portfolio of domains worth $41.3m (£28.3m) is worth a further 3.75p a share. I would also point out that less than half (£6.9m) of the funds designated for a £15m share buy-back programme have been used since it was sanctioned last autumn, so the board still has the authority to buy back a further 46m shares, or 6 per cent of the share capital, using surplus capital. Buy.

Please note that I have published four columns today, all of which are available on my IC homepage.