Bargain shares updates

In the event they have achieved this turnaround far sooner than I had anticipated as yesterday’s first half results revealed a doubling of revenues to $7.4m (£5.7m), a 28 per cent fall in operating expenses to $3.5m, and a move into profitability with underlying cash profits coming in just shy of $2m.

Billings more than quadrupled to $8m in the six month period, helped by the successful launch of the .vip gTLD in China, and the addition of 450,000 domains under management to take the total to 729,000. The importance of the Asian market should not be underestimated. Having had no exposure here at the start of this year, the board anticipates China based revenues will contribute a minimum of 45 per cent of the group total this year. In the first 21 days after the launch of its .vip gTLD, Mind + Machines achieved 405,000 registrations and $5.5m of billings alone, highlighting the positive meaning of the letters ‘VIP’ in the region, and the high levels of demand in the country. The fact that these are premium gTLDs augurs well for renewals next year.

Indeed such is the growth potential in the Chinese market, and the global new gTLD space which has seen new registrations race ahead by 114 per cent in the first six months of this year according to the latest ICANN figures, Mind + Machines has attracted a major investment by Goldstream Capital Management, a company owned by Hony Capital, a leading Chinese private equity company. Goldstream is investing £5.5m to acquire 42m shares at 13p each. It’s good business for Mind + Machines which repurchased 79.5m shares at a cost of £6.8m and at an average price of 8.5p in a share buy-back programme between September 2015 and mid-July this year.

And because the company still has a cash rich balance sheet boasting net funds of $29m in addition to net trade receivables of $2.9m after accounting for trade payables at the end of June 2016, then effectively it has $32m (£24.6m), or 3.25p a share of cash. It also has a very conservatively valued portfolio of 29 TLDs in the books for $40.3m (£31m), worth more than 4p a share, and which is now generating healthy cash profits. So, having assessed its cash requirements, the board have announced a tender offer to use £13m of the cash pile to buy back 100m shares at 13p each. Based on 756m shares in issue, prior to the subscription of 42.3m new shares by Goldstream, the tender offer equates to 13.3 per cent of the issued share capital.

In the circumstances, with the board streamlining Mind + Machines into a pure-play registry business, the company turning profitable, and attracting the attention of foreign investors, then it’s hardly surprising that the shares have soared. In fact, after another sharp rise yesterday, they are up by over 60 per cent since I recommended buying at 8p in February (2016 Bargain Shares portfolio). I last recommended buying at 11.5p (‘Bargain shares portfolio half-year report, 15 Aug 2016).

Moreover, I can see them rising further and so can new house broker finnCap who initiated coverage post yesterday’s results. Analyst Harold Evans has yet to issue a target price and is reviewing full-year forecasts, but can envisage a 20p target price under modest assumptions, implying significant upside to the 13p a share tender price. However, I feel there is little to be lost by tendering 13 per cent of your current holdings at 13p a share which reduces your average buy in price from 8p to 7.1p. It also means that you can crystallise a 62 per cent profit on part of your holding in only seven months, not a bad return at all. Run profits.

Volvere’s record net asset value

I still believe there is further upside in the shares of Aim-traded investment company Volvere (VLE:510p). I included the shares in this year's portfolio at 419p and I last recommended buying at 520p (‘Bargain shares portfolio half-year report, 15 Aug 2016).

The company is run by Jonathan and Nick Lander, who have the respective roles of chief executive and finance director, having founded the company 13 years ago to invest in distressed and undervalued businesses with a view to turning them around and exiting at a hefty profit. They have been successful as Volvere’s book value per share has increased at a compound annual growth rate of 14.3 per cent since 2003.

Half year results released earlier this week showed they are working their magic on Impetus Automotive, a provider of consulting services to the automotive sector, including vehicle manufacturers, dealerships and national sales companies. It’s proved a well-timed and shrewd acquisition. In the last six months of 2015, the business posted operating profit of £583,000 on revenue of £8.2m, a dramatic improvement on a trading loss of £43,000 in the second quarter of 2015. And this positive trend has continued into 2016 as Impetus has just reported underlying operating profits of £522,000 on revenue of £8.1m in the first six months of this year. In effect, Impetus has generated underlying operating profit in excess of £1m since Volvere took control last year, not a bad return on the £1.3m Volvere paid for its 79 per cent stake.

The company also owns a security business generating £118,000 of annual profits. So, in effect, the combined book value of £1.7m for these two holdings equates to less than 1.5 times their rolling 12-month operating profits. That’s a thumping return on capital and one that suggests the carrying value in Volvere’s accounts is far too modest.

Moreover, Volvere owns an 80 per cent shareholding in frozen pie and pasty maker Shire Foods which is in the books at only £5m, or little over 3 times Shire's underlying operating profit last year. True, the impact of higher raw material costs following sterling devaluation, and the decision of a customer to bring manufacturing in-house, means it’s unlikely Shire will match last year’s operating profit of £1.55m on revenues of £15.5m. But it doesn’t have too in order to justify a much higher valuation than the one in the accounts. I still take the view that the investment in Shire is worth double book value in a trade sale scenario.

The point being that these three investments are effectively in the price for free. That’s because at the end of June 2016, Volvere had cash and marketable securities of £18.5m available for new investments, a sum worth 452p a share. The company’s borrowings of £2.37m are modest in relation to the profitability of the aforementioned three holdings and also in relation to their conservative book values of £6.5m.

The downside risk here looks very limited given the hefty cash backing. I would also flag up that Volvere’s retained profits from the second half will undoubtedly deliver another record net asset value per share at the year-end and one that’s heading towards 600p. So, with the investment risk still skewed to the upside, and the company cashed up to make further value enhancing acquisitions, I continue to rate Volvere’s shares a buy.

Bargain Shares Portfolio 2016 performance

Making the right connection

I feel that investors have overreacted to the flat seasonal trading losses at the half year stage from fashion retailer French Connection (FCCN:41p). I included the shares in this year's portfolio at 45.7p and I last recommended buying around the current share price ahead of yesterday’s results (‘Bargain shares portfolio half-year report, 15 Aug 2016).

The key here is whether losses on the retail side can be reduced enough so that the company moves back into profit given that its wholesale and licence operations are hugely profitable. I was willing to bet on that possibility when I included the shares in this year’s Bargain shares portfolio at 45.7p, and still am.

Firstly, the retail side narrowed seasonal trading losses by almost £3m to £8.2m in the first half to end July 2016, a positive trend given the retail business makes all its profit in the second half during the crucial winter trading months. The Spring 16 collection was well received in French Connection’s outlets and resulted in first half underlying retail sales growth of 6.5 per cent in UK/Europe, a performance that was delivered against the backdrop of a difficult period for the high street, albeit against weak comparatives in the same period of 2015. E-commerce sales accounted for more than a quarter of retail revenue and growing, another positive trend.

Importantly, the initial performance of the Winter 16 collection has been encouraging and has continued the strong positive retail like-for-like sales trend seen in the first half. There was also positive news on store closures with five non-contributing stores closed in the period and a further five slated for closure in the second half. The point being that given this momentum, it’s not unreasonable to expect the retail side to deliver an improved performance on the second half of last year when it made operating profit of £4.5m in the six month period.

I would also flag up that although operating profits on the wholesale side came under pressure in the first half, down from £5.5m to £3m, historically the wholesale business lags behind the performance of retail given the buying cycle. Bearing this in mind, French Connection is now seeing an improvement in its wholesale performance in recent weeks. Chairman and chief executive Stephen Marks expects to see the recovery continue through the second half, and although the overall result will be dependent as usual on the Christmas trading period, I am hopeful that the wholesale side can make headway towards the £7.8m of operating profit it made in the second half of last year.

Of course, not everyone shares my view which is why Frech Connection's share price is down around 10 per cent on my recommended buy in price. But with the company being valued 20 per cent below net asset value, and the value of stocks, cash and receivables inline with the market capitalisation after deducting all liabilities, then I feel the valuation fails to adequately reflect prospects of a better second half performance. Numis Securities is pencilling in a full-year pre-tax loss of £3.1m, a £1.6m improvement on the prior year, implying French Connection will make second half pre-tax profits of £4.8m or 50 per cent higher than in the second half last year. And because the company books a £1.2m non-cash depreciation charge, then it's actually nearer to hitting break even on a cash profit basis.

Interestingly, US hedge fund Gatemore Capital Management, which owns 8 per cent of the share capital, is becoming active and has been pressurising 70-year old founder and 41.7 per cent shareholder Stephen Marks to relinquish his dual role as chairman and chief executive. It has also called for the company to get rid of its dated FCUK logo, cut back on its product ranges and speed up the closure of certain stores. WA Capital, the investment vehicle of 44-year-old Will Adderley, former chief executive and current deputy chairman of homewares retailer Dunelm (DNLM), has built up a 8 per cent stake since the start of this year and has yet to outline its intentions.

Frankly, something is going to give here. Either Mr Marks will turnround the business, as I think is the most likely outcome, or shareholder activism will ensue. Either way, I continue to see upside to the shares at the current price and rate them an asset backed recovery buy.

Oakley seriously undervalued

Shares in private equity investment company Oakley Capital Investments (OCL:146p) are still rated on a deep discount to book value even though the company has just reported a 7.5 per cent uplift in net asset value per share to 215p in the six months to end 30 June 2016. This means the total return over the 12 months from June 2015 is over 18 per cent. Moreover, post the half-year end the sale of a controlling stake in online dating website Parship at a 77 per cent uplift over the carrying value has added 9.4p a share to Oakley’s net asset value. Parship was acquired in May 2015 and has generated an estimated internal rate of return of 150 per cent on the capital invested.

Analysts at Liberum Capital estimate Oakley’s pro-forma net asset value at around 227p a share after adjusting for the sale of Parship and the movement in the share price of Time Out Group (TMO) since end June. So, despite posting a significant valuation increase over the past year, Oakley's discount to net asset value has actually widened to 36 per cent. This compares to a historic average of 20 per cent for the fund since inception and a current discount of 26 per cent for its direct private equity peer group.

I strongly believe this is anomalous given that key portfolio companies are performing well and the focus in the short-to-medium term will be on investing capital. Indeed, cash now accounts for 63p a share of Oakley’s net asset value after adjusting for the proceeds from the Parship transaction, so the company has ample firepower to make further value enhancing invetsments. It’s a point I made when I last updated the investment case after news of the Parship sale was announced (‘Priced to motor’, 6 September 2016). Buy.