To put the level of the offer into perspective, analysts believe 32Red generated cash profits of £10.5m in 2016 and its closing net funds are likely to have held steady at £8.3m, so net of cash on the balance sheet Kindred is paying a multiple of 16 times cash profits. Furthermore, even after factoring in the likelihood of a £5m increase in 32Red’s cash profits in 2017, based on net gaming revenue growing by a fifth to £76m, as analysts at Edison Investment Research predict, the exit multiple is around 10.6 times forecast cash profits to enterprise value, a small premium to 32Red’s larger peer group.
In the circumstances, it’s hardly surprising that directors of 32Red, who control 43.3 per cent of the issued share capital, are all backing the offer. Other shareholders controlling 27.8 per cent of the shares are supporting it too, so this looks a done deal to me with little chance of a rival bidder gate-crashing the party given the generous terms offered by Nasdaq Stockholm-listed Kindred. It also means that if you followed my advice three weeks ago to buy 32Red’s shares at 155p (‘Exploiting undervalued situations’, 6 February 2017), my 186p target price has been hit in double quick time. For longer term holders who bought in when I first advised buying at 51.75p ('Game on', 7 July 2013), the holding has generated a 313 per cent return after factoring in dividends of 17.8p a share. That’s a thumping annualised return of 47 per cent. Moreover, with 32Red’s share price now trading on a bid-offer spread of 200p to 200.5p, you don’t even have to wait for the company to pay out the 4p a share dividend as you can crystallise all of the gain now which is what I recommend doing.
As an aside, Kindred’s bid brings into sharp perspective the derisory cash offer for rival Netplay TV (NPT:9p) from acquirer Bettson, a company that has been a leading consolidator in the online gaming sector following its acquisitions of TonyBet and Racebets in 2016. Bettson is only offering an 11 per cent premium to Netplay’s average share price over the past three months, and values Netplay at less than six times analysts’ cash profit estimates to enterprise value for the 2016 financial year. Netplay’s shareholders are also being deprived of their final payout, a wholly unacceptable state of affairs as I highlighted a fortnight ago (‘Building gains’, 14 February 2017).
The other point worth noting is that no fewer than 17 of the small cap companies on my active watchlist have been taken over or exited the stock market since the start of 2015. The average gain on these is now around 60 per cent above my recommended buy in prices, thus highlighting the potential rewards to be made by selective stock picking in my small cap hunting ground. One key reason why I have been able to uncover so many of these value opportunities is because there is a dearth of equity research in this market segment, so offering potential for shares to be mispriced by the market.
Of course, there have been losers along the way, that’s part and parcel of investing in the stock market, but the magnitude of the profit on the winners like 32Red offers rich compensation. Moreover, even though stock markets are at all-time highs, I continue to find new small cap value opportunities to exploit, one of which I highlighted in an indepth online-only column this week: Sedgefield-based Kromek (KMK:25p), a radiation detection technology company focusing on the medical, security and nuclear markets (‘Follow the smart money’, 27 February 2017). If my detailed analysis proves on the money, then a target price of 34p is not unreasonable.
Amber alert for more gains
Shares in activist investment fund Crystal Amber (CRS:232p) have smashed through the 205p target price I outlined when I last rated them a buy at 189p (‘On a roll’, 19 December 2016), and are now up 58 per cent since I included them in my 2015 Bargain Shares portfolio. The company has paid out 7.5p a share of dividends too.
The main reason for the latest price surge is the dramatic increase in the value of the company’s 13 per cent shareholding in Hurricane Energy (HUR:53.5p). Hurricane is building up a huge resource base in a strategically important part of the North Sea and one that’s estimated to hold 444m-470m barrels of oil equivalent of 2C Contingent Resources and 432m-442m barrels of oil equivalent of P50 Prospective Resources. The Competent Person’s Report for the company’s Lancaster Area acreage, west of Shetland, is expected to be delivered by the end of next month, as part of the ongoing process for submission of the field development plan midway through this year.
Analysts have been warming to the investment potential too with Brendan Long at broking house WH Ireland valuing the company at US$1.3bn (£1.04bn) on a risked basis, implying a target price of 80p a share; and analysts Sanjeev Bahl and Elaine Reynolds at Edison Investment Research pencilling in a total risked net asset value of 101p a share. Dougie Youngson of finnCap has a target price half way between the two. Hurricane’s share price has risen a further 12.5 per cent since the end of January, adding 9.5p a share to Crystal Amber’s end-January net asset value of 218.5p.
The fund’s 3.4 per cent holding in the UK's largest listed residential property owner and manager, Grainger (GRI: 250p), is well worth noting too, as I highlighted in early December (‘Small cap watch’, 6 December 2016). That’s because Grainger’s board have been selling off non-core assets, and are investing £850m in the private rented sector (PRS) by 2020, of which £389m has already been secured and a further £347m is in the legal or planning process. It makes strategic sense to do so given the pressures a growing population is placing on the UK’s housing stock: with property prices becoming unaffordable for many, one in five households now rent. To put the scale of the housing shortage into perspective, analysts at PwC predict that 1.8m new rental homes will be required by 2025 just to meet demand.
Grainger’s board believe that the combination of structural demand, positive support for the build-to-rent sector and institutional investment in PRS housing presents “a very compelling opportunity”. They are not the only ones thinking this way as the company’s share price has risen 13 per cent since my December article, and a recent upbeat trading update was well received. Rated on an unwarranted 15 per cent discount to EPRA triple net asset value, and offering a dividend yield of around 4 per cent, Grainger’s valuation still looks attractive enough to support further share price gains.
The bottom line is that when Crystal Amber next reports its closing monthly net asset value per share I reckon it will have jumped from 218.5p to 237p since the end of January, with the holdings in Hurricane, Grainger and vehicle rental group Northgate (NTG:555p) accounting for two thirds of the portfolio’s value. So, with the investment risk weighted to the upside, it makes sense to run profits.
Primed for a profitable recovery
Investors have sensibly looked beyond the headline numbers for Aim-traded stockbroker and private wealth manager WH Ireland (WHI:130p) which reported a £3m operating loss on revenue down a fifth to £25.4m in the 12 months to end November 2016. That’s because once you strip out £1.78m of exceptional charges, then a second half operating loss of £150,000 represented a sharp improvement from a loss of £1.1m posted in the first half when all broking houses suffered from a severe decline in trading activity and secondary market fundraisings.
Moreover, the decision to outsource the back office functions of the company’s private wealth management arm, currently performed out of its Manchester head office, accounted for £593,000 of the one-off charges, but should lead to annual cost savings of £400,000 from the 2017/18 financial year. That’s mainly because the annual custody charge on around £2bn of assets under management (AUM) being outsourced has been priced in "single basis points" under the terms of a seven-year agreement, and headcount in Manchester is being halved. Restructuring costs, mainly staff redundancies, accounted for £1m of the loss, but has significantly reduced the cost base. Chief executive Richard Killingbeck pointed out during our results call that these measures have shaved a combined £750,000 off costs for the 2017/18 financial year.
The other take for me was the fact that WH Ireland’s higher margin discretionary assets under management (AUM) shot up by a third to £1bn, and rising, so outpacing growth in total AUM which increased 14 per cent to £2.87bn. The rally in equity markets since the financial year-end has added £110m to AUM according to Mr Killingbeck which will bolster recurring fee income as will a forecast move into profit this year for the Isle of Man office.
The second half improvement in trading conditions was also evident in the corporate broking arm which reported a trading profit of £273,000 in the six-month period, reversing a first half loss of £1m when market activity was subdued and the broking house was unable to undertake regulated activities for a 72-day period after being fined by the FCA ('WH Ireland hit by FCA fine', 23 February 2016). The back drop is now far more favourable with equity markets riding all-time highs, so much so that Mr Killingbeck says that “all the lights have been turned on and our pipeline for the first half is very robust”. WH Ireland is capitalising on this opportunity, having just poached Adam Pollock from rival Zeus Capital to lead this side of the business. It’s also introducing a higher fee structure for its 85 retained corporate clients.
It’s worth noting that the company's three main shareholders, who control 62.5 per cent of the issued share capital, all backed a placing at 123p a share in November. WH Ireland raised £1.58m of cash partly to cover a £600,000 increase in the funds set aside for regulatory capital requirements, which accounts for a third of the company’s £11m cash pile, and to cover the afrementioned £1m restructuring costs. It’s easy to see why they are supportive as there is clear value on offer: analysts John Borgars and Gilbert Ellacombe at equity research firm Equity Development have a sum-of-the-parts valuation double the current share price based on a valuation of 4 per cent of discretionary funds under management, 2 per cent for advisory, 0.5 per cent for execution-only and after factoring in net funds on the balance sheet. They also point out that recent activity in the fund management sector more than supports their valuation as financial services group Mattioli Woods recently paid 5.5 per cent of AUM to acquire a 49.9 per cent stake in Amati.
So, with a profit recovery firmly on the cards, and first half comparables soft, I feel the risk is skewed to the upside. Having initiated coverage at 68p ('Broking for success', 1 August 2011), and advised running profits at 123p (‘Investments worth checking into, 12 December 2016), I upgrade my recommendation on the shares to a buy and have a 175p target price. Buy.
MORE FROM SIMON THOMPSON...
A comprehensive list of all the investment columns I have written in 2017 is available here.
The archive of all the share recommendations I made in 2016 is available here
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com for £14.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stock picking
