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Over here and doing well

Created:
29 January 2008
Written by:
Jon Mainwaring

The alternative investment market (Aim), the stock market for small, fast-growing companies, spent much of its first decade as a home for UK-based businesses. But in recent years, there has been an astonishing rise in the number of foreign companies choosing to float on AIM.

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At the end of 2002, just 50 of Aim’s 704 companies were foreign-based (roughly 7.1 per cent). But just five years on, the proportion of foreign companies quoted on London’s junior market has risen markedly, with Aim now hosting more than 330 such businesses out of a total membership of almost 1,680 companies (approximately 20 per cent).

What has made Aim so attractive during those past five years? Well, it is no accident that 2002 was the year that the United States introduced the Sarbanes Oxley Act (known as SOX) – a piece of legislation, thought up after a series of US corporate scandals, that many business people see as draconian.

A fair proportion of the foreign businesses that have come to Aim is US-based, and there are a number of other foreign companies from countries other than the US that might have chosen an exchange like Nasdaq were it not for SOX. The annual costs of complying with SOX can run into millions of dollars, which would have a severe effect on the bottom line for any small or early-stage business.

However, 2002’s introduction of SOX is only part of the story and does not fully explain the attractiveness of Aim for US businesses, which currently account for almost 80 of Aim’s member companies compared with just half-a-dozen in 2002.

“We think [SOX] is a bad reason just by itself to come over to Aim,” says Saul Sender, a partner at international law firm Reed Smith Richards Butler, who has advised on a number of listings of US companies on Aim. Mr Sender explains that issues resulting from the difference in time zones between the US and London, as well as difficulties in communicating with investors and cultural differences can actually eat into much of the savings made by opting for Aim.

A good reason for a US business to join Aim, says Mr Sender, is if it has some kind of presence in the UK or Europe. This could be a research and development function or a manufacturing centre, or it could even be that the business sells a significant proportion of its product here. But, says Mr Sender, for companies with nothing going on outside the US, an Aim flotation “is a bit of an odd thing to do”.

“An all-American company is probably not that welcome on Aim,” agrees Chris Moe, chief financial officer at Vectrix Corporation – a Rhode Island-based developer of zero-emission electric motorcycles that owns production facilities in Poland and counts Italy, France, Germany and the UK among its target markets. “Our feeling was that the geographical centre of our universe was London.”

Meanwhile, the increasing institutional attention that Aim has received in recent years has also proved attractive to businesses that would normally look to raise funds with venture capital investors on the far side of the Atlantic. “There are almost no private investors who pick up on these companies,” says Mr Sender, who explains that the firms he has helped to bring to Aim typically gain just four or five new investors (albeit ones with very deep pockets).

In fact, Mr Sender believes that a US company coming over to Aim generally sees its flotation on the market more as a “hybrid financing”: almost like a third-round venture funding deal with a bit of liquidity thrown in.

One striking feature of the US businesses currently quoted on Aim is that they generally have a technology flavour to them. And many of these technology firms are focused on environmentally-friendly technologies (or ‘cleantech’).

“There are several factors that have encouraged North American cleantech companies to choose Aim over Nasdaq,” explains Bruce Huber, head of technology at investment bank Jefferies International (which has advised several US companies on Aim). “Mainly, the LSE’s more favourable listing regulations for growth companies, London’s strong institutional investor base, the European region’s early leadership in pro-renewable legislation and the City’s experience with international investing, especially in the energy-related sectors.”

Mr Sender points out that London also has “some very good cleantech analysts” as well as a cluster of funds focused on cleantech.

Here, we take a look at four US companies currently quoted on Aim that look likely to deliver value for new investors:

Cosentino Signature Wines

Luxury wine producer Cosentino Signature Wines is one of the few non-technology US-based businesses quoted on Aim, and it does almost all of its business in the US. However, Cosentino’s boss, Larry Soldinger, believes floating on Aim was worth doing. “Had we gone public in the US we wouldn’t have had the same attention that we’ve had by coming to Aim. We would have been a small bulletin board company,” he says.

Napa Valley-based Cosentino joined Aim in December 2005 with plans to use the £11.4m funds it raised on flotation to grow the business, both organically and through acquisition. But within a year the company hit problems due to wholesale sales being lower than anticipated due, it later transpired, to a lack of co-ordination with key distributors. 2005’s operating profit of $1.7m was turned into a loss of $2.8m in 2006 and a resulting flow of cash out of the business led to the extension of its debt facility and, soon afterwards, a refinancing of the company.

By February 2007, the firm’s top management had resigned and Mr Soldinger - Cosentino’s original boss - reassumed his role of executive chairman and chief executive officer, bringing two new non-executive directors with him. He placed the blame for Cosentino’s reversal of fortune squarely on his predecessors, who, he says, took their eyes off the ball while pursuing an “over-ambitious strategy” to acquire other wine producing assets around the world and attempting to change the company’s successful Napa Valley-based operating business.

Today, Mr Soldinger has taken the company back to basics. Cosentino’s wholesale division has repaired relationships with key distributors, and September’s interim results showed that the company’s retail division produced a record 24 per cent year-on-year increase in H1 sales despite the market traditionally being weighted towards the second half.

For 2007 as a whole, house broker Seymour Pierce expects Cosentino to be break-even on turnover of $11m, compared with a loss before tax, adjusted for goodwill charges, of $6m on turnover of $7.9m in 2006.

Despite a sale and leaseback programme of certain winery estates owned by the company that has reduced borrowings by $20m, Cosentino still has plenty of debt - Seymour Pierce estimates this at between $9m and $10m at 2007 year-end. But Cosentino wines - which have been served at the White House, US Golf Masters’ dinners and Royal receptions - have a very good reputation among more than 5,000 fine dining restaurants and fine wine stores throughout the US. With the share price now well off its high for the year of 50p (on the day of the interim results in September) we think Cosentino looks an interesting turnaround play.

Entelos

One of several of North American life sciences businesses quoted on Aim, California-based Entelos develops software simulations of disease in order to allow the virtual testing of pharmaceuticals.

The business currently has a rather lumpy revenue stream, which means that despite increasing its first-half profit this year, it is set to produce an overall loss for 2007. But Entelos is steadily building a market for its services and already boasts high profile clients such as Johnson & Johnson, Organon, Novartis, Pfizer and Roche.

And the company’s technology has gained further credibility thanks to an R&D agreement with the US Food and Drug Administration’s Center for Drug Evaluation and Research. This two-year programme will see Entelos working with the FDA to develop a computer model of drug-induced liver injury - the most frequent cause of acute liver failure in the US.

Entelos further increased its computer simulation capability last summer when it acquired another Californian company, Iconix Biosciences, in an all-share deal. Also used by the FDA, Iconix’s predictive toxicology technology is used to predict the likely side-effects of new drugs. Entelos plans to combine Iconix’s technology with its own disease models so that it can address the pharmaceutical industry’s two biggest issues concerning drug failures: safety and efficacy.

Meanwhile, the company plans to use its predictive disease models to diversify into developing its own therapeutic products. Already, a deal with a Johnson & Johnson affiliate has led to the acquisition of compounds that could be used to treat a variety of women’s health-related diseases, including breast, uterine and ovarian cancers. Entelos also has a strategic alliance with Indian drug development services business, Jubilant Biosys, to develop a portfolio of compounds.

Entelos raised $3.5m during the autumn via two private share placings, one of which included a $1.5m investment from Pfizer, and in December it arranged a $6.5m debt facility. The company intends to use some of these additional funds to build and acquire further predictive technologies, as well as for working capital.

For 2007 as a whole, Entelos is forecast to make a loss of $2m. But a leap in revenues in 2008 is expected to help the company to a full-year profit of $2m. Clearly, it is still early days for this business, but - at 21p each - the shares are a long way off their 2007 high point of 86p. So, this could be a good opportunity to get in.

PowerFilm

PowerFilm is an Iowa-based solar technology manufacturing business that is almost 20 years old. The company came to Aim in May 2006, raising $18m that it has been using to expand production capacity.

PowerFilm is focused on manufacturing thin, flexible solar panels based on its own low-cost production process. The first company in the world to manufacture monolithically-integrated solar panels on plastic using a roll-to-roll production system, PowerFilm’s solar panels use as little as one per cent of the silicon used in traditional solar panels.

This is an important point, since a shortage in the supply of silicon is currently a serious impediment to growth in the solar sector, according to Jefferies International. The investment bank estimates that silicon demand from the much bigger semiconductor industry will increase by 10 per cent annually through to 2010, while expected new additions to silicon supply from 2008 will not fully offset the increased demand.

So, because thin-film solar panels use a relatively small proportion of silicon, their cost of manufacture is not so sensitive to the price of silicon. This means thin-film solar panel manufacturers like PowerFilm have a key competitive advantage over traditional solar panel producers.

PowerFilm has a good relationship with the US Army, for whom it is developing solar portable power products. In April, the army awarded it $1.7m that will be used to fund the company’s overall manufacturing technology improvement programme over the next two years. Then in August, the army awarded the company a further $336,000 contract.

In June, PowerFilm placed more than 2.6 million shares to raise £7.9m in order to cover the costs of purchasing and installing new machinery as part of its ‘Phase Two’ production expansion plans. These plans aim to increase production capacity from 10 megawatts in 2009 to 24 megawatts by 2010.

Interim results released in September showed that PowerFilm more than doubled its first-half revenues to $5.3m (H1 2006: $2.4m), while its H1 pre-tax profit jumped to $1.9m (H1 2006: $0.2m). And house broker Nomura Code Securities says growth should continue through to 2010, when the company is forecast to deliver full-year revenues of $70.1m with a pre-tax profit of $29.2m.

As well as the demand from existing and new customers in markets for portable, remote and military solar panel applications, PowerFilm’s growth is also expected to be driven by strong demand from the building-integrated solar panel market - for which the company is about to launch products. Meanwhile, Nomura thinks PowerFilm has the potential to be a cost leader thanks to its technology advantage, which should prove valuable in an industry where unit prices are expected to decline eventually.

However, short-term delays have disrupted PowerFilm’s capacity expansion programme, which means the company will be reporting lower-than-expected revenues for last year. Instead of doubling its revenues in 2007 to $12.4m, as previously forecast by Nomura, turnover is now expected to be closer to $8m ($6.1m in 2006).

December’s announcement about these delays stressed that the company’s long-term growth plans are proceeding as planned, but the share price still lost around one-third of its value on the news. Clearly, this is not a share for the fainthearted, but now that it is trading at a lower level we think PowerFilm could prove a good way to play the solar sector.

Turbotec Products

Connecticut-based Turbotec Products, a specialist in heat transfer technology, has been trading for 35 years but only joined Aim in May 2006.

The company designs and manufactures high performance heat exchangers and flexible connectors for the oil, gas and petrochemical industries, as well as for residential and commercial heating and cooling applications.

In November, Turbotec reported record interim results that were, in part, due to increased demand for high-efficiency heat pumps from the ‘green’ construction sector. The company also benefited from increased shipments of boiler tubing as the replacement market for high efficiency boilers in schools and other public buildings underwent strong sales during the summer. Revenues for the six months to 30 September increased by 25.2 per cent to $14.5m, while first-half pre-tax profits almost doubled to $1.5m (H1 2007: $758,000).

Despite this progress, both Turbotec’s management and its house broker, Dawnay Day, warned that the worsening status of the US housing and construction markets would have an adverse impact on its order backlog and that this might eventually affect future shipments. Because of this, Dawnay Day decided not to upgrade its forecasts of $3m pre-tax profits and $26.3m sales for Turbotec’s 2008 financial year (which ends on 31 March).

However, over the longer term, the broker expects sales of all Turbotec’s products to increase as the US becomes more environmentally conscious. And it thinks the company’s introduction of new heat recovery units for air-conditioning systems could become a significant new driver of earnings.

The shares currently trade at around 11 times prospective earnings. This seems cheap considering those earnings are forecast to grow at 50 per cent this year and 26 per cent in 2009.

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