The key question now is whether the investment case is still intact, irrespective of the poor share price performance, and whether or not there is a realistic chance of recovering those lost paper profits. On both counts I firmly believe this is still the case.
True, analysts now expect profits to be flat over the next couple of years. Analyst Johnathan Barrett at brokerage N+1 Singer predicts adjusted pre-tax profits of £4.9m and EPS of 1.6p for both 2014 and 2015 even though revenues are forecast to rise from £28.5m in 2013, to £30.8m for fiscal 2014 and again to £36m in 2015. In part this largely reflects the impact of the UK government point of consumption (POC) tax which will be introduced at the end of this year. Without taking measures to offset the impact of the new tax, Netplay's board has already gone on record to say that it could wipe £1.7m off profits at a stroke.
But by taking steps to mitigate the impact of the new tax, such as amending contractual offset agreements with suppliers, where revenue generated is linked to the amount payable to a supplier, then Netplay has been able to protect its profitability. And even though margins are slimmer than before there is no doubt that the business is still continuing to pull in punters. Indeed, new depositing players to Netplay’s websites increased by almost a quarter to over 40,500 in the first half of this year and the total number of active players now stands at over 62,000, up from around 48,000 at this stage last year. Almost half of all new registrations came via a mobile or tablet device in the second quarter and this segment now accounts for 36 per cent of total net revenue. That’s important because these players have the highest average revenue per user (ARPU). In fact, it is currently four times higher than desktop players.
Targeted marketing
Equally important is news that after a period of soft trading in July, mainly due to the impact of the FIFA World Cup and the good weather, revenue trends in August and September have been improving and third quarter average daily revenue is currently up 6 per cent. The company’s management team also confirms that the business is trading in line with those aforementioned revenue and profit estimates.
Targets for the second half include raising ARPU by improving customer retention rates. This should be helped by the planned roll-out of a significant product upgrade to the “single wallet” in the fourth quarter this year which will widen the customer offering to include casino, sportsbook, bingo and a greater range of third party games. It will also enable better marketing to incentivise players in order to maximise player returns. This seems very sensible to me as is the ongoing focus on television-led marketing.
It’s also worth noting that although analysts are factoring in 10 per cent growth in marketing spend in the second half this year, if these initiatives prove successful then there is scope for targeted marketing spend to increase further to improve returns. Equally, if the spend doesn’t generate the required return on capital then it can simply be reined in to protect profits. Either way, I feel comfortable with N+1 Singer’s profit estimates.
Robust cash conversion
It’s also worth pointing out that Netplay’s cash pile continues to grow. In the latest six month period, around 84 per cent of cash profits of £2.2m were converted into net cashflow. As a result the company now has net funds of £14.3m and analysts believe the cash pile will swoon to £16.4m at the end of December, or the equivalent of 5.5p a share. To put that into perspective, with Netplay’s shares trading on a bid-offer spread of 10.5p to 10.75p, net cash will shortly account for half the share price.
Or put it another way, strip out net cash from the current share price and Netplay is being priced on a prospective cash adjusted PE ratio of 3.5. Interestingly, the board have committed to reviewing the use of this cash after the year-end. It would be no surprise at all to see a return of capital to shareholders in the absence of acquisitions. In the meantime the interim dividend was raised 22 per cent to 0.22p (ex-dividend date of 24 September) in line with analysts’ forecasts of a 20 per cent increase in the full-year payout to 0.6p a share. On this basis, the forward dividend yield is 5.5 per cent.
So with significant dividend support, and underpinned by a solid and cash rich balance sheet, I feel there is far more upside than downside to this lowly rated company. Analysts are of the same view: Amisha Chohan at brokerage Sanlam Securities has a fair value target price of 24p and Michael Campbell of Northland Capital notes that at this depressed level the “company could be a bid target”.
Interestingly, the insiders have been dipping into their pockets to exploit the valuation anomaly: non-executive Andrew Lapping bought 200,000 shares at 10.86p each post results, and a company Mr Lapping is associated with bought a further 200,000 shares at the same price too. On the same day, finance director Akshay Kumar acquired 83,333 shares at 11p. I strongly believe these buys are well worth following. Offering more than 100 per cent upside to my long-term target of 28p, I remain a buyer too.
Please note that Thalassa (THAL), IQE (IQE), Flowtech Fluidpower (FLO) and Global Energy Development (GED) have all reported half year results today. I will update my view all of these companies shortly. I have also published another two columns today, both of which are available on my IC homepage...
■ Simon Thompson's new 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 £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
