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OPINION

Powered up for gains

Powered up for gains
July 29, 2015
Powered up for gains

Firstly, Aim-traded Stadium Group (SDM: 130p), a specialist provider of niche electronic technologies, has announced the acquisition of Stontroncis, a UK based maker and distributor of power supply units, transformers and adaptors, for an initial consideration of £5.5m.

A placing and one-for-34 open offer at 110p a share will raise net proceeds of £5.5m in total net of costs to fund the deal. Existing shareholders can apply for additional open offer shares at the discounted price through an excess application facility, an option I would strongly advise taking up as this looks a smart bolt-on purchase and one that is highly complementary to Stadium’s existing power business with little overlap between products and customers.

Founded in 1988, Stontronics' key strength is its ability to provide customers with high quality customised, semi-customised or standard power products either through distribution partners or from its own manufacturing site, with a bespoke design service, which is provided through its relationship with Asian suppliers and supported by its own in-house design capability. Stontronics has a direct sales team focused on providing a power solution service to the industrial equipment and instrumentation market mainly in the UK. Products are sold to over 500 customers, with coverage into Europe and North America, who comprise both end users and distribution partners. These distributors are expected to provide a significant new route to market for Stadium’s technology products.

There are other potential benefits too as Stadium plans to consolidate certain activities, reduce costs and improve customer choice and support. The additional warehouse space provided by Stontronics will help enable the company to optimise UK manufacturing and European distribution across its technology products division. It’s also reasonable to expect cross-selling opportunities for Stadium's existing custom power solutions business, and for the other parts of the technology products division.

Complementary deal

This looks a sensible acquisition to me as it accelerates the growth in Stadium’s technology business, a segment that is expected to account for half of revenues this year, up from a third in 2014 and just over 20 per cent in 2013. It also follows on from last summer’s value accretive acquisition of United Wireless which has given Stadium exposure to the design and manufacture of electronics for the high growth machine-to-machine (M2M) wireless sector to support wireless connectivity between devices. Experts predict that demand for M2M devices will grow at a compound annual rate of 24 per cent over the next five years.

Furthermore, Stadium is paying a fair price for Stontronics. In fiscal 2014, the company made £610,000 operating profit on revenue of just shy of £5m and technology analyst Jon Lienard at broking house N+1 Singer believes that the acquisition will lift Stadium’s pre-tax profits by a further £800,000 to £6m in fiscal 2016, representing a 50 per cent increase on his previous fiscal 2015 estimates. On this basis, expect EPS to rise from 8.9p in 2015 to 12.3p in 2016, representing a 75 per increase on the 7p of net earnings Stadium reported last year. And with the equity raise covering the cost of the acquisition, and profits rising steeply, then the payout per share is predicted to increase from 2.1p in fiscal 2014, to 2.7p this year and 3p next. This means the shares are not only trading on a modest 10.5 times earnings estimates for 2016, but offer prospective yields of 2.1 per cent 2.3 per cent, respectively, for the current year and next.

It’s worth noting too that two of the vendors will be retained by Stadium in senior management roles to assist with the integration of the business. There is deferred consideration of £1m dependent on achievement of financial targets, so they are being incentivised to do so.

Moreover, I feel all the catalysts are now in place to propel the shares firmly through the 125p price level that has acted as a glass ceiling to progress this year especially as Stadium is set to report a a large uplift in profits in its forthcoming interim results. In fact, that major resistance level was taken out yesterday.

So having initiated coverage at 75.5p ('Switch onto the Stadium of light', 30 July 2014), and last recommended buying at 113p (‘Exploiting upgrades’, 9 July 2015), I have no hesitation in repeating that advice. On a bid-offer spread of 127p to 130p, I rate Stadium’s shares a buy and have raised my fair value target price to a range between 155p to 160p, or the equivalent of 12.5 to 13 times fiscal 2016 earnings forecasts. Buy.

A smart acquisition for 1pm

Stadium is not the only company on my watchlist to announce an acquisition. Bath-based 1pm (OPM: 68p), a specialist provider of finance to small- and medium-sized enterprises (SMEs) and a constituent of my 2014 Bargain Share portfolio, has just acquired MH Holdings (MHH), a provider of equipment finance and an equipment and vehicles broker to the SME market for consideration of up to £12m.

It looks a sensibly structured and funded deal and one that will be significantly earnings enhancing for 1pm’s shareholders, a fact that investors have failed to cotton onto. In fact, with head of research Eric Burns at W.H. Ireland suspending forecasts until the deal completes, inline with the house broker’s research policy, then investors are in the dark as to how accretive it will be.

However, I can shed some light as I have been running the numbers through my spread sheet and calculate that if MHH had been part of 1pm for the full 12 months of its last financial year to end May 2015, then 1pm’s pre-tax profit would have been around £3.5m on revenues of £10.6m. So based on an enlarged share issue of 52.5m shares this means that EPS would have been 5.2p net of a 21 per cent tax charge.

To put this figure into some perspective, 1pm announced its full-year results last week which revealed that pre-tax profits rose 20 per cent to £1.6m on revenues up 31 per cent to £5.5m to produce EPS of 3.7p. In other words, I estimate the effect of the acquisition is to boost EPS by about 40 per cent after adjusting for the new shares to be issued to fund the consideration. It also means that once you factor in the £400,000 profit uplift W.H. Ireland was previously forecasting for 1pm as a stand-alone entity for the current fiscal year to end May 2016, then the company should be able to turn in proforma EPS of 6p in the current financial year based on pre-tax profits of around £4m on revenues of £14m.

In other words, with 1pm shares being offered in the market at 68p, marginally below the price when I last updated the investment case (‘Small cap growth stocks’, 11 June 2015), but well above the 57p level when I included them in my 2014 Bargain shares portfolio, I reckon they are trading on little over 11 times pro-forma earnings estimates.

Significant benefits from the acquisition

And there are some compelling benefits for doing this deal too. Firstly, MHH currently undertakes both own book and brokered-on business which is all put through its Academy subsidiary, but 1pm writes all its business on its own book. So whilst Academy will continue to broker on some of its deals, the acquisition will allow more own book business to be written which should be more profitable than broking it on.

Secondly, the acquisition will provide 1pm with access to a new pool of customers. That’s because 1pm’s business is sourced through a network of 150 finance brokers while Academy's business is derived from equipment suppliers.

Thirdly, the acquisition provides 1pm with a new source of revenue being the commission revenue generated by the vehicles broking business of Academy.

Finally, the increased scale of the enlarged operation is expected to provide opportunities to negotiate reduced borrowing rates from lenders. Indeed, the enlarged group will have a combined loan book of £46m and I can easily see this growing by a third by the end of next year.

Operating in a highly profitable niche spot

Importantly, both businesses are operating in a sweet spot as not only are they benefiting from the general economic recovery – the Bank of England forecasts UK GDP growth of 2.6 per cent this year and 2.5 per cent in 2016 – but this niche area of the finance sector has a supply-demand imbalance due to the unwillingness of the banking sector to provide adequate funding to SMEs.

The majority of the credit provided by 1pm is asset finance based lending to SMEs and it’s growing strongly. In fact, the company’s lease portfolio grew by over a quarter to £25.2m in the last financial year with the average finance agreement around £10,444 for a term of 40 months. However, this is not at the expense of credit quality as defaults are at an all-time low of less than 0.85 per cent of the book. To mitigate risk no single customer accounts for more than 0.24 per cent of receivables.

1pm also entered the business loan market almost two years ago and its average advance is about £24,500 for an average term of 28 months. The business loan book is growing quickly too, having risen 10-fold to £5m in the past 12 months, highlighting a ready market of SME customers who have restricted access to bank lending.

By contrast Academy’s £16m loan book has a lower average loan size of £7,500, typically for a period of between three to six years. Lending is funded by a range of block funders who had advanced £11m out of total facilities of £19m by the end of March 2015. It’s very profitably as MHH reported pre-tax profits of £1.87m on revenue of £5.1m in the 12 months to end March 2015. That represents a thumping pre-tax return of 60 per cent on equity and explains why the acquisition is so earnings accretive. The other reason is down to the way it has been structured.

Funding the acquisition

To finance the £12m consideration 1pm is placing 10.8m new shares with institutions at 60p each to raise gross proceeds of £6.5m, and issuing a further 1.27m new shares to existing shareholders under a one-for-29 open offer at the same price to raise £763,000. These share issues will enable 1pm to pay the vendors £6m in cash on completion of the deal in addition to issuing 3.57m new shares worth £2.39m and a three-year vendor loan note of £1m which carries an annual interest rate of 5 per cent. In addition, the vendors are entitled to deferred consideration of £2.6m subject to certain financial performance conditions being met. So in effect 1pm is paying £9.4m up front for a business that made £1.8m pre-tax profits last year, but because the consideration shares and earn-out equate to £5m of the £12m acquisition, then the vendors are happy to accept these terms as they still have a financial interest in the enlarged operation.

It looks a decent deal for all parties and one that I feel warrants an upgrade to my target price from 80p to 90p, or the equivalent of 15 times my fiscal 2016 estimate of 1pm’s pro-forma net earnings. It’s worth noting too that when the new shares are issued then the company will have a market value of around £36m so will be appearing on the radar of some small cap funds too. Needless to say I would take up the open offer and continue to rate 1pm’s shares a buy.

MORE FROM SIMON THOMPSON...

At the end of April, I published an article with all of the share recommendations I have made this year. Since then I have published articles on the following companies in the past 12 weeks:

Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)

Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)

Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)

Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)

Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)

Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)

Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)

Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)

Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)

Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)

Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)

Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)

B.P. Marsh & Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)

Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)

Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)

Market strategy ('Financial Market Watch', 9 Jun 2015)

Software Radio Technology: Buy at 29.5p, target 40p to 43p; Tristel: Run profits at 92p; Creston: Buy at 136p, target 150p; Sanderson: Buy at 69p, target range 80p to 85p ('Blue sky potential', 10 June 2015)

1pm: Buy at 67p, target 80p; Vislink: Buy at 58p, target 70p ('Small-cap growth stocks', 11 Jun 2015)

Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 Jun 2015)

First Property: Run profits at 45p; AB Dynamics: Run profits at 225p and target 250p; Inspired Capital: Sit tight at 20p (Bargain shares updates', 16 Jun 2015)

Trakm8: Run profits at 159p, new target 180p; Anite: Sit tight at 126.75p; Trifast: Run profits at 129p, target 140p; Record: Buy at 37p ('Small-cap wonders', 17 Jun 2015)

Inland: Run profits at 71p, target 80p; KBC Advanced Technologies: Buy at 110p, target 165p; Caretech: Buy at 237p, target 300p ('Riding an earnings upgrade cycle', 18 Jun 2015)

Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 Jun 2015)

GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A triple play of small-cap picks', 23 Jun 2015)

Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p ('Soaring small-caps', 24 Jun 2015)

Faroe Petroleum: Buy at 86p, target 100p; Greenko: Hold at 65p; Communisis: Buy at 48p ('A slick investment', 25 Jun 2015)

Mountview Estates: Buy at 12,250p; Inland: Run profits at 71p, conservative price target ('Running bumper profits', 29 Jun 2015)

Redde: Run profits at 138p, target range 150p to 155p; Trakm8: Buy at 175p, target 200p; Cohort: Buy at 312p, target 365p; Burford Capital: Buy at 175p, target 190p; Flowtech Fluidpower: Buy at 135p, target 155p ('Riding earnings upgrade cycles', 7 Jul 2015)

Crystal Amber: Buy at 161p; Stanley Gibbons: Buy at 258p; Somero Enterprises: Buy at 150p, target 185p; Globo: Buy at 49p, target 69.5p ('A quartet of small-cap buys', 8 Jul 2015)

H&T: Buy at 200p; STM: Buy at 47p, target 60p; Stadium: Buy at 113p, target 140p ('Exploiting upgrades', 9 Jul 2015)

Cambria Automobiles: Buy at 57.5p, target 75p ('Driving a re-rating', 13 Jul 2015)

Walker Crips: Buy at 47p, target 60p; 600 Group: Buy at 18p, target 24p; Henry Boot: Buy at 235p, target 260p ('A trio of small-cap value plays', 14 Jul 2015)

Bilby: Buy at 90p, target 120p; 32Red: Buy at 67.5p, ('Exploiting a valuation anomaly', 20 July 2015) target 90p; Marwyn Value Investors: Buy at 244p, target 275p (‘Acquisitions drive earnings upgrades’, 15 July 2015)

Vislink: Buy at 53p, target 70p ('Awarding success', 16 July 2015)

SPARK Ventures: Buy at 4.5p (‘Exploiting a valuation anomaly’, 20 July 2015)

W.H. Ireland: Run profits at 120p, target 140p; Safestyle: Run profits at 235p; Charlemagne Capital: Sell at 11p (‘Cash rich small-caps’, 21 July 2015)

Amino Technologies: Buy at 150p, target 180p; Arbuthnot Banking: Buy at 1,530p; Globo|: Buy at 49p, target 69.5p ('Primed for major re-ratings', 22 July 2015)

SPARK Ventures: Buy at 4.5p; Entu: Buy at 115p, target 165p ('Cashed-up for gains', 23 July 2015)

Capital & Regional: Buy at 60.25p, target 70p ('Hot property', 27 July 2015)

LMS Capital: Vote against proposals at EGM; Marwyn Value Investors: Buy at 238p, target 275p to 280p ('Game changers, 28 July 2015)

■ Simon Thompson's 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'