Happy capital returns

In this time it has become apparent that one of the easiest ways for unloved companies to attract enough investor interest to stimulate a re-rating is to simply to return capital to shareholders. This can be done by either realising the value in the investments that are being implicitly undervalued in the company's current market valuation or by returning substantial amounts of cash on the balance sheet. A good example of this is Indigovision (IND), a pioneer in internet protocol network-based security surveillance systems and one of the stars of my 2012 Bargain share portfolio. The company returned all of its cash pile to investors last month, which brought into focus the substantial asset backing and also the low earnings multiple the shares were trading on. In effect, the capital return accounts for two-thirds of the 37 per cent gain made on the holding since I advised buying the shares in February.

It's hardly rocket science, either, because a substantial return of capital brings into focus the value on offer and, if executed correctly, can put a floor under the share price. This is exactly what has happened with two other companies - LMS Capital and Spark Ventures - I recommended buying in the summer.

Capitalising on LMS

Investment company LMS Capital (LMS) has now returned £40m of its £51.5m cash pile by tendering for 17 per cent of the share capital at 84p a share. That is slightly below net asset value of 85p a share, but substantially above the share price of 66p. A policy of returning cash in this way not only benefits shareholders who receive a premium for tendering their shares, but it offers the opportunity to use the proceeds from the tender to acquire even more shares in the market to boost holdings and reduce average buy-in prices. Moreover, with further returns due in 2013 as LMS winds up its portfolio, and equity markets enjoying a tail wind fuelled by the largesse of the major central banks on both sides of the Atlantic, this in effect creates a floor for the company's share price. So, if you followed my advice to buy LMS's shares at 64p ('Time capitalise on LMS', 25 Jun 2012), factoring in the tender offer, the holding is showing a gain of 8 per cent. I continue to rate LMS's shares, trading on a 21 per cent discount to book value, an attractive medium-term buy.

Spark a rerating

Shares in Spark Ventures (SPK), the Aim-traded investment company focused on technology and new media, have been flying and with good reason. To recap, I first made the case for investing ('The spark for a re-rating', 10 Jul 2012) when the shares were priced at 9.5p, a substantial discount to the company's book value of 16p. It proved a popular choice because the price subsequently rallied 30 per cent to 12.5p after other investors were attracted by the potential upside on offer given that the company is in the process of selling off its portfolio and has a deadline of March 2014 to do so.

It's a company I have been keeping a close eye on, too, and having seen the price drift back to 11.25p ('Time to spark a re-rating', 8 Nov 2012), I reiterated the advice again. It proved timely, because Spark's board has just announced that it will return at least 2p, and possibly 2.5p a share, in January and reported a further rise in its book value to 16.2p in results last week. Spark's share price has since risen back to 12.5p, valuing the company at £51m.

However, even though we are sitting on bumper gains there should be more upside to come, because Spark's holdings in notonthehighstreet.com, Kobalt and Mind Candy - all of which are easily realisable - now have a combined value of £24.2m, or 5.9p a share. Spark will also shortly receive £2.5m in cash from the £5.75m outstanding consideration from the sale of its holding in semiconductor company Aspex to Ericsson. The remaining £3.25m balance of the proceeds will be paid in late 2013/early 2014. Add to that a cash pile of £10m and restricted cash of £1.8m and, by my reckoning, around 10p of the current share price of 12.5p is fully backed by cash or the four realisable investments above. That means £15m in 13 other companies are in effect in the price for free.

Spark Ventures investment portfolio December 2012

So, with Spark's portfolio performing well and disposals surpassing expectations, a total distribution to shareholders of at least 14.25p a share, or £58.4m, looks realistic and, in my view, a conservative possibility over the next 12 months. That's after factoring in wind-up costs, management incentives and property liabilities. Trading 23 per cent below book value, which widens to a 27 per cent discount post next month's capital return, I continue to rate Spark Ventures' shares a buy at 12.5p.

Sutton Harbour's property shock

Plymouth marina and property company Sutton Harbour (SUH) gave shareholders a sinking feeling last week after a property valuation wiped £4.9m off the value of the company's portfolio. However, look below the headline numbers and it appears a case of a new firm of surveyors, DTZ, being incredibly cautious with their numbers given a lack of deals in this niche segment of the property market to provide comparables. Indeed, surveyors at DTZ used a bumper net initial yield of 8.64 per cent to value Sutton's properties, which is significantly more than the 8.07 per cent net yield used in March and explains all the £4.9m shortfall in their value.

True, valuations of marinas are difficult to judge, but the hike in the net yield used also reflects "reticent sentiment about provincial commercial space and a lack of relevant evidence of trading specialist assets such as our marina", according to Sutton's chief executive Mr Schofield. Importantly, he adds that "the valuation does not reflect any marked change in marina occupancy rates".

Mr Schofield has a point because, although activity slowed in the first half and he is sensibly cautious about improving property occupancy rates in the second half, revenue on the marine side, mainly berthing fees and rents, has held up pretty well. Sutton's growth story remains intact, too, as lease and construction agreements for the nearby 171-berth King Point marina development have been completed and construction work starts next month.

Understandably, investors have been spooked by the property downgrade and shares in Sutton sank 16 per cent post results. But the valuation needs to be put into perspective because, even if we accept DTZ's very conservative valuation, the shares, at 29.5p, are still trading a hefty 23 per cent below book value of 38.3p - and that's assuming 5p a share of value has been lost forever, which is hardly realistic.

My view is that the markdown in Sutton's shares - less than £50,000 of stock was traded on results day - is a massive overreaction. So, having flagged up Sutton a fortnight ago when I revisited the case for Aim-traded investment company Crystal Amber (CRS), which holds a substantial stake in the company, I would not advise bailing out now ('Small caps to buy', 3 Dec 2012). I am comfortable holding shares in Crystal Amber especially as the other holding I flagged up, packaging materials group, API (API), is nearing the end of its auction process for bids for the company and we should have some news on this in the next few weeks.

Shares in API have since moved up by 15 per cent from 70p to 82p and, although there can be no guarantee that an offer will be made for the company, it looks increasingly likely. I can still see upside here towards 100p a share if a takeover materialises.

Communisis dials the right numbers

Marketing services provider Communisis (CMS) continues to win new contracts and a few weeks ago announced a five-year contract with BT for the production of all the telecom group's billing and associated customer communications. This work will use Communisis's high-speed colour digital technology to make the billing formats clearer, more personal and more dynamic.

This contract, which starts this month, will have no impact on 2012 estimates and, although analysts at N+1 Singer have left their 2013 estimates unchanged, clearly the extra income supports those forecasts. For 2012, the broker expects pre-tax profits to rise from £9m to £10.5m, based on a 10 per cent rise in revenues to £229m. On that basis, adjusted EPS rises from 4.75p to 5.7p, which offers scope for the board to increase the dividend from 1.5p to 1.6p share. For 2013, the broker expects revenues to rise to £235m and profits to increase to £11.2m to produce EPS of 6.1p.

I advised buying shares in Communisis at 28.5p ('Small cap trading buy', 13 Feb 2012) and last reiterated the advice when they were trading at 40p ('Communisis shares to fly', 19 Oct 2012). I still maintain my target price of 49p and see scope for significant upside with the shares, at 36p, priced on six times earnings estimates for 2013 and offering a prospective yield of 5 per cent based on a dividend of 1.8p next year. Buy.

IQE's hot 'intellectual' property

IQE (IQE), a global supplier of advanced wafer products to the semiconductor industry, has received its first single order valued at more than £1m for advanced laser wafers to enable a new generation of fibre-optic communications devices. This order will be delivered during the first half of 2013 and "further significant follow-on orders are expected, driven by strong demand in China for data-centre applications and infrastructure build out".

IQE is also solidifying its position as the leading supplier of epiwafers to the high potential concentrated photovoltaic (CPV) market. IQE has an exclusive agreement to supply CPV wafers to California-based Solar Junction, which has a strong position to supply cells to the major CPV system houses. That's important because industry experts Lux Research predict the CPV system market is set to grow to £1bn by 2017. That not only represents a heady compound annual growth rate of over 30 per cent, but adds credence to IQE's prediction that the epiwafer market will be worth $250m (£156m) by 2015, over half the size of the wireless market, which currently drives most of IQE's revenue. It also underpins the significant earnings growth analysts are predicting for IQE over the next few years. Canaccord Genuity predict that the company's EPS will rise from 1.6p in 2012 to 2.2p in 2013, based on a ramp up in revenues from £92m to £113m. Peel Hunt is even more bullish, pencilling in EPS of 27p in 2013 and 3.2p in 2014 assuming sales hit £135m.

This heady growth rate was the main reason I suggested buying the shares at 31.5p with a three-month target price of 38p to 40p ('Tech that and rally', 19 Oct 2012). The share price subsequently hit a high of 34.25p, but has since retreated to 28.5p, implying the shares are currently rated on a forward PE ratio of 10.5 to 13 using the estimates above. For a company that has potential to double EPS over the next two financial years, this is an attractive rating and I continue to rate the shares a buy.