To finance the $75m (£47m) consideration IQE has placed around 8.8 per cent of its enlarged share capital with institutions at 29p a share to raise £16.5m, and has agreed a new $40m (£25m) banking facility with HSBC to fund the balance of the purchase price. Importantly, given the structure of the deal and the fact that $15m of the consideration is deferred for three years, existing shareholders are not being diluted. In fact, the acquisition is expected to boost EPS from the 2013 financial year onwards and generate annual cost savings of at least £7m from 2014.
To put this into perspective, for the year ending 31 December 2012, IQE’s chief executive Drew Nelson expects “revenue to be in the range of £87m to £88m and cash profits of between £16m to £17m.” Kopin Wireless generated cash profits of $7.5m (£4.7m) in the first nine months of 2012, so the £7m of costs savings are material for a business making combined annual cash profits in the order of £23m. Bear in mind, too, that analysts had been predicting strong EPS growth for IQE over the next couple of years even before earnings upgrades which are likely to follow in the next few days to factor in the Kopin acquisition.
Previously, analysts expected EPS to increase from 1.6p in 2012 to between 2.2p and 2.7p in 2013, rising again to 3.2p next year, but these estimates will now have to be materially upgraded. It’s worth pointing out, too, that IQE’s finances are very comfortable as December 2012 year-end net debt of £15m only represented proforma gearing of around 18 per cent of shareholders funds of over £85m. Post the acquisition I estimate that net debt of £40m would account for around 36 per cent of IQE’s shareholder funds of £110m.
This heady growth rate and the positive drivers in the epiwafer market were the main reason I suggested buying the shares at 31.5p ('Tech that and rally', 19 Oct 2012) and reiterated that advice at 28.5p (Happy Capital returns 17 December 2012). At the current price, IQE is only rated on a 2013 forward PE ratio of 12.2 before imminent earnings upgrades. For a business that has potential to double EPS over the next two financial years, this is a very attractive rating and I continue to rate the shares a very strong trading buy. My original target price of 38p to 40p is likely to prove conservative.
Value in Trading Emissions
Carbon credit investment company Trading Emissions (TRE: 30.5p), formed seven years ago with the objective of making capital profits from purchasing emissions assets in the European economic area, has announced a cash return of £15m, or 6p a share, back to shareholders. This offers quickfire rewards if you followed my advice to buy the shares at 23.25p two months ago (Rerating beckons, 12 November 2012). In fact, with the price rising to 30.5p on the news the gain is over 30 per cent in the 8-week period. The shares are marked ex-dividend on 16 January and the dividend will be paid early next month. True, it may be tempting to bank these gains, but I am going to resist the temptation as I can see a further significant return of capital over the next year.
That’s because with Trading Emissions shares being offered in the market at 30.5p, the company is only being valued at £74.7m, a 52 per cent discount to book value of £156m, or 63p a share, despite the fact that it is sitting on a cash pile of £61m. In other words, the current cash return of £15m only equates to a quarter of the cash pile. If this sounds anomalous, that's because it is and largely reflects the fact that, until now, investors were unable to quantify with any degree of certainty the carbon emission reduction (CER) liabilities of the company. However, that has changed because management has been able to contain these liabilities which in turn has enabled investors to get a grip on what the underlying value in the business really is and how much capital will be returned to shareholders as Trading Emissions winds itself up. Let me explain.
Currently, Trading Emissions' book value consists of a carbon credit portfolio with a negative liability of £17m, or 6.8p a share; a private equity portfolio worth £114m, or 45.7p a share; and net cash of £61m, or 24.4p a share. But the company's investment adviser, EEA Fund Management, calculates that the net liability payable by Trading Emissions to acquire contracted CERs is £33.6m, assuming the worst-case scenario where spot prices fall to zero and after taking into account portfolio hedges already in place. In other words, having renegotiated a number of these CER contracts after the carbon price collapsed, the maximum possible liability to Trading Emissions equates to 14p a share, which would reduce its net asset value by a further 7p to 56p a share. Importantly, the cash pile of 24p a share (before payment of the 6p a share dividend above) covers all of this 14p-a-share liability, so there is no further recourse to shareholders. In fact, as these contracts are wound down, Trading Emissions will be able to return lumps of cash to investors.
There is also clearly value in the private equity portfolio, worth 45p a share. For instance, even if we charge £10m, or 4p a share, to wind up the company, the current net asset value would fall to 52p a share. So with the shares trading at 30.5p, this implies that the private equity portfolio is being valued at 22.5p, or half book value. That looks way too low and I remain a firm buyer of the shares.
