For example, shares in Aim-traded investment company Aurora Russia (AURR: 33.25p) have pulled back around 20 per cent since the end of April. True, some investors who followed my advice to buy at 30.5p ('Time to play Russia roulette', 4 Feb 2013) will have taken some profits after tendering 36.9 per cent of their holdings back to the company last month at 52.3p a share as I advised. Factoring in the 70 per cent-plus profit on the tendered shares, this means the carrying value was only 17p on the balance of the holding, which compared favourably with Aurora's current share price of 40p at the end of April
Still, the sell-off has gone too far. In part, this is because investors have yet to work out what the remaining parts of the company are worth. Fortunately, I have a pretty good idea.
To recap, Aurora is in the process of selling off all its assets in order to return cash to shareholders. So, following the £30.6m sale of its stake in OSG, a fast-growing and profitable records management provider with operations in Russia, Poland, Ukraine and Kazakhstan, the company was sitting on a huge cash pile. In fact, it returned £20m of the £23.6m net cash on the balance sheet to shareholders through the tender process a few weeks ago. This means that Aurora's net asset value is now £39.3m and the company has 74.26m shares in issue, so book value per share is 52.9p. Or to put it another way, with the shares trading on a bid offer spread of 32.75p to 33.25p, Aurora's market value of £24.5m is a hefty 38 per cent below the company's net asset value.
Anomalous valuation
Now that share price discount would be reasonable if the assets being marketed for sale were overvalued in the accounts. However, in the notes to the tender offer document dated 30 April, Aurora clearly states that the directors have valued the stakes in Flexinvest Bank, DIY retailer Superstoy and Unistream Bank at £32m at the end of March 2013. That is £9.1m less than the carrying value at the end of September 2012 to reflect the likely sale values of these three investments after factoring in market conditions and the liquidity discounts applied to their values.
In my view, this is not only sensible practise by the board, but since all three stakes are currently being marketed for sale, it also gives investors a more accurate idea of the likely sale proceeds on disposal. That's because Aurora's board has previously stated that it is "in discussions to dispose of these assets (Unistream and Superstoy) and expects to have concrete news to report before the company's year-end results (to the end of March 2013) are announced".
So, assuming that the investment in Flexinvest Bank makes around £9m, after deducting the £3m value of the bank licence as some analysts estimate, then it is reasonable to assume that the investments in Unistream and Superstoy could potentially bring in around £23m, or 31p a share.
It doesn't take a genius to work out that with Aurora's shares priced at 33.25p in the market, that the stakes in Unistream and Superstoy and net cash of 5p a share on the balance sheet (post the tender offer) and are worth more than Aurora's current share price. That leaves the £9m stake in Flexinvest Bank, worth 12p per Aurora share, in the price for free.
Value in OSG
The investment case gets better once you consider that Aurora only received £21.6m of the £30.6m consideration from the OSG sale on completion of the deal in March. OSG was sold to private equity firm Elbrus Capital. Of the £9m balance of the consideration due from the sale, $8.5m (£5.6m) was put in an escrow account with Deutsche Bank in London, of which half - $4.25m (£2.8m) - is payable 30 days following the signing of OSG's 31 March 2013 year-end accounts, assuming they meet management's expectations of cash profits, net debt and working capital. These figures have been provided to Elbrus Capital during due diligence. The remaining $4.25m in the escrow account is payable 12 months following closure of the sale (around 8 March 2014), subject to any warranty claim under the general commercial and tax warranties.
This is an important point to note because in the notes to Aurora's tender offer document, Aurora's board clearly states that they have valued the $8.5m of funds held in escrow at its full value of £5.6m, or 7.5p per Aurora share.
That then leaves the final $5.2m (£3.3m) of the consideration from OSG. This will be paid to Aurora as long as OSG achieves cash profits of over $10m (£6.3m) for the year ending 31 March 2014. The amount payable under this earn-out will be reduced to zero in the event that cash profits for the year ending 31 March 2014 are less than $9m. It's therefore worth noting that Elbrus Capital has binding obligations to run OSG and account for cash profits in the same way as Aurora has over the past several years.
However, Aurora's board have been conservative and valued this part of the OSG 'earn-out' at nil value when they arrived at the £39.3m net asset value of the company. As a result, this means that investors are getting a free carry on the March 2014 earn-out payment, which could be worth as much as 4.5p a share to shareholders.
Sum-of-the-parts valuation
So, taking into account the likely combined sale values of the stakes in Unistream and Superstoy of around £23m, or 31p a share; net cash on Aurora's balance sheet of £3.6m, or 5p a share; the investment in Flexinvest Bank worth around £9m, or 12p a share; the escrowed deposit with Deutsche Bank of £5.6m, or 7.5p a share; this means Aurora has realisable assets worth around 55.5p a share. From this you can add Aurora's property assets and trade receivables, and then deduct management fees, realisation fees and operating expenses for the period between now and the wind-up of the company. On that basis, I still arrive at a sum-of-the-parts value well north of 40p a share.
Needless to say, with news due this summer on the sale of the investments in Superstoy and Unistream, and with £2.8m of cash (worth 3.75p a share) due to be released to Aurora from the Deutsche Bank escrow account as soon as OSG's March 2013 results are signed off, then from my lens Aurora's shares offer decent potential. I have a three-month target price of 40p, which if achieved will provide us with 20 per cent upside. Buy.
Communisis cost saving windfall
I noted with great interest the announcement yesterday from marketing services provider Communisis (CMS: 55.25p). The company should be familiar because I have advised buying the shares several times since initiating coverage when the price was 28.5p last year ('Small-cap trading buy', 13 Feb 2012).
I subsequently reiterated that advice in the autumn when the price was 40p ('Communisis shares to fly', 19 Oct 2012) and at 36p just before Christmas ('Happy Capital returns', 17 Dec 2012). In fact, I was so convinced that full-year results would not disappoint in March that I advised buying again twice in January ('Jumping the gun', 14 Jan 2013 and 'Bumper trading gains', 23 Jan 2013). So when Communisis raised £20m through a placing and open offer the following month ('A fundraising well worth backing', 18 Feb 2013), I had no hesitation telling readers to take up their allocations of new shares at 40p. The price at the time was 45p and my target price was 55p, a price that was hit weeks later.
Interestingly, the 55p level is significant for Communsis as it acted as a major support to the share price in August 2006 and April 2007, before finally giving way in the stock market crash in the autumn of 2008. It has taken four and a half years for the shares to recover back to that level. It is no coincidence, either, that the share price hit resistance at 55p twice in March. But it was third time lucky last month when the price broke through this resistance, both on an intra-day and closing basis. I highlighted this point last month ('Buy the triple top break-out', 7 May 2013).
It's text book stuff, too. Having rallied through resistance the price pulls back, finds support (around 50p) and then starts to rally again back towards the break-out point (55p). That's exactly where we are right now, which is why I was so interested in the announcement yesterday that Communisis is restructuring certain production facilities and cutting overheads. This is good news and is in line with the board's strategy to reduce exposure to the more commoditised parts of the print market by focusing on higher-margin specialist production, and to improve margins by reducing costs and improving capacity utilisation.
Restructuring
As part of the restructuring, Communisis will cease cheque production at the Trafford Wharf site in Manchester before the end of this year, and move production to the company's site in Leeds. A significant amount of the remaining, more commoditised direct-mail print will be outsourced, while the more specialist, higher-margin direct mail production will remain in Leeds.
According to chief executive Andy Blundell, indirect overhead costs will be further reduced as processes and support services are streamlined. In total, these changes are expected to generate annual cost savings of £4m in 2014. True, the reorganisation will cost £3.5m to implement, of which £2.8m of the cash cost will be incurred in the second half of 2013 and the balance of £0.7m in the first half of 2014.
Importantly, the restructuring is "consistent with the company's objective of delivering a double-digit margin on sales over the next three years". It is also positive in terms of profits.
According to analyst Johnathan Barrett at brokerage N+1 Singer "from a profit and loss perspective it is clearly a positive and supports our existing margin improvement assumptions. With the precise net benefit (what proportion of the £4m of savings will not be reinvested) to be formally clarified it is too early to assume a more material improvement in profit/margin than we already forecast." Mr Barrett is holding fire with his forecasts until the company has its next formal update at the time of the half-year results on Thursday 1 August.
Prior to news of the restructuring, Mr Barrett was expecting net operating margins to rise from 6.5 per cent in 2012 to 7.8 per cent this year; improving to 8.4 per cent in 2014; and 9.5 per cent in 2015. From my view, these margin estimates are now looking conservative given that some of the £4m of costs savings mentioned above are likely to drop straight to the bottom line. Let me explain.
Potential for earnings upgrades
Based on N+1 Singer's 2013 revenue estimate of £237m (from £230m in 2012), Communisis is currently forecast to produce pre-tax profits of £12.2m, up from £10.3m last year. And as legacy contracts are replaced with much more profitable new business wins, revenues of £245m in 2014 are expected to generate profits of £13.9m. Moreover, if margins hit 9.5 per cent in 2015, and Communisis meets N+1 Singer's revenue target of £256m, expect pre-tax profits to rise even further to £16.1m. On that basis, the EPS figures for the three financial years are 5p, 5.5p and 6.3p. However, if only a quarter of the £4m of annual costs savings are not reinvested in the business this would boost 2014 EPS by around 7 per cent.
So, ahead of likely earnings upgrades in seven weeks time, I continue to rate Communisis an attractive investment opportunity. The shares are priced 28 per cent below pro-forma book value of 76p, rated on 11 times earnings estimates for 2013, falling to only 10 times 2014 forecasts, and offer a 3.3 per cent prospective yield based on a 1.8p a share dividend in 2013. I am very comfortable with my 70p a share target price, having upgraded my fair value estimate last month. Offering 25 per cent upside to my target price, Communisis shares rate a value buy on a bid-offer spread of 54.75p to 55.25p.
