Game on

In my own case, I closely monitor a watchlist of over 200 listed companies which I have extensively researched. This includes 60 of my current live buy recommendations. I keep tabs on the newsflow and price action of the other 150 or so companies with the aim of recommending these shares as and when the valuation becomes attractive enough on a risk:reward basis. It is also important that the chart set-up, and likely forthcoming newsflow, are both positive to support a share price re-rating.

A share set to hit the jackpot

With this in mind, I noted the recent announcements from Aim-traded online casino operator 32Red (TTR: 51.75p) with great interest. The Gibraltar-based company operates eight websites including: casino site 32red.com; 32redpoker.com; 32redbingo.com; 32redmobile.com; and 32redbet.com, a sportsbetting website. It also has three other casino sites: nedplay.com, goldenlounge.com and dashcasino.com.

Clearly, the 32Red brand is all important to these businesses, which is why I had been holding off initiating coverage until the company had sorted out the legal dispute with William Hill concerning an infringement of 32Red's trade marks. This has now been resolved in 32Red's favour. At a hearing at the High Court in London on 10 June, 32Red was awarded damages of £150,000 and all its costs. William Hill has now paid the company £800,000 in cash as an interim payment with a further sum of £300,000 likely to be paid to 32Red.

That sum will have swelled 32Red's cash pile, which stood at £4.4m at the end of December 2012, up from £3.4m on a year earlier, but importantly it has removed William Hill's competing 32Vegas.com brand from the market. This can only be beneficial for 32Red's own online businesses. The cash pile also received another sizable lift after Swansea City Football Club agreed to terminate the company's five-year sponsorship agreement with the club one year before it was due to end. 32Red received a cash payment of £950,000 from Swansea in mid-March as compensation and has enabled Swansea to seek out other main sponsors who could assist with the redevelopment of the ground. That payment lifts the cash pile up to over £6.4m. The inflow of cash doesn't stop there, either.

That's because 32Red's net funds at its half-year end are likely to have risen even further once you factor in the fact that the company generated cash profits of £3.4m in 2012, up from £2.8m the previous year. Profits were split equally between the first and second half, so even if the company only maintained cash profits at this level in the first half of 2013, then by my reckoning net of the payment of the final dividend of 0.8p a share in May, accounting for £570,000, the cash pile should have risen by around £1m in the six-month period. In other words, 32Red's cash pile at the end of June could be as high as £7.4m, or over 10p a share. To put that into perspective, at the current share price of 52p, 32Red has a market value of £37m. This means that net cash accounts for around 20 per cent of the share price.

Business growing strongly

Cash generation in the past six months could be even higher because the business has been growing strongly. In fact, the company posted record revenues for the third successive year in 2012, having grown turnover from £17m in 2010 to £32.1m last year. This growth has been driven by the casino sites which have almost doubled revenues from £14.8m to £28.7m in the last two financial years. The 32Red casino accounts for almost 90 per cent of total revenues, which highlights the importance of the company winning the court case against William Hill to protect its brands.

There is little to suggest either that the rate of growth is slowing at all. Active casino players doubled to 57,338 members between the end of 2010 and 2012, having rocketed by over 40 per cent in 2012. 32Red signed up almost 42,000 new casino players last year alone. Most customers are based in the UK, and play a wide range of casino games at 32Red.com, including roulette, blackjack, baccarat, craps and poker. Importantly, player yields are among the highest in the industry at around £500, while acquisition costs, at £147 per new user, were little changed last year.

The momentum has clearly continued into this year. In the first 11 weeks of 2013, revenues increased 13 per cent on the same stage last year, which offers reassurance that analysts at broker Numis Securities are bang on the money with their forecast that revenues will rise to £39.2m in 2013. On this basis, cash profits jump from £3.4m in 2012 to around £4m this year, which in turn lifts pre-tax profits from £3.2m to £3.8m and underlying EPS by over a fifth from 4.1p to 5p. For the year after, the respective forecasts are for revenues of £45.6m, cash profits of £5m, pre-tax profits of £4.8m and EPS of 6.3p.

From my lens, those estimates look achievable especially since 32Red entered the Italian gaming market at the end of 2012. The full benefits are likely to come through next year once the operation has built up scale. In addition, both the sports betting and bingo sites are benefiting from increased activity resulting from traffic generated from the 32Red casino sites, and modestly higher marketing spend. These two sites produce around £1.1m of annual revenues, so are still quite small in terms of the total operation at the moment, but clearly have potential for growth.

The poker business is small, too, generating £1.1m of revenues last year. 32Red's poker activities are offered through the Prima Poker network with customer support and account maintenance managed in-house by the 32Red team in Gibraltar. It's an increasingly competitive market to be in, so in my view it's actually quite good news that the company has low exposure to this segment of the gaming market.

Cash returns and low valuation

Apart from offering the comfort of a burgeoning cash pile, 32Red has been returning cash to shareholders. In fact, having raised the total payout from 1.2p to 1.4p last year, the company has just announced a special dividend of 2.5p a share to be paid on 2 August (ex-dividend: 10 July). Excluding this payment, analysts at Numis Securities forecast that the normal payout will be raised almost 20 per cent from 1.4p to 1.64p this year. On that basis, the prospective yield is 3.2 per cent and the payout is covered more than three times.

The shares are also attractive on an earnings basis, trading on only 10.4 times current year estimates. However, strip out the current cash pile of around 10p a share, and that multiple falls to just 8.4 times this year's earnings forecasts, dropping to a bargain basement 6.6 times 2014 estimates. That valuation is not only anomalous, but with 32Red very likely to issue an upbeat pre-close trading update later this month ahead of half-year results in early September, there is an obvious catalyst for an immediate re-rating.

Target prices

From my lens, Numis Securities' 100p a share target price may be a tad ambitious, but Daniel Stewart’s target price of 66p looks very achievable on a three month basis to offer us 30 per cent upside. And don't forget that if you buy now there is a 2.5p special dividend (ex-dividend: 10 July) and you can also pencil in the likely payment of an half-year dividend of between 0.6p to 0.7p a share in late September or early October. Combined, these two payouts equate to over 6 per cent of 32Red's share price.

It's worth pointing out that the seven largest shareholders hold 68.7 per cent of the issued share capital. These investors include chief executive and founder Ed Ware, who has a beneficial interest in 18m shares, or 25 per cent of 32Red's issued share capital. Mr Ware was the former managing director of Ladbrokes before he set up the company as a start-up venture. Director David Fish, QC, is also a major shareholder having been a non-executive of 32Red since inception. Mr Fish holds 12.7 per cent of the equity. Therefore, the interests of shareholders and the board are aligned.

Table: 32Red's major shareholders

It's also worth noting that share price moves can be quite accentuated as a direct consequence of the lower free float. So if the forthcoming trading update is as good as I expect it to be, the shares could re-rate quite quickly. Needless to say, on a tight bid-offer spread of 51.5p to 51.75p, I rate 32Red's shares a buy and have a three-month target price of 66p. If achieved the shares would be trading on 11 times 2013 earnings estimates net of cash. Trading buy.

Capitalise on LMS Capital

Finally, I updated LMS Capital (LMS: 78.5p), an investment business in the process of winding itself up, and a company I have followed for some time, in a column late last week after the board announced the schedule of its tender offer ('Rewarding asset backed investments', 4 Jul 2014).

To recap, LMS is returning £35m of its £42.2m cash pile to shareholders, which equates to 17.4 per cent of its net asset value of £201.5m. The tender offer opens on 8 July and all shareholders (other than certain overseas shareholders) on the register at the close of business on 22 July may tender more, equal to or less than their basic entitlement. Tenders in excess of a shareholder's basic entitlement will only be accepted to the extent that other shareholders tender less than their basic entitlement and will be satisfied on a pro-rata basis.

The tender offer price will be calculated on 29 July based on the unaudited net asset value of LMS Capital at 30 June and results of the offer will be announced the following day. Crest accounts will be credited with the tender proceeds in the week commencing Monday 5 August. Cheques will also be despatched at the same time in respect of investors with certificated ordinary shares.

This is the second tender offer by LMS as the company repurchased 17.4 per cent of the issued share capital through a tender offer at 84p a share last autumn. Importantly, this method of capital return enabled shareholders to sell down further chunks of their holdings at book value without impacting the share price. It also means that existing shareholders, or anyone buying shares in LMS now for that matter, is guaranteed a 14 per cent profit on 17.4 per cent of their holding.

In addition, there is scope for the share price discount to book value to narrow further. That's because some investors will use the cash proceeds from the tender offer process to buy back the LMS shares they tender at book value of 89p, but at a lower price in the open market. So, given that the basis book value of LMS shares was 89p at the end of March, and the current share price is 78p, then it makes sense to tender your shares. You have absolutely nothing to lose at all. Realistically, we should be looking at a tender offer price of 89p.

MORE FROM SIMON THOMPSON...

Finally, I have written an online exclusive today on a company which has just issued a bullish trading update and signalled a major break-out on its chart ('Short-term trading buy', 8 July 2013).

MORE FROM SIMON THOMPSON...

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Simon's first book, Trading Secrets, is published by Pearson Education under the FT Prentice Hall imprint and is available from Amazon at £12.94 including postage and packaging