LMS worth capitalising on

This is one of the reasons why I have been playing the upside on a number of investment companies in the past 18 months where the risk:reward ratio is, in my opinion, skewed in investors' favour. It has certainly provided us with some bumper gains including Aim-traded investment companies Trading Emissions (TRE), Spark Ventures (SPK) and Aurora Russia (AURR). To that list we can also add LMS Capital (LMS: 73.5p), a company I first advised buying shares in when the price was 54.5p in February 2011 ('Capital returns', 11 Feb 2011).

I subsequently repeated that advice when LMS's share price was 64p ('Time to capitalise on LMS', 25 Jun 2012) and shortly before Christmas last year at 66p ('Happy capital returns', 17 Dec 2012). Following a first-quarter trading update, I reiterated the recommendation at 71.5p ('Target price smashed', 15 May 2013) and again in the summer at 74.5p ('Rewarding asset-backed investments’, 4 Jul 2013).

The main reason I am still keen on the shares is because we are able to purchase them on a deep discount to net asset value even though LMS has been successfully selling off its holdings in investee companies in order to return cash to shareholders. These have not been fire-sales, either, since a number of these investments have been exited at not insignificant premiums to the carrying value of the holdings in LMS's accounts. Moreover, the board has been really shrewd by returning the cash via tender offers. These share buy-backs have been priced in line with net asset value so shareholders have been able to realise chunks of cash by selling off parts of their holdings significantly above the market price.

For example, LMS repurchased 17.4 per cent of the issued share capital through a tender offer at 84p a share at this time last year and subsequently returned a further £35m of its cash pile to shareholders last summer through a tender process at 90p a share. This second return equated to 17.2 per cent of LMS's net asset value at the time. This means that in the past 12 months shareholders have been able to sell back to the company around 32 per cent of their original holdings at book value, a significant premium to the buy-in prices I recommended in the aforementioned columns. I have also advised reinvesting the bumper capital returns by buying back in the open market the shares you tendered at book value to take advantage of the share price discount to book value on offer. For good measure, LMS's share price has also risen in the past year.

Moreover, if a third-quarter trading update from the company is anything to go by, then we can realistically expect further share price gains in the coming months.

Potential for valuation uplifts

In the latest three-month trading period to the end of September, LMS made realisations of £5.2m to take the total this year to £35.1m. And factoring in the £35m cash returned to shareholders in early August, the company had net funds of £10.4m at the end of September. True, currency losses on US holdings resulted in net asset per share dropping from 90p at the end of June to 87p three months later, but since then the combination of gains on quoted stocks, and a reversal of US dollar weakness, has lifted the company's unaudited net asset value per share to around 89p.

The largest quoted investment is New York Stock Exchange listed Weatherford International (WFT: NYQ), one of the world's largest diversified upstream oilfield service companies, generating annual pre-tax profits of just under $1bn (£625m) and employing around 40,000 employees. LMS's investment in Weatherford (www.weatherford.com) was valued at £19.4m at the end of September, to account for 12.5 per cent of the portfolio. Since then, Weatherford's share price has risen by over 10 per cent, which adds £2m to LMS's book value.

It's worth noting, too, that the unaudited net asset value figure doesn't take into account gains on the company's unquoted portfolio since the half-year end in June. The next full valuation of the portfolio will take place at the end of next month. It could be significant since unquoted holdings account for £69m of LMS's last reported net asset value of £160.6m. Investments in funds account for a further £68m and quoted investment around £23.3m.

LMS Capital's principal investments by valuation at 30 September 2013

Realistically, there are likely to be further investment gains reported when the company's full-year results are released in March, underpinned by a strong operational performance of the largest companies LMS holds stakes in. In fact, in the third-quarter trading update LMS reported that the consolidated revenues for its portfolio subsidiaries had surged 38 per cent in the first nine months of this year, buoyed by significant contributions from UK-based Updata and US-based Nationwide Energy Partners. Both companies have been winning major new contracts, which augurs well for some material valuation uplifts. LMS's combined holdings in these two companies account for £27m, or almost 17 per cent of its net asset value of £160m.

UK-based Updata is a private company that designs, implements and manages networks for public sector clients under long-term contracts. Its wide area networks (WAN) offer secure, cost-effective, high-capacity broadband connectivity. The business has been growing fast all year; revenues in the first half to the end of June rose 70 per cent to £21.3m on the corresponding period last year. This reflects Updata's recent success in winning contracts, many of which have been installed and came on stream in the period. Updata accounts for 11 per cent of LMS's investment portfolio so is a significant holding.

Equally promising is LMS's investment in US-based Nationwide Energy Partners. The company specialises in the design, installation, operation and maintenance of private electric distribution systems for new housing communities. The business also offers full-service account management of electric and water utilities, including sub-metering systems, meter reading, billings and collections. It is a high-growth business, too; in the first six months of this year revenues increased by 38 per cent and this stellar growth rate has been maintained in the second half. LMS's shareholding in Nationwide Energy Partners was last valued at £10m, or 6.25 per cent of the £160m portfolio.

LMS also has a stake, valued at £5m, in UK-based Entuity, a leading provider of network management software, enabling systems integrators and enterprise customers to deploy and manage complex networks, reduce network downtime and ensure network configuration compliance. Entuity supports hundreds of customers in over 50 countries worldwide. Products are mainly marketed through resellers, systems integrators and distributors. Three of the 'big five' in infrastructure management - BMC, IBM Global Services, and Oracle - either relicense, resell, or recommend Entuity's solution for their frameworks. In the first six months of this year, Entuity's revenues increased 15 per cent.

In total, LMS's top 12 investments by value account for £120m, or 75 per cent of the company's £160m portfolio. This means it is not only relatively easy for the board to keep tabs on how the portfolio is performing, but it makes disposals far easier to execute with these companies performing well.

Anomalous valuation

So, with likely valuation uplifts at the full-year results, further major asset disposals in the offing in the meantime, and a board committed to making further capital returns through the tender offer process, I expect some very positive newsflow to emerge when LMS releases its full-year results in March. In light of this, it is not unreasonable to expect the shares to be trading far closer to book value than on a 18 per cent discount as is currently the case. In the circumstances, I rate LMS Capital's shares a buy on a bid-offer spread of 72.5p to 73.5p and have a target price of around 90p.

Finally, and in response to recent newsflow, I am currently working my way through a number of updates on my following recommendations: Eurovestech (EVT), Global Energy Development (GED), Heritage Oil (HOIL), Bezant Resources (BZT) and Eros (NYSE: EROS).

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In the past week I have published three other articles in the past fortnight on the following five companies:

■ 32Red ('Hitting the jackpot', 11 Nov 2013)

■ Macau Property opportunities ('Hot property plays', 12 Nov 2013)

■ First Property ('Hot property plays', 12 Nov 2013)

■ Inland ('Bargain shares updates', 12 Nov 2013)

■ Terrace Hill ('Bargain shares updates', 12 Nov 2013)