This positive stance was based on the expectation of further large cash returns over the next year, as well as more valuation gains on the investment portfolio. When the company implemented its asset disposal programme in August 2009, the board had a deadline of March 2014 to realise value from its investments, so there was a specific time frame to expect further capital returns and divestments to be carried out in. And the record to date has been impressive with Spark returning 8.5p a share to shareholders since March 2009, a period during which its share price has also risen sharply from 5p.
However, my positive view has been tempered by the company's last set of half-year results to end-September, which revealed that Spark's net asset value per share fell from 13.1p (adjusted for 2p capital return in October) to 11.4p. This reflects a 1.4p a share markdown in the value of the investment portfolio and 0.3p a share of operating losses incurred in the six-month period. The news sent shares in Spark down by 12 per cent from 10.5p to 9.25p, valuing the company at £38m.
Unexpected valuation downgrades
The main reason for the fall in book value is due to Spark's board reducing valuations of three main investments: California-based OpenX, a business that has developed a free open source ad server trusted by more than 30,000 web publishers in over 100 countries around the world; IMIMobile, a highly profitable provider of technology infrastructure for mobile data, voice and video services to mobile telecom operators and media companies; and Mind Candy, the company behind MoshiMonsters, one of the world's leading developers of social multiplayer children's games.
I was taken aback by the markdown in OpenX, given that Spark had previously doubled the carrying value of its investment from £2.5m to £5m in the financial year to end-March 2013. The stake has now been valued at £2.5m, or 0.63p a share, to reflect the fact that OpenX will not be planning at IPO or sale in the foreseeable future. As a result, the investment has been valued at a price Spark could achieve in an individual sale. This is disappointing because OpenX's sales growth has been robust, with trailing 12-month revenues in excess of $150m (£92m), having risen 30 per cent year-on-year.
I was also surprised by the sharp fall in the valuation of Spark's investment in Mind Candy from £3.1m to £1.6m, or 0.4p a share. Revenues in 2013 have failed to match the success of the previous year when Mind Candy's sales were up 62 per cent.
Spark's board have also cut the valuation of its investment in IMImobile from £16.2m to £14.8m, having previously revalued the holding up by £300,000 in the year to the end of March. This downgrade reflects lower cash profit multiples being attributed to the earnings of the company rather than operational issues. In fact, sales were slightly ahead of budget, reflecting ongoing strong performances from the Middle East, Africa and Europe. International businesses now account for almost 80 per cent of IMI's sales and over three-quarters of profits. The stake in IMImobile is significant as it accounts for 3.6p a share, or almost 40 per cent of Spark's current share price, so the final sale proceeds from this investment will have a major impact on the likely cash return shareholders can expect next year.
I am sure there will be keen interest in IMImobile, but it pays to be conservative with the assumptions of what the likely total return to shareholders will now be once all Spark's assets are sold off.
Assessing sum-of-the-parts valuations
At the end of September, Spark had net cash on its balance sheet of £4.75m and restricted cash of £1.15m, of which £500,000 of the restricted cash will be paid to the landlord of the company's head office in return for the early surrender of its lease.
Since the September half-year end, Spark has also sold its stake in Notonthehighstreet.com, an internet marketplace for more than 3,000 specialised UK-based businesses selling a wide variety of unique products, for £11m. This means the pro forma net cash pile is currently around £16.4m, or 4p a share. To this we can add the £2.25m balance of the cash consideration due next month from the disposal of the company's stake in chip designer Aspex. In other words, by the end of the first quarter this year, net cash should be around £18m, or 4.4p a share, net of all operating expenses. This equates to 40 per cent of Spark's net asset value of 11.4p.
It's also reasonable to assume that Spark's remaining stake in Kobalt, one of the world's leading music publishers, will be sold for carrying value of £5.5m, or 1.4p a share, given the bumper growth the business has been enjoying and the fact that the company was able to offload part of the stake easily last year. The holdings in IMIMobile, Mind Candy and OpenX are now worth a combined 4.6p a share. In other words, cash on the balance sheet plus the stakes in the above four companies are in total worth 10.4p a share of Spark's net asset value of 11.4p. That leaves holdings in three other companies worth £3.6m, or 0.9p a share.
However, with Spark's last reported net asset value less than I expected due to the valuation downgrades, and upgrades in the future now unlikely, I think that 11.4p a share is the maximum we can realistically expect to be realised from the company. It could conceivably be less because the board have stated that it is now unlikely that all of the company's current investments will be sold by the 31 March 2014 deadline. The board have also quantified that the liability under the current management incentive scheme based on disposals made to date is £1.1m, but could rise to £6.7m if all the disposals are made at net asset value. Strip this sum out of the current net asset value per share and a realistic value of the company net of all liabilities is around 10p a share, factoring in the value of the company as a cash shell with valuable accumulated tax losses.
Please note that I have not factored in any liability for the company regards a dispute between Michael Whitaker, one of the co-founders of SPARK, who has recently left the board. Mr Whitaker's departure is connected with potential claims asserted by him with regard to a carried interest scheme, which was established in 2003 for the benefit of the executives at the time. Spark's board have stated that they will vigorously refute any formal claims if they arise, but to date the company has not been notified of any formal claim.
So having assessed the timetable for future disposals, I have decided to call time on the holding and would advise taking the bumper 80 per cent and 33 per cent profits, respectively, if you followed my buy recommendations from July and November 2012, sell out at break even if you bought on my advice in May this year, and crystallise an 8 per cent and 12 per cent loss, respectively, off my buy in prices in July (9.75p) and September (10.25p).
Please note that I am on holiday this week. My next article will appear online at 12pm on Tuesday, 14 January.
