I initiated coverage on the shares at 2.65p (‘Deal makers’, 31 May 2016), and subsequently reiterated that advice at 3.05p after the company cashed out £10.44m by selling 5.8m shares in Redcentric (RCN:177p), a UK IT managed service provider (‘On the acquisition trail’, 5 Jul 2016). MXC still holds almost 50,000 shares, worth £85,000, and owns call options over 1.7m shares with a strike price of 32p, and a further 7m call options with a strike price of 80p. These options are ‘in-the-money’ to the tune of £9.25m.
Importantly, the cash proceeds from the Redncentric sale have been put to immediate use as MXC acted as lead adviser and investor to the Alternative Investment Market flotation of Tax Systems (TAX:79.5p), a leading supplier of corporation tax software to the large corporate sector and the accounting profession in the UK and Ireland. MXC subscribed for £8.7m of new shares at 67p each as cornerstone investor in a £45m placing last month, which, combined with £30m of new debt facilities, financed the acquisition of Tax Computer Systems by Aim-traded Eco City Vehicles (ECV), subsequently renamed Tax Systems (TAX). MXC originally subscribed for 109m new ordinary shares in cash shell ECV at a cost of £1.33m in December 2015, and was granted evergreen warrants over 5 per cent of the share capital at a price of 1.22p. ECV had a 50-for-one share consolidation and the new shares were issued at 67p in the placing.
This means that MXC now owns 15.2m shares in Aim-traded Tax Systems, or 20 per cent of the enlarged share capital. These shares are worth £12.1m at the current market price, so MXC has already made a hefty paper gain on its investment. MXC also own evergreen warrants over 6 per cent of the 76m shares in issue, the majority exercisable at 67p, but some at 61p. These warrants are showing a paper profit in excess of £570,000.
The key point here is that the £2.6m paper profit from MXC’s investment in Tax Systems is not being reflected in MXC’s share price which is unchanged on the level of my last buy recommendation ahead of the flotation of Tax Systems (‘On the acquisition trail’, 5 Jul 2016). I outlined the business case of Tax Systems in quite some detail in that article, but I would point out that the company is currently being valued on an enterprise value to cash profit multiple of 12 times based on forecasts from analyst Andrew Darley at broking house finnCap for the 2017 financial year.
That seems a fair valuation to me for a business with a high quality customer base - 43 of the FTSE 100 companies and 19 out of the top 20 accountancy firms are among its customers; one generating cash profit margins in excess of 50 per cent and with a high recurring revenue base; and with decent growth prospects too. Indeed, there is ample opportunity for Tax Systems to target the 33,000 medium sized companies in the UK and Ireland which currently manage their own tax in-house by offering a SaaS version of Alphatax, its end-to-end tax compliance process software product, with appropriate functionality. Clearly, Mr Darley is bullish as his target price for Tax Systems is 25 per cent higher than the current price.
Sum-of-the-parts valuation
The £22m holdings in Redcentric and Tax Systems aside, MXC’s investment in Castleton Technology (CTP:76p), a leading provider of technology products and services to the social housing and not-for-profit sectors, is doing well too.
The £4.5m investment MXC made in Castleton in return for a 23.1 per cent equity stake is now worth £13.7m and its 2.89m call warrants, which have a strike price at 22p, are 'in the money' to the tune of £1.56m. MXC also owns £2m of convertible loan notes in Castleton, which carry an annual coupon of 5 per cent and have a conversion price of 85.6p. This means that the investment in Castleton is worth about £17.26m, or just over a fifth of my estimate of MXC’s current proforma net asset value of £81m. Castleton's full-year results are scheduled for release shortly and are unlikely to disappoint.
MXC's dealmakers also acted as advisers to Aim-traded Coretx (COR:35p) when it made the earnings-accretive acquisition of C4L, a growing network services and data centre hosting business, in a £20.4m deal earlier this year. A few months earlier MXC originated Coretx's acquisition of Selection Services Investments, a UK-focused provider of IT solutions and cloud services, and backed the £34.8m deal with £12.9m of its own capital as a cornerstone investor in exchange for a 43m shares, or 22.5 per cent of Coretx’s current share capital. The shareholding is now worth £15.05m, representing a17 per cent uplift in the past seven months.
So, by my calculations the investments in Redcentric, Tax Systems, Castleton and Coretx account for £54.3m of MXC’s proforma net asset value of £81m. To this we can add a £1.3m shareholding in Aim-traded software company 365 Agile (365:35p), and a £5.3m investment in Aim-traded adept4 (AD4:7.25p), a provider of converged technology solutions. These two investments are currently showing a paper profit of £1.8m on cost. MXC's shareholdings in private companies were worth £5.5m at the end of February 2016. This means that £66.4m, or two thirds of the current market value is backed by these six-listed investments and interests in private companies. MXC also has net funds which I estimate at around £9.5m, including £6.9m raised in a placing at 2.55p in May.
The bottom line
In other words around three quarters of MXC's current market value of £103m is backed by hard cash and equity investments. That mitigates risk and means that only a modest premium of £22m to proforma book value is being ascribed to the dealmaking ability of MXC’s corporate financiers. Clearly, the £7m profits earned on the Redcentric share sale, and the quickfire multi-million pound gains made from the holdings in Tax Systems and Coretx highlight the added value of MXC’s deal makers.
So, with the company cashed up to make further investments, and having access to credit facilities too, I feel that MXC’s shares are worth buying on a bid-offer spread of 2.92p to 3.02p and maintain a target price of 3.75p. Please note that the official spread is wider, but it’s easy to deal between the spread in sensible bargain sizes.
