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Small-cap value buys

Small-cap value buys
August 9, 2016
Small-cap value buys

The same is true of the Aim-traded shares of Gresham House Strategic (GHS:780p), an investment company focused on using strategic public equity strategies to create value for shareholders primarily in the small-cap space, my own hunting ground. I included the shares in my 2016 Bargain shares portfolio and updated the investment case six weeks ago ('Exploiting a pricing anomaly', 27 Jun 2016). The price is unchanged since then even though the company's net asset value (NAV) per share has risen by another 5 per cent and I estimate a spot NAV per share of 1,089p. This means that the share price discount is around 28 per cent even though the company has net funds of 312p a share on its balance sheet, not to mention a valuable investment portfolio too.

For instance, Gresham House Strategic owns 10.5m shares in Aim-traded technology company IMImobile (IMO:195p), a business that helps companies engage with their customers across all mobile devices by offering smart software products based on proprietary technology. It's doing rather well as last month's full-year results highlighted: organic revenues grew by around 10 per cent in the 12-month trading period, propelling adjusted cash profit up 17 per cent to £10.7m and prompting analysts at brokerage Investec to upgrade their forecasts. They now expect adjusted pre-tax profit of £9.4m and EPS of 11.3p in the current financial year, up from £8.5m and 10.4p in the 12 months to end March 2016.

IMImobile's shares have reacted positively and have risen by a further 14.5 per cent since my June article, implying that Gresham House Strategic's stake is now worth £20m, or 542p a share. If you decided to ride off the coat tails of IMImobile ('Bargain shares updates', 12 May 2016), a company I have highlighted the potential of several times in the past 12 months, I would run your hefty profits. Furthermore, with IMImobile's share price making strong headway this year, this means that cash on Gresham House Strategic's balance sheet and the IMImobile shareholding are now worth a combined 854p per share, or almost 10 per cent more than Gresham House Strategic's own share price. That's an anomalous valuation to say the least.

 

Gresham House Strategic: Portfolio breakdown (prices on 9 August 2016)

Holding

Shares held (m)

Percentage of share capital (%)

Latest offer price (p)

Value (£m)

Value per GHS share (p)

IMI Mobile10.517.419020.0542
Spaceandpeople2.110.6370.821
Miton5.02.9251.334
Be Heard72.111.12.92.157
Quarto0.94.62582.363
Northbridge Industrial Svcs2.810.8782.260
Quoted equity portfolio28.6777
Cash11.2312
Total portfolio39.81,089
Market value28.76780

 

A free ride

Indeed, that still leaves investments in five other small quoted companies in the price for free, the largest of which is a 4.6 per cent holding in Quarto (QRT:261p), a global illustrated book publisher and distribution group that has been listed on the London stock market since 1986. The company sells books across 45 countries and in 35 languages through a variety of traditional and non-traditional channels. It's an interesting investment and one that's been making the news this week.

To recap, over 60 per cent of Quarto's turnover comes from a backlist of over 9,000 titles, providing a stable revenue stream. The board's strategy is to acquire smaller niche operators at attractive multiples (between four to five times cash profit) and deliver growth by leveraging the distribution and purchasing base of a larger business. Bearing this in mind Quarto has a pipeline of identified acquisition opportunities worth over $25m (£19.2m) and has just pulled off the first of these deals, the earnings accretive acquisition of the publishing assets of becker&mayer and its SmartLab book-plus and toy business.

Quarto is paying a consideration of $9.8m (£7.5m) together with a working capital adjustment payment capped at $1m and further deferred contingent consideration of up to $1.25m. The deal is being funded from Quarto's existing $90m multi-currency debt facility. Last year, becker&mayer reported revenues of $19.4m, its book publishing group business turned in cash profits of $1.4m while the SmartLab business recorded a cash loss of $1.1m. The SmartLab unit will be 're-engineered' to focus on producing products that maximise the reach of Quarto's sales channels worldwide.

The acquisition looks a sound strategic fit as half of becker&mayer's business, including SmartLab, is in children's publishing, so this increases Quarto's revenues from this segment by close to 30 per cent. It also strengthens Quarto's offering in North America and means that its US revenue now accounts for about 45 per cent of total revenues. That factor is well worth considering given the strength of the greenback should provide a significant positive currency tailwind to profits.

True, the benefits of the acquisition have been offset somewhat by a softer first half performance from Quarto's Books & Gifts Direct subsidiuary, but a recovery in trading is expected in that unit in the second half based on the current order book. In any case, analyst Malcolm Morgan at brokerage Peel Hunt is maintaining his full-year pre-tax profit estimate at $15.2m on revenues of $186m, implying EPS of 52.3 cents (about 40p at current exchange rates) to support a full-year dividend of 15.3 cents (about 11.8p). The first half dividend was maintained at 5.13p (3.93p) in this morning's interim results.

Trading on a miserly 6.5 times earnings estimates, offering a prospective dividend yield of 4.5 per cent, and with a strong likelihood of further acquisitions of smaller publishing companies on attractive earnings multiples, Quarto's are attractively priced on a bid-offer spread of 258p to 261p. I rate the shares a buy and initiate coverage with a 300p target price.

 

Tooled up for recovery

It was clear from a recent meeting I had with Tony Dalwood, the chief executive of Gresham House (GHE:315p), the investment manager of Gresham House Strategic's portfolio, that he has high hopes for that company's investment in Northbridge Industrial Services (NBI:83p), an industrial services and rental group. Northbridge primarily hires and sells specialist electrical testing and oil and gas equipment to a global customer base including companies in the marine, natural resources, power reliability, data storage and utility sectors. In particular, revenue is generated from the sale and rental of load banks and packaged transformers and drilling tools for the oil, gas and geothermal sectors. Northbridge operates from hubs in the UK, Belgium, the UAE, Singapore, Australia and New Zealand.

Since my June article, Gresham House Strategic has acquired a further 450,000 shares in Northbridge to lift its stake to 2.815m shares, or 10.86 per cent of the issued share capital. Bearing this in mind, it's worth noting that in a recent pre-close trading update Northbridge stated that "looking forward into 2017 and 2018 there have been some more reassuring announcements from the oil service majors who form part of our customer base. They rely more on the activity levels in the oil fields rather than the oil price and they believe the worst is over and are predicting a return to more positive levels of business in the future".

If this proves to be the case, Northbridge is well positioned to benefit from the market upturn as and when it arrives. In the meantime the board will continue to reduce costs and maximise cash generation. I would flag up that the plunge in sterling since the end of June will have a material positive impact on Northbridge's balance sheet. That's because over 90 per cent of its assets are held overseas.

Admittedly, it's early days in the recovery story here, but the stakebuilding by Gresham House Strategic is worth noting. I will keep the shares on my watch list with a view to initiating coverage as and when there is clearer evidence of a recovery in Northbridge's markets.

 

Miton on course for higher profits

Gresham House Strategic also owns 5m shares in fund manager Miton Group (MGR:26p), a company whose shares I rated a buy last week ('Miton primed for recovery', 4 Aug 2016). The bottom line here is that after paying out bonuses and last year's dividend, the company's net funds still increased from £14.1m to £17.4m in the first half of this year, a sum worth more than 10p a share. Net of cash the business is in effect being valued at £28m, or 1.1 per cent of AUM of £2.54bn, an incredibly low rating for an asset manager.

Offering a prospective dividend yield north of 3 per cent, and rated on a cash adjusted PE ratio of 8 times' likely earnings for 2016, Gresham House Strategic should do well here.

 

Anomalously valued

So with investors warming to the investment case of IMImobile, the holding in Northbridge offering recovery potential, and the investments in Quarto and Miton rated outright buys in my book, then it seems overly harsh to value Gresham House Strategic's portfolio so modestly. In fact, its equity portfolio is now being rated on a 40 per cent discount to its spot book value once you strip out the hefty cash pile. That's a bargain basement rating and I reiterate my previous buy recommendation with the shares priced on a bid-offer spread of 760p to 780p. Buy.

Please note that Gresham House Strategic's net asset value per share was 1,051.7p at the end of last week as per yesterday's filing to the London Stock Exchange. Since then IMImobile's share price has risen by 13p, adding 37p a share to Gresham House Strategic's net asset value to give a spot figure of 1,089p. Gresham House Strategic will next publish its weekly net asset value next Monday and I would expect another rise in line with my estimate.

Finally, I have published three columns this week, and 13 since the start of August, all of which are available on my homepage