In the event, the shares rose from the 2.65p level at which I advised buying to hit a high of 3.5p over the summer, and the company subsequently completed a £3.8m tender offer pitched at 3.6p a share, in line with the board's policy of returning part of the proceeds from investment disposals back to shareholders. The tender offer was funded from the £10.44m bumper cash windfall received by selling 5.8m shares in Redcentric (RCN:69p), a UK IT managed service provider. MXC still retained 50,000 shares, 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 were 'in-the-money' to the tune of £9.5m when I last updated the investment case at the end of the summer ('A quartet of small-cap buys', 31 Aug 2016). Some market-sensitive announcements have been made since then.
Firstly, MXC updated the market and confirmed that its net asset value (NAV), including the cash proceeds from the Redcentric sale, was £72m at the August financial year-end, a sum worth 2.1p a share. That excludes the cash spent on September's tender offer and a £1m cash inflow from an equity investment made by an operating partner of the company later that month. MXC co-founders, Tony Weaver and Ian Smith, who between them own over 32 per cent of the issued share capital, participated in the tender offer, but have since used some of the cash they received to buy back a combined total of 4m shares in the market at 3p each last month.
However, the reason why MXC's shares fell by 16 per cent from 2.9p to 2.45p yesterday was solely as a result of an announcement from Redcentric, which revealed that an "internal review by the company's audit committee in relation to the interim results for the six months ended 30 September 2016 has discovered misstated accounting balances in Redcentric's balance sheet".
A forensic review of Redcentric's current and historic balance sheets has identified that audited accounts for previous years are "likely to need to be restated, resulting in some write-down in historic profits. Current indications are that all issues relate to prior periods". New business sales and recognition of those sales into revenue over the six months ended 30 September 2016 have been in line with management's expectations. However, the "impact of correcting these cumulative historic accounting misstatements will reduce net assets by at least £10m".
To compound matters the net debt guidance announced in Redcentric's earlier pre-close trading update is believed to be unreliable. The board now believes net debt at the half year was around £30m, significantly higher than the £16.6m previous estimate of analysts at brokerage finnCap. In addition, the underlying net debt position at 31 March 2016 was "materially higher than as reported". The accounting adjustments arising will result in a recalculation of Redecentric's banking financial covenants, which will take some time to complete, and Redcentric's half-year results, which were due to be released on Monday, 14 November, will now be postponed pending the outcome of the forensic review.
Redcentric finance director Tim Coleman has resigned, and a search for an external applicant to fill the position has commenced. Unsurprisingly investors dumped the shares, marking them down to an all-time low yesterday.
That said, until the forensic report into Redcentric's accounts is complete it's nigh on impossible to quantify the full financial impact of the accounting misstatements, nor for that matter how they impact the company's banking covenants and its reported operating profit of £8.4m in its last financial year. Clearly though the board of MXC believe that the market has seriously overreacted as the company invested more than a third of its £13m cash resources to acquire 7.61m shares at 59.68p and at a total cost of £4.54m during yesterday's rout. This transaction increased its stake to 7.66m shares, or 5.2 per cent of Redcentric's issued share capital. Together with the 8.7m call options, MXC now has an interest in 10.5 per cent of the diluted share capital.
Announcing the share purchase to the market, MXC chairman Peter Rigg explained: "We are shocked by the recent developments at Redcentric; accounting misrepresentations are every investor's worst nightmare. Despite this set back, we strongly believe in the fundamental quality of Redcentric's business and remain confident of its future prospects." One reason for the board's faith is that MXC co-founder Tony Weaver had previously served on the Redcentric board since the company floated in April 2013 and only stepped down a fortnight ago in order to concentrate on his activities as a partner at MXC Capital. The company is retained as M&A adviser to Redcentric, having advised the business since its demerger from Redstone. If anyone has an insight into the financial impact of the accounting misstatements, and for that matter the company's current trading, then it should be him.
That's worth bearing in mind because at the current share price Redcentric's market value is £101m, or only slightly above the last reported balance sheet value of £97m prior to the aforementioned £10m asset write-down. True, the value of MXC's call options has been significantly devalued, but if "the value can be restored in Redcentric with swift action" as Mr Rigg belives will be the case, and "MXC will seek to play an active role in this process", then MXC's shares will re-rate sharply.
In the circumstances, I continue to rate MXC's shares a buy at 2.5p. Buy.
Accrol an IPO winner
Accrol (ACRL:127.5p), the Aim-traded Blackburn-based maker of toilet rolls, kitchen rolls and facial tissues, has issued an upbeat pre-close trading statement ahead of the release of its half-year results in early January.
The company has a 35 per cent market share in the discount retail segment following a raft of contract wins with budget retailers in recent years. In the latest six-month period it also landed a £10m contract with German retailer Lidl, in addition to numerous others. This vindicates the board's decision to install two high-speed converting lines in its new 168,000 sq ft manufacturing facility in Leyland, Lancashire, in order to boost total capacity to 143,000 tonnes a year. The premises will initially house the two high-speed tissue converting lines that were purchased by the company in April and the increased capacity will support ongoing growth with both the retail discounters and major multiples in the UK.
I would flag up that the company took the sensible decision to hedge off its foreign currency liabilities for the current financial year to the end of April 2017 ahead of the EU referendum, so it has a cost advantage over unhedged smaller rivals. It is also targeting a market segment that should benefit from a likely squeeze on consumers' real disposable incomes next year as some economists predict UK consumer price inflation could soar to as high as 4 per cent by end 2017 due to the inflationary impact of sterling's decline against the euro and the US dollar since Brexit. A move towards the non-discretionary economy and private-label products accelerates in periods of weaker consumer confidence, so I fully expect Accrol to be a beneficiary in the post-EU-referendum environment.
And as I pointed out when I first recommended buying the shares when they floated at 100p in the summer ('Clean up with Accrol', 6 Jun 2016), the company has reported compound annual sales growth of 16 per cent over the past four years, and profitably, too. Cash profit increased by 14 per cent in the period to £15m in the 12 months to the end of April 2016, and analysts expect a rise to £16.4m in the current financial year to produce pre-tax profit of £13.4m, EPS of 11.5p and support a dividend of 6p a share. On that basis, the shares are rated on 11 times earnings estimates, and offer a prospective dividend yield of 4.7 per cent, hardly an exacting rating for a company that has a track record of delivering double-digit profit growth and one targeted at the high growth discount sector. Indeed, Aldi and Lidl now have over 10 per cent of the UK retail market and are opening five times as many new stores as all their 'Big Four' rivals combined, so expect them to make further market share gains in the coming years.
So, having raised my target price to 160p when I last rated the shares a buy at 140p ('High fives', 4 Oct 2016), I have no hesitation reiterating that advice. Buy.
Bioquell earnings accretive share buy-back programme
The board of Andover-based Bioquell (BQE:135p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets, has just announced a £2.5m share buyback programme in order to repurchase up to 8 per cent of the 22.9m shares in issue.
I have a strong interest here, having recommended buying Bioquell's shares at 149p in my 2016 Bargain Shares Portfolio in anticipation of the company returning £40.8m of its cash pile through a tender offer at 200p a share. I also felt that the company's bio-decontamination unit could be sold at a premium valuation, so I recommended reinvesting the 200p a share of cash proceeds to buy back the shares in the market at 145p, which lowered your entry point to 125p. In the event, a deal could not be done at a price that reflected the value of the business, nor the potential for profit growth, as I highlighted when I last advised buying Bioquell's shares at 142p ('Bioquell ends bid talks and restructures board', 25 Aug 2016).
However, that's not to say there isn't value in the shares which the market is failing to acknowledge: the board clearly believes there is, and justifiably so. Based on revenue estimates of £27m for the 2016 financial year, analyst Chris Glasper at broker N+1 Singer believes Bioquell can drive up cash profit by 9 per cent to £3.7m and deliver a 50 per cent hike in adjusted pre-tax profit to £1.4m. Bioquell's cash profit rose by 14 per cent to £1.6m in the first half to the end of June 2016 and, with the benefit of a seasonally stronger second half, this momentum is expected to be maintained. I don't think Mr Glasper's forecasts are unreasonable.
I would also point out that sterling has weakened by 16 per cent against the US dollar, and by 14 per cent against the euro since the Brexit vote. Bioquell derives 46 per cent of its bio-decontamination revenues in US dollars and 26 per cent in euros, so is now benefiting from a major currency tailwind.
Industry drivers are supportive, too. A new European standard comes into force in the next three months which will require companies selling airborne disinfection systems to pass demanding microbial inactivation tests, including the inactivation of 'hard-to-kill' fungal spores. Experts anticipate that a number of nebuliser systems will be removed from the European market when the new standard comes into force, which will open up an opportunity for Bioquell's hydrogen peroxide vapour (HPV) technology products, which are highly effective at eradicating micro-organisms such as bacteria and viruses at room temperature. Indeed, they are already used by bio-pharmaceutical, biotechnology and research institutions to provide sterile equipment and eradicate 'superbugs' from hospitals.
I would also flag up a new standard relating to the "Manufacture of cell-based healthcare products - control of microbial risks during processing". This specifically highlights the challenges associated with viral vectors used in the production of cell-based healthcare products and the advantages of using closed systems such as Bioquell's QUBE over more common biological safety cabinets. Bioquell QUBE is an aseptic work-station incorporating HPV technology which can be used to provide a range of applications including: sterility testing; the production of toxic, intravenous oncology drugs; and the production of small-scale cell-based healthcare products.
But how much of the good news is priced in?
After factoring in a restructuring of the company's US sales force, increased investment in digital marketing and scope to cut costs in other areas, N+1 Singer predict that Bioquell can deliver cash profit and pre-tax profit of £4m and £1.9m, respectively, next year based on a modest £1.2m rise in revenue to £28.2m. Moreover, using a lower average share count post last summer's tender offer, but excluding the earnings-accretive impact of the share buyback programme, N+1Singer forecast EPS to soar from 3.7p in 2016 to 6.5p in 2017. But if the company uses £2.5m of its £7.3m net cash pile to repurchase 1.85m of the 22.9m shares in issue, then this will have the effect of raising next year's EPS estimate to 7p and the business will still retain net funds of £4.8m, a sum equivalent to 23p a share.
This means that post the proposed £2.5m buyback programme, Bioquell's shares are being rated on 16 times forward cash adjusted earnings, and on a modest enterprise value to cash profit multiple of six times. There are decent prospects of further cash returns, as Mr Glasper at N+1 Singer is pencilling in a 1.8p a share payout this year, rising to 2.5p a share in 2017.
The bottom line is that the value embedded in Bioquell's technology and the earnings upside from the proposed share buyback programme, new legislation and products, a strong currency tailwind, and operating margin improvements is not being adequately reflected in the valuation. I have a fair value target price of 180p, or 33 per cent higher than the current share price, equivalent to an enterprise value to cash profit multiple of eight times post the planned share buyback. Buy.
My next column will appear on my home page at 12pm on Monday, 14 November.
