First-half results from Crossrider (CROS:70p), a provider of security software and an online distribution platform, highlighted the dramatic change in the business in the past year, and are highly supportive of my view that fair value for the equity is at least 100p, or double the level when I included them in my 2017 Bargain Shares Portfolio ('Bargain Shares: second chance', 17 Aug 2017).
The company now sells four products to over 800,000 consumers including Reimage, a patented Microsoft-based product tool that enables users to clean up their computers; DriverAgent, a PC maintenance software products company offering a leading device driver search and update service, which scans computers for outdated drivers; and Cyberghost, a leading cyber security SaaS (software as a service) provider of secure virtual private networks (VPNs) which enables users, who pay an annual subscription of about $30, to connect through a secure tunnel to pass data traffic over public networks, an area of the market predicted to grow at a compound annual growth rate of 20 per cent over the next five years, according to experts.
Crossrider acquired Cyberghost six months ago for $9.8m (£7.4m) including an earn-out of $3.2m, and it already looks a shrewd purchase after the business increased paying subscribers by 17 per cent to 167,000 in the first half. It’s easy to see why given the threat posed by cybercrime to the security of personal data. For example, around 689m people were victims of cybercrime last year, and $16bn was lost to identity fraud. Not surprisingly, computer users are taking this threat seriously; in the US, a region accounting for a third of Crossrider’s overall revenue, over 40 per cent of working Americans have installed a virtual private network (VPN) on their laptop.
Bearing this in mind, chief executive Ido Erlichman revealed during our results call that the US only accounts for 16 per cent of Cyberghost’s revenue, so there is scope to tap into the growing adoption of VPN there. Importantly, it’s an increasingly profitable business as Crossrider has managed to cut Cyberghost’s cost of sales by an eye-catching 30 per cent since acquisition, the upshot of which is that analyst Ben McSkelly at house broker Shore Capital believes Cyberghost will produce cash profit of $1m in the second half, or 40 per cent above his previous estimate. There should be potential to leverage Cyberghost’s fast-growing customer base too by cross selling Crossrider’s other cybersecurity and identity protection products to them.
Solid profit build
The recent launch of Reimage for Mac is really interesting as the new product has significantly increased the company’s addressable market, something well worth doing given that its two main rivals here are generating double-digit cash profit growth, according to Mr Erlichman. Crossrider’s other app distribution businesses are posting robust growth, too, which is why revenue from this segment shot up by 17 per cent to $21m in the first half to account for 70 per cent of the total. It also explains why Crossrider’s underlying cash profit rose by 131 per cent to $1.5m, excluding the contribution from a legacy web apps business that will be closed shortly.
The full-year results will also benefit from a much higher contribution from Clearvelvet, a highly profitable programme video advertising company whose customers include the likes of Disney Corporation and Reckitt Benckiser, and one in which Crossrider has raised its stake from 16.6 per cent to 50 per cent for a maximum consideration of $3.1m including earn-outs. Guidance suggests Clearvelvet could make cash profit of around $1.3m this year, while next year’s earn-out only kicks in when cash profit hits $1.47m, or 67 per cent of the $2.2m aggressive target.
Factoring in all of these contributions, Shore Capital believes annual cash profit will rise from $6.4m to $8.3m on revenue up 17 per cent to $67m and deliver a 31 per cent rise in pre-tax profit to $6.3m. On this basis, expect EPS of 3.9¢ (3p). Mr Erlichman is confident of hitting those numbers. Shore Capital is just as bullish on prospects for next year, pencilling in a $2m rise in both cash profit and pre-tax profit to $10.3m and $8.3m, respectively, an outcome that supports a 31 per cent hike in EPS to 5.1¢ (3.9p).
This implies the shares are rated on just 8.5 times forward earnings net of 37p a share of cash on the balance sheet, an attractive multiple that fails to reflect the growth drivers of the business and the potential for Crossrider’s management team to deploy the company’s $68.7m cash pile on strategic earnings-accretive acquisitions. Mr Erlichman is actively considering bolt-on deals, so watch this space. Strong buy.
STM on the upgrade again
Aim-traded shares in STM (STM:61p), a company specialising in the administration of assets for international clients in relation to retirement, estate and succession planning, and wealth structuring, jumped 10 per cent after the company doubled first-half pre-tax profit to a record £2.4m on revenue up 36 per cent to £10.7m, prompting analyst Jeremy Grime at house broker finnCap to hike his full-year EPS estimate up by 18 per cent to 5.3p. This follows a 10 per cent EPS upgrade in July when I last rated the shares a buy at 52p (‘On the upgrade’, 18 Jul 2017), having first spotted the investment opportunity at 35p ('Tapping into a pensions payday', 27 Apr 2015).
It’s a dramatic turnaround from the dark days in March this year when STM’s qualifying recognised overseas pension schemes (QROPS) business, an offshore scheme approved by HMRC and used by expatriates and mobile employees whose tax domicile can change as a consequence of employment, was hit by the imposition in the UK Budget of a 25 per cent tax on transfers into QROPS for residents located outside the European Economic Area. As anticipated by STM’s management at the time, this led to an 80 per cent decline in new QROPS applications to a current run rate of around 400 per year to take the company’s book to 11,215 plans at the end of June.
However, the shortfall is being made up by STM's international Sipp business which launched in April and has “gone a significant way in replacing the fall-off of new QROPS applications”, says chief executive Alan Kentish. STM is now receiving 100 new applications a month on which it earns an annual management fee of £500, a third less than on QROPS, but the Sipp plans are far more efficient to run so have a similar level of profitability. STM also charges a £300 establishment fee whereas the QROPS plans have no charge. The company has also made annual cost savings in the order of £150,000 to £200,000 in its Malta and Gibraltar operations to reflect the drop in new QROPS business there.
Mr Kentish points out that the high-margin and annuity style recurring income generated from existing QROPS plans accounts for over four-fifths of STM’s revenue, placing it in an ideal position to acquire smaller players lacking its critical mass. The company is cash generative, too, and has ample firepower for bolt-on deals: net funds have increased by 20 per cent to £11.4m, a sum worth 19.5p a share, and this excludes a portfolio of gilts and corporate bonds worth £5.3m, or 9p a share. Mr Kentish also highlights the imminent launch of an Australian Superannuation product, currently awaiting HMRC approval under the QROPS regime, which will open up the market for the 1.3m expatriate and Australian nationals with a UK pension living in the country. Analysts have not factored in any contribution from this product into their forecasts, suggesting a further catalyst for outperformance.
Last autumn’s acquisition of Haywards Heath-based independent financial services company London & Colonial has not only provided the platform for the launch of STM’s international Sipps offering, but having made cost savings of around £750,000 to date, according to finance director Therese Neish, the actuaries of L&C’s life assurance business have reduced its technical expense reserve by £465,000 to £2.34m, with prospects of further capital being released in the future.
There is clearly momentum in the business, not to mention a recurring revenue stream that accounts for around three-quarters of finnCap’s full-year revenue estimate of £20.5m and supports expectations of a 36 per cent rise in both pre-tax profit and EPS to £3.8m and 5.3p, respectively. Shareholders have just been rewarded with a 20 per cent hike in the half-year dividend to 0.6p and expect similar growth in the full-year payout to 1.8p. This implies STM’s shares are being rated on just eight times full-year earnings estimates net of cash on the balance sheet, offer a prospective dividend yield of 2.9 per cent, and are priced on a modest premium to book value of 50p.
The rating is anomalous, making a return to the share price highs around 70p, dating back to the autumn of 2015, a real possibility, and beyond if earnings-accretive acquisitions are made. Buy.
1pm on track for strong growth
Aim-traded shares in 1pm (OPM:51p), a specialist Aim-traded provider of finance to small- and medium-sized enterprises (SMEs) and a constituent of my 2014 Bargain Shares Portfolio, has delivered a modest profit beat in the financial year to the end of May 2017.
Buoyed by a 32 per cent increase in its gross lending portfolio to £89.5m, reflecting a two-thirds rise in new originations to £83m, revenue increased from £12.6m to £16.9m and supported a 17 per cent hike in adjusted pre-tax profit to £4.3m. Around half of new lending was funded by 1pm itself with the balance brokered on. A return on equity of 11.6 per cent is a decent return for shareholders who enjoyed a maintained dividend of 0.5p a share.
Admittedly, a higher tax charge held back full-year EPS, which edged up from 5.9p to 6.1p, but with the benefit of some smart looking acquisitions as well as realistic levels of underlying growth, a platform is in place to deliver strong EPS growth this year. For example, the post period-end acquisition of Gener8 Finance, a leading invoice finance provider to SMEs, and Positive Cashflow Finance, a factoring and invoice financing provider, have added businesses that posted combined annual pre-tax profit of £2m on revenue of £6.7m in their last financial years. That’s a decent return on the aggregate consideration of £18m including earn-outs paid by 1pm, most of which was funded by a £13m placing and open offer.
Strategically, the move into invoice discounting and factoring makes sense as these products can now be offered alongside 1pm’s existing asset finance and business loan products, and diversifies its revenue streams. Moreover, debt facilities are generally provided on a 5:1 basis for established invoice finance businesses which means that equity can generate a return of 30 per cent a year or more.
After factoring in a £10m revenue contribution from four recent acquisitions, cross-selling benefits and organic growth, analyst James Fletcher at house broker Cenkos Securities is forecasting a £12.5m rise in 1pm’s revenue to £29.4m in the 12 months to the end of May 2018. On that basis, he expects a step change in pre-tax profit from £4.3m to £7.8m to deliver a 16 per cent rise in EPS to 7.1p, implying the shares are rated on just seven times prospective earnings. They are also trading in line with book value.
In my view, the modest rating fails to acknowledge the fact that the company is now lending around £120m to 16,150 SME customers so is no longer a small player; has funding lines in place to support ongoing growth in receivables – only £49m of its £74.5m credit facilities were drawn down at the year-end representing gearing of 3.6 times tangible net assets; and has maintained a prudent approach to credit quality – impairment rates are only 1 per cent.
So, having last rated 1pm’s shares a buy at 44p (‘A trio of small-cap buys’, 10 Jul 2017), I feel a target rating of 10 times earnings estimates and 1.25 times forecast book value, implying a price of 70p, is still reasonable. Buy.
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com for £14.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: Secrets to successful stock picking
