The truth of that homespun wisdom was staring up at Bearbull when I returned from a four-week study break. The Bearbull Income Fund’s latest holding – satellite communications provider Inmarsat (ISAT) – had tanked and an investment from late 2015 – student accommodation provider Empiric Student Property (ESP) – wasn’t far behind. Losses sustained on these two in the second half of 2017 – Inmarsat shares were only bought in August – are £11,000, which has removed over 3 per cent from the fund’s value. That isn’t catastrophic, but it means gains in the second half will be only nominal.
Intriguing speculation surrounds both companies, especially Inmarsat where the contrast between what its bosses say and what the market portends via the share price could hardly be more stark.
Inmarsat is dashing for growth as it attempts to capture enough of the newish market to supply broadband via satellite, particularly to in-flight passenger aircraft. To the winners, providing in-flight connectivity should mean a plentiful stream of cash profits. But Inmarsat’s window of opportunity is limited, the market is competitive, agreeing contracts with airlines takes forever (each deal is bespoke) and the upfront capital spend is daunting. These factors will drain profits and cash flow in both 2017 and 2018 more than was guessed 12 months ago. That much is acknowledged both by Inmarsat’s bosses, City analysts and institutional investors.
As to the divergence between the ostensible confidence of Inmarsat’s bosses and the message coming from the share price, Inmarsat’s chief executive, Rupert Pearce, says the seamless coverage provided by Inmarsat’s Global Xpress broadband network puts it in a strong position and that “we are probably doing better than anyone else in the market right now”. Meanwhile, the share price says Inmarsat is a wreck. At 462p, it is 60 per cent below its all-time peak, hit just two years ago. More telling, if 2017’s final dividend were maintained, the dividend yield would be 9.1 per cent. Yields of that level don’t emerge from trouble-free companies. Rather, they signal strongly that the payout is unaffordable and will be slashed. Yet that was the elephant in the room during the company’s Q&A with City analysts for the third-quarter results last month. In a strange dance, both Inmarsat’s bosses and the analysts avoided any mention of the subject.
This has left me reworking my valuation figures. A level of about £11 a share (see Bearbull, 28 July 2017) now looks too optimistic. Focusing harder on cash profits – rather than the accounting variety – reduces the annuity value of the average annual free cash that one could expect from Inmarsat based on the past five years. That value now lies pretty much in line with the share price. Besides that is the great unknown – how much value to give to the barrow loads of capital spending Inmarsat has done in the past five years and will continue to do for another two. Tweaking the assumptions – chiefly, the discount rates used – can generate almost any figure you want.
However, the core message is that the overall value should be – but only ‘should be’ – still well clear of the 462p share price. In which case, I am holding on, but with a sense of foreboding.
Signals coming from Empiric Student Property have been equally confusing. In late summer its share price started indicating problems and last month its management acknowledged that lettings at the student accommodation provider were poor, that costs were overrunning and that some developments seemed too small to be viable; the underlying message being that controls and reporting systems were inadequate. Simultaneously, dividend targets were trimmed by a sixth, which is disappointing but hardly disastrous – at 87p, the prospective yield is 5.8 per cent.
So the odd things are not just that chief executive Paul Hadaway was sacked but, first, that his dismissal took a further three weeks to materialise and, second, that his temporary replacement, Tim Atlee, Empiric’s investment officer, is a business clone of Mr Hadaway; they are long-standing business partners who founded the property company from which Empiric emerged. One wonders, why should one be sacked and not the other?
We may never know, and there is the supplementary thought that Empiric’s assets or its business model may carry deeper flaws. Certainly, the share price indicates that because it is 17 per cent below net asset value (NAV). At the most similar listed companies, shares in GCP Student Living (DIGS) trade in line with NAV, whilethose in the biggest student landlord, Unite (UTG), are at a 16 per cent premium.
At least that discount to NAV may help support the share price, which is chiefly why I will stick with my holding. But that may be only temporary. It’s not that I think I could have spotted problems at Empiric or Inmarsat in advance – that’s possible only now and again. Rather, there is the bigger thought that the Bearbull income portfolio has reached that stage of maturity where a substantial rebuild may be needed. That will be a task for 2018. Meanwhile, next week I will report fully on 2017.
