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Bargain Shares: On the M&A beat

Simon Thompson reports on corporate activity from two of the constituents of his market-beating 2016 Bargain Shares Portfolio
October 22, 2018

As is the case with the undervalued small-caps I target, there is a fair amount of corporate activity to report. This is to be expected given that the majority of companies I highlight in this column are anomalously priced special situations. Indeed, no fewer than 21 small-cap companies I follow have exited the stock market in the past four years as higher-rated rivals have taken advantage of the valuation anomalies in my under-researched small-cap space.

The trend is not abating, either, as French Connection (FCCN:65p), a constituent of my market-beating 2016 Bargain Shares portfolio, is firmly in play. No fewer than four interested parties have approached the company with regards to a corporate transaction. It’s a good time for chief executive and chairman Stephen Marks to consider selling his 41.7 per cent stake as the company he founded in 1972 is on course to return to underlying profitability in the current financial year.

As I noted when I covered the half-year results last month (‘French Connection approaches profitability’, 21 Sep 2018), it’s not going to take much in the way of incremental margin improvement to get profits rising on £135m-worth of annual sales once the business hits this inflexion point. Moreover, the company’s wholesale business is highly profitable even though underperformance from retail activities have led to overall losses in the past. Importantly, with the four largest shareholders controlling 81 per cent of the £62.5m market value company's shares, and net cash accounting for 22 per cent of net asset value of £40.8m, there is a deal to be done and at a premium to the current share price. So, having first advised buying the shares at 45.7p, I would run your 38 per cent paper profits.

 

Bargain Shares Portfolio 2016 performance 
Company nameTIDMOpening offer price (p) 5.02.16 Latest bid price (p) 22.10.18Dividends (p)Total return (%)
Bioquell (see note one)BQE1254400252.0%
VolvereVLE41910000138.7%
Bowleven (see note two)BLVN18.93525.7056.9%
Gresham HouseGHE312.5466049.1%
French ConnectionFCCN45.763.5038.9%
Oakley Capital OCI146.518211.2531.9%
Juridica (see note three)JIL36.1143227.4%
Gresham House StrategicGHS79691532.2519.0%
Mind + Machines (see note four)MMX87.502.8%
Walker CripsWCW44.9345.01-13.1%
Average return    60.4%
Deutsche Bank FTSE All-share ETF index tracker (LSE:XASX) 341396.747.9630.4%
      
Notes:
1. Simon Thompson advised buying Bioquell's shares at 149p in February 2016. Bioquell bought back 50 per cent of shares in issue at 200p each in June 2016 through a tender offer and Simon recommended buying back the shares in the market at 145p to give an average buy-in price of 125p (‘Bargain shares updates’, 22 June 2016).
2. Simon Thompson advised banking profits on half your holdings in Bowleven's shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The total return reflects this share sale.
3. Simon Thompson advised buying Juridica's shares at 41.2p in February 2016. Juridica subsequently paid out a special dividend of 8p a share in June 2016 and Simon recommended buying shares in the market at 61p using the cash proceeds to take the average buy-in price to 36.1p (‘Brexit winners', 1 August 2016). Juridica then paid out a special dividend of 32p a share in Sep 2016 and total return reflects this distribution. Simon advised selling the holding at 14p ('Taking Q1 profits and running gains', 4 April 2017), hence the price quoted in the table. Please note that Juridica has since paid out a further special dividend of 8p a share and current bid price is 4.1p.
4. Simon Thompson advised buying Mind + Machines' shares at 8p in February 2016. Mind + Machines subsequently bought back 13.22 per cent of the shares in issue at 13p a share. The total return reflects this capital distribution. Simon advised selling the entire holding at 7.5p, which is the exit price stated in the table ('Strategic acquisitions', 9 May 2018).
Source: London Stock Exchange share prices

 

French Connection is not the only constituent of my 2016 Bargain Shares Portfolio in the news as Aim-traded investment company Volvere (VLE:1,100p) has announced the disposal of its largest investment, Impetus Automotive, a provider of consulting services to the automotive sector. Volvere’s founders, Jonathan and Nick Lander, who have the respective roles of chief executive and finance director, have proved adept at investing in distressed and undervalued businesses with a view to turning them around and exiting at a hefty profit. They have been mightily successful as the disposal of Impetus highlights.

Volvere acquired loss-making Impetus for £1.25m including debt in March 2015, and owns an 83 per cent economic interest in the company. Impetus has since repaid all borrowings and paid interest and dividends of £520,000 to Volvere after the Landers engineered a dramatic turnaround in the company's fortunes. In fact, in the 2017 financial year Impetus posted pre-tax profits of £3.3m on revenues of £27.3m, and in the first half of this year reported pre-tax profits of £1.9m on revenues of £14.8m. After accounting for all costs and settling management incentives, Volvere will retain £23.1m of the £31m disposal proceeds, quite some return on its £1.25m original investment. It also represents a thumping premium to the £4.8m book value of the investment in Volvere’s half-year accounts. Indeed, I reckon that Volvere’s spot net asset value is now £45.2m, or 1,233p a share, of which net funds equates to over £41.6m.

This means that you are effectively getting a free ride on Volvere’s other major investment, an 80 per cent stake in Leamington Spa-based food manufacturing business, Shire Foods. The business was acquired by Volvere in 2011 and is valued in its accounts at £6m, representing seven times the underlying pre-tax profit of £830,000 Shire reported in 2017 on revenues of £15.8m. True, Shire’s profits have slipped in recent years as higher raw material and staff costs dented margins, not helped by lower availability of labour and sterling’s depreciation post the EU referendum in June 2016. However, a £950,000 investment in new equipment is now largely complete and will enable Shire to manufacture its products at a higher level of profitability. It’s worth noting that Shire’s first-half revenues were a record for the six-month trading period, so the business is winning business.

Not surprisingly, Volvere’s tightly held shares have done incredibly well, rising from the 940p level at which I suggested running profits in the summer (‘Volvere’s record results’, 19 Jun 2018), and is up 138 per cent on an offer-to-bid basis since I included the shares, at 419p, in my 2016 Bargain Shares Portfolio. However, they are still priced on an 11 per cent discount to my 1,233p a share estimate of spot book value even though by my reckoning Volvere’s book value per share has increased at a compound annual growth rate of 17 per cent since the company listed its shares, at 100p, on Aim in December 2002. So, ahead of news on the next turnaround situation the Landers plan to invest in, I would definitely run your bumper profits.

 

■ Simon Thompson's new book Successful Stock Picking Strategies can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source and is priced at £16.95 plus £2.95 postage and packaging. Simon's second book Stock Picking for Profit has been reprinted and is available to purchase online at www.ypdbooks.com for £16.95, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. Details of the content of both books can be viewed on www.ypdbooks.com.