Aim-traded shares of MXC Capital (MXCP:1.3p), a technology-focused merchant bank run by a management team that backs investee companies they represent, have been trading sideways all year and are unchanged from the level at which I rated them a recovery buy 14 months ago (‘A trio of small-cap buys’, 22 Aug 2017).
The main reason for this lacklustre performance is that one of MXC’s main investee companies, IDE (IDE:2.65p), a mid-market network, cloud and IT managed services provider, has been going through a cost reduction programme in order to create a more appropriate and profitable cost base going forward. However, some of the supplier agreements entered into previously (relating to fibre, data centres and outsourced support) have impacted IDE’s profitability in the near term, while the expected benefits of the cost-cutting programme have not been realised at the anticipated rate.
Ultimately, IDE had a working capital cash crunch and one that necessitated a rescue equity raise from its shareholders, including MXC which has invested a further £3.25m in equity (at 2.5p a share) to lift its stake to 45.6 per cent. The collapse in IDE’s share price has meant that MXC’s original stake in IDE, which had a £9.9m carrying value at the end of February 2018, is now worth a paltry £1.1m. Earlier this month MXC used £3m of its healthy cash pile to provide a loan for a management buyout of one of the business units of IDE. The loan is secured on the assets of that business and MXC will earn annual interest income of 12 per cent over the three-year term of the loan and a £75,000 arrangement fee, too.
The issue at IDE has overshadowed the good news from the rest of MXC’s investment portfolio. Most notably, the company’s shareholding in Castleton Technology (CTP:96p), a provider of technology products and services to the social housing and not-for-profit sectors, has reaped massive gains. The stake had a fair value of £13.8m at the end of February 2018, or more than double cost of £5.7m, since when MXC has offloaded the holding for total proceeds of £19m, of which £4.3m was used to increase its holding to 20.66m shares in Tax Systems (TAX:99p), a leading supplier of corporation tax software to the large corporate sector and the accounting profession in the UK. The stake in Tax Systems is currently worth £20.25m, a valuation that looks warranted in light of the company’s latest financial results. MXC also realised £1.66m by cashing in all of its call share options in Castleton Technology.
The company is starting to put its burgeoning cash pile to good use, having signed a joint-venture agreement at the end of last year with a subsidiary of Liberty Global, the international TV and broadband company. The aim is to create an IT services provider focused on small- and medium-sized business customers within the UK through a series of acquisitions. The first investment was made in April this year in a Leeds-based IT infrastructure and network specialist provider. Both MXC and Liberty invested £2.35m each.
Importantly, MXC is cashed up to do more deals with its heavyweight new partner. I reckon its pro-forma net cash pile is around £14.4m, and it also has a £750,000 receivable that is payable in January from Ravenscroft, an independently owned investment services group based in the Channel Islands with £4.7bn of assets under administration for private and institutional clients. MXC acts as consultant to Ravenscroft in its role as investment manager to the GIF Technology & Innovation Fund in which the States of Guernsey and MXC are invested. It’s worth noting that over the summer Ravenscroft paid £2.25m for a 25 per cent stake in MXC’s transactional businesses, so clearly sees value in MXC’s deal makers.
By my reckoning, MXC’s realised profit on the Castleton stake, the aforementioned call options it cashed in, and the £2.25m realised from the Ravenscroft stake sale, offsets the majority of the £8.8m paper loss on the IDE stake. This means that MXC’s tangible net asset value (NAV) of £51.7m at the end of February 2018 should be pretty much intact by my reckoning. Moreover, MXC’s market capitalisation of £43.7m is effectively fully backed by its estimated cash pile of £14.4m, the £20.25m stake in Tax Systems, the 75 per cent stake in its transactional businesses (see through valuation of £6.75m), and the £2.35m co-investment MXC has alongside Liberty Global.
This means that MXC’s share price attributes nil value to its private equity portfolio (carrying value of £7.55m), the £4.35m current value of its shareholding in IDE, the aforementioned £3m loan it made to the management buyout team of one of IDE’s business units, and a £570,000 shareholding in Adept4 (AD4:1.55p), an Aim-traded provider of 'IT as a service' to small- and medium-sized businesses in the UK.
Of course, investors rightly have reasons to be cautious especially as a previous investment MXC made in Redcentric (RCN:84p), a UK IT managed services provider, hit major trouble a couple of years ago. But with MXC heavily cashed up, and some smart operators (Ravenscroft and Liberty Global) backing its deal makers, I see recovery potential in the shares, which are trading 10 per cent below my tangible NAV estimate of 1.5p. More cautious investors may wish to wait until the final results are released in early December, but I feel the shares are worth buying now. That’s because if the company has indeed turned a corner, as newsflow would suggest, then a decent share price premium to tangible NAV looks warranted. Buy.
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