Bargain Shares: Exploiting pricing anomalies and top-slicing

Indeed, a trading update has revealed that last summer’s acquisition of Intego, a Mac and iOS cybersecurity and malware protection software-as-a-service (SaaS) business, is progressing ahead of management’s expectations. Intego’s purchase price of $16m equated to a sensible looking 11 times its 2017 pre-tax profit of $1.4m. However, if Kape’s management works its magic as it has so far with its March 2017 acquisition of CyberGhost, a provider of secure virtual private networks (VPNs) that securely pass data traffic over public networks, then there could be significant potential to grow Intego’s profits by leveraging off Kape’s larger customer base.

Bearing this in mind, the directors have revealed that the “implementation of Kape's user acquisition technology with Intego has been extremely encouraging and will have a positive impact from the first quarter of 2019. In addition, Kape has recently launched cross-promotion campaigns between CyberGhost's VPN and Intego's malware protection software, and there are early signs of strong traction across these products”.

This autumn’s acquisition of Berlin-based ZenMate, a digital privacy company focused on encrypting and securing internet connections and protecting individuals' privacy and digital data through VPNs, is performing ahead of expectations too. The previously lossmaking business should turn cash profitable from the first quarter of next year, which is supportive of analysts’ predictions that ZenMate could report cash profits of $500,000 on revenues of $2.5m in 2019, thus warranting the €4.8m (£4.2m) cash consideration Kape paid. It’s also supportive of forecasts that Kape can boost pre-tax profits from $8.7m in 2018 to $12.3m on revenues of $72m in 2019.

On this basis, Kape’s shares are rated on a cash-adjusted PE ratio of 14.5 for 2019, hardly a punchy rating for a company that is successfully recycling its cash pile – I estimate net funds of around $41m, or 22p a share, post the ZenMate and Intego acquisitions – into high-growth cyber security markets and successfully creating cross-selling opportunities across its entire product range for its 1m customers in 160 countries. Retention rates are high at 74 per cent, and rising, suggesting Kape’s income stream is becoming more valuable too.

So, having first advised buying Kape’s shares, at 47.9p in my 2017 Bargain Shares portfolio, and last reiterated that advice at 120p when the ZenMate acquisition was announced (‘Kape’s growth underpriced’, 18 October 2018), I note that the oversold shares have drifted back to support around the 100p level and look primed for a rally.  Buy.

Tiso asset sales hold the key to a rerating

My 2017 Bargain Shares portfolio has produced a 29.8 per cent total return since February 2017, well ahead of both the FTSE All-Share index and FTSE Aim All-Share index, which have produced a total return of 5.4 per cent and 6.7 per cent, respectively, in the same period. The portfolio has also held its own this year and is unchanged on when I updated it in February at the 12-month stage whereas the FTSE Aim All-Share index has declined by 12 per cent in value in the past 10 months.

However, it hasn't been a one-way street as South Africa-focused investment company Tiso Blackstar (TBGR:R290) has proved a drag on performance, knocking off more than 6 percentage points, a reflection of the painfully slow progress being made selling off non-core holdings in order for the group to become a single-sector investor in the media industry, building on its wholly owned investment in The Times Media Group (TMG), the premier news group in South Africa. Titles owned include Business Day, Financial Mail and The Sunday Times. Apart from newsprint, TMG’s activities also encompass television, films and radio stations.

Tiso’s net asset value (NAV) of R3.1bn (£176m) is almost four times higher than its market value of R800m (£44m). As has always been the case, the key to narrowing the gap is realising the [written down] value in Tiso’s non-core investments, which have a net carrying value of R1.4bn (£80m). It would wipe out group net borrowings and financial liabilities of R1.1bn (£61.6m) and still leave a tidy sum for new media-focused investments. Bearing this in mind, the vast majority of Tiso’s non-core assets are accounted for by its 20 per cent stake in KTH, a South African investment company that holds stakes in both listed and private companies in the media, resources, infrastructure, power and financial services sectors. KTH is implementing a plan for shareholders to try to facilitate the realisation of the value held in its investments.

The good news is that Tiso’s core media interests increased operating profit by 12 per cent to R245m (£14m) in the 12 months to end-June 2018. So, if the value from non-core businesses can be realised and the balance sheet de-geared, then the distress risk embedded in Tiso’s share price should unwind sharply given that the profitability of its media interests clearly warrants a market value significantly higher than £44m. Hold.

BATM’s shares on a tear

Shares in BATM Advanced Communications (BVC:49.9p), a provider of medical laboratory systems and cyber security and network solutions, and a constituent of my 2017 Bargain Shares portfolio when the price was 19.25p, have now achieved my target price range of 45p to 50p.

The share price has been on a tear ever since I highlighted the company had entered into a joint development agreement (JDA) with Softbank-owned Arm Holdings, a leading multinational semiconductor and software design company, to develop and market infrastructure solutions for network function virtualisation (NFV) ('Profit from 5GM with BATM', 8 June 2018). In layman’s terms, NFV decouples the network functions, such as network address translation, firewalling, intrusion detection, domain name service (DNS) and caching from proprietary hardware appliances so they can run in software. 

The technology could be a real money-spinner for both parties given that NFV is going to play a critical role in supporting the services 5G network operators will be able to offer. It can also be used to run applications such as autonomous vehicles. Moreover, network operators and virtualised network function providers will be able to deploy their applications and operate across all major hardware architectures, so leveraging the advancements in different processor technologies. BATM has already conducted successful proof-of-concept trials with tier 1 and 2 telecom operators.

The royalty stream from major network operators adopting the JDA’s technology could easily run into millions of dollars. Trading prospects were further enhanced when BATM announced that it has advanced its strategic partnership with Arm in becoming a part of the Arm® Neoverse™ ecosystem, a new brand and roadmap of technologies that will enable the next generation cloud infrastructure support the demands of a trillion intelligent devices. 

In the circumstances, it’s hardly surprising that BATM’s shares have rerated and are now priced on a multiple of 29 times Shore Capital’s cash profit forecast of $8m (£6.3m) for the 2020 financial year to its enterprise value of £184m. Please note that these estimates don’t factor in the contribution from the JDA and are based on expectations that BATM’s adjusted pre-tax profits will double to $3.2m in 2019, rising to $5.3m in 2020, based on annual revenues of $118m and $126m, respectively.

It’s not the only exciting technology BATM is commercialising. The company’s joint venture, Ador, with Netherlands-based private group Gamida, will start shipments next year of its novel molecular diagnostic platform that fully automates the rapid analysis of nucleic acid samples ('BATM reveals potential of ground breaking diagnostic kit', 29 August 2018). The bench-top analyser can probe 100 targets in a single proprietary carbon array whereas existing products only probe on average between four and six targets per test sample. It is being targeted at screening for hospital-acquired infections such as MRSA and C. Diff, and to identify tropical infections in travellers returning home with fevers, some of which can be life-threatening and need early and accurate diagnosis. If the technology proves as successful as the directors believe it could be then it’s only reasonable to expect a big player such as Abbott Laboratories or Roche Diagnostics to be interested in acquiring it.

In the meantime, BATM’s cyber security division is going great guns, winning a raft of government agency contracts as I have highlighted previously, another reason why I remain positive on the investment case. However, nothing is ever certain and there is execution risk to consider. So, having seen BATM’s shares run up 90 per cent in the past six months, and increase in value by 157 per cent since I outlined the investment case in my 2017 Bargain Shares portfolio, I feel the prudent tactic is to top-slice your holdings in the £201m market capitalisation company by selling half and running the balance for free. Top-slice.

Bioquell receives a knock out bid

I clearly wasn’t the only one running the slide rule across Bioquell (BQE:600p), a provider of specialist microbiological control technologies to the international healthcare and life science markets, when I suggested the company was on course for another earnings beat four weeks ago. Bioquell has just received what looks like a knock-out £140m cash bid, worth 590p a share, from Ecolab (NYSE:ECL), a $40bn market capitalisation New York Stock Exchange listed company and a leader in water, hygiene and energy technologies boasting $14bn annual sales. The announcement sent Bioquell’s shares surging by 40 per cent from the 420p level at which I suggested buying last month.

It’s easy to see why the US giant is interested in the UK minnow. A rising gross margin – highlighting the pricing power behind Bioquell’s hydrogen peroxide vapour (HPV) patented technology, the gold standard for bio-decontamination – healthy turnover growth and operational leverage are contributing to strong earnings momentum at a time when Bioquell’s end markets are being buoyed by a raft of factors including the need for customers to achieve and maintain regulatory compliance, the growing threat posed by antibiotic resistance, and ongoing growth in research and small-scale production associated with cell-based healthcare products.

Importantly, the value of the bid looks more than fair. After stripping out Bioquell’s forecast closing net funds of £17.1m at the end of this month, a sum worth 77p a share, from its market capitalisation of £140m the company’s enterprise valuation of £123m equates to 20.5 times cash profit estimates for 2018. The cash-adjusted PE ratio is 42 for 2018 based on Bioquell delivering cash profit of £6m, pre-tax profit of £3.5m and EPS of 12.2p on revenue of £31.8m. In my view, that rating accurately reflects potential for Bioquell to deliver mid-teens operating margins on a revenue base of £40m in the years ahead.

Shareholders representing 55 per cent of Bioquell’s shares in issue have either accepted or indicated their backing for the 590p-a-share cash bid, including Harwood Capital LLP, whose principal is the highly respected fund manager Christopher Mills. I would back it too and in the process crystallise a 372 per cent gain made in only 32 months for long-term holders of my 2016 Bargain Shares portfolio who averaged into Bioquell’s shares around the 125p level.

This means that the 2016 Bargain Shares portfolio is now up 71.4 per cent on a total return basis, well ahead of the respective 36 per cent and 42.6 per cent total returns on the FTSE All-Share and FTSE Aim All-share indices. Accept the offer.

Walker Crips targets second half improved performance

Shares in small-cap stockbroker and asset and wealth manager Walker Crips (WCW:35p) are down slightly since my last article after taking into account the payment of the final dividend of 1.29p a share (‘Walker Crips targets finntech to boost profits’, 16 August 2018), and remain the laggard in my 2016 Bargain Shares portfolio.

However, I continue to see medium-term upside even though interim results to end September 2018 revealed that operating profits halved to £188,000 on modestly lower revenue of £15.1m, a reflection of a £900,000 decline in commission income to £4.7m mainly due to weaker trading volumes. Assets under management and administration (AuMA) actually increased from £5bn to £5.2bn, a stellar performance in light of the reversal in UK equity markets this year. Importantly, the directors expect an improved second half performance, partly reflecting cost savings, but also driven by targeting high-margin investment products.

Ultimately, profits and margins need to start moving in the right direction to narrow the gap between Walkers Crips’ market value of £14.8m and net asset value of £21.8m. With net cash and liquid assets backing up £6.5m of its market value, it’s not going to take much in the way of margin improvement – the company made an operating margin of 3 per cent in 2017-18 – on £30m of annual revenues to warrant a much higher equity valuation. Medium-term buy.

■ Limited Offer until 31 December 2018. Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit are available to purchase online at www.ypdbooks.com at the promotional price of £12.50 per book plus £2.95 postage and packaging per book, or by telephoning YPDBooks on 01904 431 213 to place an order. Postage and packaging is only £3.75 for purchasers of both books. They are being sold through no other source. Full details of the content of the books are available on YPDBooks website and in the following articles Simon has published: Successful Stock Picking Strategies and Stock Picking for Profit.

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