Our portfolios are based on the investment ideas of Benjamin Graham (see ‘Rules of Engagement’ below) and they have certainly withstood the test of time, beating the FTSE All-Share index in 16 out of the 20 years in which we have run them. During that time, they’ve generated an average return of more than 20 per cent in the first 12-month holding period, compared with an average increase of 4 per cent for the FTSE All-Share index.
My 2018 Bargain Shares proved no exception, generating a 12-month positive total return of 12.5 per cent on an offer-to-bid basis and including dividends. By comparison, the FTSE All-Share Total Return index, the index against which we benchmark our annual performance, fell by 4.9 per cent, and the FTSE Aim All-Share Total Return index lost 14 per cent of its value. That’s not to say this investment strategy is a one-way bet – investing rarely is, as the laggard in the 2018 portfolio, currency manager Record(REC), has lost almost a quarter of its value, thus highlighting the benefits of having a diversified portfolio.
|Bargain Shares portfolio: 20-year track record|
|Year||Bargain Portfolio 1-year performance (%)||FTSE All-Share index 1-year performance (%)|
|Average one-year return||20.8||4.0|
|Source: Investors Chronicle|
As usual, the hidden gems we uncover in the stock market are found among the under-researched small and microcap segment. Targeting smaller-cap companies has reaped handsome rewards over the years, so justifying our long-term bias here, but it works both ways as companies that disappoint can be punished severely given the less liquid nature of these shares. The flipside is that, when we get it right, you can expect substantial long-term outperformance, as our track record shows.
It’s worth pointing out that no portfolio can be immune to a market crash: the collapse in share prices in the global financial crisis in 2008 wreaked havoc, but readers who kept faith subsequently recovered all their paper losses, which again highlights the solid asset backing of the companies. In fact, two of those companies from the 2008 portfolio – Indian Film Company and Raven Mount – both succumbed to takeovers. It was a similar story in 2011, with that portfolio recouping all its losses – and going on to reward investors with some mightily handsome gains in later years.
Merger and acquisitions (M&A) activity has been a regular feature of all our portfolios, as predators, attracted by the asset backing on offer, run their slide rule over the numbers. It’s understandable, as in some cases valuations are so depressed that we are getting all the fixed assets in the price for free, thus offering the substantial “margin of safety” Benjamin Graham was aiming for. Indeed, Bioquell (BQE), a provider of specialist microbiological control technologies to the international healthcare and life science markets, has received a knockout bid from Ecolab (NYSE:ECL), a $40bn market capitalisation New York Stock Exchange-listed company, and one that crystallises a 372 per cent gain for holders of my 2016 Bargain Shares portfolio.
So, once again, I have run the rule over 1,700 listed companies on the Alternative Investment Market (Aim) and the main market of the London Stock Exchange to come up with a portfolio of companies where the asset backing should be strong enough to overcome any short-term trading difficulties – and, in time, reward our loyal following of long-term value investors.
|Bargain Shares portfolio 2019|
|Company name||TIDM||Market||Activity||Offer price||Market value||Bargain rating|
|Inland Homes||INL||Aim||Brownfield land developer, housebuilder and partnership housing company||55.5p||£115m||0.62|
|Jersey Oil & Gas||JOG||Aim||Independent North Sea-focused upstream oil and gas company||199p||£43.4m||0.49|
|Ramsdens Holdings||RFX||Aim||Financial services||165p||£50.9m||0.49|
|Futura Medical||FUM||Aim||Pharmaceutical company focused on sexual health and pain products||14.75p||£30.2m||0.41|
|Augmentum Fintech||AUGM||Main||Venture capital investor in the fintech sector||103p||£96.8m||0.45|
|TMT Investments||TMT||Aim||Venture capital company that invests in high-growth, internet-based companies||252¢||$71.0m||0.43|
|Mercia Technologies||MERC||Aim||Asset manager and investor in innovative UK technology businesses with high growth potential||28.8p||£87.3m||0.41|
|Driver Group||DRV||Aim||Consultancy servicing clients in construction and engineering sectors||75p||£40.4m||0.39|
|Litigation Capital Management||LIT||Aim||Litigation funding of legal claims||78p||£84.9m||0.39|
|Bloomsbury Publishing||BMY||Main||Consumer, academic and B2B publisher||218p||£163m||0.39|
|Source: London Stock Exchange|
Inland Homes (INL)
Aim: Share price: 55.5p
Bid-offer spread: 54-55.5p
Market value: £115m
Inland Homes (INL) is a south-east of England-focused housebuilder and brownfield land developer, and one that is incredibly lowly rated if the company delivers on the expectations of house broker Panmure Gordon.
Analysts at the broking house believe that Inland can raise full-year pre-tax profits and earnings per share (EPS) by 6 per cent to £20.5m and 7.7p, respectively, on revenues of £185m in the 12 months to the end of June 2019. On this basis, the shares are priced on a forward price/earnings ratio (PE) of 7. They are also priced on a 45 per cent discount to Inland’s last reported EPRA net asset value (NAV) – ie NAV per share calculated in accordance with the methodology of the European Public Real Estate Association – of 102p a share. For good measure, the analysts forecast a hike in the payout from 2.2p to 2.6p a share, implying that the shares offer a prospective dividend of 4.7 per cent.
Of course, one reason for the low rating is the economic uncertainty caused by Brexit. However, management’s update last week confirmed that Inland achieved 81 private new-build housing sales at an average price of £238,000 in the first half to the end of December 2018, and a further 63 sales of social housing partnership homes, and has a forward order book of £15.3m, so expect a similar performance in the second half. The point is that by targeting the lower end of the housing market in the regions, Inland’s private housebuilding activities are proving resilient even in a less benign market environment. Around 60 per cent of sales come from buyers using the government’s Help to Buy housing scheme, so the extension of this initiative in the autumn Budget is obviously positive.
Partnership deals de-risk the sales pipeline
It’s also worth noting that Inland has been de-risking its future earnings by entering into partnership deals with housing associations and local authorities. These partnerships enable Inland to recognise land profits early while securing a self-funded, cash-positive and profitable construction contract. In turn, cash proceeds from these low-risk contracts can be used to reduce borrowings, and avoid the need to raise financing, or invest in sales and marketing. The company’s residential construction order book for its Inland Homes Partnership Housing business was £90m at the end of last year, since when the company has exchanged contracts on a site in Dagenham, east London.
The site forms part of the former Ford manufacturing plant and lies within the London Riverside Opportunity Area, a 3,000 hectare major regeneration zone that could deliver up to 26,500 homes across the boroughs of Barking and Dagenham. It has a gross development value of £95m and planning consent for 325 homes. Inland is in negotiations to deliver the homes in a joint venture with a top-five housing association, with 116 homes earmarked for affordable housing and the remaining 209 units to be sold on the open market. Completion of the site purchase is expected next month, and construction of the first units is due to commence in the summer.
This illustrates that revenues and profits earned from the company’s rapidly growing social housing partnerships are forming a larger part of the mix, thus making it even harder to justify the huge share price discount to EPRA NAV and the modest single-digit earnings multiple too.
Conservatively valued land bank and well-funded balance sheet
It’s only right to point out that the majority of Inland’s profits are still made from selling down a conservatively valued £100m land bank to housebuilders, which consists of a 7,000-plot owned or controlled land bank, of which 1,700 plots are consented and around 2,000 are in the planning pipeline. These numbers exclude the recent sale of 386 plots at Ashton Clinton, Buckinghamshire, to a top-10 housebuilder, which earned Inland a £7m management fee. These deals can be lumpy and are difficult to predict, but nevertheless Inland has proved adept at delivering in the past. There is no reason why it shouldn’t continue to deliver in the future either, given that the supply demand imbalance for housing starts is most marked in the lower end of the market, which is the area Inland has been concentrating on.
It’s worth noting, too, that on or around 19 February this year Inland expects a decision to be made on its largest ever planning application, a 1,853-unit regeneration project in Cheshunt, Hertfordshire, that is located just outside the M25 and only 27 minutes from London's Liverpool Street station by train. It could be the catalyst for a decent rerating if the project is given the go-ahead by the planners.
I would also flag up that Inland owns £52.8m of investment property, producing an annual operating profit of £2.4m, the vast majority of which comes from renting residential homes and commercial units at the Wilton Park scheme close to Beaconsfield in leafy Buckinghamshire, where the company is targeting the development of more than 300 homes on the prime 100-acre site. This provides solid asset backing and a potentially lucrative investment offering significant capital upside when it is developed.
Importantly for investors, there is a hefty ‘margin of safety’ to de-risk an investment in the shares. That’s because Inland has substantial asset backing and a well-funded balance sheet. Net borrowings of £79.7m equate to 38 per cent of EPRA NAV of £206.7m, and the company has untapped credit facilities to fund construction costs, and finance site acquisitions, so there are no financial concerns to warrant the deep share price discount to the value of its assets. In fact, the company expects to complete a new four-year revolving credit facility with HSBC later this month, and on improved terms compared with the existing one it has with Barclays. In addition, Inland has £19.9m of listed zero-dividend preference shares outstanding, which don’t mature until April 2024.
Ultimately, the equity risk premium priced into Inland’s share price is extreme and is factoring in an Armageddon economic downturn that, frankly, is highly unlikely to materialise even if the UK leaves the EU on World Trade Organization terms. On a Bargain Share rating of 0.62, Inland’s shares are priced to outperform in the year ahead. Buy.
Jersey Oil & Gas (JOG)
Aim: Share price: 199p
Bid-offer spread: 197-199p
Market value: £43.4m
It’s shaping up to be a pivotal year for shareholders inJersey Oil & Gas(JOG), a British independent North Sea-focused upstream oil and gas company that owns an 18 per cent interest in the P2170 licence (Blocks 20/5b & 21/1d), Outer Moray Firth, in which the operator, Equinor UK (formerly known as Statoil), owns a 70 per cent interest and CIECO V&C UK owns a 12 per cent interest. That’s because drilling of an appraisal well on the partners' flagship Verbier discovery in Block 20/5b is scheduled for the first quarter this year as part of Equinor’s larger drilling campaign.
Initial operator estimates suggest gross recoverable resources associated with the Verbier discovery of between 25m and 130m barrels of oil equivalent (boe) with an estimated mean of 69mboe. The purpose of the appraisal well is to accurately determine the potential volume range in the discovery. Internal management estimates of the value potential for the estimated recoverable oil volume ranges, together with an opinion that all outcomes are potentially commercially viable, suggest a net present value (NPV) in excess of £30m could be attributable to Jersey Oil and Gas at the low end of the range, and a NPV in the order of £200m at the top end. Neither of these scenarios factor in the additional valuation upside potential of the Cortina prospect, located on the licensed acreage, which is estimated to hold mean prospective resources of 124mboe, or for that matter additional prospectivity across the licence area.
Verbier offers material upside potential
In fact, when Jersey Oil and Gas doubled its size by raising £23.7m in a placing and open offer of shares, at 200p, in October 2017 to part-fund its share of the drilling costs on Verbier, management estimates for gross recoverable resources attributable to Jersey Oil and Gas across all of the P2170 licence prospects (Verbier, Cortina and Meribel) ranged from 70mboe in the low case scenario to 273m in the upside case. This corresponds to an unrisked NAV of £83.7m attributable to Jersey Oil and Gas in the low case scenario, rising to £400m at the top end of the range.
To put these large sums into perspective, analyst Brendan Long at broking house WH Ireland estimates that Verbier’s gross recoverable resources alone could be around 77.5mboe in a mid-case scenario of which 14mboe are attributable to Jersey Oil and Gas. The company has 21.8m shares in issue and a fully diluted share capital of 23.4m shares after taking into account 1.6m options, which if exercised would raise £2.5m cash for the company.
Based on the fully diluted share capital, Mr Long estimates that Verbier could have an unrisked NPV of £97.8m – a sum worth 417p a share and more than double the company’s current share price – attributable to Jersey Oil & Gas based on $7 per barrel of oil and factoring in first production in the second half of 2021.
Balancing risk and reward
Of course nothing is guaranteed in the oil exploration industry, but with net cash of £22m at the end of June 2018 – more than double its £9m to £11m share of the cost of drilling the Verbier appraisal well (of which £7m to £8m will be expensed in the 2018 financial year) – then even if the prospect only has 25mboe of gross recoverable resources, representing the low end of the estimated range, this is still worth £30m to Jersey Oil and Gas shareholders. That sum and surplus net cash of £11m on the balance sheet after expensing the appraisal drilling costs virtually backs up 100 per cent of the company’s current market value of £43.4m.
This means that, based on some very conservative assumptions, Jersey Oil and Gas’s interests in both the Cortina and Meribel prospects are effectively in the price for free. Moreover, if the company hits pay dirt on Verbier, then there will be a positive read-across for prospectivity across both Cortina and Meribel. Management estimates suggest that the company’s share of an exploration well on the Cortina prospect, if drilled, would be around £6m.
Newsflow from the appraisal well aside, expect the partners to deliver a fully processed data set from a 3D seismic survey over the licence area during the second quarter of this year. This has potential to add further substance to its commercial viability. True, drilling of the Verbier appraisal well was pushed back from the fourth quarter last year to the first quarter this year, but it made sense to do so. That’s because the partners now have access (prior to drilling) to the fast-track data analysis of the newly shot 3D seismic survey completed in December 2018. An optimised well location is clearly beneficial when drilling an appraisal well.
Interesting director appointment and notable shareholder interests
Interestingly, Jersey Oil and Gas appointed a new financial officer in mid-November 2018, Vicary Gibbs. He has over 20 years' experience as a corporate financier advising oil and gas companies on mergers and acquisitions, capital-raising and restructuring transactions. In the past couple of years, Mr Gibbs has acted as an independent oil and gas consultant, providing advice to Jersey Oil and Gas, so has in-depth knowledge of the company. Prior to this, he worked at Canaccord Genuity Hawkpoint Limited, Bank of America and Deutsche Bank, so has significant experience in corporate finance, too.
The cash backing of Jersey Oil and Gas aside, the directors have material skin in the game. Chairman Andrew Benitz owns 627,142 shares, or 2.9 per cent of the share capital, and chief operating officer Ron Lansdell holds 900,000 shares, or 4.1 per cent of the share capital. Also, institutions Schroders and Legal & General hold 17 per cent stakes, having taken these positions at the time of the autumn 2017 equity raise at 200p, highlighting significant backing from institutions with a decent track record.
Trading on a Bargain Share rating of 0.49, and on half of analysts’ risked fair value estimates of 401p a share, Jersey Oil and Gas’s shares offer significant upside potential if the Verbier appraisal well delivers. Buy.
Ramsdens Holdings (RFX)
Aim: Share price: 165p
Bid-offer spread: 160-165p
Market value: £50.9m
Middlesbrough-based Ramsdens (RFX), a diversified financial services company whose main activities encompass foreign currency exchange, retail jewellery, pawnbroking and a precious metals buying and selling service, listed its shares on London's junior market two years ago with the intention of expanding its store format through organic expansion. The directors are delivering on this commitment.
Four new stores were opened in the second half of the 2017-18 financial year, another four in the six months to the end of September 2018, four more since the half-year-end, and three stores are in the pipeline to open before the end of March 2019. All the new stores were trading ahead of management’s expectations when I interviewed the directors. Moreover, based on a 30-month targeted payback of capital, it makes sense to target an organic roll-out programme by recycling the company’s strong operating cash flow.
In fact, Ramsdens' last reported net cash of £12.4m, a sum worth 40p a share, was little changed on the closing level at the end of March 2018, even though the company spent £1.2m purchasing property and equipment, and £1.36m paying out the final dividend of 4.4p a share in the six-month trading period to end-September 2018. The progressive dividend policy is a key attraction as analysts at Liberum Capital forecast a payout of 7.1p a share for the 12 months to the end of March 2019. On this basis, the dividend is more than two times covered by forecast record full-year EPS estimates of 17p. Earnings forecasts are de-risked by the fact that £5.1m of Liberum’s pre-tax profit forecast of £6.54m was booked in the first half, which reflects the seasonal bias to the numbers.
Diversified revenue stream mitigates risk
True, Ramsdens' first-half profits were slightly down on the prior year, but the directors have reiterated guidance that points towards another record pre-tax profit outcome despite the company earning lower profits from foreign exchange in the summer of 2018 due to the UK’s record-breaking heatwave. The fact that the business is still on track to achieve a record profit outcome highlights the major benefit of having a diversified product offering.
For instance, cross-selling its retail jewellery to a growing customer base, investing in new stock and improving display, branding and product mix were all drivers behind the 27 per cent rise in first-half jewellery sales to £4.5m, on which Ramsdens earned a 50 per cent-plus gross profit margin. Both pawnbroking and precious metals buying also posted growth to boost Ramsdens' overall gross profits by £600,000 to £16.7m in the half-year on revenue of £23.9m.
Gold price could provide silver lining to pledge book and scrapping profits
It’s worth noting that, since the company released its half-year numbers at the end of November, the gold price has been rising strongly, and at £1,012 an oz is only 14 per cent below the September 2011 all-time high of £1,182 an oz hit during the depths of the eurozone banking and credit crisis. The price of the yellow metal has scope to rise further if the thesis I outlined at the start of the year (‘A game changer’, 7 January 2019) pans out. To recap, I anticipate a weakening of the US dollar and a rally in the commodity complex as the US central bank eases off its monetary tightening by halting the draining of liquidity from the global financial system. If I am right, then I would expect precious metals to outperform a falling dollar, thus offering a boost to the sterling gold price and, in turn, the profits Ramsdens earns from precious metals buying and scrapping unredeemed pledges. It would also boost interest income earned from the pawnbroking pledge book as the company could make larger loans given the greater security.
To put the potential upside into some perspective, when the gold price was higher in 2014, Ramsdens’ earned gross profits of £9.1m from buying precious metals, or double the level factored into Liberum forecasts for 2019. The point being that a high percentage of any increase in gross profit from precious metals buying will drop down to the bottom line, so in effect you are getting an option on a rising gold price thrown in for free.
Other factors underpinning growth in 2019-20
Upside from movements in the precious metal prices aside, it’s worth considering that as Ramsdens’ new stores move towards profitability in their second year post opening, then we can expect an unwinding of the initial drag on profits – administration costs rose by £750,000 in the latest six-month reporting period, of which half was a result of the new store openings. Also, not even the most optimistic staycation UK holidaymaker would bank on another record summer heatwave in 2019, thus offering scope for a boost in the 2019-20 financial year to profits from Ramsdens' market-leading foreign currency exchange. This operation earned a 2.3 per cent gross margin, providing £315m of its currency offering to more than 500,000 customers in the first half. Moreover, if the US dollar does weaken as I expect it will over the next 12 months, this can only be positive for profits earned from currency exchange.
Progressive dividend policy aligned with director interests
So after factoring in the drivers of Ramsdens' four business units, I feel comfortable with the forecasts from analysts at Liberum, who predict the company can achieve another record result in the 2019-20 financial year, too, forecasting pre-tax profit of £6.94m on revenues of £49m to produce EPS of 18p, up from 17p forecast for the financial year to end-March 2019. On this basis, expect the dividend per share to be raised from 6.6p in the 2018 financial year, to 7.1p in the current financial year, to 7.8p in 2019-20. The board can certainly afford to be generous given that net cash on the balance sheet is worth 40p a share, a sum equating to a quarter of the current share price.
It’s reassuring to know that the directors are financially invested in the company. Chief executive Peter Kenyon owns 3.7 per cent of the issued share capital and is clearly confident of his company’s prospects as he purchased £80,000-worth of shares at the 165p level following the half-year results at the end of November. I also like the fact that director remuneration of £508,000 in the 2018 financial year equated to just a quarter of the £2m cash cost of the dividend, so the lion’s share of profits are being recycled back to shareholders rather than lining the pockets of the directors.
Bargain basement valuation
On any measure, Ramsdens’ shares are well into bargain territory, priced on a forward PE ratio of 7 after stripping out 40p a share of cash on the balance sheet. The shares also offer a prospective dividend yield of 4.3 per cent for the financial year to end-March 2019, and are rated on less than 1.7 times book value even though the company reported a post-tax return on equity (ROE) of 18 per cent in its last financial year. Given the high ROE, it clearly makes sense for Ramsdens to continue to recycle operating cash flow into solid organic growth prospects, especially as new stores have a relatively short cash payback period of 30 months.
On a Bargain Share rating of 0.49, I feel that prospects for Ramsdens turning in another record trading performance this year and next are being woefully undervalued by the market. Buy.
Futura Medical (FUM)
Aim: Share price: 14.75p
Bid-offer spread: 14.5-14.75p
Market value: £30.2m
Shares inFutura Medical(FUM), a pharmaceutical company that is developing a portfolio of innovative products based on its proprietary, transdermal Dermasys drug delivery technology and one that is focused on sexual health and pain, have been battered in the past 12 months, shedding 70 per cent of their value. They are also priced almost 90 per cent below their all-time high of 110p hit in 2012 after long-suffering shareholders became increasingly frustrated at the lack of licensing deals to monetise the company’s intellectual property.
However, sentiment has improved markedly since the company raised £5.85m, at 7p a share, through a placing and open offer last October. This boosted Futura’s cash pile to £11m and has provided the cash required for the company to take its flagship product, MED2005, a breakthrough topical gel for erectile dysfunction (ED), through Phase III development with a view to seeking a partner or selling the asset. Please note that MED2005 is the codename used by Futura for the 'locked' formulation for use in clinical trials. MED2002 is the codename used by Futura for all proprietary formulations of glyceryl trinitrate (GTN).
The cash raised also provides additional headroom for the long-term, open-label arm of the Phase III trial in Europe, which will provide additional safety reassurance as well as enabling Futura to conclude arrangements for a second, confirmatory Phase III trial. Expect top-line Phase III data from the first trial to be announced at the end of 2019.
Reasons for enthusiasm
It’s easy to see why investors are becoming enthusiastic as MED2005 has the potential to be a highly differentiated therapy for the treatment of men with ED, especially in mild and mild-to-moderate cases. MED2005's rapid onset of action means that it has potential to become the world's fastest-acting treatment for ED, with a speed of onset of around five minutes. Its rapid clearance offers a favourable safety profile too.
An earlier Phase I pharmacokinetic study highlighted that doses of 0.2 per cent, 0.4 per cent and 0.6 per cent of GTN were shown to be safe and well tolerated, along with an absorption profile to similar systemic doses of GTN in the form of Nitrostat. This will be the reference drug for safety, if Phase III data are positive, in the planned regulatory filings.
The Phase III study builds on Futura’s promising Phase II data, particularly in mild and mild-to-moderate ED patients, as scientifically published in the Journal of Sexual Medicine. This demonstrated rapid speed of onset with 44.2 per cent of patients reporting a positive impact within five minutes and 69.5 per cent reporting it within 10 minutes. This is significantly faster than oral PDE5 inhibitors (Viagra and Cialis) which typically have an onset of action of between 30 and 90 minutes.
Moreover, patient uptake research conducted by Cello Healthcare has highlighted that more than half of physicians consider that MED2005 is a significant improvement over currently available ED treatments and believe it could attract high levels of patient uptake, ranging from 20 to 33 per cent of the potential patient pools. In addition, at least 10 per cent of patients are unable to take oral inhibitors because they are on nitrate therapy, so would benefit from MED2005. An average of 72 per cent of physicians considered that helping to restore spontaneity and intimacy in their sexual relationship would be very appealing to their patients too.
Details of the Phase III study
The first European Phase III study of MED2005 involves the participation of 1,000 patients in 61 centres across nine countries: Czech Republic, Hungary, Poland, Slovakia, Georgia, Russia, Ukraine, Latvia and Bulgaria. The protocol is to incorporate feedback received from potential commercial partners, opinion-leading clinicians and also US and EU regulatory agencies to optimise the commercial value and maximise the likelihood of regulatory approval.
As part of the study, Futura will be conducting a long-term open-label study to provide additional safety reassurance involving 300 patients for six months, and 100 patients for 12 months across all 61 centres. The total cost of the first Phase III study and the long-term open-label study is expected to be £8m. A second Phase III study is planned to commence by the end of 2019 to test 700 patients in Eastern Europe and the US using two of the doses from the first Phase III study, and a placebo.
The market for ED undoubtedly offers Futura a huge opportunity. Independent market research conducted on the company’s behalf indicates MED2005 could generate potentially $1bn (£781m) in annual sales from both prescription and over-the-counter sales priced at $5 (£3.90) per dose. The prescription market alone was worth over $5.6bn in 2016. The profit margin on the product, which will have patent protection, is massive, too, as the cost is expected to be under €0.30 per dose (26.5p). Extensive work is being carried out to produce the chemistry, manufacturing and controls package required for regulatory submission and to establish the supply chain. A huge addressable market and profit margin makes this a blue-sky opportunity. However, it comes with a fair amount of risk too.
Firstly, expect the £6.3m cash burn from the first Phase III data trial to deplete the £11m cash pile on Futura’s balance sheet post the October 2018 placing, albeit a £1.3m research and development (R&D) tax credit is expected in the summer to offset the cash impact. There is an additional £3.3m working capital requirement, too.
Secondly, there is absolutely no guarantee that the first Phase III trial will be a success, and if it isn't then Futura’s share price will be hit. Also, partnering discussions ahead of the start of the Phase III trial indicated that commercial partners would like to see positive Phase III data on MED2005, especially at the higher doses being tested ahead of advancing licensing discussions. The flipside is that commercial partners have indicated that they are willing to pay more for the product after such data has been generated.
Other products in the portfolio
That said, the company is not a one-trick pony. Although the focus is firmly placed on the planned Phase III programme on MED2005, Futura is exploring ways to ensure income streams for its Erotogenic condom (CSD500) and pain relief gel products.
The rapid skin permeation rates enabled by Futura's transdermal delivery system, DermaSys, offer potential benefits in pain management, including: improved onset of action, duration and degree of pain relief. Futura has demonstrated statistically significant results from its two non-steroidal anti-inflammatory drug programmes, TPR100 (2 per cent diclofenac gel) and TIB200 (10 per cent ibuprofen gel), in a clinical study. TPR100 is partnered for manufacturing and distribution in the UK with Thornton & Ross, one of the UK's largest consumer healthcare companies.
Bearing this in mind, last summer Thornton & Ross filed the product's marketing authorisation application with the UK Medicines and Healthcare Products Regulatory Agency. Futura has received expressions of interest from a number of parties that will enable the company to expand the geographical reach of TPR100, and in particular within the EU. However, it is awaiting regulatory authorisation in the UK, expected in 2019, before progressing further.
Futura’s CSD500 condom contains the erectogenic Zanifil gel and benefits from three clinically proven claims: the maintenance of a harder erection, maximising penile size and a longer lasting sexual experience. Futura's unique intellectual property for CSD500 has been protected throughout the world through the filing and granting of a range of patents. Both of the company’s manufacturing partners have the required approvals to ship CSD500 to any country in which the product is approved.
However, Futura does not have the marketing or regulatory resources to support the day-to-day requirements in a growing compliance-driven medical device market and is focusing its efforts on licensing the condom product and/or technology with partners. Futura still expects to benefit from the intellectual property of CSD500 through potential royalties, but in the absence of a large global brand 'carrier' to take the product forward, the immediate potential for substantial royalties is low. Discussions are ongoing with potential partners to license the product in a number of markets, but this has been the case for some time.
Potential for Futura’s share price to rise several-fold
Ultimately, the investment case rests on Futura delivering positive data results on the Phase III study of MED2005 to support the potentially huge market opportunity for the product. There is no hiding from the fact that the shares are speculative, and are highly volatile so not for the faint-hearted. But equally the company’s market capitalisation of £30.2m could increase several times over if the ongoing Phase III study proves successful, and a licensing deal with a partner is signed or the product is sold. Please note that the company will be hosting an R&D day for analysts and institutional investors on Monday 11 February 2019. Speculative buy.
Augmentum Fintech (AUGM)
Main: Share price: 103p
Bid-offer spread: 102.5-103p
Market value: £96.8m
Augmentum Fintech(AUGM), a leading venture capital investment group, became the first publicly listed fintech fund in the UK when it listed its shares on the London Stock Exchange in March 2018 and raised £94m, at 100p a share.
The company’s objective is simple: back Europe’s most exciting fintech businesses that are disrupting and enhancing the traditional financial services industry. Typically, this will be at an early stage, not seed capital but at Series A and B investment rounds where there is more visibility on a company’s potential. At the same time, Augmentum’sinvestment team looks for value in fintechs that have not fulfilled their early promise and perhaps lofty valuations. These companies can require fresh capital, restructuring and impetus to build on a solid base that has sometimes taken longer to mature than early investors had anticipated. The ultimate aim of Augmentum is to have a portfolio of around 15 to 20 holdings once it is fully invested.
Portfolio offers strong investment prospects
Augmentum’sstarting portfolio of five holdings was valued at £33.3m at the fund’s launch in March 2018, the largest of which is a stake in Zopa, the world’s first – and Europe’s leading – peer-to-peer (P2P) consumer lending platform. Zopa directly matches people looking for a competitive loan rate with investors looking for a higher rate of return, and has lent more than £3.7bn to low-risk UK borrowers since it was founded in 2004. Following closure of a £60m funding round for Zopa at the end of 2018, Augmentum’sshareholding in the company has increased in value from £18.5m in March 2018 to £22m.
Moreover, having recently acquired a UK banking licence, Zopa is on the way to launching a next-generation bank alongside its peer-to-peer business. At launch it will focus on credit cards, car finance, deposits and open banking in addition to personal loans and P2P investments. Augmentum offers a smart way of playing the financial upside. It also offers a smart way of playing the upside in interactive investor(ii), a leading UK investment platform offering analysis, tools and expert ideas to help investors make better informed investment decisions. ii’s award-winning trading platform provides access to an extensive choice of markets, instruments and currencies within trading, individual savings accounts (Isas) and self-invested personal pensions (Sipp) accounts.
Since 2013, the investment platform market in the UK has almost doubled in size to £500bn of assets under management, buoyed by the opening of 2.2m new customer accounts. ii has a 10 per cent share of the UK direct-to-consumer investment platform market and is the second-largest player in this space. It’s set to get much bigger too. That’s because ii agreed last autumn to acquire Alliance Trust Savings, subject to regulatory approval, to bring together the two largest fixed-price retail investment platforms.
In an increasing technology and data-driven environment, the greater scale of the enlarged operation will support the investment in technology and talent necessary to provide the best customer experience and service in the sector. Augmentum’s holding in ii should also deliver further financial gains for its shareholders, who have already seen the stake rise by 50 per cent in value from £3m to £4.7m (including a £200,000 further investment) since the fund’s launch in March 2018.
Other interesting investments in Augmentum’s portfolio include an £8.4m holding in BullionVault, the world’s largest physical gold and silver online market, and one that offers private investors cheap access to investment-grade bullion. Founded by Paul Tustain in 2005, BullionVault has enabled more than 70,000 private investors across 183 countries to benefit from the low dealing costs, deep liquidity and ultra-high security of the wholesale bullion market.
BullionVault users – almost 90 per cent of whom live in North America or Western Europe – currently own around $1.5bn (£1.18bn) worth of gold bullion between them, more than is held by most of the world’s central banks, plus a further $350m in physical silver and $17m in physical platinum. In 2008, BullionVault became a full member of professional trade body the London Bullion Market Association (LBMA). Alongside Augmentum Fintech, BullionVault’s investors include the World Gold Council and Piton Capital.
BullionVault also holds a stake in WhiskyInvestDirect, the online market for buying and selling Scotch whisky as it matures in barrel – a new asset class that has produced an annual appreciation after storage costs and inflation of more than 7 per cent over the past decade. Accounting for a quarter of the UK food and drink exports by value, around 35 bottles of Scotch whisky are sold overseas every second of the day. WhiskyInvestDirect supports this business by providing cash flow to distillers, and by introducing an electronic exchange where brand owners can source a range of high-quality single malts and grain whiskies.
The business was co-founded by Mr Tustain in 2015. It may seem an odd combination, but BullionVault and WhiskyInvestDirect have strikingly similar business models and use the same software trading platform to offer a wholesale marketplace investable to the private investor. It’s a growing business too, as WhiskyInvestDirect cares for more than 6m litres of pure alcohol worth over £20m at current wholesale prices, enough spirit to make almost 17m bottles of Scotch once mature.
Prospects of positive newsflow from fintech investee companies
Augmentum’s investee company, Unmortgage,is set to hit the headlines this year, too. Founded in 2016 with significant backing from the government and institutional investors, Unmortgage has found a solution to help the growing number of families who are unable to buy their own homes. In the past decade, the number of families in rented accommodation in the UK has soared from 3m to 5.5m. The solution is to replace mortgage debt with institutional equity finance. It’s also based on the principle that if someone can afford to rent then they should be able to buy. Unmortgage’s proposition will launch to the public later this year. Augmentum’s investment here is in the books for £2.5m.
Other investments in the portfolio include stakes in Seedrs, a leading European marketplace for private equity investment that offers growing private companies access to a broad base of investors; Tide, an SME challenger bank in the UK; and Monese, a smart and globally connected banking service for internationally mobile individuals. These three stakes are being carried in Augmentum’s accounts at a combined £10.8m.
Risk-to-reward ratio favourable
The point is that with Augmentum’s shares trading in line with its last reported NAV of £97.8m, or 104p a share, of which £43.9m is cash held for future investments, then investors are not paying a premium to gain access to the upside from the fund’s portfolio of 10 investments, which have an aggregate valuation of £57.9m. That’s an attractive entry point given that the management team and advisory panel are all experienced investors in the fintech space. I note that Ed Wray, co-founder of online gambling group Betfair, is on the advisory panel. They also invested £6m at launch of the fund.
Importantly, they also have an impressive track record, as Augmentum’s investment team generated a net internal rate of return (IRR) of 16.5 per cent from their fund, Augmentum Capital LLP, between 2010 and 2017. RIT Capital Partners(RCP), the £3bn market value UK investment trust in which Jacob Rothschild and family are substantial investors, was the sole backer of that fund. The fact that RIT Capital Partners retained an investment of £18m in Augmentum Fintech as part of the latter’s acquisition of its initial portfolio when the fund launched speaks volumes.
Bearing in mind that positive newsflow from several of Augmentum’s investments could lead to significant valuation uplifts, and exits, in time, then it’s worth noting that 50 per cent of gains realised through the disposal of investments in each financial year will be returned to shareholders, either through share buybacks, tender offers or special dividends. Furthermore, with £260m of investment opportunities in the pipeline, we are not going to be short on news of fresh investments either.
On a Bargain Share rating of 0.43, Augmentum’s shares look a relatively safe holding, and one that could deliver sizeable gains for shareholders in the coming years. Buy.
TMT Investments (TMT)
Aim: Share price: 252¢
Bid-offer spread: 242-252¢
Market value: $71m (£55.5m)
TMT Investments(TMT), a venture capital company that invests in high-growth, internet-based companies across a variety of sectors – and with a significant number of Silicon Valley investments in its portfolio – has proved its worth since listing its shares on the Alternative Investment Market (Aim) in December 2010. Founded in 2010, TMT has invested in more than 40 companies to date, having raised $20m (£15.6m) at 100¢ a share on listing. The company has raised further equity capital since then, which is why it now has 29.18m shares in issue, the latest being a placing of 1.27m shares at 243¢each, which raised $3.5m in March 2018.
At the time of the last share placing, the directors noted that they had invested a total of $32m in 40 companies, and realised $13m from the full or partial exit of certain of those investments. The March 2018 equity raise was pitched in line with the company’s end-December 2017 NAV per share of 243¢, up from 97¢ when TMT made its first investment in June 2011, implying an impressive internal rate of return (IRR) of 15 per cent.
Wrike disposal priced at 23 times invested capital
The company’s IRR on its portfolio has just ratcheted higher as TMT completed the disposal of its fifth largest investment at the start of this year, a stake in Wrike (www.wrike.com), the collaborative work management platform that provides workplace teams with a single digital platform to maximise their operational performance. It is used by 18,000 organisations, including Google, and has nearly 2m users across 130 countries. TMT had originally invested $1m in Wrike in 2012 when it was the company’s first institutional investor, and had booked $0.8m from partial exits in 2017. The holding in Wrike was valued in TMT’s accounts at $8.4m at the company’s half-year end on 30 June 2018, so the $22.3m net consideration received by TMT on divestment represents a total return of over 23 times its original investment. There is also deferred consideration of $0.3m payable over the next 18 months.
What this also means is that TMT’s NAV is around $92.9m, or 312.5¢, so the company has more than trebled its NAV per share in the eight years since listing, implying an IRR of 19.5 per cent. TMT also has more than $25m of cash on its balance sheet to fund new investments, a sum that equates to 35 per cent of its market capitalisation. Not that TMT’s existing portfolio lacks promise as it includes a stake in Taxify, a leading international ride-hailing company (www.taxify.eu). Taxify completed a $175m funding round in May 2018 led by automotive giant Daimler AG and European venture capital fund Korelya Capital that raised Taxify's valuation to $1bn. This raised the value of TMT’s stake in Taxify from $3.7m to $17m, highlighting a conservative approach to the carrying values of its investments.
Large gains on other investee companies
It’s not the only investment that has made significant gains, as TMT sold a small holding in Pipedrive, a leading sales customer relationship management (CRM) software provider (pipedrive.com), for $2m in May 2018. The transaction was pitched at a 34 per cent premium to the fair value of TMT's investment in Pipedrive. The remaining holding in Pipedrive is valued at $10.3m in TMT’s accounts. Other exciting investments include a $10.5m holding in Backblaze, an online data back-up and cloud storage provider (backblaze.com).
Of course, not all investments work out and there are write-offs too. Indeed, alongside news of the disposal of the stake in Wrike, TMT wrote down the value of its holding in online curated shopping mall Wanelo (wanelo.com) by two-thirds to $1.8m, albeit that still represents a chunky uplift on the $350,000 that TMT originally invested back in 2011.
Share price discount to NAV unwarranted
There is clearly value on offer here, with TMT’s shares priced almost 20 per cent below NAV per share post the disposal of the Wrike stake, and cash on the balance sheet accounting for 85¢ a share, or 35 per cent of the current share price. Effectively, TMT’s investment portfolio is in the price for 26 per cent less than its conservative-looking valuation. That’s harsh given that TMT’s divestment of Wrike clearly demonstrates the company's ability to identify and invest in early-stage high-growth companies within the technology sector that have the ability to create significant shareholder value through capital appreciation.
I also like the fact that the co-founders (including family members) of TMT control around 50 per cent of the share capital so are heavily invested personally in the success of the company’s investee companies. They are also directly involved in the day-to-day running of their company. German Kaplun is the head of strategy, Alex Morgulchik is head of business development and Artyom Inyutin is head of investments.
The bottom line is that, with the Jersey-registered company set to report another positive set of annual results in March, there is a likely catalyst to correct the valuation anomaly. On a Bargain Share rating of 0.43, the US dollar Aim-traded shares are worth buying.
Mercia Technologies (MERC)
Aim: Share price: 28.8p
Bid-offer spread: 28.4-28.8p
Market value: £87.3m
It’s not often that you get the chance to buy into a cash-rich fund management business that also invests in some of its investee companies at a deep share price discount to book value at a time when the company has delivered a double-digit annual IRR on its directly held investment portfolio. However, that is exactly what’s on offer at Mercia Technologies(MERC), a company focused on the identification, creation, funding and scaling of innovative UK technology businesses with high growth potential.
Mercia raised £70m when it listed its shares at 50p each on Aim in December 2014, and a secondary placing of shares raised £40m for investment purposes at 46p in January 2017. The fact that the share price, at 28.8p, is languishing more than a third below the level of the placings in no reflection of the progress Mercia has made. In fact, it has posted an IRR of 15 per cent on its directly held investment portfolio since the end of 2014. Moreover, funds under management are on the rise and increased by 17 per cent to £395m in the latest 12-month trading period. That’s good news for management fee income earned on Mercia’s mandates. Indeed, in the last financial year Mercia earned total fees of £10.2m, which was not far off the £10.6m of administration costs the company incurred.
Understanding the business model
Mercia’s business model was conceived with the aim of generating investment returns from investing in technology-led businesses. This is often university-derived as it has 19 university partnerships, which generate around 6 per cent of all dealflow and account for a quarter of Mercia’s managed fund portfolio. But Mercia also has direct access to high-quality, regional dealflow through nine offices across the UK. By focusing initially on the provision of finance through Mercia's managed funds, which have so far invested £395m in around 170 different businesses, the company can identify, help build and de-risk managed fund portfolio companies ahead of providing, on a selective basis, scale-up balance sheet capital.
Mercia is increasingly seen as the go-to regional investor and in its relatively short time on Aim is now recognised as one of the most active venture investors in the UK. In the first half of the current financial year, Mercia received 1,800 business plans and made on average 10 managed fund investments per month across the Midlands, the north of England and Scotland. Its sector specialists work alongside the funds' portfolio investment teams in order to drive investee company growth. By combining both commercial and investment expertise Mercia identifies and helps accelerate growth in young businesses with the most potential. It targets four key technology sectors:
■ Software & the internet: artificial intelligence, cyber security, software as a service, analytical tools and adtech.
■ Digital & digital entertainment: virtual reality, augmented reality and gaming entertainment.
■ Electronics, materials, manufacturing and engineering:energy, communications, high-value electronics and manufacturing applications.
■ Life sciences & biosciences: diagnostics, digital health, medical devices and synthetic biology.
Equity harshly valued
The point is that the company’s market value of £87m is 30 per cent below Mercia’s last reported NAV of £125m even though it holds £39m in net cash. This means that if you attribute nil value to £10.3m of intangibles on the company’s balance sheet, and clearly the fund management business has to be worth something – analysts at Edison Investment Research value it at around £27m, or 9p a share – then Mercia’s £77.8m investment portfolio is effectively being valued 38 per cent below its carrying value. This is a harsh valuation given that the directly held portfolio is made up of 20 direct investments, so is well diversified, and has decent prospects of maintaining Mercia’s enviable track record of generating an IRR of 15 per cent. Indeed, in December’s annual results Mercia’s management highlighted positive progress from four of its largest investments.
Multiple investee companies offer scope for valuation gains
For instance, Mercia holds a 31.4 per cent equity interest worth £4.6m in Impression Technologies, a Coventry-based company that has a proprietary Hot Form Quench (HFQ) technology for manufacturing complex, high-strength and lightweight aluminium components for the automotive, aerospace and industrial sectors. It already has parts in production on Aston Martin and Lotus cars and is making “significant commercial and technological progress with a world-class consortium including Gestamp, one of the world's largest suppliers of automotive body and chassis components”.
Mercia also holds a 28.8 per cent stake worth £4.2m in Intelligent Positioning, a company that owns a software platform, Pi Datametrics, that combines search ranking data, market intelligence and analysis of large datasets to help clients make business-critical decisions. Pi Datametrics has a client base of blue-chip customers, generating high-margin recurring revenues, which have grown by 62 per cent in the past two years as a result of running analytics on behalf of more than 150 brands. New customers include Dyson (providing intelligence for a new platform roll-out), GoCompare (market intelligence for strategic development) and the gaming business LeoVegas (intelligence for strategic market development).
Mercia’s largest holding is a 45.6 per cent stake in nDreams, a provider of creative content for the interactive virtual reality (VR) entertainment market. The company was originally founded to provide content for the PlayStation Home platform, but pivoted in 2014 to take advantage of the significant investment in VR headset technology by leading companies including Samsung, HTC, and PlayStation. nDreams is capitalising on this rapidly growing sector, which PwC estimates will be worth £1.2bn by 2022. Indeed, nDreams is delivering over 50 per cent growth in annual revenues and has secured its largest multi-million-pound contract to date, with a high-profile global technology company. It has also launched its games and experiences for the fast-growing location-based entertainment market, where VR is being brought to consumers at arcades and shopping centres.
Equally exciting is a 40.5 per cent stake in Oxford Genetics, a specialist designer and developer of biological molecules such as proteins, viruses and cells within the growing synthetic biology market. The company operates in a market that analysts at Allied Market Research estimate will be worth circa $38bn (£29.7bn) by 2020, with cell line development services alone having an estimated value of $2bn. Oxford Genetics achieved a significant commercial milestone last year when the business secured its largest multi-million-pound contract to date with a global ecommerce provider of reagents and tools to the research and clinical community.
The bottom line is that as Mercia’s managed fund portfolio scales up then management fees earned should in time cover all of the company’s operating expenses, so not only is there hidden value in the fund management business, but we are also getting a cheap entry point into the shares on a 23 per cent discount to hard NAV, which excludes goodwill and other intangibles assets. By comparison, peer IP Group(IPO) is priced on an 11 per cent share price discount to hard NAV, and the darling of the sector, Draper Esprit(GROW), is priced on a 33 per cent premium.
It’s not as though Mercia hasn’t exited its holdings profitably either, as it sold off a stake in Allinea Software to semiconductor maker ARM to realise a gain on investment of £825,000. Add to that substantial cash backing, and the fact that the directors and the management team own 23 per cent of the issued share capital so have a significant equity interest, and Mercia shares are being far too lowly rated on a Bargain Share rating of 0.41. Buy.
Driver Group (DRV)
Aim: Share price: 75p
Bid-offer spread: 70-75p
Market value: £40.3m
Established in 1978, Driver Group(DRV) is a consultancy that provides clients in the construction and engineering sectors with specialist commercial management, planning, programming, scheduling, project management and dispute resolution support services. The range of services offered encompasses project evaluation; pre-contract preparation, tendering, and procurement; various stages in the construction phase, from managing change, through to completion and agreement of final accounts; and finally supporting the asset when it’s in use. The company’s mission statement is to ‘make the difference’ in delivering robust and dynamic commercial solutions to its clients.
It has been doing just that, as annual results for the 2018 financial year clearly highlight. Driver reported an eye-catching 54 per cent increase in pre-tax profits on revenues up 4 per cent to £62.6m. A keen focus on working capital management coupled with strong operating cash flow meant that net cash flow from operating activities soared from £2.1m to £5.7m, and the company ended the financial year to end-September 2018 with net cash of £6.9m, a marked improvement on a net debt position of £200,000 only 12 months earlier.
A dramatic turnaround
The rude health of the business represents a dramatic turnaround from two years ago when the board, led by its new chief executive Gordon Wilkinson, tapped shareholders for £8m of new equity to de-gear the balance sheet. The problem back then was that, after a period of rapid growth from 2011 to 2014 when Driver was generating pre-tax profits of £3.5m, profitability waned badly in 2015 and, by the early months of the 2016 financial year, the business was in real difficulty.
Mr Wilkinson was appointed in March 2016 and commenced a detailed review of all aspects of the business. It concluded that the previous growth strategy was flawed. The overseas expansion of project management services in the Middle East carried significant commercial risk as the roll-out involved hiring of staff in anticipation of winning new contracts in order to tender credibly for new work. The revenues upon which the recruitment plan was predicated largely failed to materialise.
Moreover, the expansion of project management services in the UK through an acquisition in 2014 created a perceived conflict of interest with Driver's core contract claims and dispute resolution business, resulting in slower growth in sales of higher-margin dispute resolution services. That’s because engineering and construction disputes are usually concerned with time and cost overruns and may involve the owner, developer, contractor, sub-contractor and suppliers depending on the contractual matrix. Driver delivers dispute solutions whether under formal legal proceedings or alternative dispute resolution. Its support covers analysis of commercial, planning and scheduling, project management, and technical issues.
The expansion of operations overseas also had a negative impact on the working capital profile of the business, most notably in the form of a sharp increase in the capital tied up in receivables, especially in the Middle East. The full extent of the challenges facing Driver became apparent when it posted an underlying loss before tax of £1.5m on revenues of £27.9m in the first half of 2016.
Decisive action taken
Recognising the need for decisive action, a new finance officer and chief operating officer were also appointed and corrective action was taken to facilitate the turnaround of the business and improve profitability. Central overheads were slashed, as were the number of underperforming fee earners. More rigorous contract planning and bidding controls were put in place too, as were tighter cash collection procedures to improve working capital management.
The strategy worked, as the company posted an underlying operating profit of £1.1m in the second half of 2016. However, the new management team concluded that a more radical reshaping of the business had potential to restore the high single-digit operating margins Driver had regularly delivered in the past. To achieve this they scaled down Driver's non-core project management services through a combination of disposals and a managed wind-down of the residual contract book.
At the same time, the directors pursued selective expansion of Driver’s existing offices both within Europe and further afield, in order to strengthen its position in its core activities of contract claims, dispute resolution and expert witness services. In the Far East, new hubs in Hong Kong and Singapore serviced the wider region, including Korea, Vietnam, Cambodia and Indonesia. In the Middle East, a plan to grow the claims and disputes team in Oman was put in place. New areas of expertise were identified too, thus widening the offering to include sectors such as shipping and forensic accounting by recruiting small, specialist teams.
Putting the scale of the turnaround into perspective
Since the placing and open offer in February 2017, analysts at house broker N+1 Singer have upgraded both their 2018 and 2019 EPS forecasts by more than half. There is every reason to expect the positive momentum in the business to continue, buoyed by rising utilisation rates (up almost four percentage points to 80 per cent in 2018), a diversified revenue stream, which mitigates any domestic risk from Brexit (70 per cent of the company’s turnover is derived outside the UK), and a growing blue-chip client base attracted by Driver’s global offering.
Furthermore, with cash conversion rates north of 100 per cent, analysts at brokerage N+1 Singer believe that Driver’s cash pile will have soared by almost half to £10.2m by the September 2019 financial year-end, a sum worth 19p a share and equating to a quarter of Driver’s current market capitalisation of £40m. Analysts also expect a 16 per cent increase in pre-tax profits to £4.4m on revenues of £65m to lift EPS to 6.3p and support a dividend of 0.9p a share. The board has just reinstated the payout, having declared a dividend of 0.5p a share for the 2018 financial year (ex-dividend date of 21 February 2019).
It’s worth noting that, as utilisation rates rise, so too does the gross margin Driver earns, one reason why you can expect profit growth to outpace that of revenues, as analysts predict. And with the balance sheet much stronger, more of Driver’s rising net profit can be redirected to shareholders’ coffers.
The point being that Driver’s strong earnings upcycle is far from over. On a Bargain Share rating of 0.4, and a cash-adjusted forward PE ratio of 9 for the current financial year, the shares are worth buying as the combination of positive earnings momentum, cash build and rising dividends is likely to attract wider investor interest as the recovery story becomes mainstream. Buy.
Litigation Capital Management (LIT)
Aim: Share price: 78p
Market value: £84.9m
Sydney-headquartered Litigation Capital Management(LIT), a leading provider of litigation financing to enable third parties to pursue and recover funds from legal claims, listed its shares on Aim just before Christmas 2018 when equity markets were falling out of bed. However, the company had strong support from investors, who backed a £20m placing (£18.1m net of expenses) of 38m shares at 52p each. That was a bargain entry point at the market low, but there is still scope for the rerating since then to gather pace.
Importantly, all of the proceeds from the equity raise were kept by the company, and there was no selling by existing shareholders. Funds managed by asset managers Miton Group, River & Mercantile and Standard Life Investments acquired 30m of the placing shares to give them a 27.6 per cent stake in the company. Litigation Capital also raised A$10m (£5.6m) from investors in Australia in October prior to cancelling its listing on the Australian Stock Exchange (ASX) when it moved to Aim. The company had previously listed its shares on the ASX in 2016 when it raised A$15m on admission.
A growing alternative investment class
It’s easy to see why both UK and Australian investors have been willing to back a company that is a mini version of market leader Burford Capital(BUR), shares in which have risen 12-fold since I spotted the company’s potential in the summer of 2015 (‘Legal eagles’, 8 June 2015). In a nutshell, litigation financing involves the funding of third parties’ legal claims in exchange for receiving a share of any amounts recovered from those claims. It’s a growing alternative asset class with returns determined by the skill of selecting and managing profitable litigation projects. Indeed, over the past decade, there has been significant growth of the industry and expansion beyond insolvency claims to commercial claims, class actions and international arbitration in an increasing number of jurisdictions.
Company background and trading history
Founded in Australia in 1998, and led by chief executive and 6.8 per cent shareholder Patrick Maloney since 2013 – the board of directors hold 9.1 per cent of the issued share capital between them – Litigation Capital has experienced significant growth in recent years. In the seven financial years to 30 June 2018, the company generated a cumulative return on invested capital of 138 per cent, and posted an eye-catching portfolio IRR of 83 per cent.
Around 88 per cent of litigation projects the company backed were profitable in the seven-year period, with the average time from investment to settlement of a litigation case only 27 months, a relatively short holding period. Moreover, momentum is building as Litigation Capital delivered its strongest returns ever in the financial year to 30 June 2018, posting a profit before tax of A$12m (£6.7m) on 231 per cent higher revenues of A$31.2m, and reported a return on equity of 41 per cent.
The current portfolio consists of 16 unconditionally funded litigation projects and five conditionally funded projects. Litigation Capital is also targeting a further pipeline of 49 projects with estimated capital commitment of A$365m. This pipeline represents a set of qualified opportunities at various stages of due diligence. The move to Aim provides the company with access to additional capital in a larger and more mature market and complements its business expansion in the UK.
In line with the strategy for international expansion, the board of directors recruited a highly experienced UK litigation finance team of six staff, headed by executive vice chairman Nick Rowles-Davies, who joined Litigation Capital in 2018. He has a wealth of experience in this space, having created and defined the concept of portfolio litigation finance. Mr Rowles-Davies was a director of Burford Capital until 2016, where he had led the group’s non-US operations as managing director. Other members of the UK team are Matthew Denney and Tobey Butcher, both of whom were partners at Enyo Law, one of the UK’s largest and most respected litigation-only firms.
Not that Litigation Capital’s board lacks experience, as chief executive Mr Maloney has acted in more than 200 commercial litigation cases so knows the market inside out, while finance director Stephen Conrad has 25 years' investment banking experience. Indeed, the strategic addition of the UK team has provided Litigation Capital with a major opportunity to enter the European market. The company is also adding a corporate portfolio approach to the single-case funding that has been the origin of the business in Australia.
Peer group comparisons
Importantly, the listing of the shares on London’s junior market enables investors to value the business relative to peers. There’s value on offer. The company had net assets of A$25.4m (£14.2m), including cash of $13.8m and litigation cases with a book value of A$11m at the end of June 2018, since when it has raised £25.7m of net cash through the aforementioned placings to give a pro-forma NAV of £38m. This means Litigation Capital is being valued on a price-to-book value of 2.2 times, a hefty discount to Burford, which is valued on a price-to-book value of 3.8 times Numis Securities end-2018 NAV estimate of 572¢, albeit Numis Securities expects Burford’s NAV to rise to 670¢ by the end of 2019, and to 828¢ by the end of 2020, highlighting a strong earnings profile and realisation of profits from investments.
Clearly, Litigation Capital has a long way to go to emulate Burford’s success and the higher rating investors ascribe to its shares. However, it is clearly moving in the right direction as an IRR of 83 per cent and an 88 per cent success rate on its completed litigation cases highlights. These bumper returns reflect a conservative accounting approach in valuing legal claims, which results in the release of hefty profits when cases are settled.
Bearing this in mind, eight of Litigation Capital’s litigation projects are forecast to complete by the end of the 2019 financial year, two of which have already completed, a further six projects are forecast to complete by June 2020, and seven in the 2021 financial year, thus offering prospects for both newsflow and realisation of healthy profits on Litigation Capital’s investments in these ongoing claims.
With a smart team of legal eagles behind it, not to mention some heavyweight UK institutional investors, Litigation Capital shares look a decent long-term buy.
Bloomsbury Publishing (BMY)
Main: Share price: 218p
Bid-offer spread: 215-218p
Market value: £163m
This could be a magical year for shareholders of Bloomsbury Publishing(BMY), the company best known for publishing author JK Rowling’s Harry Potter series of best-selling books. It may be 21 years since the little wizard’s adventures at Hogwarts first put a magical step into Bloomsbury’s profits, but the appeal of the children’s books are showing no signs of waning.
In the financial year to end-February 2018, sales of Bloomsbury’s children’s books soared by almost a quarter to £69m, accounting for 42 per cent of the company’s total sales of £162m, helped in no small part by the special editions of Harry Potter and the Philosopher's Stone to mark the 20th year anniversary of its publication, the illustrated Harry Potter and the Prisoner of Azkaban and Fantastic Beasts and Where to Find Them. Bloomsbury also published two colour background titles for the British Library Harry Potter exhibition: Harry Potter – A History of Magic: The Book of The Exhibition; and Harry Potter – A Journey Through A History of Magic. It’s worth noting that as creator of these two new background titles, Bloomsbury can sell the rights internationally, which has potential to boost its profits.
But even excluding Harry Potter, Bloomsbury’s children’s book sales were still up by 14 per cent last year, helped by over 1m sales of Sarah J Maas’ book Throne of Glass and Kate Pankhurst's Fantastically Great Women Who Changed the World, the bestselling children's general non-fiction title of 2017. The book list for autumn and Christmas of 2018 was equally strong and included the latest work from Sarah J Maas, Kingdom of Ash, the illustrated version of The Tales of Beedle the Bard by JK Rowling, The Restless Girls by Jessie Burton and To Obama by Jeanne Marie Laskas. In addition, Bloomsbury published Tom Kerridge's Fresh Start, a major new cookery book to accompany his new BBC TV series, and two further books from Peter Frankopan, The Silk Roads Illustrated Edition and The New Silk Roads.
Bloomsbury’s 2020 digital strategy delivering
There has been positive newsflow too from Bloomsbury’s 2020 digital strategy which is on track to deliver £5m of operating profit and £15m of revenues by the 2021-22 financial year. The strategic initiative aims to accelerate growth of digital revenues and reposition the business from primarily being a consumer publisher to a digital B2B publisher in the academic and professional information market. In the first half of the financial year to end-February 2019, digital revenues increased by 13 per cent on a like-for-like basis, and revenues from academic and professional segments, an area the company has targeted to diversify the sales mix, grew by 9 per cent. The internally funded £5.8m acquisition of London-based academic publisher IB Tauris in May last year has further enhanced the offering in the non-consumer segment.
Moreover, at the end of October last year, Bloomsbury entered a major five-year digital subscription contract with the Institute of Chartered Accountants of England & Wales for Bloomsbury Professional Tax Online, providing further substance to its digital content offering with a new B2B partner. The company has also entered new partnerships with Spotifyand Yoox Net-A-Porter Group, which demonstrates management’s ability to develop innovative ways to market its digital offering.
The operational progress aside, Bloomsbury’s strong financials are highly supportive of the investment case. Cash conversion rates are eye-wateringly good. For instance, in the six months to end-August 2018, the company had a cash conversion rate of 172 per cent. Working capital management is improving, as the company is aiming for a 5 per cent reduction of inventories in the current financial year, thus freeing up more cash for organic investment and potential bolt-on acquisitions.
As always, there is a heavy second-half weighting to the full-year numbers. That’s because October is a key selling month for academic books, Christmas sales are all important for consumer titles, and rights and services income is dependent on securing a number of new contracts close to the February financial year-end. That said, the 13 per cent rise in Bloomsbury’s first-half adjusted pre-tax profits to £2.9m is supportive of expectations of full-year pre-tax profits rising from £13.2m to £14m on revenues of £163m, as analyst Malcolm Morgan at Peel Hunt predicts.
More importantly, as the restructuring of the business to enhance the digital offering gains traction, Bloomsbury is set to benefit from the attractive combination of rising operating margins on higher sales, a key reason why Mr Morgan thinks that pre-tax profits can rise by 12 per cent to £15.7m in the 12 months to end-February 2020 on revenues of £172m. The company’s operating margin is forecast to approach 10 per cent in the 2020-21 financial year. On this basis, expect EPS of 14.3p, 16.1p and 17.3p for the financial years to end-February 2019, 2020 and 2021, respectively.
Income stock with growth potential
This earnings growth profile is good news for the dividend, especially as Bloomsbury’s balance sheet is in rude health. Analysts predict a closing net cash position of around £29m at the end of this month, a sum worth 39p a share. This means that the board of directors can maintain its progressive dividend policy by recycling some of Bloomsbury’s bumper cash flow back to shareholders. Mr Morgan predicts a payout per share of 8p, 8.4p and 8.9p for the financial years to end-February 2019, 2020 and 2021, respectively.
Prospects for a step change in Bloomsbury’s profitability are not being reflected in the current rating, with the shares priced on a cash-adjusted PE ratio of less than 11 for the 2019-20 financial year and offer a prospective dividend yield of 3.9 per cent too. They are also modestly rated on a price-to-book value ratio of 1.2 times, so you’re not paying much of a premium to NAV for the strong likelihood of Bloomsbury delivering double-digit earnings growth from this point onwards. And because a chunk of net assets are held in inventories and cash, the shares are only rated on a Bargain Share rating of 0.4. Buy.
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