When I suggested buying shares in private equity investment company LMS Capital (LMS:49.3p), it was predicated on top-rated fund manager, Gresham House Asset Management (GHAM), recycling LMS’s cash pile (currently accounting for £28.5m of LMS’s market capitalisation of £39.8m) into new investments and replicating its success at Gresham House Strategic (GHS:1,245p), a constituent of my market beating 2016 Bargain Shares Portfolio and one of the best performing small-cap funds this year. The majority of LMS’s board concluded that GHAM should continue as the appointed investment manager for the next five years, a decision that Robert Rayne, a major shareholder, opposed as he wants to take the investment management in-house.
He has succeeded. That’s because although shareholders controlling 28.6m of the 80.7m shares in issue voted in favour of keeping the mandate with GHAM, and only 8.5m backed Mr Payne’s proposal, the 32.6m shares attributable to Mr Rayne’s family holdings tipped the balance. LMS’s independent directors have all resigned and Mr Rayne has appointed three non-executives of his own, and a managing director, too, the board being chaired by Mr Rayne. GHAM’s £58m investment mandate will terminate on 31 May 2020. The mandate is not material to the £2.45bn assets under management (AUM) of Gresham House (GHE:580p), but that’s not the issue.
My concern is that the concert party has effectively taken control of LMS without paying a premium for doing so. In my view, this will create an overhang of shareholders (who had previously been backing GHAM) who will want to exit. The fact that LMS’s share price reversed from a 12-month high of 59.5p at the end of October is telling, as is the fact that, at 49.3p, the shares now trade on a 32 per cent discount to net asset value (NAV). I can see no reason why new buyers would want to back Mr Rayne’s team at this juncture given that LMS now has fewer resources at its disposal and also needs to recruit expertise it currently doesn’t have.
So, having recommended buying the shares, at 48.8p, in my April Alpha small-cap report, I recommend exiting at around break-even. Sell.
Mercia’s acquisition and controversial fundraise
Several readers have contacted me regarding last week’s equity raise and proposed acquisition by Aim-traded Mercia Asset Management (MERC:27.6p), a cash-rich specialist asset manager focused on supporting regional small- and medium-sized enterprises (SMEs), and a constituent, at 29.57p, of my market-beating 2019 Bargain Shares Portfolio when the company was called Mercia Technologies.
The company also announced half-year results that revealed a £1.9m operating profit post a £3.2m valuation gain on its £102m directly held investment portfolio, closing unrestricted cash of £17.8m and a NAV of £128m, or 42.3p a share. There is nothing new to report on that front. What is new is the company’s fundraise. That’s because in order to fund the proposed £25m acquisition of the venture capital trust (VCT) fund management business of NVM Private Equity, Mercia has conditionally placed 120m shares to raise £30m, the 25p issue price representing an eye-watering 40 per cent discount to NAV. The equity raise equates to 39.6 per cent of the existing issued share capital. There is no open offer, so the vast majority of small shareholders who have been unable to participate in the accelerated book build will have been shut out and will see their economic interest in the equity diluted. Mercia’s post-placing NAV per share falls to 37.4p.
I don’t dispute the strategic rationale for making the acquisition as it adds AUM of £270m to increase Mercia’s AUM to £770m, brings in £4m of annual net income to turn Mercia’s fund management business profitable, and expands the universe of direct investment opportunities available. What I am deeply uncomfortable with is an investment company raising new equity at a 40 per cent discount to NAV, and issuing £4.2m of new shares to the vendors at the deeply discounted placing price of 25p as part of the initial consideration of £16.6m. Please note that £12.4m of the £30m placing proceeds will fund the cash element of the acquisition, £2.6m will fund transaction costs, and the balance of £15m will be used to fund new investments. Furthermore, Mercia’s board had an opportunity at the end of July this year to raise new funds and make an acquisition when the shares, at 38.5p, were trading on a slim 7 per cent discount to end March 2019 NAV of 41.5p.
In my view, there is no way Mercia’s share price discount to NAV will narrow markedly if investors have, and rightly so, concerns that the board could, and clearly will, issue shares that dilute the economic interests of existing shareholders in this way. The transaction is subject to shareholder approval at a meeting on 20 December, but I am unable to sanction it given the destruction of the economic interest of the private retail investors who follow my column.
In fact, I feel so strongly about this that I am exiting the holding altogether at the current bid price of 27.5p. True, this crystallises a small paper loss of 7 per cent on my entry point, but I can stomach the hit as my 2019 Bargain Shares Portfolio is showing a 29 per cent total return since inception on 1 February in a flat market for Aim-traded stocks. Please note that this reverses my previous buy recommendation, at 23p (Exploiting a glaring valuation anomaly, 31 Oct 2019). Sell.
|Simon Thompson's 2019 Bargain Shares portfolio performance|
|Company name||TIDM||Market value||Opening offer price 1.02.19||Lastest bid price 9.12.19||Dividends||Percentage change|
|TMT Investments (note one)||TMT||$163m||250¢||580¢||20¢||140.0%|
|Futura Medical (note two)||FUM||£70m||14.85p||34p||0p||129.0%|
|Litigation Capital Management||LIT||£81m||77.5p||74p||0.81p||-3.5%|
|Jersey Oil & Gas||JOG||£35m||205p||162p||0p||-21.0%|
|FTSE All-Share Total Return index||6,852||7,506||9.5%|
|FTSE Aim All-Share Total Return index||1,023||1,034||1.0%|
|Note 1: Simon advised taking profits on TMT Investments at 580¢ a share on Monday, 9 September 2019 ('Takeovers, tender offers and taking profits', 9 September 2019).|
|Note 2: Simon advised taking profits on Futura Medical at 34p a share on Monday, 14 October 2019 ('Bargain Shares: golden opportunities', 14 October 2019).|
|Source: London Stock Exchange opening offer prices at 8am on 1 February 2019 and closing bid prices on 9 December 2019|
Bowleven downgrades Etinde resource
I included shares in Africa-focused oil and gas exploration group Bowleven (BLVN:5.5p) in both my 2016 Bargain Shares Portfolio and 2017 Bargain Shares Portfolio (at 18.9p and 28.9p, respectively). I subsequently advised taking profits on half of your holdings, at 33.75p (‘Hitting pay dirt', 9 Apr 2018) and you will have banked a 15p a share special dividend on the balance earlier this year. This means that the holding is showing a 43 per cent gain on the 2016 portfolio entry point, and a modest 6 per cent loss in the 2017 portfolio.
The issue I have is that the economic value of Bowleven’s 20 per cent equity interest in the Etinde field offshore gas project in offshore Cameroon has been impaired by $62m (£47m) in the company’s latest annual accounts following a resource downgrade – it is clearly taking longer to progress to production, and the development is unlikely to be signed off by the time the current licence expires in January 2021. Moreover, the final investment decision (FID) on the project was previously scheduled for late 2019 or early 2020, at which point Bowleven will receive a $25m cash payment from its joint-venture partners under the terms of the original farm-out agreement. However, this has now been pushed back to the third quarter of 2020. In the circumstances, I see little point maintaining an interest and am selling out.
|Simon Thompson's Bargain Shares Portfolio 2016 performance|
|Company name||TIDM||Opening offer price (p) 5.02.16||Bid price (p) 9.12.19||Dividends (p)||Total return (%)|
|Bioquell (see note one)||BQE||125||590||0||372.0%|
|Volvere (see note six)||VLE||419||1,150||0||188.2%|
|Gresham House Strategic||GHS||796||1245||43.35||61.9%|
|Bowleven (see note two)||BLVN||18.935||5.5||15||43.2%|
|Juridica (see note three)||JIL||36.1||14||32||27.4%|
|Mind + Machines (see note four)||MMX||8||7.5||0||2.8%|
|Walker Crips (see note five)||WCW||44.9||25||5.59||-31.9%|
|FTSE All-Share Total Return||5,180||7,506||47.2%|
|FTSE Aim All-Share Total Return||747||1,033||41.5%|
|1. Simon Thompson advised buying Bioquell's shares at 149p in February 2016. Bioquell bought back 50 per cent of shares in issue at 200p each in June 2016 through a tender offer and Simon recommended buying back the shares in the market at 145p to give an average buy-in price of 125p (‘Bargain shares updates’, 22 June 2016). Company was taken over at 590p cash per share in January 2019.|
|2. Simon Thompson advised banking profits on half of your holdings in Bowleven shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019. The total return reflects this share sale.|
|3. Simon Thompson advised buying Juridica's shares at 41.2p in February 2016. Juridica subsequently paid out a special dividend of 8p a share in June 2016 and Simon recommended buying shares in the market at 61p using the cash proceeds to take the average buy-in price to 36.1p (‘Brexit winners', 1 August 2016). Juridica then paid out a special dividend of 32p a share in September 2016 and total return reflects this distribution. Simon advised selling the holding at 14p ('Taking Q1 profits and running gains', 4 April 2017), hence the price quoted in the table.|
|4. Simon Thompson advised buying Mind + Machines' shares at 8p in February 2016. Mind + Machines subsequently bought back 13.22 per cent of the shares in issue at 13p a share. The total return reflects this capital distribution. Simon advised selling the entire holding at 7.5p, which is the exit price stated in the table ('Strategic acquisitions', 9 May 2018).|
|5. Simon Thompson advised selling Walker Crips' shares on Monday, 4 March 2019 at 25p ('Bargain Shares Portfolio updates', 4 March 2019). This is the exit price quoted in the table.|
|6. Simon Thompson advised rendering 41.18 per cent of your holdings back to the company at 1,290p a share. Tender completed 19 June 2019 ('Tenders, takover and hitting target prices', 3 June 2019). Return is adjusted to factor in this capital return.|
|Source: London Stock Exchange share prices|
I have decided to bank my remaining profits on Aim investment company Volvere (VLE:1,175p), having recommended tendering your basic entitlement (41.18 per cent of your holdings) at 1,290p a share earlier this year, so realising an eye-catching 208 per cent premium to the 419p entry level in my 2016 Bargain Shares Portfolio. The gains have also driven a 78.9 per cent portfolio total return, significantly higher than that of the FTSE All-Share (47.2 per cent) and FTSE Aim All-Share (41.5 per cent).
The company is heavily cashed up (net funds of 915p a share) and the shares are also priced on a discount to last reported NAV per share of 1,356p, so there is solid firepower for co-founders, Jonathan and Nick Lander, to finance their next turnaround situation. They are smart investors, which is why Volvere’s book value per share has increased at a compound annual growth rate of 17 per cent since the company listed its shares, at 100p, on Aim in December 2002. However, until they have made their acquisition, and delivered valuation upside, I can see the share price discount to NAV persisting. Bank profits.
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Simon Thompson has been named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards, a prestigious event celebrating the best and rewarding the finest professionals and companies that work within the AIM and NEX communities. It is attended by institutions, fund managers, brokers and advisors operating in the sub-£100m market cap quoted company sector.