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Exploiting companies under the radar

Our stock picking experts highlights share price catalysts to spark re-ratings for two small-cap companies.
Exploiting companies under the radar
  • In active contract talks worth “seven figures” in revenue.
  • Contracted order book covers 90 per cent of 2021 estimates.
  • Proforma net cash and access to low-cost debt facilities.

Annual results from Pennant (PEN:39p), an Aim-traded supplier of products and services that train and assist engineers in the defence and civilian sectors, were in line with the directors’ guidance given at the interim results (‘Companies on the rebound’, 24 September 2020).

A Covid-19 pandemic induced first half underlying operating loss of £2m on revenue of £6m, reversed into a second half operating profit of £1m on revenue of £9.1m. These figures exclude £0.54m of restructuring expenses which will produce £1m of cost savings in 2021. Prospects for the momentum to build are undeniably positive.

Firstly, £14.4m of Pennant’s £31m order book is for delivery in 2021 and includes two valuable government multi-year contracts (£5.4m of annual revenue) with the Canadian and Australian defence departments to use Pennant’s Oracle-based OmegaPS software product (reduces the support cost of major capital equipment). The 2021 order book also includes £1.4m of revenue from Absolute Data Group (ADG), a Brisbane-based software company that complements Pennant’s OmegaPS software. ADG helps its client base (military aviation, commercial aerospace, and marine, rail, nuclear and automotive sectors) to manage vast quantities of maintenance and training data.

Pennant’s chief executive Phil Walker informed me that ADG, which was acquired for £3.4m last year, is “performing exceptionally well” and is in active contract talks with a US defence original equipment manufacturer (OEM) and an Australian company in relation to contracts worth “seven figures in revenue”. ADG’s North American trading subsidiary accounts for two-thirds of its annual sales. Winning either award would drive up earnings markedly given the high margins earned on software sales.

Secondly, having landed a £1.5m training aids contract from a long standing Middle East customer last year, Walker revealed that the balance of the contract (around £3m) needs to be signed by the autumn for it to be fulfilled for the start of the 2022 academic year.

Thirdly, Pennant’s £50m bid pipeline includes the 'Major Programme', for which it was 'down-selected' in August 2018. Progress to contract award (£15m to £20m) has been impacted by the UK Government's 'Integrated Review of Security, Defence, Development and Foreign Policy'. The Review was finally published last month and reaffirmed the UK Government's commitment to the relevant military platform. This means that the overarching programme should proceed, albeit Walker doesn’t expect any contract award until the latter part of 2021, at the earliest.

Importantly, Pennant has balance sheet flexibility to fulfil its working capital requirements as business ramps up again. Proforma net cash is £1.1m and Pennant has a £4m low-cost bank facility with HSBC.

The bottom line is that although house broker WH Ireland’s 2021 revenue estimate of £16m produces a modest pre-tax profit, there is a live chance of material outperformance if ADG lands any one of several live contracts in its pipeline. Buy.


Frontier IP’s hidden value

  • Exscientia latest fundraise at material premium to carrying value of Frontier’s holding.
  • Annual results to be “be materially ahead of management expectations”.

Shares in Frontier IP (FIPP:83p), a company that provides a range of commercialisation services to university spin-outs in return for ‘free equity’ stakes, have increased 40 per cent in value since I highlighted the company’s ‘hidden value’ (‘Exploiting two small-cap pricing anomalies’, 5 March 2021). The re-rating is far from over.

That’s because Frontier’s largest portfolio company, Exscientia, a clinical stage pharma technology company pioneering the use of artificial intelligence (AI) to design new drugs, has just raised US$225m (£162m) in a Series D funding round led by Softbank’s Vision fund. It was backed by a host of shrewd investors including GT Healthcare Capital and Bristol-Myers Squibb. In addition, Softbank is providing an additional US$300m equity commitment to Exscientia that can be drawn at its discretion. Exscientia has advanced the first two fully AI-designed drugs into clinical trials and now has over 20 active programs in its pipeline

Frontier’s 2.27 per cent stake in Exscientia was revalued up by £1.87m to £6.269m (11.4p a share) at 31 December 2020, implying a read through valuation of £276m ($384m). However, Sky News subsequently reported Exscientia’s March 2021 $100m Series C investment round managed by BlackRock was priced at a $650m (£464m) valuation, implying a £9.8m (17.8p a share) valuation for Frontier's 2.11 per cent diluted stake.

Although Exscientia has yet to reveal valuation details of this week’s US$225m Series D funding round, Frontier’s corporate broker N+1 Singer expects the company to deliver £6m valuation gains in the second half to June 2021 and has a £61m (111p a share) sum-of-the-parts valuation on the portfolio. My 100p target price could prove conservative. Buy.


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