Simon Thompson's 2023 Bargain Shares Review

The negative market backdrop in my favoured hunting ground, coupled with the share price collapse of CleanTech Lithium (CTH), meant that the portfolio delivered a loss of 4.5 per cent compared with our in-print offer prices. The portfolio loss widened to 8.7 per cent if the opening offer prices on the day of publication are used. The FTSE All-Share index declined 1.2 per cent on a total return basis.

Although it is scant consolation that the portfolio managed to outperform the 13.4 per cent loss on the FTSE Aim All-Share Total Return index, it does show relative strength against the wider market in small and micro-caps, a positive that should work in our favour in a more benign equity market environment. There is also scope for the underperformers to recover their paper losses.

Gattaca

Investors latched onto the turnaround potential of Gattaca (GATC), the specialist science, technology, engineering and mathematics (Stem) recruitment business.

Driven by self-help measures that have seen the cost base rationalised, low-margin legacy business exited, the UK property portfolio slimmed down from five to three offices, and a keener focus on working capital management, the group is delivering strong earnings growth.

In fact, underlying pre-tax profit rocketed eightfold to £2.6mn in the 2022-23 financial year even though net fee income (NFI) dipped from £44.2mn to £43.4mn, a reflection of the much improved conversion of NFI to operating profit and a focus on more profitable work. At the same time, enhanced cash collection and payment terms slashed receivables and accrued income balances, so much so that net cash surged 75 per cent to £21.6mn to account for 62 per cent of Gattaca’s market capitalisation. 

In addition, better staff attrition rates have boosted sales productivity – NFI per recruiter increased 7.8 per cent to £125,100 in the 12 months to 31 July 2023. With the benefit of efficiency gains and improved standards, there should be further upside to this key metric.

The Stem markets are recovering to their pre-pandemic levels and a focus on Stem skills in well-defined markets should insulate the business from any significant swings in demand. Defence and infrastructure sectors account for half of NFI, and demand from both segments is robust. Moreover, more than a third of the £2.2mn forecast increase in NFI in the 2023-24 financial year is likely to come from Gattaca’s restructured international division. Sensibly, management has increased exposure to contract placements to mitigate any weakness in permanent recruitment given ongoing UK economic uncertainty. 

For the current year, Equity Development expects adjusted pre-tax profit to rise from £2.6mn to £2.8mn, and earnings per share (EPS) to surge from 4.5p to 6.5p with the benefit of a lower tax charge. Adjust for net cash per share of 67p, and the shares are rated on a modest forward price/earnings ratio of 6.6 times. Earnings per share (EPS) accretive share buybacks are supportive of the investment case, as is a progressive dividend policy. Excluding a special dividend of 2.5p that doubled last year’s payout to 5p, the dividend is expected to be hiked a third to 3.3p this year to underpin a prospective dividend yield of 3 per cent. Buy.

*Gattaca issued a trading update on 15 February 2024. The company confirmed that it is trading in line with profit expectations for the financial year to 31 July 2024.

Arix Bioscience 

Arix Bioscience (ARIX), a global venture capital company that holds a diversified portfolio of unlisted and listed investments in early-stage biotechnology businesses, was a classic Ben Graham recovery play 12 months ago.

Arix’s cash pile backed up 90 per cent of its market capitalisation of £137mn at the time, leaving a £106mn portfolio of biotech investments in the price for 13 per cent of their value. By the end of last year, Arix’s net asset value (NAV) of £229mn (178p a share) had edged up to £234mn (181p), of which £106mn was still held in cash, £59mn invested in listed equities and £66mn in an unlisted portfolio. Since then, NAV has been boosted by the acquisition of portfolio company Harpoon Therapeutics (US:HARP) by Merck (US:MRK). Arix will receive cash proceeds of £14.9mn, representing a £10.9mn (8p per share) increase on the £4mn carrying valuation of its stake. It raises Arix’s pro-forma NAV to £245mn (189p).

I was not the only one running the slide rule over the company, as Arix’s shareholders have recently agreed, at a 12 February meeting, to an all-share takeover from RTW Biotechnology Opportunities (RTW:101p). RTW is a specialised life science investor with a 14-year track record and one that has delivered an annualised net return of 21.6 per cent since inception from its leading private fund. Managed by a team of 43 investment professionals, RTW adopts a science-led investment approach. Combining the two funds will not only create an enlarged group with greater scale and a more diversified portfolio across both private and public assets, but it should improve the potential for a rerating.

The all-share deal was worth 131p per Arix share when RTW made its initial offer in November 2023, but is now worth 146.5p, a reflection of the subsequent 29 per cent increase in RTW’s NAV to $399mn (£317mn). If RTW can continue delivering healthy investment returns to its enlarged shareholder base, expect further share price upside from your newly issued RTW consideration shares. Hold.

TMT Investments

TMT Investments (TMT) is a venture capital company with a portfolio of 55 high-growth, internet-based companies in high-growth market segments: software as a service (SaaS), marketplaces, big data/cloud, EdTech, FinTech, ecommerce and foodtech solutions. The below-the-radar company continues to offer material share price upside, as well as hidden value in its portfolio.

For instance, when TMT reported a modest $2mn fall in NAV to $199mn (632¢) in the first half of 2023, the carrying valuation of its 1.3 per cent stake in international taxi and food delivery group Bolt was conservatively raised by $1.5mn to $71.3mn (226¢), implying a $5.7bn valuation for the whole company. Since then, the stock price of its closest and comparable rival, Uber Technologies (US:UBER), a $145bn market capitalisation company, has rallied 63 per cent. Bolt continues to record double-digit annualised revenue growth, and is targeting a move into profitability this year and a potential IPO in 2025.

In addition, TMT’s 10.4 per cent stake in Nasdaq-quoted cloud storage group Backblaze (US:BLZE) has risen 110 per cent in value from $16.2mn (51¢) to $34.1mn (107¢) since TMT’s half-year end. The holding now backs up more than a third of TMT’s market capitalisation of $97.8mn. Furthermore, TMT should still retain cash of around $6mn (19¢) after factoring in $0.9mn of new investments and $0.7mn of estimated second-half administration costs.

TMT’s undervaluation is even more anomalous when you consider that it has delivered an internal rate of return (IRR) of 16.3 per cent since IPO in December 2010, having invested in 95 companies, and realised 19 profitable full and partial exits. TMT was one of the earliest investors in four technology sector unicorns: Wrike (exited in 2018), Pipedrive (exited 2020), Bolt and Pandadoc, a proposal automation and contract management software provider.

Source: TMT Investments interim results presentation (15 August 2023). * 2023 NAV per share at 30 June 2023. All other figures at 31 December.

True, TMT’s shares are tightly held, with 12 shareholders holding three-quarters of the shares in issue. However, the below-average liquidity certainly doesn’t warrant a read-through 55 per cent share price discount to spot NAV, and one that could be substantially wider if the Bolt stake is (as seems highly likely) revalued upwards in the 2023 annual accounts to reflect the higher ratings of listed peers. In any case, an IPO of Bolt will highlight the hidden value on offer in TMT’s shares and should drive a material rerating. Buy.

Netscientific

Aim-traded investment company Netscientific (NSCI) trades at a 55 per cent discount to the £35.5mn (151p) last reported fair valuation of its portfolio, even though multiple investee companies have had funding rounds at materially higher valuations. In fact, I estimate the pro-forma portfolio valuation is now at least £37mn.

For instance, Netscientific’s 25 per cent stake in Vortex Biotech quadrupled in value to £2.8mn after the company raised £3.2mn in an Enterprise Investment Scheme (EIS) funding round in June 2023. It was a similar story at University of Leuven spin-out DName-IT, a company that has developed a platform to avoid sample authentication errors in genetic sequencing laboratory tests. It is of keen interest in high-priority areas such as cancer diagnostics, precision medicine and non-invasive prenatal testing. Netscientific's corporate finance boutique, EMV Capital, led a £0.5mn EIS investment round that sent the valuation of Netscientific’s retained 36.9 per cent stake soaring from £0.1mn to £1mn.

The finance boutique also led a funding round for Ventive, a designer and manufacturer of intelligent heating and ventilation solutions to make buildings healthy, efficient and affordable. Ventive’s passive air ventilation system has been installed in more than 30 schools and five leisure centres. EMV Capital retains an 11 per cent stake on a fully diluted basis that has a fair valuation of £0.9mn, or 17 times higher than the £52,000 carrying value in Netscientific’s 2022 accounts.

Another astute call is the investment in Q-Bot, a London-based robotics and artificial intelligence company that has developed a patented energy-saving robotic system for applying insulation in tight spaces and suspended floors (to reduce heat loss and prevent draughts, damp and mould). The holding was last valued at £4.1mn in June 2023, or double the valuation 12 months earlier, and accounted for 11 per cent of the company’s total portfolio valuation in its 2023 interim accounts.

It’s worth flagging up that Netscientific’s market capitalisation of £15.5mn places no value on the £26.1mn capital under advisory (CUA) of EMV Capital. EMV syndicates investments between financial and corporate investors, and earns a mixture of corporate finance fees, management fees and carried interests in the syndicated investments. Based on an average two times portfolio return on CUA, these carried interests could deliver returns of £4.5mn (19p) to EMV, a sum equating to 28 per cent of Netscientific’s market capitalisation.

The share price discount is even more extreme when you consider that the company holds 1.33mn Nasdaq-listed shares worth £5.7mn (24p) in PDS Biotechnology Corporation (US:PDSB), a clinical-stage company that is developing cancer immunotherapies and infectious disease vaccines based on its proprietary technology platform. Buy.

Logistics Development Group 

There have been some disproportionate de-ratings of companies in the small and micro-cap hunting ground in the past year. Logistics Development Group (LDG), an investment company managed by asset management firm DBay, is a case in point.

LDG holds stakes in four companies: Alliance Pharma (APH), a distributor of consumer healthcare and pharmaceutical products; Finsbury Foods, a speciality bakery manufacturer of cake, bread and morning goods; SQLI (FR:SQI), a leading pan-European digital transformation business; and Trifast (TRI), an international distributor of industrial fasteners.

True, the holding in Alliance Pharma is underwater, having lost a third of its value. Although the company’s board managed to hit 2023 profit guidance, the directors expect a flat outcome in 2024 due to higher investment in sales and marketing, implying an 18 per cent downgrade to consensus estimates. On this basis, the shares are rated on a price/earnings (PE) ratio of 8, a rating modest enough that even analysts at Peel Hunt, who have taken a cautious approach to date, have fair value a third higher than Alliance Pharma’s current share price.

LDG’s investment in private holding company Synsion, which holds shares in SQLI, has made good some of the paper loss on Alliance Pharma. LDG’s 9.5 per cent read-through equity stake in SQLI was acquired for €15mn (£12.8mn) and is currently worth €18mn. Based in Paris, SQLI has leading positions in the fast-growing ecommerce/omni-channel integration space and its blue-chip clients include global giants LVMH, Airbus, Nestle, L'Oreal, and Adidas.

LDG also booked a £4mn paper profit on its 12.4 per cent stake in Finsbury Foods after the speciality bakery manufacturer was acquired for £143mn by funds managed by DBay. The offer valued Finsbury on 8.3 times operating profit to enterprise value, a low multiple for a growing business. I can see Finsbury being relisted or sold on for a decent gain at some point.

The bottom line is that although LDG’s pro-forma NAV per share of 19.36p is 8 per cent below the 21p level recorded when I included the shares in my 2023 Bargain Shares Portfolio, its share price has fallen 18 per cent per cent to 12.13p even though LDG retains net cash of around £43.1mn (8.1p). It means that the four shareholdings, which have a combined value of £59.2mn (11.1p), are in the price for £21mn (4p), or almost two-thirds below their carrying valuations. That’s an extreme discount, and one that has scope to narrow in a more benign equity market environment for small and micro-cap companies. Buy.

CML Microsystems

Maldon-based semiconductor chip designer and manufacturer CML Microsystems (CML) is reaping the benefits of the strong secular drivers in its end markets.

In the first half of the 2023-24 financial year, the group delivered underlying revenue growth of 9 per cent at constant currencies, an impressive result given the macroeconomic backdrop and a healthy outperformance of the global semiconductor market, which reported falling sales in the second and third quarters of 2023.

It highlights the resilience of CML’s end markets, where the focus is on industrial and critical communications applications, in contrast to the memory, personal computer and consumer markets, which tend to exhibit more volatility. The group’s key markets include mission-critical communications, wireless networks and satellite, industrial internet of things and broadcast radio. Furthermore, the recent acquisition of Microwave Technology expands and complements CML’s growing product portfolio in high-growth market segments.

The underlying strength in the business is such that the directors are guiding investors to expect full-year revenue to be slightly higher than previous expectations, prompting house broker Shore Capital to edge up its estimate at the end of 2023. On this basis, annual pre-tax profit is predicted to increase by 22 per cent to £4.4mn on 13 per cent higher revenue of £23.3mn, but earnings per share (EPS) will be flat at around 22.2p due to a higher tax charge.

CML is not only delivering strong profit growth, but has a rock-solid balance sheet, one of the reasons I selected the shares for last year’s portfolio. That’s because recycling the cash pile into earnings-accretive acquisitions creates a favourable tailwind for investors. Analysts estimate closing net cash of £18.3mn (114p) at the forthcoming financial year-end (31 March 2024), a figure that should get a boost in due course from the disposal of a surplus £2mn freehold commercial property in Fareham, Hampshire and 15 acres of excess land at the company’s Maldon head office, which is now being marketed for sale.

Trading on a cash-adjusted PE ratio of 14, and on a modest 7.4 times cash profit to enterprise valuation, CML’s ongoing outperformance of peers is underrated. A 2.8 per cent prospective dividend yield adds to the attraction. Buy.

Checkit 

Cambridge-based workflow management software technology group Checkit (CKT) has been winning some notable contracts, giving shareholders confidence that it can accelerate its move to profitability, and markedly reduce cash burn, as the directors believe.

To achieve this, management is pursuing a “land and expand” strategy focussed on higher quality and higher value recurring revenue growth. Last year’s awards include an expanded three-year contract worth £6mn with John Lewis and Waitrose, and three contracts with FTSE 100 food and support services group Compass. The Compass contracts added annual recurring revenue (ARR) of £35,000 each, but Checkit is targeting 15 more opportunities with the FTSE 100 group, several of which are worth £100,000 in ARR. It’s easy to see why the technology is becoming increasingly popular.

That’s because Checkit’s workflow management software platform provides its customers with data-driven remote monitoring and automated systems surveillance to manage their teams of deskless workers. By digitising the scheduling and reporting of workflows, it can boost staff efficiency and deliver better management insight. Furthermore, Checkit has been adding artificial intelligence (AI) tools to provide customers with valuable predictive insights, making the company an under-the-radar AI-enabled data play.

Importantly, Checkit has a captive target market across its key healthcare, food retail and hospitality market segments as inflationary pressures have placed even greater pressure on organisations to make operational savings and improve the productivity of workers. They are faced with increased regulatory compliance, too.

Checkit will release a pre-close trading update on 15 February 2024, which I expect to detail the progress being made with new contracts as well as the customer beta testing of its AI tools (which optimise the maintenance of their assets and energy usage). Ahead of the announcement, analysts at Edison expect the annual cash loss to have narrowed from £6.4mn to £3.6mn in the 12 months to 31 January 2024 and predict a much reduced net operating cash outflow of £3.9mn. There could be a dramatic fall in net operating cash outflow in the new financial year as Edison expects this to reduce to £0.9mn based on its financial forecasts (see table).

Once the business hits cash flow break-even, the ramp-up in cash profitability (driven by growth in ARR) thereafter should see its cash position build and force investors to reassess the merits of the business model. Checkit has the cash funding to reach that inflexion point.

That possibility is certainly not being priced in as Checkit is being valued on a multiple of only one times ARR relative to its enterprise valuation. To put the modest rating into perspective, software as a service (SaaS) listed peers in the US are rated on a multiple six times higher. It is a relevant comparable given that the US market is a key growth driver for Checkit: the segment accounting for a quarter of its ARR and delivered 41 per cent growth in the first half of 2023. Buy.

Source: Company data, Edison Investment Research estimates (September 2023). ** continuing operations only.

*Checkit issued a pre-close trading update on 15 February 2024. The company expects to report a better than expected cash loss of £3.4mn for the 12 months to 31 January 2024. 

CleanTech Lithium

CleanTech Lithium (CTL), a lithium company that is advancing sustainable lithium projects in Chile, has seen its share price collapse in the past 12 months.

In April 2023, investor sentiment took a hit after the government in Chile announced a National Lithium Strategy that will focus on ‘majority state control’ for assets of strategic importance to the country. It related primarily to the Atacama and Maricunga ‘Salars’ (salt flats), due to their lithium reserves, size and high levels of lithium concentration.

By comparison, CleanTech’s assets are considerably smaller compared with Salar de Atacama, which has 37 per cent of the world’s lithium reserves. They have lower levels of lithium concentration and, while still highly economic, they are not of the scale that could be considered assets of national strategic importance.

CleanTech’s board subsequently confirmed that its projects are not subject to majority state participation requirements, but as the company works towards licensing it may invite the state to take a minority stake in the projects, thus aligning interests and allaying investor concerns. Clearly, some investors have yet to be convinced.

Investor sentiment has also been materially undermined by the precipitous fall in the lithium carbonate equivalent (LCE) price. It has declined 78 per cent to $13,700 per tonne in the past 12 months. The reversal is best explained by analysts at commodity price reporting agency Fastmarkets. They note that “while electric vehicle (EV) sales remained robust [in 2023], they could not match the exceptional year-on-year growth rates observed in recent years. Excess EV production capacity, a build-up of inventory and destocking by cathode producers resulted in thin demand for battery materials. This coupled with upstream expansions and market oversupply led to a notable softening of battery raw material prices in 2023.” It also meant that the market swung from a supply deficit to a surplus in 2023.

The weaker pricing environment has implications for all lithium miners as it impacts the economics of their projects. In the case of Cleantech, its Laguna Verde and Francisco Basin flagship projects require capital investment of $384mn and $450mn, respectively, to first production. Based on annual production of 20,000 tonnes of battery-grade lithium carbonate and a long-term LCE price of $22,500 per tonne, the projects were expected to deliver cumulative operational cash flows of $6.3bn and $2.5bn, respectively, over their operational lives of 30 and 12 years.

However, the current spot LCE price is 40 per cent below the long-term price embedded in the financial models. It means that the projects’ post-tax net present value (NPV) estimates of $1.8bn and $1.1bn (based on an 8 per cent discount rate) are materially lower at spot LCE prices.

That said, they are still economically viable as they have forecast operating costs of $3,875 and $3,641 per tonne, respectively, well below the spot LCE price of $13,700 per tonne. It’s just that the payback of capital investment will take longer, and the internal rate of return (IRR) could be far less than originally projected.

There is no doubt that the directors are doing the right things, commencing a drilling programme at Francisco Basin in the final quarter of 2023, the results of which should enable CleanTech to extend the production life and enhance the project’s economic returns.

They have also commenced a pre-feasibility study (PFS) at Laguna Verde, which will enable CleanTech to enter substantive discussions on strategic partners, offtake arrangements and financing to further progress the project. In addition, CleanTech has commenced a five-well drilling programme at Laguna Verde to increase its JORC resource, and is completing the Direct Lithium Extraction (DLE) Pilot Plant to produce battery-grade lithium carbonate.

An oversubscribed open offer and placing raised £8.5mn, at 22p a share, in November 2023 to fund these programmes, taking the total capital spend on them to £25mn since the start of 2022. Investors also received one warrant for every two new shares purchased in the November placing. They have an exercise price of 33p and three-year term.

Ultimately, CleanTech’s share price will be driven by a recovery in the lithium price.

Analysts at Fastmarkets believe “we are approaching the bottom of the market, considering the industry is moving [fairly] deep into the cost curve. This is likely to support lithium prices as producers consider further production cuts to balance the market and stem further losses”. They are predicting “some restocking in the second quarter of 2024, which should result in a mild recovery in prices and may also prompt some fast price swings”.

True, it could prove short-lived as many analysts are maintaining their bearish outlook on lithium prices given that the uncertain economic climate and relatively high interest rates continue to weigh on the buying decisions of new EV purchasers. However, it wouldn’t take much of a recovery in the LCE price to send bombed-out share prices of lithium miners surging given the impact on the profitability of their projects. Buy.

■ Special offer. Simon Thompson's books Successful Stock Picking Strategies and Stock Picking for Profit can be purchased online at www.ypdbooks.com at the special discounted price of £5 per book plus UK P&P of £4.95, or £10 for both books plus UK P&P of £5.75, subject to stock availability.

They include case studies of his market beating Bargain Share Portfolio companies outlining the characteristics that made them successful investments. Simon also highlights other investment approaches and stock screens he uses to identify small-cap companies with investment potential. Full details of the books’ content can be viewed on www.ypdbooks.com