activist investors, Amberley Group, blind stock valuation, Brookwell Ltd, Brulines Group, catalyst, Ennismore, GemPAY, HTEC, Jewel in the Crown, P/S Ratio, Progressive Asset Mgmnt, Robert Goddard, segment/divisional reporting, Stephen McLeod, Universe Group, Vianet Group
Continued from here, and here. So, from a whole universe of stocks, what’s my bloody blind stock? Universe. No, seriously mate, what is it..? Universe! OK, you’re taking the piss, what the hell’s your blind stock?! Universe..! It’s Universe Group plc (UNG:LN) :-)
Its core operating sub. (HTEC) has over 30 yrs of experience in providing Loyalty, Payment & Forecourt Technology Solutions to petrol retailers, primarily in the UK & Ireland. This is a specialized & attractive niche, with many of the major oil companies & UK supermarkets as customers. Universe reports in three functional segments: i) Petrol Forecourt Solutions (PFS): POS & payment systems, business analytics, and automatic number plate recognition (APNR) software, ii) Universe Data Services (UDS): Loyalty schemes, and APNR software, and iii) Contract Electronic Manufacturing (CEM): Contract design, development, manufacturing & repair services. Let’s jump straight into some total company figures¹ (for 2007-10):
Oh Jesus, look at that net income history – it’s horrible! I should have just posted that in my blind stock challenge and asked: Would you buy this stock..?!
Aah, that’s a little better… This is what I was highlighting in my Jewel in the Crown post. PFS is the obvious jewel, UDS is the erratic division, and then we’ve got CEM, the dud. Sigh…like any red-headed step-child, Universe should simply abandon CEM at the next petrol station! But then UNG’s been struggling with legacy businesses/issues for years. In 2005, they sold a money transfer business, followed by the sale of a bureaux de change business in 2007. This promised a better focus on HTEC…no, instead they came up with the half-witted idea to set up Jet Set and sell car wash & valet systems. A low-margin hardware business if I ever saw one. It took 2-3 years of losses before they threw the towel in and disposed of it in 2010…
Then, of course, there’s the original core of HTEC, i.e. CEM, and its steadily declining revenues & increasing losses! Plus constant goodwill/restructuring write-downs, coupled with an apparently wasteful level of R&D spending… Not surprisingly, all accompanied by numerous management & director changes. All a part of Universe’s long, painful & stop-go evolution from a manufacturing & product sales company to a software/transaction solutions provider, focused on increasing recurring revenue streams.
This finally led to a clean sweep in May/June 2011, with Stephen McLeod and Robert Goddard appointed CEO & Non-Executive Chairman. Both engineers by training – McLeod’s had a career working in corporate strategy and the chemical & travel management industries, while Goddard’s background was with Burmah Castrol, managing their fuels & chemicals business. They’ve also shared certain company directorships, having worked together over the years.
Goddard’s focus on advisory & turn-around assignments, in the past decade or so, is particularly relevant here. In fact, this new career phase kicked off with a v successful 3 yr CEO stint at Amberley Group, where he turned-around & sold off their chemical businesses. Rather intriguingly, a significant UNG shareholder (Progressive Asset Management) was on the register at the time. Is there a connection? Checking the latest Brookwell Ltd (BKWD:LN) annual report, we find: ‘Brookwell introduced a new chief executive and chairman to the board of Universe Group.‘ Aha! And their latest interims confirms UNG as a small but Top 10 holding for them.
So, how has the new team done since? First, they immediately reorganized the business units, combining PFS & UDS into a Solutions business. Makes sense, considering their degree of business overlap – hopefully, it will offer some margin opportunities and/or an elimination of UDS’ margin volatility. CEM’s now the sick beast separated from the herd… Another million of expense is also re-allocated to Solutions, reducing Central Costs to a minimum². Let’s look at the figures³:
OK, seems like some improvement has occurred… But don’t forget the new team arrived just before mid-year, and has made tremendous progress since then. The annual results don’t show this v well, but we’ve some insight into the new team’s pragmatic & bullish perspective. I like McLeod’s comment: ‘The strengths and many successes of the Company and its people have hitherto been largely hidden and unappreciated by all except industry insiders. This will change.‘
And at the recent AGM, Goddard stated: ‘Under the new management team, Universe was restructured and reorganised in line with a new three year growth plan. We now enter the second year with a more efficient structure and customer-led focus. I am pleased to report that trading in the new financial year to date is ahead of the comparable period last year and in line with market expectations. We continue to view the Group’s prospects positively. A key objective for the year is to complete our product enhancement programme [fyi GemPAY, and a suite of other next-gen products], which will open up new opportunities for us with both existing and new customers.‘
With no apparent seasonality, and considering the new team’s progress & commentary to date, I think it’s only logical to construct an annualized run-rate from H2 2011 results (with a minor tweak for net interest) as follows:
Now we’re talking..! There’s significant progress with Solutions’ revenues & margins – the stand-alone value of this business would obviously vastly exceed Universe’s GBP 2.7 mio market cap. But we’re not finished: Cashflow’s kept pace with adj operating profit in 2009-11, but things are changing quickly and depreciation/amortisation etc. aren’t necessarily the same as cash spent. Let’s repeat the exercise above with EBITDA, and some capex, product development & restructuring assumptions, to gain another perspective on underlying profitability. If I’m a little more aggressive, and assume capex4, product development & restructuring cash spend is maintained at H2 2011 levels, we get:
Think this is too aggressive? Well, overall R&D expense in the 2011 P&L was actually GBP 1.6 mio, a rather colossal 13.1% of Revenues! This suggests plenty of scope to trim R&D spending and increase Operating Profit to this higher level. With the new suite of products coming on-line, this also suggests a significant R&D reduction in the near-term (and increased revenue opportunities, of course!).
Now, let’s talk catalysts: I didn’t highlight a change in management in my catalyst series. Mainly because it’s mostly not (particularly if there’s internal recruitment), it’s usually more of the same… I don’t have a great rule of thumb either for you to identify management that will actually effect significant/immediate change – it’s v case-specific! But with Universe, the arrival of Goddard & McLeod is clearly a catalyst. We also have at least two activist investors on board as another potential catalyst..!
The first I mentioned, Brookwell (with a 10.6% stake) is an AIM realization vehicle, and is quite prepared to use activism to liquidate holdings at a good price. The second I’ve saved as a surprise: Vianet Group (VNET:LN) (formerly Brulines Group), a much larger competitor to UNG! Yes, Vianet’s had an 11.5% shareholding ever since a failed bid for Universe in 2009/10. Ennismore Fund Management has an even larger 13.5% stake – they aren’t noted for activism, but they’re a v well respected small company investor. Finally, current & former directors hold 12.1% (and McLeod has 3.4 mio zero-cost options exercisable only if the share price is at/above GBP 5p). If all that doesn’t ultimately spark an ‘event’, I don’t bloody know what will..!?
To recap: Universe has been slowly transforming itself into a high-margin software/transaction solutions provider. But underlying margins & success have certainly not been apparent in the last 5 years worth of P&Ls! That’s what this post, and my Jewel in the Crown strategy, are all about: Digging for true underlying business value. The core business is high-margin, with a blue-chip client roster and high barriers to entry5. But it’s been far too starved of capital, and dedicated management attention, over the years. Imagine the scope for UK consolidation & European expansion if the business was truly unleashed..!?
Sure, Universe can generate healthy revenue growth from here on (esp. with its new product suite), and debt won’t be a risk much longer – but turbo-charged expansion (which is entirely possible) requires much more capital. A share placing would be dilutive, and in terms of amounts raised it just doesn’t move the needle anyway… A takeover by/merger with Vianet is the obvious answer. Or perhaps Universe can find a much larger sponsor to partner with in European expansion? But for any interested party, it would simply make more sense to pay up a little & acquire Universe.
So, what’s this all mean in terms of valuation? Well…first: UNG’s a v small-cap company, debt needs to be paid down a little more, and (by the v nature of its business) clients are highly concentrated6. And, as usual, I’ve competing priorities for cash & other potential buys. This will limit the size of any stake. But I know the valuation will be tempting..!
Revenue run-rate’s at GBP 12.9 mio, with adj operating profit’s at 9.1%, or as high as 13.8% on an underlying basis (based on GBP 1.8 mio, as per above). Let’s run with an avg. 11.4%, which prompts a v reasonable 0.875 Price/Sales Fair Value multiple7, in my opinion. However, net interest’s still a little high, so to include an appropriate debt haircut to my valuation, I’d peg Fair Value lower at:
GBP 12.846 mio * 0.75 Price/Sales = GBP 9.635 mio / 114.705 mio shares = GBP 8.4p Fair Value per share
However, I’m highly confident CEM’s losses will be eliminated – well, unless McLeod & Goddard have identified some magic fix, I actually mean CEM will be eliminated! Closure, or a sale for the proverbial pound, is the likely outcome. Therefore, I’m also setting a Secondary Fair Value target to reflect that event scenario. Once the CEM dud is eliminated, revenue drops to GBP 11.3 mio. Operating margins might be crimped slightly as CEM was also an internal supplier – but I expect other margin improvements & revenue growth to compensate. Therefore, we should expect operating profit to expand to about GBP 1.6 mio, a 13.8% margin again, and interest coverage to improve enough to obviate the need for debt adjustment. This would prompt a 1.125 P/S Fair Value multiple:
GBP 11.260 mio * 1.125 P/S = GBP 12.668 mio / 114.705 mio shares = GBP 11.0p Fair Value per share
Versus the current GBP 2.375p UNG share price, these targets offer 250-350%+ of Upside Potential! Think these share price targets are a little dizzying?! Well, in 2004, the share price was GBP 25p, market cap. was GBP 15 mio, and operating profit was scarcely higher than today’s OP run-rate..?! Take a look at the Yahoo price chart:
I currently have a 1.75% portfolio stake in Universe Group (UNG:LN).
- Mkt Price: GBP 2.375p
- Mkt Cap: GBP 2.7 mio
- Net Int/Adj OP%: 23%
- P/S: 0.21
- Tgt P/S: 0.75
- Fair Value: GBP 8.4p
- Upside Potential: 254%
- (Secondary) Tgt P/S: 1.125
- (Secondary) Fair Value: GBP 11.0p
- (Secondary) Upside Potential: 365%
¹ All figures on a pre-exceptional/continuing basis, if possible. Net Income figures are all actuals. Op Cashflow & Net Op CF are before/after working capital adjustments, respectively. Op Free CF = Net Op CF less net Capex/Development spending. btw Email email@example.com if you want the entire file.
² A reminder of the widespread variability that still exists in allocation methods. Ideally, more aggressive allocation provides a far better indicator of the potential stand-alone/sale value of a division, and is therefore v welcome.
³ The Adj 2010 column is my own check of the Restated 2010 figures – I’m pleased to see everything ticks & ties! More surprising than you might think ;-)
4 Capex includes a FY GBP 310 K of finance leases, and ignores any actual/potential property, plant & equipment sales.
5 Universe provides mission-critical services to its clients. It draws up tailored Service Level Agreements (SLAs) which are monitored weekly and discussed quarterly with clients. SLA performance of 98% was achieved in 2011. The requirements for obtaining and maintaining bank/security approvals & certifications is onerous. These allow the company to operate as a payment system provider, and require continuous product & process refresh.
6 Top 5 clients (all blue-chip, of course) accounted for 71% of revenues in 2011.
7 (I’m definitely showing my trading age with some of these ‘fractions‘..!) Some readers might like a recap re my valuation methodology: Over the years, I’ve observed a (v logical) correlation between operating profit margins and the Price/Sales multiple at which a company’s market capitalization trades. Observing market and M&A multiples, I’ve concluded on average a 10-12.5% operating margin is awarded a 1.0 P/S multiple. Of course, every case is different – you’ll find plenty of companies trading above/below this, often deservedly. And if they’re over-leveraged, this all goes out the window (like most valuation metrics).
As margin expands, so does the P/S multiple, but at a faster pace (akin to the expansion of the P/E ratio for faster growth companies) – this might imply a 40% operating margin could easily be awarded a 6-8.0 P/S multiple!
Others may prefer an EV/EBITDA approach, but P/S works really well for me. Relying solely on P/E ratios is dangerous, in my opinion, but let me try relate what I’ve laid out in a P/E context. Let’s say a company’s got 100 revenue, and 12 operating profit. This deserves a 1.0 P/S multiple, i.e. a 100 market cap. Now, let’s look via earnings: After avg. net interest, we’ve 11 pre-tax profit. Assume an avg. 30% tax rate, giving us about 8 net income. We’ve no idea on earnings growth, but the avg. historical P/E ratio’s around 12, implying a 96 market cap., almost dead-on with our P/S methodology!