Tags
Brookwell Ltd, Brulines Group, dilution, Ennismore, HTEC, Jewel in the Crown, Margin of Safety, placing, Universe Group, Vianet Group
I posted last w/e about Universe Group (UNG:LN), having first used it as a bit of a blind stock valuation challenge. If you’re ever bored waiting for some news on a stock, just write a blog post – all too often, news will pop within days..! In this case, a Placing was announced just two (working) days after my post, wow! Which reminds me – note to self:
I Must Remember: If you find yourself saying something like ‘I can’t imagine management would do X…‘, you can be reasonably sure they’ll actually do X¹!
I Must Remember: Most management are agents, not owner-operators – they (always) believe in raising/utilizing cash to expand the business².
I Must Remember: Management’s compensation is usually far more rewarding than the impact of a rising/falling share price – again, they’re not owner-operators. Their compensation also generally grows with the business… Therefore, expansion at all costs is usually far more important than share price, or intrinsic value per share.
I Must Remember: Adding or changing a nominated adviser/broker is often a sure sign a company is looking to line up a placing.
I Must Remember: The company will usually only tell me (the private investor) about the placing after the fact. I’ll have no chance to sell down the shares in the pre-placing call-around period (so much for insider trading/Chinese wall rules), I won’t get to buy shares at a huge discount – but I do get to enjoy the dilution…
OK, before anybody gets too excited, these are all general observations and may not apply in Universe‘s case!
In fact, the GBP 2.3p placing price wasn’t bad at all (and presumably reflects enthusiastic institutional support), in the context of the share price in the past year. And the 12.4% discount to the previous day’s GBP 2.625p close (on Mon, July 23rd) was excellent. Even better, the share price actually traded up +10.5% that Monday, as I remarked – so the placing was only at a measly 3% discount vs. the closing price that w/e, and to my GBP 2.375p write-up price. Considering that, and today’s GBP 2.25p share price, regular shareholders weren’t disadvantaged (for once!) by the fact this was a non-pre-emptive placing, rather than an open offer or rights issue. In general, however, this is just another issue where the Exchange leaves private investors high & dry – championing PIs in the city shouldn’t just be the subject of a stirring speech or two, gentlemen..!
Of course, this doesn’t forgive the dilution suffered… When you consider the share price, and the size of the company, it was almost impossible to raise more than the (gross) GBP 1.675 mio actually raised. The small size also means a hefty 10% will be consumed in expenses, resulting in net cash of GBP 1.507 mio. As I stated in my last post: ‘…in terms of amounts raised it just doesn’t move the needle anyway…’. Not to talk of the cost – but we’ll tackle that with a fresh look at valuation. I’m also bemused how companies present dilution – here, the 72.8 mio new shares represent 38.8% of the enlarged share capital. Is it just me..?! I unfortunately prefer to focus on the fact that to raise the intended amount, they actually had to sell shares amounting to 63.5% of the pre-existing share capital!
At least I factored in a huge margin of safety in the (smaller) size of my position, and the (higher) upside potential involved – for risks like this, among others. We’ll see if that has helped shortly. First, let’s consider Use of Proceeds: Cash will be apportioned between i) expansion which will be focused, as you’d expect, on completion & roll-out of the ongoing new product suite development programme (in the Solutions division), and ii) retirement/replacement of high interest rate debt.
I didn’t bother mention UNG’s debt breakdown before – I was actually hoping for a (good!) restructuring as a pleasant future surprise! Because their debt service costs are rather appalling… UNG has GBP 1.1 mio in finance leases/discounting at an avg. 5.5%, 0.9 mio bank loan @ 10.5% (HBOS…bastards!) and, worst of all, 0.2 mio in directors’ loans @ 15%! Actually, I should mention Universe also intends to issue (alongside the placing) a GBP 0.2 mio 9.5% 5 year loan note (to Downing LLC, an existing 5.3% shareholder). Therefore, we can expect retirement of the directors’ loans, plus retirement/replacement of a major portion of the bank loan. The expected operating profit increase, and interest reduction, should hopefully eliminate the need for a debt haircut in any valuation analysis.
Now, let’s look at proposed subscriptions for the Placing: Only two groups have committed so far – directors & Ennismore. Both are basically maintaining their stakes, a good sign: a) directors will go from 9.1% (interestingly, former Chairman Ray Mackie recently bought a separate 3.1% stake) to 8.5%, and b) Ennismore will go from 13.5% to 13.3%. The absence of the two other major shareholders is no big surprise: Brookwell Ltd (BKWD:LN) is an AIM realization fund – as for Vianet Group (VNET:LN), well, I guess they lost their phone number..!
We’ve saved the best for last, the Current Trading Update: ‘Trading…is ahead of the comparable period last year…‘ echoes the recent AGM statement. What’s really interesting, though, is this statement about the CEM division: ‘While unrelated to the decision to raise further capital, and as part of their original restructuring plan, the Directors are exploring a range of options in respect of the Group’s HTEC Contract Electronics Manufacturing business‘. This is exactly what I flagged up in my Secondary Fair Value scenario..! I think it’s now reasonable to assume this confirms CEM will be closed down, or sold off, within the next year and its losses eliminated from the P&L. Summing it up, we’ve 1 negative & 2 positives here – let’s assess dilution first (plse ref. the valuation analysis in my last post):
i) GBP 12.846 mio * 0.75 Price/Sales = GBP 9.635 mio / (114.705 + 72.826) mio shares = GBP 5.1p Fair Value per share, and
ii) GBP 11.260 mio * 1.125 P/S = GBP 12.668 mio / 187.531 mio shares = GBP 6.8p Secondary Fair Value per share
Negative: Euch, this illustrates how cavalier management can be with shareholder value – this dilution pushes valuations down 39%... Positive: Against that, UNG now has significantly reduced financial risk (note, likely v important to existing & potential clients also), and improved growth capacity. Positive: We’ve now got a clear management signal re CEM, so I think it’s an appropriate time to offset a portion of the dilution with a valuation upgrade. A jump to my Secondary Fair Value target is tempting, but let’s not be too ambitious (after all, we’re already assuming a H2 2011 run-rate going forward).
All in all, I’m happy for the moment to average the above valuations into a single new GBP 5.9p Fair Value target per share. This offers a revised 164% Upside Potential vs. the current GBP 2.25p UNG share price. I now have a 1.7% portfolio stake.
- Mkt Price: GBP 2.25p
- Mkt Cap: GBP 4.2 mio (presuming approval of the placing)
- Net Int/Adj OP%: 16% (estimated)
- P/S: 0.33 (presuming placing/current revenue run-rate)
- Tgt P/S: 0.87 (based on current revenue run-rate)
- Fair Value: GBP 5.9p
- Upside Potential: 164%
¹ Actually, looking back, I didn’t write management would not do a placing, simply pointing out: ‘A share placing would be dilutive, and in terms of amounts raised it just doesn’t move the needle anyway…’
² Before anybody points out my stupidity – yes, usually expansion’s a good thing & ultimately enhances shareholder value. I’m actually trying to make a different point here – a decision to expand is often simply that, i.e. a decision to expand..! Often, there’s precious little else to the analysis – certainly not the true cost of the cash utilized, or the projected (resulting) shareholder value.
On too many occasions I’ve seen managers, for example, spend $15 of capex and tie up $15 in working capital simply to make an extra $1 of profit – and then they get rewarded for it!? Nice work if you can get it… Top management & directors should be ashamed of creating/permitting such a financial environment – but I guess they’re playing their own, more sophisticated, version of this game for themselves.
Wexboy 
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Thanks. Yes, I’ve kept an eye on UNG for years – never dug too deep, but intuitively knew Jet Set would be a disaster when it was announced…and so it came to pass! In theory, the amount of debt is now manageable, so management can probably continue focusing on debt replacement (at cheaper rates), rather than retirement.
Not too concerned about illiquidity. In most cases, it means a share’s neglected & going nowhere, so you’ve the ‘luxury’ of plenty of time to build a position (one painful trade at a time). Do it right, and you can mostly avoid driving the price away – of course, you’ll pay the offer every time (pretty much true of all UK shares!). And commissions may prove disproportionate for small trades. I demand much higher upside potential to compensate. But illiquidity can work in your favour – if your thesis is correct, events/results line up, etc. the price can jump v sharply & overshoot. And you’re often offered greater liquidity at that point to exit…because so many PIs only buy a share only after good news & a price double!
I think it’s clear proceeds will be used to complete the new product suite development, roll it out to existing clients, and use it for a big push for new UK clients. That, plus great execution & delivery on the kind of margins I expect, should be a game changer for the share price.
Interestingly, that may present an even better decision/opportunity point for the share: a) it would be a perfect time for a takeover (and small market cap. permits a v healthy premium), and/or I wouldn’t be surprised if Goddard/McLeod launched a sale process themselves, or b) UNG has huge opportunity – revenues could easily be doubled or tripled outside the UK. Perhaps I’m wrong, but I don’t believe new clients necessarily soak up huge amts of working capital – but a drive into Europe obviously implies losses/reduced margin business, at least initially.
That could be v interesting – unless you’re a sexy tech co, aggressive revenue increases often go v unrewarded if they’re accompanied by reduced margins. That would be v wrong – as long as it’s clear (?!) historical margins can ultimately be regained, I’d be thrilled at accelerated growth & lower margins! In that scenario, intrinsic value’s also increasing rapidly, while the share price may actually be getting punished…lovely jubbly!
Insightful as ever, thanks. I have been expecting a cash raising ever since it was first mooted that the company needed to grow another leg. The company has been in decline for years and management have been cutting away dead wood. Quite why the old management decided to replace some of that dead wood with the millstone that was Jet Set is beyond me, but I am comfortable that that the new management won’t make a similar mistake.
I note that the loan notes are for a very small amount and still not at a great rate (though much better than the directors’ loans!). I believe they have tried to restructure the debt, but the ongoing situation with our banks has not allowed this to bear fruit. I therefore accept there is a need to come to the market for the money and I also accept, as an investor in several micro caps, that placings as opposed to RIs / OOs are a fact of life when you are talking about such small amounts of money
So the question for me was why right now? Things are improving – so we are told and indeed your analysis of the figures confirms this and it should be further confirmed when the interims come out in a couple of months. So why not wait a couple of months, then have a big marketing push to get the share price up and then either issue fewer shares at a better price or issue the same number and raise a lot more money?
One of the major problems this share has is its illiquidity – it is virtually impossible to buy a decent number of them without paying well over the odds and this is a really hard problem to solve, Hence waiting a couple of months and having a good marketing push may not do much to improve the share price – although it has improved a bit since the annual results and the AGM statement there has not been any great volume behind it and therefore no real upward momentum.
The other key thing for me was to find out whether the money was to be raised was for generic improvements or if it was actually for specific value enhancing projects that, if the opportunity was not taken now, would disappear – (I agree with you that the money raised does not seem to be enough to move the needle unless there are some really specific projects that are going to deliver real benefit) Obviously I could not get any detail (I did not ask for or expect it) However I did get clear assurance that the money was for specific projects and not funding them now would mean missed opportunities.
I was also concerned that the capital reorganization, which is needed to get new shares out below the old nominal price of 5p, could open the door to more ever diluting placings. I have been assured that this placing is a one off.
I have therefore voted my shares in favour of the placing. PIs can and should stand up for themselves, but to do this we have to stand together and make our voices heard and had I not got the assurances I wanted, I would have done my utmost to give the board a bloody nose over this (I was winding up to do this when a capital reorganisation was mooted by the previous management a year or so ago – funnily that resolution never appeared on the AGM agenda).
I am a long term UNG shareholder, I only live just down the road from them and I intend to hold their feet to the fire to deliver the growth that this dilution will fund.