[First, I should give a hat-tip to Universe Group (UNG:LN) – my first write-up, and this recent post particularly, may prove quite relevant here. Despite a significant retracement in the past year, UNG’s delivered a 125%+ return in the past two years, and I believe it continues to offer substantial upside potential. Which inspired me to seek out & research a number of other (relatively) similar companies…]
…And I came across Newmark Security (NWT:LN), which has been AIM-listed since 1997. Newmark’s a leading provider of electronic and physical security systems to ensure the safety & security of company personnel and assets. It has two divisions, consolidated around two companies which have been in business since the ’80s: The Electronic division (Grosvenor Technology, acquired 2002) – design, manufacture & distribution of access control and workforce management systems, and the Asset Protection division (Safetell, acquired 2000) – design, manufacture, installation & maintenance of bullet/attack-resistant screens (doors, walls, etc.) and cash management systems.
At first glance, a GBP 19 million revenue/9 million market cap company looks like a real tiddler in the security industry. But a client list (see here & here) which includes the Post Office, Tesco, Broadgate Estates, Network Rail, and the Met, plus relationships with Assa Abloy (ASSAB:SS) & Loomis (LOOMB:SS), all demonstrate Newmark punches well above its weight. And despite selling an OEM product range via value-added resellers & installation companies, an impressive 42%+ gross margin also attests to the quality of the company’s products, service & relationships (and the profitability of its niche). But why don’t we let the numbers do the talking…
I’ll tackle this in two stages, beginning with the six year period ending in 2012. [Note the April year-end – e.g. FY-2012 is the financial year ending Apr-2012. btw To highlight I’m not cherry-picking here, 2005-06 revenue averaged GBP 12.9 million (i.e. similar to the subsequent 6 yrs)]:
You’ll notice it’s a remarkably stable business: Revenue of GBP 13.1 million & a 42% gross margin in 2012 are very similar to the averages for the entire period. But we should note eligible development expenditure is capitalised, plus there’s been some exceptional expenses/impairments over the years. So I prefer to use Operating Free Cash Flow (Op FCF, i.e. cash generated from operations, less net PPE & development/intangible asset expenditure) as a more reliable proxy for underlying operating profit. [And for small companies, it provides an additional margin of safety. It does complicate my analysis – even stable companies have outlier years, in cash flow terms – but it’s worth it (& averaging helps)]. Again, NWT’s 2012 Op FCF margin of 5.8% isn’t far off the average 7.6% margin – obviously, 2012 or (average) 2007-12 financials could be used to produce equally valid (& relatively similar) valuations. Sounds good, but the underlying Op FCF margin trend is troubling. We can treat 2011 as an outlier, but clearly margins have compressed in the second half of the period. And investors reacted accordingly in 2012, hammering NWT’s shares to an all-time low of GBP 0.625p. Which was actually pretty short-sighted…
An activist investor must always look below the surface (& into the footnotes) – because on rare occasion, they’ll see a very different company & perspective. Here, we have two specific issues affecting margins – the first I’ll return to (later), while the second deserves a repeat of our financials table:
Breaking out capitalised development expenditure, we see it grew an astonishing 55% pa in 2008-10 – a brave decision by management, and even braver in the face of an unprecedented recession… By 2012, annual development spend had quadrupled, expanding from 2% to 9% of revenue. Which understates the true scale of investment, since it includes none of the research & (uncapitalised) development spending that was expensed to the P&L each year. There’s no break out of those figures – regardless, Newmark has a hell of an R&D intensity (vs. your average listed company). But it may take years for R&D (and any related manufacturing & sales build-up) to deliver a tangible & positive result. Meanwhile, shareholders will often punish companies with increasing R&D/related expenditure (& decreasing profits). But at the right price, this presents investors with a classic free option – a company priced for today, even though its cumulative R&D investment may deliver a substantially more valuable company tomorrow…
In this instance, if we re-base NWT’s 2009-12 annual development expenditure back to the 2007-08 average of GBP 331 K pa, we see a different picture emerge. 2011 remains an outlier, but underlying cash profitability otherwise looks far more stable – with an average 10.8% adjusted Op FCF margin for the entire period. We can view the glass as half full or empty here – this cumulative R&D should ultimately deliver (a substantial increase in revenue and/or profitability), or it’s a bust & we can (rationally!?) presume management will retrench and scale back R&D accordingly. Either way, a valuation based on this adjusted Op FCF margin seems reasonable – particularly if we rely on average revenue & margin for the entire period:
– A 10.8% adjusted Op FCF margin deserves a 1.0 Price/Sales multiple.
– Newmark’s latest balance sheet is in great shape, with net cash & no pension or deferred consideration liabilities. Let’s adjust our valuation accordingly to include (gross) cash of GBP 1.4 million.
– Such a stable business can sustain higher debt levels to fund increased investment, acquisitions, and/or a return of capital. 2014 interest expense was GBP 78 K, and debt declined yoy by a third, so we’ll assume a 52 K interest run-rate. An additional GBP 3.3 million of debt would still keep interest expense limited to 15% of the average adjusted Op FCF margin. Let’s conservatively haircut this by 50%, and include it as another adjustment (my P/S multiple already accommodates this level of sustainable debt).
– As of end FY-14 (plus this recent award), the company’s granted (up to) 64 million dilutive warrants/options, about 14% of the outstanding 450 million share count. Which looks excessive (future awards should be monitored), but reflects cumulative option awards back to 2005…the evolution of the share price hasn’t really encouraged exercises!? [The warrants were awarded – far too generously, in my opinion – in return for a directors’ loan. However, the strike was nearly a 30% premium to the share price at the time]. And note the absolute NWT share price – in monetary terms, unfortunately it takes a lot of options to incentivise directors (& employees). Some may never vest/get exercised, but it’s simple & prudent to include GBP 0.8 million of (exercise) cash here & adjust outstanding shares accordingly.
– Newmark’s paid a GBP 0.3 million final dividend since (for a tasty 3.7% yield), but we can presume YTD FCF covers it:
GBP 13.5 Million Avg 2007-12 Revenue * 1.0 P/S + 1.4 M Cash + 3.3 M Debt Adj * 50% + 0.8 M Warrant/Option Cash = 17.4 M / (450 M Shares + 64 M Warrants/Options) = GBP 3.37p per Share
Let’s call this our 2007-12 Scenario – a fair value of 3.37p per share offers 67% Upside Potential. But who cares, what you really want to know is…what happens next?! Fair enough, time for another table:
Wow…answers your question, I hope?! A dramatic ramp-up in 2013 revenue, and further progress in 2014, leaves Newmark’s revenue-rate almost 50% higher than 2012. So let’s repeat our analysis: Noting the step-change in revenue, I think we can now comfortably assume capitalised expenditure has significant long-term value – in fact, let’s presume development and PPE expenditure makes a valuable contribution for at least the next 3 years. [NB: Not unreasonably, NWT amortises capitalised development costs over 7 years, so I’m being conservative here]. Adjusting accordingly, i.e. backing out two thirds of the annual investment spend, we arrive at an average 11.4% adjusted Op FCF margin:
– Which deserves the same 1.0 Price/Sales multiple.
– We’ll include the same (gross) cash of GBP 1.4 million. And Newmark can obviously sustain a higher level of debt now – an additional 5.4 million of debt still limits interest expense to 15% of the average adjusted Op FCF margin. Again, we’ll apply a 50% haircut & include as a further adjustment. Finally, we’ll make the same cash & shares adjustment for warrants/options (and assume the dividend’s covered):
GBP 18.7 Million Avg 2013-14 Revenue * 1.0 P/S + 1.4 M Cash + 5.4 M Debt Adj * 50% + 0.8 M Warrant/Option Cash = 23.7 M / (450 M Shares + 64 M Warrants/Options) = GBP 4.60p per Share
Let’s call this our 2013-14 Scenario – a fair value of 4.60p per share offers 127% Upside Potential.
OK, let’s lose our heads a little now & envisage a sale of Newmark: Here’s the wonderful thing about small companies – no matter how parsimonious management might be, the costs of a listed company HQ (in absolute terms) can be a heavy burden on the margins of its underlying business(es). NWT currently spends GBP 1.4 million pa on key management & auditor remuneration. [Not dissimilar to the 1.1 million they reported as unallocated corporate expense]. It’s reasonable to assume an acquirer could quickly eliminate this layer of expense. Which doesn’t necessarily mean they’d get rid of management entirely – but totting up potential management & employee savings, plus likely economies of scale in purchasing, manufacturing & sales, I expect this cost savings target is (somewhat arbitrary) but eminently achievable. This would bump us up to:
– An average 18.6% adjusted Op FCF margin, which now deserves a 1.75 Price/Sales multiple.
– We’ll include the same (gross) cash of GBP 1.4 million. Again, a higher level of debt can be sustained – an additional 9.4 million of debt still limits interest expense to 15% of our average adjusted Op FCF margin, and as usual we’ll haircut by 50% & include as a further adjustment. Finally, we’ll make the same cash & shares adjustment for outstanding warrants/options (and assume the dividend’s covered):
GBP 18.7 Million Avg 2013-14 Revenue * 1.75 P/S + 1.4 M Cash + 9.4 M Debt Adj * 50% + 0.8 M Warrant/Option Cash = 39.8 M / (450 M Shares + 64 M Warrants/Options) = GBP 7.72p per Share
Now, a bidder would obviously prefer to harvest the benefit of these savings & valuation uplift for itself…I’m just trying to illustrate the potential underlying value of a small company, like Newmark, in the hands of an acquirer. But if management can continue growing revenue, and expanding underlying divisional margins, we’d see a disproportionate impact on consolidated operating/cash flow margins – so in due course, NWT could well grow into this kind of intrinsic valuation. For the moment, we’ll call this our Sale Scenario – a fair value of 7.72p per share now offers 281% Upside Potential. OK, now is a good time to ask:
Why the disconnect between NWT’s current share price & its obvious intrinsic value (under any reasonable scenario)?!
Aah, the eternal value question… Let’s hazard a few answers (while avoiding the usual message board conspiracy theories):
– Occam’s Razor: The simplest explanation may not be so rational, but it may well be true – this chart illustrates it nicely:
With a chart like this, the share price may end up lagging (often severely) a fundamental step-change/turnaround in the business. A dozen years going nowhere tends to do that…it’s the classic 3U curse: Under-loved, under-owned & under-performing! A 100% price rally’s often required before investors will even notice, let alone consider, such a share. But technicals can highlight when a stock’s finally escaping such a curse… In July, NWT nicely broke (& recently held) long-term GBP 1.7-1.85p resistance, while a clear break of the 2.25p level would likely herald a far more substantial & sustained rally.
– Sustainability of Revenue: Newmark clearly remains reliant on UK project work – service revenue’s been declining in absolute/percentage terms (to 19% of revenue), while non-UK sales are still a relatively small component (15%) of revenue. [But note international revenue’s grown 27% pa in the past couple of years, inc. a spectacular 57% US growth rate]. But the company’s high-profile wins (particularly the Post Office itself!), the high level of R&D spend, its consistently high gross margins, plus the stability (& now the step-change) in its revenue, all attest to the strength and durability of its business franchise & niche. And I believe this surge in revenue is a direct result of NWT’s escalation of its R&D investment (and accompanying sales & marketing strategy). A second year of GBP 18 million+ revenue reinforces the idea this isn’t some flash in the pan. And momentum’s half the battle – business wins & increasing size are often a virtuous circle leading to new/broader client & revenue opportunities. [As for the PO, it spends 8.8 billion pa & it’s been a customer for years…would it be so extraordinary if NWT kept winning a tiny sliver of their business each year?!]
At this point, it’s a pointless debate/concern – nobody buys into a company/stock expecting revenue to reverse substantially. But if we saw that happen here, we’ve already considered it! [Hence, my laborious approach to NWT’s valuation above. Sorry…] Doubtless, such a transition might be a little challenging, but I’m comfortable assuming management could right the ship quickly enough, i.e. revert to our 2007-12 Scenario. And we know today’s share price should offer a significant margin of safety, in terms of underlying intrinsic value, even in that scenario.
– Family Control: Maurice Dwek (75) is the eminence grise here, with a business record stretching back to the ’60s – he co-founded Dwek Group in 1963, listed it on the LSE in 1973, and finally sold out to a management buy-out team in 1988. He then led turnarounds at Arlen and Owen & Robinson, before concentrating on Newmark Technology Group (as it was named then) in 1997. Last year, he stepped back from the daily business – reverting to non-executive Chairman, while his daughter Marie-Claire Dwek was appointed Newmark’s first CEO in a decade (after joining the board as an NED in 2012). For long-term shareholders, this shouldn’t come as much of a surprise…the last CEO (in 2003) was Sasson Rajwan, Marie-Claire’s ex-husband! And Marie-Claire previously worked in the business (from 1997-2001, as marketing director) – as did her brother, David Dwek.
Some investors get a little hysterical about nepotism, but I’m fairly relaxed myself… Management’s an intangible asset after all – being raised at your father’s knee, and discussing the family business(es) over dinner each evening, may confer a substantial intangible advantage another CEO candidate can’t hope to match (even if they look much better on paper). [Richard Beddard wrote about this recently, linking to an excellent study which details the compelling ‘family premium’ investors earn from listed European businesses]. And such continuity is relevant: All too often, the father who makes a poor family choice (for CEO) also leaves behind him a consistent record of poor business decisions, egregious compensation & disadvantaged shareholders. I see no such record here – aside from the warrant issue, there’s no history of related party deals, while total board comp’s GBP 563 K pa (not cheap, but certainly not out of the ordinary).
In reality, like most small companies, what Newmark needs most is more aggressive sales & marketing to keep growing revenues (for increasing economies of scale, and to enhance its reputation with potential clients). Marie-Claire Dwek’s definitely a globe-trotter, and worked at Motcomb Estates (a Reuben brothers company) for more than a decade – a great place to earn your chops in sales & marketing, and building client relationships, I’m sure. She’s got a safe pair of hands in Brian Beecraft (Finance Director since 1998), while Safetell & Grosvenor have traditionally operated on a fairly autonomous basis. And ’til we see Maurice Dwek retire (and/or pass along some or all of his shareholding), we can be sure he’ll also continue to exert a strong hand/influence here.
Anyway, if push came to shove, I suspect many investors are over-estimating the Dwek family’s actual control & influence here. Maurice Dwek’s stake is 13.1% (via Arbury Inc. – just 51% of which is beneficially owned by him), Elie Dwek (his brother – who appears to be a passive investor here) owns 16.8%, while Marie-Claire Dwek just owns options. [If all family warrants/options are exercised, their aggregate holding increases to 35%, but this would force a takeover (or require a waiver)]. In my opinion, a family shareholding of 29.9% may represent a bit of a sweet spot – it assures investors of an owner-operator mentality, but protects them from majority control & abuse.
Frankly, I don’t believe any of these factors should impede the share price in the medium-term. On the other hand, I can’t highlight a specific catalyst right now, which often seems a necessity with small-caps. But I obviously consider the step-change in revenue to be a catalyst, in the more general sense – albeit one investors still refuse to recognise. And I do see two specific catalysts on the horizon – they present risk, but also considerable opportunity:
– First, I hinted at another margin issue earlier – let’s take a closer look at the Electronic division (Grosvenor Technology):
Ulp… Pays to keep track of the segment reporting, eh?! Electronic’s revenue has gone nowhere for years, while margins have fallen off a cliff since 2010 – clearly, the Asset Protection (Safetell) division’s been doing all the heavy lifting here. [And it’s worse than it looks: Electronic’s net assets actually tie up 3.5 times the capital invested in Asset Protection..!?]. I don’t know the reason for this trajectory – maybe it’s become a horribly competitive business, or maybe management’s just shifted all its focus to Asset Protection? Oddly enough, I’m encouraged… I believe Newmark’s prudently run – I really don’t see a potentially loss-making Electronic division being tolerated for long. [And if it was, it could just make the company vulnerable to an activist or acquirer]. In the near future, management may be forced to embark on a:
i) Restructuring: A restoration of the division’s historical margins could add over 7 percentage points to the company’s overall operating margins (which would have a substantial positive impact on intrinsic value, under any Scenario!), or a
ii) Sale: The division’s probably worth more in the hands of a larger competitor. Freeing up capital and management time & attention, to better exploit Asset Protection’s growth opportunities (and perhaps return capital to shareholders), might be the catalyst required for a step-change in investor sentiment & the value of the business.
In this year’s results, the Chairman actually highlighted a recent restructuring of the division, but the scale or impact (in terms of margins) isn’t very clear at this point. And there appears to be no plan to replace Derek Blethyn (Grosvenor’s MD, who resigned in late-2013 after 24 years of service), so it wouldn’t surprise me if management’s potentially anticipating a sale of the division.
– And second, let’s talk about control of Newmark: A 29.2% stake – basically equal to the Dwek family’s shareholding – is actually owned by the estates of the late Mr. Alexander Reid & Mrs. GAB Reid. [Alex Reid knew Maurice Dwek for thirty years, and was an NWT investor & non-executive director since its formation]. And Robert Waddington (appointed as an NED in 2012) is a representative for the Alexander Reid family trust – clearly an unusual situation! You know, it’s one thing for a foundation to own a (semi) permanent shareholding, but an estate holding’s a very different proposition – even though this particular situation certainly seems to be dragging on rather interminably…
But the executor of an estate has a fiduciary duty to its beneficiaries. If Newmark’s business/shares took a turn for the worse, having a 29% stake tied up in a micro-cap company/stock (even within a large & diversified estate) might suddenly look quite imprudent – a situation beneficiaries might love to second-guess. Estate investments are inevitably sold, sooner or later, or they’re distributed to often needy & impatient beneficiaries (who may be far less attached to Newmark & its shares). Who knows the timeline here, or the specific circumstances, but I’m sure you can see the potential for a major change in ownership… Shareholdings of this size, owned or administered by possibly anxious and/or motivated seller(s), can be an ideal purchase for an activist or acquirer – and a specific catalyst for realising value.
For management, there’s actually an obvious remedy for this Sword of Damocles – and fortunately, it’s beneficial for all concerned:
A preemptive buyback of this (estate) shareholding!
Returning to my Scenarios: Newmark clearly has the capacity to retire these shares, without any meaningful risk to its financial stability. Of course, if the company went ahead with such a plan, you can be sure dozens of small shareholders would automatically (& incorrectly) presume they’re somehow getting screwed & would scream blue murder. Unfortunately, this would probably dictate a tender offer instead, so all shareholders are satisfied they’re being treated equally. But ideally it’s a tender pitched at a fairly minimal premium – leaving the executor(s), or beneficiaries, as the main participants (I mean, what’s their alternative…sell out to the highest bidder?!), while other shareholders are disincentivised (or smart) enough to avoid participating.
For the sake of it, let’s assume a tender at a 15% premium. [And only the Reid estate(s) tender (frankly, any other shares tendered would be a bonus) – so it costs GBP 3.1 million]. Referencing my 2013-14 Scenario, Newmark’s average 11.4% adjusted Op FCF margin would remain unchanged, along with 20 times+ interest coverage (on slightly higher debt). Therefore, it’s still entirely reasonable to assume a 1.0 Price/Sales multiple:
GBP 18.7 Million Avg 2013-14 Revenue * 1.0 P/S + 1.4 M Cash + 5.4 M Debt Adj * 50% + 0.8 M Warrant/Option Cash – 3.1 M Buyback = 20.6 M / (450 M Shares + 64 M Warrants/Options – 132 M Buyback Shares) = GBP 5.38p per Share
We’ll call this our Share Buyback Scenario – clearly a buyback would significantly enhance intrinsic value per share, with a fair value of 5.38p per share offering 166% Upside Potential.
OK, let’s sum up: Two years ago now, Newmark enjoyed a step-change in revenues, driven by its Asset Protection division. Business continues to look healthy in the UK, while international’s a real sweet spot – for the moment, management will ideally continue to cherry-pick clients/projects (via trade shows, etc.) on a fly-in/fly-out basis. [In my opinion, Safetell really has boundless opportunity in the US]. Last year’s GBP 0.4 million embassy win highlights a promising line of business, the late-2013 acquisition of Gunnebo offers obvious revenue synergies, and greater emphasis on targeting end-users & installers should improve gross margins. On the other hand, it looks increasingly likely management may be forced to radically restructure or sell Grosvenor Technology in due course. And finally, almost a third of the company’s outstanding shares could be up for sale at some point – a substantial tender offer could prove a more palatable (& value enhancing) alternative for all concerned.
For the moment, let’s just put the Sale & Share Buyback Scenarios (which offer Upside Potential of 281% & 166%, respectively) in our back pocket, and keep ’em as possible aces in the hole. And if, for some reason, Newmark’s current revenue run-rate turns out to be a flash in the pan (after two years?!), our 2007-12 Scenario still looks pretty viable & appears to offer a decent 67% Upside Potential regardless. But I obviously lean towards the 2013-14 Scenario myself – which offers 127% Upside Potential – even more so, if we see FY-2015 continue the same revenue & margin trends. [But don’t forget the potential volatility & vulnerability of a micro-cap stock…not a suitable proposition for all investors!].
Finally, let’s hedge our bets that little bit more, by averaging these two 2007-14 Scenarios – that’s a Fair Value of GBP 3.98p per share, for a 97% Upside Potential. To place this in proper context, Newmark’s now trading on a 6.0 P/E & a 0.48 P/S (or a 0.40 P/S on an ex-cash basis, despite a pre-exceptional 9.6% operating profit margin). At a 3.98p target price, NWT would trade on an 11.8 P/E & a 0.94 P/S – not exactly scary multiples, eh?
I now have a 3.8% portfolio allocation to Newmark Security.
- Newmark Security (NWT:LN): GBP 2.025p
- Market Cap: GBP 9.1 M
- Price/Earnings: 6.0 (based on diluted pre-impairment EPS)
- Price/Sales: 0.48
- Ex-Cash P/S: 0.40
- Tgt Fair Value: GBP 3.98p
- Tgt Mkt Cap: GBP 17.9 M
- Tgt P/E: 11.8
- Tgt P/S: 0.94
- Upside Potential: 97%