Weekly Commentary 21/06/21: Diamond hands vs 10x Future

The FTSE 100 finished the week flat, ending at 7,130. Both Nasdaq and the S&P500 also moved less than 1%; it was almost as if the sun was shining and traders were watching football matches. There were more significant moves in Govt bond markets, the US 10y bond yield rising to 1.57%, responding sharply to news that the Fed may look to raise interest rates in 2023, a year earlier than previously anticipated.

Techcrunch reported that Antony Jenkin’s 10xFuture had raised $187m in a funding round, valuing the business at around $700m. Antony is the former Chief Executive of Barclays, but was pushed out by the Chairman John McFarlane and Senior Non Exec Sir Mike Rake after a disagreement over the Barclays investment bank. Antony went on to found 10xbanking, a cloud-based bank technology platform that uses APIs. There’s a good interview with Antony from Marc Rubinstein at Net Interest here, where he is scathing of “Davos man thinking” that banks are technology companies. Banks are not technology companies, they are data companies, he says.

In my bank analyst days I met Antony a few times, and he came across as thoughtful and competent, but unlike his predecessor Bob Diamond, lacked the Machiavellian skills to run an organisation dominated by American investment bankers. It’s good to see Antony go on to be successful after leaving Barclays.

Bob Diamond, his predecessor, was widely regarded as very talented by investors and analysts, and certainly earned a lot more money. Though he seemed to be everyone else’s idea of what a banking executive should look like, I was never quite taken in. I feel that subsequent events after Bob left Barclays (resigned following Libor rigging scandal) support my scepticism. Bob went on to found an African bank, Atlas Mara, the performance of which has been less impressive than 10x. Atlas Mara’s share price fell -90% even before the pandemic, while issuing more shares so investors were diluted (Bob raised over $800m). Antony Jenkin’s 10xbanking is now worth 10x the market cap of Bob Diamond’s Atlas Mara. Diamond hands!

The lesson I take from this is that often we can be taken in by people who “look the part” but ultimately don’t deliver. NN Taleb expresses the same thought like this:

Things that are good, but don’t look good, must have some edge.

Retail investors now have access to vastly more online presentations than in the past, with sites like piworld, investormeetcompany and Mello this evening. These add colour, but it’s also easy to be misled. The Undercover Fund Manager has put together a useful list of things to look out for here. They include:

  • Excessive optimism and focus on growth (with little emphasis on returns)
  • Lack of independent thought
  • Liberal use of exceptional items, regular accounting changes and other signs of financial jiggery pokery, combined with a focus on adjusted metrics (e.g. Adjusted EBITDA)

This week I look at 3 multi baggers, GB Group, BOTB and Volex. Readers might not be very excited about following companies that have risen in value +203%, +968% and +1,060% in the last 5 years. I think it’s important to follow success, because it gives you a better template for deciding what’s likely to be a future multi bagger, and also thinking about what might precipitate a sell decision. It’s notable that in the case of GB Group and BOTB, management sales signalled that short term performance had likely peaked.

If you’re reading this on Monday 21st June, then it’s Mello Events in the evening. It looks a good line-up and if you haven’t attended before then it’s free with the code SSCNEWM. * Company presentations include Ken Wotton of Gresham House, an interview with Nabil Lawandy, CEO of Spectra Systems (SPSY), Time Finance (TIME) Bacanora Minerals (BCN) and finishing with the entertaining BASH, where people pitch different ideas which the audience vote on.

GB Group FY to March

This digital identity company with a March year end reported revenue +9% to £218m and statutory PBT +66% to £34m. It’s a global operation, with over 19,000 customers in 70 countries, and the software helps organisations verify the identity and location of users to prevent fraud. They’ve been involved in the distribution of stimulus cheques in the US and verification of Covid testing facilities, but the core business is identity verification for financial institutions: there’s a case study of helping Plus500 sign up customers and Anti Money Laundering. The last 18 months saw a large number of new customers sign up to try their hand at trading (Matt Levine’s Bored Markets Hypothesis), because there wasn’t much else to do during lockdowns. I’m wondering what the sustainable rate of revenue growth is? GB has been around for 30 years, but growth only really took off a decade ago, growing from market cap of £12m to £1,679m today.

The jump in statutory PBT to £24m was helped by a swing in exceptional items, which were negative last year due to reorganisation costs and a contingent consideration write down of £800K. There were a number of negative exceptional items this year too, but offset by a £1.4m gain on disposal. That £1.4m is actually the net figure of two disposals, one a loss of £1.2m (Marketing Services) and the second a profit of £2.6m (Employ & Comply). Excluding the revenue from these two businesses that have been sold gives organic revenue growth for GB Group of +12%.

I reported on this in October last year, when both the Chief Executive (Christopher Clark sold £1.3m) and the Finance Director (David Wilson sold £936K ) sold significant amounts of shares at 934p (current price 851p). The Finance Director is now stepping down at the end of June after being with the company for 12 years, replaced by David Ward previously of Aveva.

Intangible Assets A large item in the p&l is goodwill amortisation £17.7m to FY March 2021 down from £19m the previous year. The balance sheet is top heavy with intangible assets, £378m vs shareholders equity of £364m. I’m not too worried about negative tangible assets, according to this article by John Authers of Bloomberg, 40% of the S&P500 have negative tangible book value. In part this is a reflection of accounting standards, and in part the shift in the economy to intangibles, rather than widget bashing companies. I’d suggest that the cash generative nature of this business should reassure; the company had net cash of £21m at the end of March 2021, an improvement of £56m vs March 2020. It does highlight though that investors need to think about competition, because intangible assets can quickly become impaired. Helpfully the company splits out the assumptions of the useful life of acquired intangibles (software: 2 to 5 years, brands: 2 to 3 years, non-compete agreements: 3 to 5 years, customer relationships: over 10 years.)

SharePad shows a low ROCE (c. 6% over the last 3 years) despite gross margins being attractive at 70%. That’s because “Capital Employed”, the denominator of the ROCE calculation is inflated by paying up for prior year acquisitions. If the company can grow without relying on more incremental capital, then that ratio understates the future returns. It’s more art than science figuring this out.

Outlook statement The new financial year has got off to a good start, in line with the Board’s expectations. Though the company doesn’t feel confident enough to tell us what those expectations are! They’ve been helped by crypto currency trading, which requires companies to verify customers identities. The outlook implies that though the shares have not participated in the “vaccine rally” (shares down -3% since the start of the year) management expect to benefit from lockdown restrictions being relaxed. Though they warn the pandemic isn’t over and there’s a wide range of outcomes possible for the rest of the year. The Chairman’s statement points to an internal employee engagement survey and record customer advocacy as evidence that the softer side of the business is going well, though he doesn’t actually give figures that would allow investors to keep track of trends year on year.

Valuation The shares are not cheap, trading on 36x EV/EBITDA and 8x FY 2021 sales. SharePad suggests forecast PER of 32x for FY March 2023F. This is not cheap, but in this market there are plenty more expensive stocks.

Ownership Octopus owns 6.4%, Aegon 6.3%, Capital 5.5%, Abrdn 4%, so some good institutional backing.

Opinion It’s good to see a UK company enjoy global success in a sophisticated area like identity verification. Gross margins are attractive at 70%, so it could be that if management can deliver organic revenue, growth returns improve. That could justify the high valuation. An interesting company to follow; everything feels expensive at the moment, so I’ll avoid paying up at the current valuation.

BOTB FY results to 30th April

This online “spot the ball” competition company released FY results, and the shares fell -30% on the morning of the RNS. The results themselves were very impressive, revenues up 2.6x to £45.7m and PBT up 3.4x to £14.1m, helped by people playing the game over lockdown. There was £11.8m of net cash on the balance sheet at the end of April. A special dividend of 50p will be paid on 16th July. The company used to offer competitions to win prizes, mainly sports cars, in airports. But this left them vulnerable to losing contracts with airports, in 2012 they lost 48% of revenue from physical sites when they failed to agree an extension to their contract with British Airports Authority (BAA).

Lucky Generals Hence they shifted the competition online, by early 2018 just 20% of revenue was from physical sites like airports and shopping centres. In retrospect this was fortuitous timing given the lack of footfall through airports during the pandemic. However, I don’t think that this was just luck (as Napoleon used to ask, “don’t tell me if a general is any good, tell me if he is lucky”).* Most UK airports are now owned by Ferrovial, the Spanish conglomerate who financed the acquisition with debt, so needs to earn a Private Equity style return. Regulation means that Ferrovial can’t raise landing fees steeply, so they tend to try and make as much money from renting out retail sites as they can get away with. As an aside, I hear from a friend with a dog, that this is happening to vets surgeries: they’re being bought up by Private Equity players, loaded up with debt and much more focused on financial aspects of the business, charging pet owners as much as they can get away with.

I’m impressed that the BOTB management could see long term this dynamic would damage the economics of their business, and took the difficult decision to move online. I should probably mention that I went to university with Rupert Garton the Commercial Director, he strikes me as someone who is determined and competent. According to SharePad Rupert has two middle names, Carlton and Erskine…I’ll add this to the long list of “things that I didn’t learn while I was at university, which could one day prove useful to know.”

Outlook statement The damage to the share price seems to be caused by the outlook statement: “in contrast to the summer 2020 period, we have experienced somewhat of a reduction in customer engagement since the latest easing of lockdown restrictions on April 12, 2021, specifically relating to the understandably long-awaited re-opening of hospitality and non-essential retail. We are closely monitoring this, but with our flexible model, growth strategy and plans for the year ahead, we expect customer engagement to return to normal levels before too long.” I think that it was inevitable that as lockdown restrictions eased, the company would see reduced activity (the Bored Markets Hypothesis states that when people are allowed to go to the pub, they’ll do less online gambling / trading/spot the ball competitions).

Share sales / ownership The Chief Exec William Hindmarch and Rupert Garton sold shares at £24 at the end of March., giving them proceeds of £41m and £12m respectively; nice work if you can get it! They still own substantial interests in the company, William Hindmarch and his wife own 31%, and Rupert Garton owns 9.4%. Management also conducted a “strategic review”, but after talks with many potential buyers failed to find anyone willing to make a bid. The review was terminated in February this year. I can imagine that investors who bought in the placing are perhaps feeling a little sore, but it doesn’t strike me that there is anything seriously wrong with the business (other than valuation got ahead of itself).

Valuation FinnCap, their broker, left forecasts unchanged, but clearly the risk is downward. FinnCap forecasts 142p EPS FY April 2022F and EPS 165p FY April 2023F, implying 12x PER. But last year’s PAT was £3.5m, which implies a PER of >50x, even after the -30% fall. That’s a wide range, I’ll stick my neck out and suggest the true value lies somewhere in between 12x and 50x PER! It’s also worth flagging regulatory risk, in that currently BOTB’s competition is categorised as a game of skill, but if regulators decided that it was online gambling, then it would face stricter regulation and different tax treatment.

Opinion The shares have risen +40% in the last year, and in contradiction to what you’d expect from the Bored Market Hypothesis have participated in the vaccine rally. I think this is a case of expectations getting ahead of themselves, the longer term investment case remains unchanged in my view. Instead the main risk is that the management are multi millionaires, and are not as invested in the business. It would be understandable if they don’t work as hard and get distracted by rich people activities (they don’t seem the types to buy a football team, but perhaps Rupert and William would buy a polo team instead?). I’d also highlight that there could be “read across” to other Covid winners, like the computer games companies (Frontier Developments, Keywords Studios, Sumo Group and Team 17).

Volex FY results to 4th April

This cable company, that is benefiting from the rise in Electric Vehicles (EVs) reported revenues +13% to $443m and statutory PBT +85% to $29m, for FY to 4th April. Much of that growth has been driven by six acquisitions they’ve made in the last 3 years, so it’s rather disappointing that they don’t give an organic growth figure. There’s $105m of goodwill and intangible assets recorded on the balance sheet vs shareholders’ equity of $183m. The company had net debt of $7m at the year end (ex lease liabilities), they have negotiated a $100m Revolving Credit Facility.

They highlight growth from the sales in cables used in EVs +193% to $53m, so 12% of total revenues. They also reported revenue growth +13% to £113m in the Complex Industrial Technology division (mainly for products used in data centres, but also smart meters and industrial automation). Copper is a significant input cost but Volex say that their contracts allow them to pass these costs through to most customers, and where they are exposed they hedge in the futures market.

Cashflow This is another company that doesn’t show a full cashflow statement, but instead starts with “net cash generated from operating activities”. I think I should begin keeping track of which companies do this, and see if I can spot any common themes. We have to go to note 7, which does provide a reconciliation of profit to cash generated from operating activities. Large items include a $9.5m income tax credit, and $6.6m of share-based payments adjustment. As an aside, the tax means that “underlying basic” EPS was up +76% to $c32 (of which $c9 was the tax credit vs $c6 last year.) I’m fairly confident that when that tax charge reverses in future years, management will use a lower EPS figure to calculate “underlying basic” EPS growth for year on year comparisons. Similarly revenue and profits include a contribution from DE-KA, the Turkish power cord manufacturer that they bought for $60m for 6 weeks, which can hardly be called “underlying”.

There are significant movements in working capital: $12m from an increase in inventories, $17m from an increase in receivables (both negative for cashflow) and a $21m increase in payables (positive for cashflow). The company’s definition of free cashflow decreased by $16m to $31m. Much of that will be driven by acquisitions.

Outlook Strong start to the year and an “exciting pipeline of acquisitions”. Executive Chairman Nat Rothschild reiterates the five-year plan set out in October 2019 of $650m in revenues and $65m of underlying operating profit (ie 10% margin) by 2024. There’s a link to the management presentation on InvestorMeetCompany here.

Valuation The shares are on 19x FY 2022F and 18x FY 2023. But the valuation looks less attractive on a price/free cash flow basis 28x FCF FY 2022F, according to SharePad forecasts.

Opinion This is my least favourite of the companies I’ve looked at this week. The economics are less attractive: gross margin of 23% compared to 62% at BOTB and 70% at GB Group. Instead I think Volex is benefiting from the EV hype cycle, which is generating revenue growth and an increased share price which allows management to expand with acquisitions. I also don’t like the options/share-based payments and management’s definition of “underlying” EPS growth. I think we need to see how the business is performing organically rather than with the help of tax credits and acquisitions. I’ll avoid.

Bruce Packard


*SSCNEWM Mello code applies for the first 20 users who apply, who haven’t attended before

*Fact checking on the internet really spoils a good anecdote sometimes. Apparently, it wasn’t Napoleon. Instead, according to this website, the quote is Cardinal Mazarin, chief minister of France in the 17th century, who noted:

one must not ask of a general “Est-il habile?” (“Is he skillful?”), but rather “Est-il heureux?” (“Is he lucky?”)

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