Weekly Commentary 20/09/21: Entities multiplied beyond necessity?

UK and US markets remain quiet, with the FTSE 100 at 7,013, struggling to keep its nose just above 7,000 last week. There continue to be spikes and drops in some commodities; earlier this year it was Rhodium hitting $25,000 an ounce, now Uranium is up +48% in the last 3 months, while Iron Ore is down -36% over the same time period. The FTSE China 50 sold off heavily and was down -6% last week. Alibaba is down -26% in the last 3 months and Tencent is down -27%.

China Evergrande continues to be a slow-motion train wreck. Out of curiosity I’ve downloaded the property developer’s most recent set of results. It looks like the business will default without ever having reported a loss (H1 2021 PBT was RMB14.5bn). Total assets on 30th June were RMB2.3 Trillion (US$360bn), of which RMB1.3 Trillion (US$200bn) is “properties under development” in current assets (ie their value should be realisable before June next year).

Yet TheLastBearStanding points out on Twitter that Evergrande has admitted that it can’t convert any of those assets into cash at the moment. So, in effect $200bn of assets that the company’s accountants were happy to record as “property under development” on the asset side of the balance sheet are probably worth a fraction of their accounting value. If Gordon Brown could nationalise Royal Bank of Scotland, which had £2 trillion of liabilities, it’s worth pondering the reason that the CCP seems reluctant to quickly step in and stabilise the situation at Evergrande. Perhaps a coincidence, but the Chinese Communist Party has had a crackdown on independent financial bloggers.

This may be contained to one company, or the Chinese property sector, or it may signal a problem with Chinese accounting standards across the entire economy. Steve Clapham has published a report on the five largest Chinese tech stocks (Alibaba, Baidu, JD.com, Meituan Dianping and Tencent) which have invested 3 trillion RMB (US$460bn) in Chinese software startups in the last 5 years. That’s the equivalent of c. 5 Softbank VisionFunds – and so far they have not recognised losses and written down the value of their investments. Either these Chinese tech companies can teach Andreessen Horrowitz, Y Combinator and Peter Thiel how to invest in start-ups without making any losses – or the accounting is suspect. I think that we can apply Occam’s razor (entities should not be multiplied beyond necessity) to come up with the most likely answer. Below is SharePad’s chart of $BABA showing increasing NAV (accounting book value), but a falling Price/NAV suggesting that some investors are concerned about the quality of that NAV.

Good news I wrote a couple of weeks ago that September would be a particularly important month, seeing whether vaccines prevent the very high cases of Covid converting into hospitalisations and deaths. The good news is that in the UK that does indeed seem to be the story. Hospitalisations remain low, and the Office of National Statistics estimates 90% of UK adults have Covid antibodies, suggesting that either people have had the infection in the past or have been vaccinated.

But John Authers at Bloomberg has highlighted that this is not the story everywhere; in the US particularly the third wave is now almost as bad as the first. Once again, not multiplying any of those entities beyond necessity would suggest a simple reason for the difference. Texas and Florida, two states with Republican governors who have expressed scepticism towards the vaccine and also masks, have seen higher deaths than the first two waves of the virus. This is bad news if you live in Florida or Texas, it was also unnecessary. But I think we probably shouldn’t extrapolate to the UK and Europe.

So if that interpretation is correct, then the “vaccine rally” trade may reassert itself more strongly here than the US or China. That is, some AIM listed companies that enjoyed a strong rally in Q1 and then ran out of steam (The Mission Group springs to mind, but I’m sure there are many other stocks with a similar profile) could enjoy renewed vigour in the last quarter of this year.

We are approaching the end of September, but there are still plenty of companies reporting H1 results. I tend to view companies that take a long time to report with some scepticism. Perhaps a delay is innocent, but there are other explanations for slow reporting (for instance, complexity, lack of integrated systems, window dressing numbers or just poor management.)

This week I look at Kape, the Israeli VPN business, Anexo and RBGP, plus a brief comment on Equals. Of the four I think Anexo could be at an attractive valuation but Equals has the best turnaround story, particularly if you take the “glasshalfull” view.

Kape buys ExpressVPN

This Israel-based Virtual Private Network (VPN) and anti-virus company announced a placing of $354m (or £257m) to buy ExpressVPN. Issuing 77m new shares at 338p (a 5% discount to the previous day’s market price). There was also an offer on PrimaryBid which raised less than £2m from retail investors. Unikmind, Teddy Sagi’s investment vehicle based in the Isle of Man, now holds 181m Ordinary Shares, equal to 60% of the company’s shares.

Acquisition Kape is using the money raised to go towards the US$936 million total consideration for ExpressVPN: $354m in cash, $237m worth of Kape shares to be given to the founders of ExpressVPN (Peter Burchhardt and Dan Pomerantz) and deferred cash consideration paid in two instalments of US$172.5m each, 12 and 24 months after the deal has completed. The company has said that no additional equity will be needed to pay the deferred consideration. They’re expecting $30m of annualised synergies, which assuming a 10x multiple would justify around a third of the $936m price paid.

ExpressVPN was founded in 2009, and had FY 2020 revenues of $279m and adjusted EBITDA of $75m (no profit figure given). There’s a footnote saying that adjusted EBITDA figure is in accordance with IFRS, and under US GAAP resulted in $25m reported EBITDA. That seems like a huge difference between accounting standards! Maynard has done some digging on Kape’s accounting previously, and highlights that adjusted EBITDA is not a good proxy for cashflow, because marketing costs are capitalised on to the balance sheet and then amortised. SharePad shows that Kape’s quality metrics are rather low too.

Recent Trading Kape put out an H1 trading update on 20th July, saying that the Group will deliver Full Year revenues in the range of $197-202m and Adjusted EBITDA of between $73-$76m. They said last week that the enlarged group should generate FY 2022F (ie next year) revenues of between US$610-624m and proforma Adjusted EBITDA of between S$166-172m. We are still waiting for H1 2021 figures though, due this week Tuesday 21st September, which suggests that there is some execution risk as the company grows by acquisition and it becomes increasingly complicated to integrate acquisitions (not just ExpressVPN but also Webselenese total consideration $149m March 2021 and PIA $95m December 2019).

Opinion So far the wheels haven’t fallen off, and the shares have more than doubled, up +133% from the start of the year. Revenue was less than $5m 10 years ago vs US$610-624m FY 2022F range, but growth only creates value if it generates a decent return. The company is trading on 10x historic sales, which drops to 5x 2022F, so I’d urge some caution and encourage investors to understand the risks.

Anexo Group H1 results to June

This niche insurance / legal company helps drivers that have been in car accidents, providing them with a replacement vehicle and then reclaiming the costs from the at-fault-driver’s insurance company. Anexo describes their customers as “impecunious”, which is a lawyer’s way of saying that they don’t have much money. Referrals come from a network of garages, who after an accident put potential customers in touch with Anexo. No fee is paid to the referrer, but the garage does benefit from doing the repair work and accelerated payment of invoices. Sometimes Anexo does also pay the garage a marketing retainer in return for branded signage at the garage.

At no upfront cost the customer has their car repaired and receives a replacement. Since Anexo’s customers are impecunious, the group is able to charge insurance companies a commercial credit hire rate that is 2-3 times higher than that normally agreed by the ABI (Association of British Insurers).

Results They reported strong H1 results, with revenue +32% to £48.3m and PBT +41% to £10.4m. I saw management present a few months ago, and can remember thinking that’s it’s an unusual niche, but also being surprised how fast growing it was. For instance revenue doubled in 3 years from £45m in FY 2017 to £87m FY 2020. The trend has continued into H1 this year, and despite the share price halving in February / March 2020 and not really recovering, this share ought to be relatively “recession proof”. The company had £44m of net debt on the balance sheet at the end of June.

It’s also worth mentioning that the company has a very high level of receivables on their balance sheet, £160m vs shareholders equity of £117m, because the nature of their business model is to incur costs immediately, but they then take some time to collect the money that they’re owed from insurance companies. Looking at note 4 of their accounts the gross claim value of £289m is an even higher figure, and there must be some risk because management also accrue a balance sheet provision of £19m against possible impairment.

History The business was founded by a barrister, Alan Sellers and goes back to 1996. It was originally a credit hire business that relied on a panel of law firms to recover costs from insurers. They listed on AIM in mid-2018, raising £25m gross, of which £15m went to the selling shareholders and £10m to the company. The placing price was 100p, and valued the company at £110m. Alan Sellers remains the Executive Chairman with a 17% stake in the company.

Then in June this year the company received a takeover approach from DBAY advisors, an Isle of Man investment vehicle, for 150p in cash. Saki Riffner, founder of DBAY, was already a non Exec of Anexo, and DBAY held just under 30% of Anexo’s shares. Then on the 18th of August, under the “Put Up or Shut Up” rules, DBAY confirmed that they did not intend to make an offer for the entire company.

Ownership DBAY Advisors still owns 29% of the company, and presumably this could create an overhang if they try to exit their investment. Directors Samantha Moss and Alan Sellers both own 17%, and the lack of free float rather restricts the amount of institutional ownership. Gresham House owns 3.7%, AXA 3.4% and Miton 3.4%.

Forecasts The most recent note from Progressive Research, which shows FY 2022F revenue is expected to be £102m and Adj EPS of 14.9p. That implies a PER of below 10x, which seems attractive for a fast-growing business.

Opinion This looks an interesting company, although the overhang from DBAY is likely to hold the company back in the short term. I also wonder how large the market for impecunious drivers who’ve been in car accidents is. In this market there aren’t many growth stocks on below 10x, so this makes more sense to me than Kape above, or RBGP covered below.

RBGP H1 to June

This professional services firm, previously known as Rosenblatt Group, reported strong headline numbers for H1. Revenue was up +53% to £18.3m vs H1 last year. In H1 they bought Memery Crystal, a law firm that has found a niche advising the (legal) cannabis sector for £30m. Without the acquisition organic revenue growth was a still impressive +35%.

Group PBT rebounded even more strongly almost trebling to £3.9m. The company claims that this is +279% growth from £1.4m H1 last year, but I think that they have made an embarrassing typo. I make the calculation (3.9/1.4-1) so +179% growth; or put another way double is +100% growth and treble is +200% growth. A rather silly mistake that does not inspire confidence.

Balance sheet The momentum of results looks good, but there are risks. The company had £9.8m of net debt, and an untapped Revolving Credit Facility of £15m. However that net debt figure excludes £5.6m of deferred acquisition cost for the acquisition of Memery Crystal, and also some earn out obligations from LionFish, their litigation finance company. My view is that earnout obligations and deferred consideration should be added to the net debt calculation.

Deducting intangible assets of £56.1m from shareholders equity of £58.7 shows there’s only a sliver of tangible equity. Included within intangible assets is a £1m payment made to Ian Rosenblatt last year in return for him extending a restrictive covenant put in place at the IPO to an additional two-year term through to 2023. That is, the company has paid its largest shareholder (who is no longer an employee) a large sum of money, and recorded the payment as an asset on the balance sheet. That seems an “interesting” accounting decision.

There’s also £7.7m of litigation assets and £17m of trade and other receivables. Hence while the business is generating operating cashflow (£2.4m H1 this year, but negative H1 last year) I think that this is OK, but if revenue disappoints or the receivables are hard to convert into cash, then it doesn’t leave much margin for error.

Outlook Management highlight strong demand for all the Group’s services, and they are on track to meet the recently upgraded market expectations for the full year (without saying what those expectations are). The most recent trading update was on 16th July when the group was “in line” with market expectations (again without saying what those expectations were.)

I dislike this way of communicating, because it implies there’s a gap between the guidance that management are prepared to commit to in an RNS and what they are privately telling brokers. I’ve included the forecasts from SharePad below, EPS of 9.4p implies a PER of 15x in 2022F.

Ownership Ian Rosenblatt still owns 17.7% of the company. Nicola Foulson, the current Chief Exec, owns 12.1%. Miton is the largest institution with 12.8% and Schroders owns 4.3%.

Opinion The shares are up +144% since the start of the year. Well done to holders, it’s significantly outperformed Manolete (see chart which uses the SharePad “multigraph” feature to compare the two).

RBGP bought Convex Capital, which initially looked badly timed but is currently benefiting from buoyant corporate finance conditions, so they haven’t been as exposed to the temporary halt in insolvencies which has hit MANO hard. But I’m cautious, as I feel like there are too many, if not red flags, then orange flags. However, others have been well rewarded for backing RBGP, so well done Carcosa61 and Glasshalful, plus any others who also have caught the bounce.

Equals H1 to June

This foreign exchange and payments “FinTech” released H1 to June results, with revenue +23% to £16.9m and a loss of £2.2m before tax vs £3.3m loss H1 last year. They’ve also given an update for Q3 so far (ie 1 July to 10 Sept), with revenue up +58% to £5.8m vs same time period last year. They had £12.3m of cash in the bank and £10.2m of net liquidity (ie with customer balances and balances required by the regulator deducted).

Forecasts Having been loss-making the last two years, the group is forecast to return to profitability for FY 2021F. Management commentary supports the turnaround story, talking about “further acceleration” since the end of June. Last year they cut costs (mainly headcount) by 25%, so the risk was that they’d been to aggressive and wouldn’t be able to grow the top line. These results dispel that fear.

Valuation The shares are trading on a PER of 20x 2022F and 2.8x 2022F sales. Historically return on capital has been poor, but if they can continue to grow revenue then the economics could look much more attractive, given the gross margin has been around 60-70% over the last 5 years.

Opinion I mentioned this stock in April, and though it seemed like a good recovery play, I mentioned the competitive threat from FinTech firms like Wise and Revolut, funded by deep pocketed Venture Capitalists. The progress this year suggests that my concern was overplayed.

Well done to Glasshalfull on Twitter, who highlighted it as one of his top picks at the start of the year. He points out that revenue per day has now climbed to £180k in Q3 (to 10th Sept) +32% when compared to £136k in H1. Also Equals Solutions, the group’s recently launched multicurrency product aimed at larger businesses, contributing £1.2 million of revenue, or 13% of total, in Q3-2021 to date as another area that could create further upside. For readers who like their share price charts to resemble breakfast crockery, there is a nice bowl forming.

Bruce Packard


The author owns shares in The Mission Group

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