Weekly Commentary 29/11/21: Turkey before Christmas?

Markets sold off sharply towards the end of last week, with the FTSE down almost 3% to 7,106. IAG (the old British Airways) and Rolls Royce were both off c. 10% last Friday. Novacyt was up +27% last week, after the company said its genesig® COVID-19 Real-Time PCR tests have been approved in the UK under the UK Health Security Agency’s Medical Devices regulations.

Oil was down -4% to $77 a barrel for Brent crude, gold rose above $1,800 but is still down -5% since the start of the year. The damage seems to have been done by a new Covid variant B.1.1.529, which first emerged in Botswana but has led to a surge in cases in South Africa. The South African Rand, which had reached 13.5 ZAR to the dollar in early June, has now fallen in value to 16.3 ZAR to the dollar.

The latest bout of selling also hit crypto with Bitcoin falling -6% to c/ $55,000, Ethereum -8% c. $4,100 and Cardano down -18% in the last week (though still up +777% since the start of the year.) John Authers at Bloomberg points out that crypto is a method of doing away with trust in institutions, and relying on an algorithm instead. But perhaps, he suggest that, we would be better to improve trust in the institutions we have, or create new ones?

The Turkish Lira has been one of the worst performing currencies this year, down -38%. A naïve view might suggest that a “strongman” in charge of an economy, centralising power ought to result in a strong currency. The opposite seems to be the case, I think because the driver of productivity in countries is not the leader at the top, but the power of institutions (rule of law, independent judiciary, Central Bank independence, functioning capital markets, journalists able to publish awkward stories etc). Most of those seem to be lacking in Turkey at the moment.

Autocrats as diverse as Lukashenko in Belorussia, Chavez/Maduro in Venezuela and Mugabe in Zimbabwe end up devaluing their currency. It looks like we may soon be adding Erdogan and Turkey to that list.

I wouldn’t recommend Venezuela or Zimbabwe but Minsk in Belorussia is an interesting city to visit. I flew there from Tbilisis a few years ago, and it felt a little bit like going back in time, visiting a museum of the Soviet Union, where the KGB still exists. At the time I visited, the price of local public transport hadn’t been updated to reflect recent hyperinflation, so it was possible to ride the buses or underground for a fraction of a pence. It was fun; I have a photo of me taking a million Roubles in cash from the ATM (worth £50 at the time), but also rather inconvenient. One time I didn’t have the right banknote, and was caught and fined for fare dodging. This caused much amusement to the other passengers on the bus, because the fines hadn’t been updated for hyperinflation either. So I should have been fined the equivalent of £50, but the actual fine was much less than £1 and the ticket inspector was rather annoyed that my “fine” wasn’t more punitive – not helped by the laughter of the other passengers.

Mello The Mello investor events are coming thick and fast this time of year. This evening (assuming that you’re reading this on Monday 29th) highlights include an interview with fund manager Rosemary Banyard, K3 Capital Group presentation, Steve Clapham and Cockney Rebel, both of whom have a different investment process to me, but who I nonetheless enjoy listening to.

Stocks this week This week I look at Alpha Financial Markets Consulting, an acquisitive people business like K3 Capital with a healthy cash balance but significant earn-out liabilities, Cerillion the software provider to telco’s and Frontier Developments which was knocked more than 30% after it warned that sales of new computer games have not lived up to expectations.

Alpha FMC H1 Sept 2021

This consulting firm that advises asset managers and insurance companies announced revenue for H1 to Sept +44% to £68m, but statutory PBT down -5% to £4.2m. There is a large gap between “adjusted PBT” of £14.4m (+59% y-o-y) and that statutory PBT figure. They have broken down the £10.2m of adjustments in the notes. The large items are amortisation £2.3m (fair enough), share-based payments £2.4m (most companies do this, but I think this is a real cost to shareholders) and £3.6m earn-outs and related finance expense (again a real cost to shareholders).

Net cash balance was £40m end of September, after they raised £30m in a placing at 325p in May to buy Lionpoint, a consultancy to the Alternative Investment Industry in the USA, for £63m maximum consideration. On an organic basis, net fee income was up +22%. However, they do comment that currency translation had a noticeable effect on net fee income and profits during the first half of the financial year, which resulted in a negative effect on net fee income of £2.2m. That suggests that on a constant currency basis revenue would have been circa +4% higher.

The gross profit margin 38.7% has improved (H1 21: 34.3%), helped also by both i) consultant utilisation levels and ii) charging more for consultant day rates.

Outlook Management now expect to deliver full-year results ahead of market expectations (which sounds like a 5-10% increase.) This is driven by strong sales momentum and a healthy pipeline of new business.

History Founded in 2003, the business has grown to over 650 consultants across 15 offices spanning the UK, North America, Europe and Asia Pacific. They IPO’ed at 160p in October 2017, raising £35m valuing the company at £163m following admission. They split their business into three areas: i) Alpha Financial Markets Consulting, ii) Alpha Technology Services and iii) Alpha Data Solutions. The consulting business gives strategy advice, helps fund managers with outsourcing and technology decisions and implements front and back office projects. They also have a database of benchmarking data to compare costs, performance and KPIs across the finance industry. The technology business specialises in software for asset managers, historically focused on distribution. The data solutions business was acquired in July 2017, and was previously a German company called TrackTwo GmbH that has a product called 360 SalesVista, which reconciles disparate transactional data of varying quality to generate company-wide reporting and analytics. In June 2019 they bought Axxsys, a technology implementation consultancy, and in Nov 2019 they bought a software business called Obsidian Solutions, both for £8m each.

Acquisitions and growth There was a Capital Markets Day in October focusing on a couple of growth areas for AFM: wealth management consulting and ESG reporting. They believe there are four drivers of growth: AUM increases, regulatory demand, cost pressure and client expectations. That makes sense, but I wonder if this is signalling that they might look to make more acquisitions? There’s currently £134m of goodwill and intangible assets on the balance sheet versus shareholders’ equity of £125m, so net tangible book value is negative. That’s not a problem at the moment given that cash generated from operations was £6m at H1, but I do wonder if consulting fees will be cut back sharply if markets go into a sustained downturn.

I should also note that while the cash balance of £40m looks healthy, there’s a £39.5m (of which £18.8m is due within one year) liability from earn-out and deferred consideration from previous acquisitions. This isn’t a separate item on the face of the balance sheet, but instead recorded as part of “trade and other payables” then split out in note 8 of the accounts. This £39.5m figure could turn out to be higher because for instance, management give a range (£5.3m to £9.3m) in the notes discussing their Obsidian acquisition, but record this at fair value on the balance sheet at the lower figure in the range: £5.3m.

Ownership There are many high quality institutional shareholders on the register, perhaps because they are familiar with AFM as clients (Alpha has worked with 95% of the world’s top 20 asset managers by AUM). Janus Henderson owns 7.9%, Fidelity 7.4%, Allianz 7.3%, Abrdn 7.1%, M&G 6.8%, Nordea 4.7%, Gresham House 4.4%.

Valuation The shares are trading on 16x FY Mar 2024F cashflow or 18x forecast EPS. That’s not too expensive given the raised expectations. However, RoCE has been trending downwards to 8.5% FY March 2021, so we really need to see that the most recent acquisition means that the growth is creating value for shareholders. I don’t think we’ll see any multiple expansion from here unless RoCE improves from 8.5% and EBIT margin rises above 10%.

Opinion This company has done well, with the share price up 2.5x since coming to market. I’d like to know how badly revenues were hit between 2007-2010, because that would give an indication of how sensitive AFM is to financial market cycles. In the absence of that information I’m a little wary given how frothy markets currently are and the nature of people businesses where the assets walk out the door (or work from home) every day.

Cerillion FY to Sept

Cerillion the mobile billing and CRM software company announced revenues +25% to £26.1m (of which a third is recurring revenue). The business was originally part of Logica plc before its management buyout, led by CEO, Louis Hall (current Chief Exec) in 1999 and joined AIM in March 2016. I previously wrote about the company here.

The gross margin was an impressive 78%, which was an improvement versus 74% H1 last year. This looks like a business with significant operational gearing because statutory PBT was up 2.8x to £7.4m and net cash was up +71% to £13.2m at the end of September. Unusually for a fast growing company the depreciation and amortisation charge fell -2% to £2.88m. That non cash £2.88m charge in the p&l is higher than the £1.3m cash used in investing activities in the cashflow statement (£970K capitalisation of intangible assets, £301K of purchase of fixed assets), so the company is generating significant amounts of cash and management aren’t trying to flatter accounting profits.

Competition They presented to Mello last week, explaining their business as helping telcos with billing, allowing customers to monitor prepay balances, bundled products and security. They are a low code solution, easy to configure rather than needing to write bespoke software. Competitors are telco’s equipment makers (Ericson, Huawei, OTE) and software companies like Oracle, Netcracker (owned by NEC) and Amdocs, which has a market cap of $9.2bn and a relatively low fc PE of 13.9x according to SharePad. Amdocs has significantly underperformed the S&P 500 in the last two years and the cheap PE and Price/Sales Ratio multiple (below) for a software services company is worthy of further investigation, because it may indicate the industry is being disrupted by another player?

One thing I noticed on the Q&A is that Louis Hall the Chief Exec didn’t mention $283bn Salesforce (fc PE of 65x, see valuation below) as a competitor, then stumbled somewhat when a questioner mentioned the company. That could be because Salesforce bought Vlocity last year, which has solutions targeted at Cerillion’s market. Even if you don’t invest in international companies, I’d definitely recommend using SharePad to investigate the valuation of competitors to UK listed stocks.* Below is the SharePad valuation summary for Salesforce.

Outlook The outlook statement is a little vague and doesn’t talk much about the start to the current year, except to say that the back order book (+36% to £42m) stands at a record level, providing strong visibility of revenues. Within this there’s £7.2m of customer support revenue, plus £35m of contracted sales that haven’t yet been recognised. They expect 75% of the £35m to be recognised with the next 12 to 18 months. They also point to the pipeline of new business (+43% to £33m.)

They flag some “inorganic growth opportunities” which I think means that they’re on the look out to buy companies operating in the same space. They say that telecom companies are increasing spend on their networks which should benefit Cerillion.Valuation As you would expect for a company growing revenue at +25% y-o-y with a high and improving gross margin of 78%, the shares are not going to show up on anyone’s “value filter”, trading on 32x PER and a price/sales ratio above 9x. However, it’s worth pondering whether the operational gearing means that RoCE could expand from the low teens the company has reported over the last 5 years to above 30% in the most recent FY Sept 2021, driving a re-rating towards a Salesforce type of valuation.

Opinion Looks good, it’s already 12 bagged from its IPO price. I came across this company when it listed at 76p in March 2016, because Lord Lee mentioned it at a ShareSoc event in Richmond upon Thames. I’m generally sceptical of IPOs, there’s a pareto distribution with the occasional “winner” making up for 4-5 “losers”. I feel like I’d need to do more work understanding the industry trends, competition and US peers, but well done if you have bought into the shares.

Frontier Development trading update FY May 2022

This computer games publisher with titles such as Jurassic World, Planet Coaster and Elite released a RNS saying that they are lowering their FY revenue guidance for FY22 to £100 million to £130 million. Previous guidance, which was in the outlook statement for the FY May 2021 results, released on 8th September was £130 million to £150 million. That was enough to knock -32% off the share price on the day of the results.

The disappointment was due to the lacklustre sales of Elite Dangerous: Odyssey which was released on PC in May 2021 and consoles a couple of months later. This has been compounded by Jurassic World Evolution 2, released in early November also suffering from lower-than-expected sales on PCs (PlayStation and Xbox console sales numbers are largely as expected). They still expect significant sales around Christmas and also a boost from the Jurassic World Dominion film in June 2022. Frontier Foundry, their 3rd party label publisher is scheduled to release 6 titles, of which at least 3 (Lemnis Gate, FAR: Changing Tides and Warhammer 40,000, Chaos Gate – Daemonhunters) should be in this year’s FY May 2022F.

One interesting statistic in the FY 2021 Annual Report that caught my eye, was that 96% of revenue comes from games that are digitally downloaded, and just 4% from physical discs. That suggests that loss making, $16bn market cap meme stock GME has a real challenge to turn its business around.

Below I’ve shown the release cycle from a handy graphic that they published in their Annual Report (FY to end May) which they published in September.

Ownership David Braben founder / Chief Exec owns 33%, Tencent the Chinese games/app company holds the next largest stake at 8.6%. Swedbank owns 8.1%, Oppenheimer 7.6%. The Tencent stake suggests that eventually the company will be sold, when David Braben decides that he’s had enough. As a teenager who programmed the original Elite game in assembly language, it strikes me that he is likely not just smart, but an extremely tenacious character, so he may want to keep driving the company forward for longer than some expect.

Valuation This is an attractive business, but with unpredictable revenues dependent on the timing and success of releases. Following the profit warning, the shares are trading on 37x the average EPS of the last 3 years. For contrast, BOTB which was also “Covid winner” turned “vaccine loser” trades on 11x the average EPS of the last 3 years. FDEV had £42m of net cash at the end of May, so clearly the games publisher is in no way distressed. All the UK computer games companies have had a difficult 2021, ex Sumo Group, but still trade on quite demanding valuation multiples.

Opinion FDEV strikes me as a good quality company in the medium term, though the chart on the next page shows how volatile RoCE and EBIT margins have been historically. I think that it’s probably worth waiting for the price to settle after last week’s profit warning. We may see some excitement over the Warhammer: Chaos Gate – Daemonhunters, which is planned for release in spring 2022, then the F1 management game should be released early in the company’s financial FY2023 (ie after 1 June 2022) followed by Warhammer: Age of Sigmar in the same financial year. I’m not sure that there’s any reason to buy before Christmas though.

Bruce Packard


*Hat Tip to Mark and Leo’s Discord channel, where there were some knowledgeable contributions in the discussion forum from people who obviously knew the industry background well.

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