Weekender #26

A weekly recap on high-quality European micro-caps

Good morning and welcome to your weekly source of high-quality European micro-caps news. What a week to be away! I was going to summarise my holiday in Mexico in numbers (i.e. number of tacos eaten/number of margaritas drunk) but there has been so much news flow that there are more important things to talk about, most notably CBOX (Cake Box Holdings). I’m pleased to say that we have doubled our position in CBOX in what we believe is a unique opportunity given the recent share price movement. We look at the points raised in Maynard Paton’s report and explain why we think investors are overreacting. In this Weekender we also highlight some read-across news flow for our position in TFPG (The Property Franchise Group) and cover the many trading updates for our watchlist.

Let’s go!

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Companies mentioned

UK

• CBOX (Cake Box Holdings)

• ANX (Anexo Group PLC)

• EAH (ECO Animal Health Group PLC)

• BOTB (Best of the Best PLC)

• OTMP (OnTheMarket PLC) (*TPFG read-across)

• SPSY (Spectra Systems Corporation)

• FIPP (Frontier IP Group)

• ELCO (Eleco PLC)

• PGH (Personal Group PLC)

• RBGP (RBG Holdings PLC)

• FOXT (Foxtons Group PLC) (*TPFG read-across)

• LSL (LSL Property Services PLC) (*TPFG read-across)

France

• ALFOC (Focus Home Interactive SA)

• ALBFR (Sidetrade SA)

Germany

• MWB (Mwb Fairtrade Wertpapierhandelsbank)

Denmark

• TCM (TCM Group)

Poland

• MRC (Mercator Medical SA)

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Deep Dive news flow

CBOX (Cake Box Holdings) - Cake franchise, mkt cap £100m

On Friday 21, Maynard Paton published the following note: Cake Box Holdings has some accounting issues. Just to give a bit of context, Maynard Paton used to be an investment writer for The Motley Fool UK and now is a full-time private investor/blogger who writes occasionally for SharePad. We have come across his articles before and have enjoyed reading them as he does quite a bit of financial analysis which we appreciate. We would also say he has a strong retail following, which we believe explains the share price movement in what is a relatively illiquid stock with a higher than average retail following. On Monday 24, the stock closed down 22%. On Friday 28, the stock was down 27% from the undisturbed price.

So what do we think about the article? We enjoyed reading it and are pleased that someone has done the work on the accounts and is holding management accountable. So why did we double our position? 1) Part of our research process before publishing a Deep Dive is reading the annual reports, some of the points highlighted in the Maynard Patons’ report we knew already and were publicly available; 2) The issues that we weren’t aware of seem like minor mistakes with no clear evidence of manipulation/benefitting from the error; and; 3) CBOX's equity story is unchanged (and trading remains in-line), the only thing that has changed is the price that provides us with a unique opportunity.

Let’s analyse the note point by point:

1. Tax charge: Correct on original RNS, admin error in annual report

2. Cash flow statement: Correct on original RNS, admin error in annual report

3. Related-party transactions: Change of opinion and immaterial

4. Website hack undisclosed for >1yr: Public information/already knew, not well managed by company/advisors

5. Historic errors/control weaknesses: Public information/already knew, new stock system was rolled out in FY21

6. Stock expense restatement: I think this is irrelevant. In 2020 report they’ve used the cost of sales number as the “stock recognised as an expense” whilst in the 2021 report (for 2020 numbers) they’ve allocated 88% of the cost of sales to “stock recognised as an expense”. This is a breakdown number for the operating profit and has been allocated differently in the two years. The overall P&L of the company in both cases matches and therefore I believe this is irrelevant.

7. Transactions posted outside of the normal revenue cycle: Highlighted in risk section and have been investigated by auditor with no further mentions.

8. Auditor resignation: Letter posted on website and publicly available/we knew already, Auditor gave unqualified audit opinion on FY21 accounts, so not a problem. Also worth highlighting here is the auditors conclusion on FY21 accounts i.e. immaterial

9. Trade payables/receivables: Reporting ageing of payables may be unnecessary but not a negative. With 0 bad debt write-offs for FY21 reporting ageing of trade receivables seems unnecessary. Regarding the seven day payment term, we are not accountants but perhaps this has to do with the other revenue sources potentially having longer payment terms (sponge sales + cake supplies vs. store fit out, franchise fee, equipment, other). i.e. if you only look at the accounts receivables for the purchases of products, it might actually be in line with the stated seven day payment term. I will try and clarify this with management when I get a chance.

10. Interest on overdue tax: Immaterial

11. Cake innovations: interesting, I wonder if it has anything to do with vegan or less sugar etc.

12. Property revaluation: We knew already. Holding at fair value instead of book is fairly common. The number of revaluations, probably a tad excessive but given what the property market has done and perhaps taking into account local considerations, could have been necessary. Either way, the value is immaterial. For anyone worried about where those profits are going, they flow through OCI and not P&L.

As Maynard Paton pointed out, the company had already addressed some of these historical issues by taking a number of actions to enhance the Company’s control and governance framework. These include 1) appointing an additional new Non-Executive Director; 2) appointing BDO LLP to fulfil an internal audit function; and; 3) hiring additional senior staff.

The company issued an RNS in response to the share price movement stating the obvious. The key takeaways are:

1. The errors noted have no impact on the Group's reported profits, cash flows or balance sheet

2. The Board confirms that, since the Company updated the market with its half year results in November, trading in H2 has continued strongly and in line with expectations for the full year.

We also note that the COO, Jaswir Singh, bought 14k shares at 250p and 6k shares at 247p (overall value £50k) on Monday 24. The only institutional seller we have seen is Axa (5.65% to 4.83% on Monday 24), suggesting the share price movement has mostly been driven by retail investors. We wouldn’t expect institutional holders to sell on the back of the note.

Just to put this whole episode into context. This is a micro-cap stock, founder led, that has only been listed since 2018. The founders are entrepreneurs. They spend 75% of their time figuring out how to drive top-line growth, 20% of their time making sure the costs don’t spiral out of control, and 5% of their time making sure the checks and controls are in place. Personally I wouldn’t want it any other way. All they need is a strong team around them to make sure that these historical issues do not recur.

One last point. Our view is that nothing has changed apart from the price. Our initial position was taken at 23x TTM EBITDA. We can now buy the company at 14x TTM EBITDA and the company has just told us “trading in H2 has continued strongly and in line with expectations for the full year.” (March y/e). This is a company that is growing revenue at >20% p.a. (locations + LFLs) and is likely to see even higher EBITDA growth due to margin expansion and you can buy it at 14x TTM EBITDA… it is the sort of opportunity that only exists in the micro-cap space.

We expect to see more volatility given the lack of liquidity and retail involvement. Our strategy is buy and turn your monitor off. Switch it back on when the company announces FY22 results or even FY23 results.

Tags: Deep Dive #1, Weekender #16, Weekender #17, Weekender #18, Weekender #20, Weekender #21, Weekender #22

Read across for our TPFG position - TPFG (The Property Franchise Group) - Real estate/letting franchise, mkt cap £102m

OTMP (OnTheMarket PLC) - Online property portal, mkt cap £81m

• Trading update (y/e Jan) - Adjusted operating profit ahead of expectations

• Original guidance: breakeven adjusted EBIT 2H22

• New guidance: Positive adjusted EBIT 2H22 and at least £2.5m for adjusted EBIT FY22

• Operational performance has continued to be strong through 2H22

• Disciplined operational/cost management + higher level of investments capitalised

• Quick take: A small beat is always a positive for the sector. However, I’m a tad confused as to whether the beat was due to operational outperformance, cost savings, or capitalising more costs than expected? Either way operational performance has continued to be strong which is the important point.

FOXT (Foxtons Group PLC) - Real estate/lettings, mkt cap £129m

• Year end trading update - Profit at top end of expectations

• Much improved performance in 2021

• Revenue across all business segments ahead of prior year and 2019

• FY21 revenue c.£133m, adjusted EBIT £7m, at top end of market expectations

• Outlook for next year: A further improvement in adjusted EBIT partly due to increased rental levels in London residential market

• Quick take: The outlook statement is probably more bullish for WINK (M Winkworth PLC) as it has more exposure to London, but still a positive for our TPFG position.

LSL (LSL Property Services PLC) - Real estate/lettings services, mkt cap £414m

• Year end trading update - In line with Board’s expectations

• FY21: Record underlying EBIT

• Estate Agency residential pipeline conversion slowed in 2H21, following the record market levels experienced in the lead up to the 30 June 2021 Stamp Duty deadline and capacity issues in the conveyancing market.

• "We retain a strong residential sales exchange pipeline at 31 December 2021, 7% lower than the record pipelines reported at the same date in 2020.”

• Quick take: A slowdown in the estate agency residential pipeline conversion post the stamp duty holiday was expected. Supple issues have been noted by all the real estate operators. A 7% drop in residential sales exchange pipeline YoY doesn’t seem drastic.

Tags: Deep Dive #2, Weekender #16, Weekender #17, Weekender #18, Weekender #21, Weekender #24, Weekender #25

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Watch list news flow

UK

ANX (Anexo Group PLC) - Credit hire/legal services, mkt cap £171m

• FY21 Trading update - PBT significantly ahead of market expectations

• Revenue growth has exceeded the Group's forecasts and PBT will be significantly ahead of market expectations

• Strong performance due to 1) strong growth in the motorcycle courier market; 2) withdrawal of competitors due to Covid; 3) implementation of the Civil Liability Act in May 2021; and; 4) deal with MCE

• Re-opening of courts has been beneficial to legal division

• The Group expects considerable growth in the newly formed Housing Disrepair team in 2022

• Quick take: We still need to do some work on the business model (cash flow), but with the MCE deal and the newly formed Housing Disrepair team there is a lot to look forward to. Also, the number of vehicles on the road in the Group's credit hire division, EDGE, reached record numbers in 2H21….

Tags: Weekender #20, Weekender #22

EAH (ECO Animal Health Group PLC) - Pharma (animal health), mkt cap £130m

• New CEO and CMD

• New CEO - David Hallas appointed CEO with effect from the 1 April 2022 following announcement on the 26 July 2021 regarding Marc Loomes' intention to retire from ECO during 2022

• David Hallas - 30yrs experience animal health industry and a qualified veterinarian, currently MD of Sure Petcare, a wholly owned subsidiary of Merck Inc. (sales> $170m). Has substantial experience managing profitable growth through the introduction of new products, including vaccines, and successful M&A integrations

• CMD - The company started a programme of significant R&D investment in vaccines four years ago. The CMD was an opportunity for management to detail the potential commercial value that exists within the new product development pipeline. Below is the opportunity slide:

• Quick take: The investor presentation is packed with useful information. We now understand what has been driving capex. Flicking through the slides isn’t good enough. We will need to find time to watch the presentation.

Tags: Weekender #25

BOTB (Best of the Best PLC) - Win a car competitions, mkt cap £41m

• 1H22 results (Apr y/e) - FY22 guidance lowered

• Operational gearing, higher customer acquisition costs and increased prizes
  have reduced margins on broadly stable revenues

• 1H22 revenue £19m, PBT £3m, in line with management’s expectations

• Outlook: Cost of acquiring players increased by a further 37% in November/December 2021 vs prior 6m average, resulting in fewer customer registrations. This combined with a “cautious outlook” = FY22 expectations revenue £34-35m, PBT £4.25-4.75m (previously c.£6m)

• Company taking steps to reduce the bottom line impact of reduced revenues by maintaining a sharp focus on costs, and prioritising only the most efficient marketing channels

• “It is now also becoming apparent that the business benefitted more than originally assumed from a tailwind during the Covid period” - no comment

• “We recognise that there is potential volatility ahead”

• Quick take: I am convinced that there is a great business somewhere in here. I can’t tell if the problem is lack of predictability of earnings (in which case low quality) or if the problem is poor guidance. Either way, given the number of profit warnings, management should really rethink how it delivers guidance. Some work also needs to be done on the shareholder register.

Tags: Weekender #18

SPSY (Spectra Systems Corp) - Authentication/secure transactions, mkt cap £61m

• Three new contracts

• “In total, these three new contracts will generate $700,000 of additional
  unforecasted revenue for the 2022 calendar year” (c.4% boost)

• 1) Received additional order for covert materials from its largest
  central bank customer, increasing this year's initial order by 20%. This brings the aggregate order for the current year to 75% of last year's record order size

• 2) The same customer renewed its sensor service contract at nearly double its historical annual value

• 3) New contract for existing USA state lottery customer worth at least $500k for the ten-year contract period

• Quick take: Moaty business (patents) and is constantly winning contracts (the last two times we mentioned it were also contract wins). One of the more exciting names on our watchlist. Despite this, the share price has been disappointing.

Tags: Weekender #17, Weekender #22

FIPP (Frontier IP Group) - Commercialising IP, mkt cap £55m

• Sale of shares in Exscientia (portfolio company)

• FIPP sold 183,901 American Depositary Shares ("ADSs") of portfolio company Exscientia plc (Nasdaq:EXAI) for net proceeds of c$4.0m (c.£2.9m) at an average price of $21.68 per ADS

• Sale generated an estimated realised gain of £1.38m for FIPP

• Net proceeds will be used for general working capital purposes and to provide further support to FIPP's existing portfolio companies

• Post sale, FIPP holds 1,380,899 shares in Exscientia

• Quick take: Since FIPP holds 1,380,899 shares in Excscientia and each ADS represents one share and every ADS is worth $21.68, then FIPP’s Exscientia holding is worth £22m. Not bad for a company that has a market cap of £55m, is net cash, and has 16 other portfolio companies. Also, the selling of IPO’d portfolio companies is how they plug the lack of cashflow.

Tags: Weekender #16, Weekender #21, Weekender #25

ELCO (Eleco PLC) - Construction software, mkt cap £80m

• FY21 trading update - Revenue/EBITDA expected above market expectations

• Revenue expected £27.3m - above market expectations (£26.9m) - driven by core Building Lifecycle portfolio

• EBITDA expected £7m - above market expectations (£6.7m)

• FCF expected £5.5m - in line with prior year and above market expectations (£3.6m)

• Quick take: This is the 1st time we look at this company. Our eyes were drawn to this: “Recurring revenue overall increased by £1.2m (9%) to £15.4m, following the successful launch and acceleration of the Company's SaaS/Subscription strategy”. That means SaaS accounts for 56% of revenue and is growing. The business is also net cash.

PGH (Personal Group PLC) - Employee benefits/services, mkt cap £111m

• FY21 trading update - in line with expectations

• FY21 revenue c.£75m, adjusted EBITDA c.£6m

• Encouraging rebound in insurance sales in 2H21

• “Our market has never been more relevant”, “this trend is set to continue
  accelerating into 2022”

• Good start to FY22, 11 new client wins across the Group

• Quick take: Covid has created a long-term structural tailwind for this company “Our market has never been more relevant”…. however the shares are still lower than where they were trading pre-Covid.

Tags: Weekender #18

RBGP (RBG Holdings PLC) - Legal/professional services, mkt cap £106m

• Pre-close trading/divided update - FY21 EBITDA c.10% > current market expectations

• Strong financial quarter = expects FY21 EBITDA c.10% > current market expectations = pay a second interim dividend of 3p/share in 2H21. FY21 dividend paid to shareholders = 5p/share

• Quick take: This is the 1st time we look at this company. The business has legal services (Rosenblatt/Memery Crystal), litigation finance (own clients and third-party solicitors matters/LionFish), and an M&A business (Convex Capital). Like the other professional services companies on our watchlist, the operating margins are attractive. The balance sheets suggests acquisitions and is not as clean as those of its peers.

France

ALFOC (Focus Home Interactive SA) - Video games, mkt cap £190m

• 1H22/3Q22 results (Mar y/e) - Guidance set

• 1H22 revenue -18%, EBITDA -13%

• 3Q revenue EUR37.1m - solid performance from recent releases

• FY22 guidance EUR120-150m, likely to be mid-range

• Impairment of two games (Hood: Outlaws & Legends and Warhammer Age of Sigmar: Storm Ground’s) due to performance below expectations

• Strong pipeline for the upcoming years

• Quick take: Weak share price, solid 3Q22 results, a “strong pipeline”, and M&A activity in the sector, this could be a turning point for ALFOC.

Tags: Weekender #16

ALBFR (Sidetrade SA) - Software, mkt cap £181m

• FY21 trading update - Record bookings in 4Q21

• 4Q21 bookings +23% (70% international, 24% North America - aiming for 33% NA by 2H22)

• Annual SaaS revenue +16%

• “Booming Order-to-Cash market”

• “Our technology offering is two to three years ahead of our main North American competitors”

• “Never in our history have we been so sure of exactly where we stand, and so confident about where we are headed”

• Quick take: “For the first time, Sidetrade has achieved 90% recurring revenue
  for the entire year, one of the highest ratios in the software industry”. Do we have you attention now? Valuation appears to be the main issue here however it could be that the long-term growth opportunity more than offsets this. The question is around predictability.

Tags: Weekender #18

Germany

MWB (Mwb Fairtrade Wertpapierhandelsbank) - Investment bank, mkt cap £73m

• FY21 trading update - Decline in earnings expected

• Expects FY21 EBIT EUR18.7m (FY20 EUR24.5m)

• Expects FY21 Net income EUR12.1m (EUR17.7m)

• Quick take: This is the 1st time we look at the company. A quick look at the financials suggests we shouldn’t spend anymore time on this. No clear trend in revenue, volatile operating margins, poor cashflow, and suspiciously low valuation. We will remove this name from our watchlist next time we run our quality screen.

Denmark

TCM (TCM Group) - Kitchen/bathrooms, mkt cap £144m

• FY21 trading update - Revenues in line but earnings below expectations

• Expected revenue DKK1,108m - in line with guidance (DKK1,090-1,120m)

• Expected adjusted EBIT DKK138m - 10% below guidance (DKK 148-160m)

• Miss in guidance driven by continued price increases on raw materials and supply chain constraints

• Unfavourable sales mix in 4Q21 with many customers postponing the delivery of high margin orders

• Quick take: Does this mean that we will get a favourable sales mix in 1Q22 once the postponed orders are delivered? CEO - ”2021 has been the most challenging year in the many years I have been in the wood and furniture industry.” Despite this the company was able to deliver earnings on par with last year. FY22 performance is likely to improve. With pricing power and attractive financials, the recent share price weakness could be an interesting entry point.

Tags: Weekender #18

Poland

MRC (Mercator Medical SA) - Medical supplies, mkt cap £130m

• 4Q21 prelim results - losses

• 4Q21 rev -57%, EBITDA -99%, net loss of PLN7.7m

• As at Dec 31 2021 net cash/other financial assets PLN530.7m

• Quick take: Volatile earnings and a lot of noise. A clear Covid beneficiary and slowing down as expected this year and next year but still meaningfully above 2019 numbers. The market is becoming more relevant so it really depends on what the normalised level is. Too hard to predict in our opinion and unlikely to be a stock we invest in.

Tags: Weekender #19

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Have a great weekend!

Stefano Bertolini / Dark Horse Research