Small Cap Report (22 Feb) - VNET

Pre 8 a.m. comments

Well I've had better starts to the day, let's put it like that!

Sod's Law has kicked in this morning I'm afraid, in that just 2 days after I published a note on Vianet (LON:VNET), they have warned on profits. There is a lot of detail in the note, but the key points as I see it are these:

• H2 trading (Oct 2012 - Mar 2013) below mgt expectations
• However, it is quantified, which helps - operating profit likely to be £3.2m vs £3.9m last year (pre exceptional, pre amortisation), so not disastrous.
• Cash generation remains strong
• Crucially - final dividend maintained at 4p, giving 5.7p for the full year, so that should support the share price.
• Increased costs related to launch of iDraught in USA
• However, that launch has gone ahead this month (Feb 2013), with customers who have over 2,000 bars - very significant, as this is over 10% of the entire existing customer base added in one go, showing big potential for expansion now they are launching internationally (Edit: I misunderstood this point initially, and have clarified with the company that it is a mixture of pilots & roll-outs, so not 2,000 bars all in one go, but gradually).
• Delays in iDraught installations in UK, but "many pub retailers conducting extensive evaluations".
• Vending will trade at breakeven in H2, due to a delayed significant order that will kick in 2013/14.
• Fuel business - reached breakeven in Q4, they anticipate a strong start to 2013/14.
• USA roll-out of iDraught has begun, but £0.4m loss vs expected small profit due to increased start-up costs going for 10 US states, instead of just Colorado as originally planned.

So it seems to me the overall message isn't that bad at all. These are temporary factors, a bump in the growth road, but the business is still strongly profitable & the growth story is intact. Therefore I am expecting to see the shares drop to around 100p today, where I shall be buying more. That's a personal decision, and as always this is in no way intended as advice, readers are urged to do your own research as usual.

Crucially, the maintained 5.7p dividend should prove a strong support for the shares, and today could give an opportunity to lock in a 6% yield if they drop to just below a quid.

I don't see anything in the trading statement which undermines the business model, just temporary glitches.

By my calculations, on a zero tax charge (due to utilisation of tax losses), £3.2m operating profit should translate into 11.5p EPS. So the shares are priced on a modest PER of 10 before the profits warning, hence we might get a chance to buy in around a PER of 8, if it drops 10-20% today, as I expect.

Hopefully we should see how a value share can absorb a profits warning without doing too much damage, but we'll have to wait & see!

Right, I'll publish this at 7:57am, and report back with more news of the day a bit later.

Post 8 a.m. comments

Vianet has completely dominated my day, and my hunch on price was right. After an initial spike down in the first few minutes of trade, to below 90p, VNET shares gradually recovered throughout the morning, settling at just under 100p.

 Special Offer: Invest like Buffett, Slater and Greenblatt. Click here for details »

I've noticed this is a pattern with profits warnings lately - the initial plunge seems to be worst move, and a good time to buy, with most shares that warn on profits recovering around 10% intra-day after the initial drop. So a good trading idea there - i.e. if a profits warning is not too bad, but the shares initially spike down, one could wait for them to stop falling with your finger on the buy button, then buy some for a short-term trade. Obviously this approach needs great care, to only pick sound companies with profits warnings which are less serious.

I managed to buy two tranches of VNET at 87.8p and 90p today, which meant that I locked in a cracking dividend yield of around 6.5% on that latest, and cheapest lump of shares I've bought.

I spoke with a Director later in the day, and am satisfied that the dividend is safe, it's not a maybe, it's a firm yes from the company. Also, if you look at the figures, the total dividends cost £1.6m, which is roughly half what reduced operating profit will be for this year. There is no tax, and very little interest charge, so that means cashflow should be ample to continue paying the dividends, and hence my view is that the now very high yield is sustainable, and therefore should underpin the shares around the current price.

The most embarrassing thing for me, is that I recently helped set up a new company called Equity Active, with an old friend, and a team of very bright analysts & financial PR/IR people, with a plan to shake things up a bit in the small cap space by idnetifying & publicising high quality, under-valued shares, then helping those companies improve their Investor Relations (IR).

My role is to select the best quality, most under-valued target companies, and write a brief introductory "broker note" on them, which is circulated to a large mailing list of City people & investors. The beauty is that the notes are completely independent, as they are not paid for by anyone, we issue them free as an introduction to the company, and of course they are shares that I already personally hold, so just like everyone who posts on bulletin boards, I'm talking my own book - never a problem with anyone, as long as what you say is true, and you disclose that you hold the shares.

Anyway, the first report I did, earlier this week, was on Vianet (VNET). Talk about Sod's Law kicking in, just 2 days after issuing my note, they warn on profits! So it's been a bit of a mad scramble to deal with all the fall-out from that today. Anyway it's all interesting, and it has certainly got people talking about Equity Active, my phone has been ringing like mad all day! A bit of a baptism of fire into the world of financial PR!

Anyway, I'll be working on a more detailed update note over the weekend and issuing that on Monday morning, which I hope will bring some clarity to the profits warning. It's essentially just delays on new contracts, and a decision to accelerate the USA roll-out, with more up-front costs. Hence I believe the panic should subside, and investors will look at growth again in a few weeks' time, especially when the positive contract news is announced in due course. I like buying when sentiment is lousy, because these things pass, as long as the underlying company is sound, which I think this one is.

 Anyway, I've belatedly looked through all the other results announcements for today, and there's actually nothing else that fits my remit. So I don't feel quite so bad for abandoning my post earlier today to focus on Vianet.

For your general amusement, I got my Brighton Half Marathon official picture today, this is me putting on a spurt just before the finish line last Sunday after running 13 miles. Don't I look fat! Horrendous, am going on a serious diet having seen this. Thought it might give you a laugh anyway & thanks again for all the charity sponsorship.