Small Cap Report (30 May) - ZZZ, PGB, DEMG, CUP, RSOX, NBI, OMG, CAU, VLX

30th May '13 by Paul Scott

18 comments 16339 reads

Pre 8 a.m. comments

My prophecies of doom with regard to Snoozebox Holdings (LON:ZZZ) have turned out to be misplaced, as perhaps surprisingly they have successfully refinanced again at 24p, which is a negligible discount to last night's closing price. 42.3m new shares are being issued to raise £10.1m before expenses.

It is interesting to note that the funds are being predominantly raised from existing shareholders and Directors. As was pointed out at the London Value Conference by one speaker, it's much better for a Fund Manager's career (for a year or two) to continue pouring money into a failed investment in Placings, than to admit he got it wrong and pull the plug earlier. Later, when the (larger) hit has to be taken, it's done by the next manager, who clears out all his predecessor's mistakes as his first task. The cost is borne by the investor.

We private investors tend to behave very differently, as it's our own money on the line. The enlarged share capital will be 108.9m shares, so the market cap for this second attempt to make its business model work will start at £26m. I wonder how long this latest dollop of cash will last?

A share which I'm very keen on is Pilat Media Global (LON:PGB), and I hold some in my own portfolio. As they have a joint UK & Israeli Listing, they report quarterly, which I rather like actually. Maybe we should move towards quarterly reporting in the UK, as they do in America? (for larger companies anyway).

There are some interesting remarks in the narrative to the Q1 results today from Pilat (pronounced "pill - at"). It's a Q4-loaded business. However, Q1 looks to have been pretty good - revenues are up 15.3% to £5.82m, and gross profit is up 22.3% to £2.8m. Much of the increased gross profit has been ploughed back into (relatively) large R&D spending of £1.2m in the quarter - I very much like businesses that spend heavily on R&D, as that will create the profits & competitive advantages of the future, if spent wisely.

The outlook is strong, due to two big contract wins (previously announced), and they are confident in saying at this still fairly early stage in the year that they expect revenues should exceed last…

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rmillaree

30th May '13

Hello Paul

Having held PGB for some years i would certainly not ignore the amortisation charge- they have historically (although not in the very recent past) capitalised development expenditure at certain stages and presumably will do so again in the future - its probably a bit of a feast and famine that they will not need to do this every year but unless they have permanently changed their policies (i am not aware this is the case) - a period of low capitalised R&D/amortisation will likely make the company look more profitable than it actually is.
I would say £1 mill a year w/off per year though is hopefully more than they need to invest on an ongoing basis - so i am not saying its all a cost.
Hopefully the company have changed their policies and i have not noticed - perhaps i will chuck them an email when i get time to ask the question.

It's also not true to say nothing has been capitalised for some time as there is 576k this 3 month period - although i will give them the benefit of the doubt here that that relates to OTT which is hopefully a bit of blue sky stuff thrown in for nowt once they have finished the product and it starts paying for itself.

Paul Scott

Hi Millaree,

Thanks for that, you're absolutely right - my apologies, I hadn't spotted that they had capitalised some development costs in Q1.
I'd previously checked back to the last 2 Annual Reports, and seen that they had not capitalised any development spending then, so it appeared to be that they were no longer capitalising Dev spend. Although as you spotted, they actually have done so in Q1.

Thanks for pointing this out, and sorry for the error *red face*!

I see from note b to the Q1 cashflow statement, that they give a breakdown of the £576k capitalised in Q1 as being £435k "purchase of intangible fixed asset - intellectual property", and £141k "purchase of intangible fixed asset - internal development".
I wonder what the distinction is? Might be worth one of us asking the company.

Thanks for the v. useful feedback, I shall make a note in the main article referring to your correction here. More haste, less speed on my part unfortunately, which is an occupational hazard with trying to report on so much info so quickly. I don't make many mistakes, but am happy to correct it when I do!

Cheers, Paul.

Mark Simpson

Re: Quarterly reporting - although it enables the astute investor to monitor things like receivables & inventory trends more closely, as someone who works for a company that reports quarterly to the NYSE then I've lost count of the number of senior management decisions that favour meeting next quarter's expectations at the cost of what's right for the business long-term.

I fear that introducing quarterly reporting to the UK would make corporate decision making even more short term than it already is.

ericb

Well that would certainly highlight the short term brigade and allow us to take advantage of their stupidity and lack of professionalism. Excellent - bring it on.

Well that would certainly highlight the short term brigade and allow us to take advantage of their stupidity and lack of professionalism.

How exactly would you do this? Because what you have is companies that consistently hit their quarterly forecasts but do so by taking short term actions that give lower long-term profits. The problem is that this is not visible to shareholders because you don't know what actions have been taken to hit the short term numbers or what a future profit number would have been if the short term action hadn't been taken.

Shorting companies that consistently hit their quarterly forecasts and going long ones that consistently miss isn't going to be a great strategy because you can't separate quarter by quarter which companies took short term actions and which simply hit their figures because their business is performing well.

This is a long term cost to the owners of the business not a tradable market effect. And of course it can be argued that a company that consistently hits its figures has a higher rating, a lower cost of capital and generates higher returns to shareholders. My argument is not that consistently hitting the figures is wrong just that the higher the frequency of reporting the more short term focused management actions will be.

marben100

Good points, Danger.

Whilst quarterly reporting may appear superficially attractive to investors keen to have the latest on their investments, it does undoubtedly encourage short-term thinking. Professor John Kay came out firmly against quarterly reporting in the Kay Review: http://www.ft.com/cms/s/0/39cc4a68-6266-11e1-820b-00144feabdc0.html

As investors rather than traders, we should be taking a long term view of our investee companies - and encouraging their managements to take a long term view too. Quarterly reporting has the opposite effect.

If you feel that quarterly updates from one of your investments are important, then perhaps you should ask yourself: am I investing here, or speculating (gambling)?

Cheers,

Mark

Exactly - so over time you will find out who is playing the game. Short term focused management actions will lead to lackluster performance and eventual decline. It would be clearer looking back, and reputations will have been established.

Hi Mark,

I accept the point about management needing to take long term decisions, and for that we need a change of culture in Britain - i.e. one where investors and analysts learn that actually in the real world, performance does vary due to factors which cannot be controlled or foreseen. Therefore investors need to learn to cope with lumpiness in profitability, which is how life actually is in the real world, certainly for smaller companies anyway.

However, this I strongly disagree with;

If you feel that quarterly updates from one of your investments are important, then perhaps you should ask yourself: am I investing here, or speculating (gambling)?

Surely the information vacuum being 6 months between results means that you're far more of a gambler if you don't want to have up-to-date financial information?! If I owned or managed a company I would insist on timely monthly management accounts. I wouldn't put them in the bin un-read because I like to think long-term!

So for me, the more information the better, and in my view quarterly reporting allows shareholders to spot trouble earlier, by seeing trends more quickly. It also forces companies to have better financial controls.

Regards, Paul.

Cisk

I think providing the market with regular updates is a good think, and therefore support quarterly reporting.

Smaller companies may well complain that it places additional overheads on them in terms of management time - my view is that if they don't already have this information available internally then I don't want to own shares in them; after all, we're talking about unaudited financial statements anyway.

Likewise I try and steer clear of any companies who cannot issue their results on time.

However, the bigger issue is will the city ever move away from short term thinking? Personally, I don't know what can be done to achieve this. As an investor, I've realised that I get far more pleasure from seeing (rising) dividends dropping into my accounts - rather than seeing day-on-day unrealised gains in portfolio valuation.

Think it was Buffet who said that investing was the only place where he observed that people like to see prices going up all the time - clearly if you believe in the company, adding at appealing prices (and hence getting better dividends) can be a profitable way to invest.

Paul, welcome to the band of Deltex Medical (LON:DEMG) shareholders. Patience required with this one, as world healthcare providers are never a quick bunch to adopt new techniques (rightly so, it could be argued).

However the slide in DEMG's share price in the absence of bad news has been brutal, and clearly at odds with the newsflow from the company and the near-term opportunities it has. Did you find out who the sellers were?

Anyway, good luck with this one. If they realise just a fraction of the potential market then you won't see the share price for dust - here's hoping.

CantEatValue

I think the key point here is that it changes the incentive structure in a subtle way that alters the end results. Imagine you're the manager of a company and you know you only need to report in five years time on how well you've done - you'll think and act long term, with an eye always on the big goal in the distance. You'll happily take short term profit hits, even for years maybe, if you're confident you'll come out much bigger in the end and it will all be worth it.

However, even if you know that your shareholders say "we want you to act long term", they'll be really mad if the results in 3 months time aren't what they were hoping for and the share price takes a drop. You're going to focus on making the 'next numbers' look good regardless of the long-term damage - the career risk from short-term pain is just too great and the incentives are all wrong for genuine long term value creation.

Paradoxically, by hoping to keep a closer eye on the numbers and check managements are still 'doing the right things' on a quarter by quarter basis, you're creating strong incentives to not perform the very act you want them to do.

EDIT: This is why I'm a huge fan of owner-operator shares - you could set up monthly reporting for all it mattered and it would make no difference as the main incentive is to build long term business value through the CEO's ownership stake. In a sense, they care less about what the market thinks of their business in the short term because their equity ownership is the over-riding incentive. Very few of my holdings don't have significant insider ownership - as Charlie Munger says, never under-estimate the power of incentives.

Thats full of contradictions. If you are focused on the big goal in the distance, short term will not be so important. If you are focused on short term performance and ego massage you will try and hoodwink the shareholders. These are the people we dont want running businesses. Let them be estate agents, recruitment, and general sales people.
In any case shareholders - or the market - over reacts to short term variation as it is, but it is exaggerated by 6 monthly reports, and then there is doubt for the following 6 months while further news is awaited. Quarterly reporting would smooth that out.

The real incentive is in the direct returns to the management. Are their bonuses being paid quarterly? They should be paid for long term value creation, not annually. And they should be penalised for long term value destruction. If they are only focused on how the head hunters see them over the last 3 months then get rid of them.

With pgb i have always found the 3 monthly figures to be what they are with big swings in the amounts - this being the case there doesn't seem much point trying to manipulate them - altho presumably its always inbred that there will be a tendancy to window dress em when it suits em.

Give me a 3 months set of figures any day of the week over a directors trading update waffle/spin as you like. With the figures i know exactly what PGB are hiding away in capitalised intangibles - with the waffle of bobsmith limited i don't find out till much later they have exceeded earnings expectations for the year but have capitalised £10 mill of R&D costs that i did not know about.

EssexPete

Hi Paul,

Don't worry about speaking on stockopedia's webinar. You're passionate about trading and analysing value shares and all the people listening in share you're interest, just pretend you're at home or at a Mello and consider it, 'business as usual.'

:)

Pete

Edward Croft

Paul - did I really just read a public affirmation that you are going to join the Stock Report webinar !!! Can I hold you to that?

Ed,
Yup why not I'll give it a go!
I can't do 13 June though, as will be on Uncle duty with the family.
But after that should be fine.

P.

cig

1st Jun '13

Wouldn't for your requirements monthly or weekly or simply live reporting be better (at least as a thought experiment)? Quarterly seems to combine the worst of both worlds: it is lumpy and discrete enough to warrant explaining and massaging and thus wasting management energy, yet not that much more timely for the data geek to see trends earlier.

Technically nowadays it shouldn't be hard to just mandate making the accounts public in real time by adding a module to SAP or whatever system they're using that shows the (aggregated) accounts to investors live on the company website (or perhaps with a fixed delay of a few days/weeks). Best of both worlds: you have your live view that you can check every day, and because the data flows continuously management can't massage it as easily, nor do they need to pause to explain it all the time, so can go back to managing the business and communicate with investors when there's some actual significant event rather than following an arbitrary regulatory calendar. Also it may eliminate (some of) the pointless volatility created by lumpy news speculators.

mpat89

There's no hope in hell of any live set of figures being audited though, it's pretty important that the figures be audited!

fek47

7th Jun '13

Interesting to see Pilat Media Global (LON:PGB) also being trumpeted by Simon Thompson in this week's Investors Chronicle.

Personally I won't touch any Israeli company with a bargepole, following my experience with the erstwhile Delek Global Real Estate (:DGRE) - extreme caution is advised!

Small Cap Report (30 May) - ZZZ, PGB, DEMG, CUP, RSOX, NBI, OMG, CAU, VLX

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Paul Scott

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