Strategic Equity Capital NAV edges higher

Strategic Equity Capital NAV edges higher – Strategic Equity Capital has announced results for the year ended 30 June 2018. On a total return basis, the NAV per share increased by 1.8% during the year, behind the Small Cap ex Investment Trusts return of 6.4%. The share price fell during the year by 1.6%. The board is proposing a final dividend of 1.0p per share (0.78p in 2017).

The board has cut the notice period on the management contract from 12 months to six months, effective from 1 October 2018.

Extract from the manager’s report – positives

Alliance Pharma was a new investment made in May 2017. As detailed in the prior year Annual Report; we believed ‘the high free cash flow yield at investment is very attractive and, in our view, unreflective of the potential opportunities’. Our thesis at the time of investment was that there was an undue concern with gearing levels depressing the rating, which ignored the cash generation ability of the company. As it degeared, we believed the shares would re-rate. In addition, we believed improvements in the business model through European expansion and product diversification were underappreciated. Alongside solid growth and sensible product acquisitions, the rating improved significantly over the course of the last year. This was aided towards the end of the period with the approval of the anti-nausea treatment Diclectin. With the thesis playing out ahead of our expectations, with, in our view, limited scope for further re-rating, we have realised a significant proportion of the investment (substantially all of the initial cost), with the investment delivering an IRR of 87%.

The share price of Equiniti was very strong over the first half of the period and into the beginning of 2018. This followed the company announcing the acquisition of Wells Fargo’s Share Services business in July 2017. We view this as a long-term positive development for the company. Our belief is that the asset provides the company with the opportunity to replicate the success they have demonstrated in the UK market in the North American market which is seven times larger. Alongside the acquisition, underlying trading was strong with market share gains (in a traditionally stable market) and good revenue growth in the two core divisions. Computershare’s acquisition of Equatex in May 2018 for a reported 19x EV/EBITDA demonstrates the intrinsic value of these businesses.

Our investment in Harworth was significantly increased (c.1 million shares) in the prior year, first, in a placing in March 2017 and again in May 2017 with a block purchase. These were acquired at a significant discount to NNNAV. (NNNAV is the group’s measure of asset value, it includes the market value of development properties, less notional deferred tax). The share price increased by over a third over the period through a combination of continued growth in the net asset value and a closing of the discount of the shares to that value. Pleasingly, the company continues to generate NAV growth through internal actions such as successful planning permissions and uplifts on lettings, rather than the appreciation of land values. Furthermore, the company continues to realise sites at attractive premia to book value and recycle this into growing its strategic land bank and income generating portfolio. We took part in a visit to the company’s sites in Yorkshire which demonstrated the scale of Harworth’s development activities.

The share price of Clinigen was volatile over the period. Results demonstrated strong growth in the Asia Pacific region and also in their portfolio of commercial medicines. The company acquired Quantum Pharma in September 2017 for GBP156m. This acquisition provides the company with in-house development capability and a pipeline of potentially new products.

Numis, the institutional stockbroking and corporate advisory firm, was a new investment made in October 2017, with the share price total return of 46% over the period. Underlying business performance has been very strong with Numis gaining market share from larger and smaller competitors and undertaking additional higher margin advisory work from its growing corporate client base. This has generated a substantial cash pile, which should provide the company with a strong market position through the cycle.

Outside of the top five contributors, there was strong share price performance from Oxford Metrics which delivered a 32% total shareholder return. We took part in a site visit in January 2018 to evidence the progress being made in both the motion measurement division, Vicon and the infrastructure asset management business, Yotta. Recent results have been encouraging.”

Extract from the manager’s report – negatives

After a strong initial share performance following Medica’s IPO last year, the shares were weaker in the second half of the period. The main reason was the company’s full year organic growth rate of 18% was slower than the market expected based on guidance provided by the company. Whilst the poor guidance is disappointing and frustrating, the market appears to have taken umbrage whilst overlooking the continuing operational progress. The company is performing strongly, broadly in line with expectations at the time of investment and has made significant progress since listing. Underlying sales and profit growth are strong and radiologist recruitment is increasing at a supportive rate. The company is largely degeared and continues to generate strong cash flow. We do not feel that the current valuation reflects the company’s future prospects. We continue to engage closely with management on messaging in the public markets and the long-term business strategy. We bought shares in the company at what we believe were heavily depressed valuation levels through the first half of 2018. Following a strong interim results trading statement in July, with another period of 18% organic growth, the share price is back above its IPO price.

The share price of IFG Group weakened towards the end of the period. This largely resulted from the aborted sale of the Saunderson House division. In February 2018, the company announced that in response to incoming interest and with a view to maximising shareholder value, they would look to sell their independent wealth management business. Despite indicative offers in line with expectations, the company decided against a sale owing to transaction risks which could negatively impact value for shareholders. Whilst disappointed with how this was handled and that our thesis wasn’t realised through a transaction, the intrinsic value of the assets is unaffected. The company’s assets under management have grown over 15% per annum over the past three years to over GBP 30bn and, in our view; both companies have enviable levels of client retention and have improved their business models over recent years. Our view remains that the two individual businesses (James Hay and Saunderson House) are independently more valuable than in the current group structure and than the prevailing share price suggests. Ongoing consolidation and an increasing incidence of listed peers in both the wealth management and platform industries demonstrate considerable valuation upside in our view.

Dialight was a disappointment over the period. The investment thesis is predicated on a leading business in a niche industrial electronics market undertaking conversion from conventional to LED lighting. The company has high market share and strong intellectual property. However, the long-term growth opportunity was only part of the thesis, with the company’s strategy to enhance its business model providing further potential margin and cash flow benefits. This included product modularisation and development, sales force improvements, increasing addressable markets and improving the manufacturing process. The last of these caused significant issues over the period with execution problems at Dialight’s outsourcing partner. This resulted in significant downgrades to profitability. Owing to the issues encountered, we expect the company to pursue a hybrid manufacturing strategy, outsourcing subassembly of certain elements, whilst retaining key techniques in-house. While disappointed to have incurred this disruption so early into our investment, we believe the expected scale and manufacturing benefits still pertain. Underpinning the investment is the long-term attractive characteristics of the market, the strong product position and intellectual property and a strong balance sheet. We continue to monitor the progress of the company against our investment thesis.

Proactis was a new investment made in the period as detailed in the following section. Following strong updates in October last year and February of this year, the company warned on profits in April. The primary reasons were the loss of two large customers, adverse foreign exchange movements and an incrementally slower pipeline of new business. The extent of the downgrade was magnified in the share price reaction. This was unexpected by us and the market given the market leading levels of customer retention (95%) and history of operational delivery. The company later disclosed that the two customers took a single product as opposed to a suite, were multinationals as opposed to their core base of SMEs and public sector bodies and had given notice to transition away over a number of years, but left sooner than this. Whilst this is very disappointing, the levels of retention remain very high, the ongoing customer concentration risk is low and the product quality is unaltered as evidenced by the continuing high win rate and a demonstration we attended at their Head Office. We believe the company is well positioned in the growing, but fragmented Procure-to-Pay (P2P) software market. We note a number of recent trade and private equity transactions in the space.

Brooks Macdonald’s share price suffered from additional costs relating to regulatory requirements and the addressing of legacy legal issues. Despite the company having one of the higher growth rates amongst its peer group, its valuation is at a significant discount.

The average cash balance held by the Company was 8.42% over the period. The approach of the Board and Investment Manager is one of no gearing and to retain sufficient cash to enable the ability to participate in liquidity events without being a forced seller of existing holdings. The ending cash balance was 7.6%, the same level as at the beginning of the period.”

SEC : Strategic Equity Capital NAV edges higher

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