InvestSMART Australian Small Companies Fund - November 2018
Adding to Adacel, Thorn Group's first half and a bid for Trade Me.
During November, the Small Ordinaries Accumulation Index declined by 0.37%. The InvestSMART Small Companies Fund declined by 2.66%.
The fund was impacted by a smaller holding in Adacel Technologies (ASX:ADA), an air traffic software business, which fell by 59% after announcing that this year’s earnings are expected to be 25-30% lower than the prior year.
The main reason for the downgrade was a legal stoush with its competitor, Adsync, which has cast uncertainty over Adacel’s FAA Tower Simulation System (TSS) contract.
Adacel believes that Adysnc has infringed its intellectual property (IP) rights and it’s commenced legal proceedings to defend its position. But due to the uncertainty of the situation, Adacel has decided to remove any contribution from the TSS contract from its forecast, as there’s a chance it will be unsuccessful with the legal proceedings, and that Adsync will displace it on the contract. There’s also a decent chance that Adacel wins the legal dispute, placing it in pole position to retain the TSS contract and cause a reversion in its earnings forecast.
Either way, we don’t think that Adacel’s business is broken, as its IP is very difficult to replicate (so much so that its competitors resort to stealing, it would seem) and its customers tend to be incredibly sticky, which makes for high margins and strong cash generation. And as Adacel continues to win new contracts overseas, particularly with the software air traffic controllers use to direct inbound and outbound flights, it’s got a decent chance of quickly regaining lost ground. We’ve recently added to our holding, comforted by its strong net cash position, insider buying and low valuation.
Thorn Group (ASX:TGA) also trended 6% lower after the release of its first half accounts, which included a small earnings downgrade.
Things are still tough for Radio Rentals, which continues to originate fewer leases than prior years whilst incurring elevated corporate costs due to the Maurice Blackburn class action. However, some early signs of stabilisation have appeared, with lease originations increasing 34% on the prior half, which aligns with what we’ve recently seen firsthand in their stores.
We remain of the view that Thorn’s challenges are more than adequately compensated for in the price, with a share price at 40% of its conservatively valued net tangible assets, which we expect to be unlocked once the class action has been settled.
The key contributor for the month was Trade Me (ASX:TME), which increased by 27% after receiving a takeover offer from UK based private equity firm, Apax Partners.
It was bittersweet news, as we’d prefer to hold Trade Me for the long term, as it’s not easy finding high quality businesses, with long runways for growth, and an attractive price tag, like Trade Me had when we first bought it.
But we’ll happily sell our shares if we receive an appropriate price, and with US based private equity firm Hellman & Friedman rumoured to also be considering a bid, there’s a chance we’ll get one. We’ve reduced our position to 7% of the portfolio to mitigate the risk of the bidders walking away, whilst stilling retaining some exposure in case they receive a higher bid.
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