InvestSMART Australian Small Companies Fund Update - August 2018
The fund's largest investment produced a cracking full-year result.
The biggest movers were a smaller holding in Domain ( 14%) as well as larger holdings in Thorn group ( 13%) and MSL Solutions ( 13%). Detractors included Academies Australasia (-15%), Matrix Composites (-12%) and Redflex (-9%).
A lot can change in New Zealand over the next 10 years. The Ardern family could expand again, Lord of the Rings producer Peter Jackson could become Prime Minister and the All Blacks could regain their reputation as world cup chokers. But something that’s unlikely to change is Trade Me’s dominance of the classifieds space.
The fund’s largest investment produced a cracking full-year result, with accelerating classifieds revenue, capped off with a special dividend.
Competition has been on investors’ minds with Facebook and Amazon entering the general marketplace. But that hasn’t stopped Trade Me’s jobs, auto and real estate classifieds from powering ahead, and we’re enthused by their long-term outlook.
Thorn Group, another important fund investment, made good progress during the month when it introduced a mezzanine investor to its securitised trust, the vehicle which houses the loans of its Business Finance division (TBF).
That might sound like an ordinary development, but it helped reduce downside risk while keeping the upside intact. That’s because Thorn liberated $36m of its own funds - instead of financing 20% of the trust’s receivables it will now finance just 8% - with the proceeds used to reduce Thorn’s corporate debt to negligible levels.
We’ve been critical of TBF in the past as it seemed that too much capital had been allocated to a business with too thin a competitive advantage. With less money at stake, Thorn has less to lose if TBF goes belly up, but its upside is intact as it’s still entitled to TBF’s earnings, which are expected to grow thanks to an enlarged facility with Westpac.
Could TBF be worth more than Thorn’s entire market cap (which stood at $96m at the time of writing)? Possibly. AxsessToday (ASX:AXL), another securitised business lender that also has around $330m of receivables, is valued at $106m. The argument against that is AxsessToday’s better loan origination platform (even though it licenses it) and its higher growth.
But even so, when you throw in Radio Rentals, Thorn’s crown jewel consumer financing business, there’s a strong argument that Thorn Group is materially undervalued at current prices. We expect several strategic options to open up once the Maurice Blackburn class action has been put to rest.
We’re big fans of time arbitrage - the process of buying companies that are trading cheaply due to short term issues, even though the long-term is attractive – and we think we’ve found one in MSL Solutions.
MSL Solutions provides modularised software to member based clubs throughout the world, boasting an impressive customer base such as 60% of the English Premier League venues for its member database, point of sale system and business analytics.
MSL Solutions is also particularly strong in golf, offering add-ons like tee time bookings, tournament management as well as the national handicapping system on behalf of Golf Australia.
The company has many of the features we like. Its software is business critical and difficult to replace. Its addressable market is global with most of its revenue recurring, and the board and management hold a significant stake in the business.
But despite having good bones, investors are fixated on the flesh wounds MSL’s incurred during its formative years as a listed company.
Despite accelerating organic growth, MSL Solutions committed the cardinal sin of missing its prospectus forecasts. And it made matters worse by attempting to obfuscate this with the classification of one-off items. Its operating cash flow was also weak due to IPO costs and working capital moves.
These missteps have understandably unnerved investors, but we think they’re largely temporary in nature, and herein lies the opportunity. We expect cash conversion to resolve itself with time, and we expect long-term growth to be more than satisfactory, both of which would render MSL Solutions cheap at current prices.
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