Microequities Conference June 2015

Microequities is an asset manager that specialises in microcaps – companies ranked between 350 and 600 on the ASX in terms of market capitalisation. Each year the firm holds a conference in Sydney where the CEOs of selected microcaps give presentations on their companies.

Most of these companies have market capitalisations less than $100m and so are too small for us to recommend formally (due to the undue influence any Buy recommendation might have on their share prices). Instead, we'll present our pick of the stocks for members who are willing to conduct a bit of their own legwork.

Note that we haven't fully researched these ideas and won't be providing ongoing coverage. That said, there were some interesting companies presenting.

Gaurav Sodhi

Pro Medicus (ASX:PME)

Gaurav Sodhi was impressed by Pro Medicus, a 30-year old software business that has been selling the same software suite – imaging software for hospitals and clinicians – for most of its existence. The acquisition of Visage Imaging during the global financial crisis, however, makes it a far more interesting business.

Visage renders large, data-rich images for doctors to manipulate and use to make diagnoses. Hospital scans are now all digital; they must be stored on hospital servers and loaded by doctors for use. Each file, however, is huge, so a common problem has been to speed up load times of software to make diagnoses quicker. Visage uses clever technology to stream images from servers to computers faster than anything else. It is quick, it is detailed and it can be scaled to work for any sized hospital.

Pro Medicus has been building a US sales team and is quickly winning contracts to install and use its software. Typically, clients guarantee minimum revenue per contract but pay for the number of scans used by the software. That makes the economics of the business very attractive. Profits can potentially rise quickly with revenue. That hasn't happened yet but, with so many contract wins, it will.

There are two problems. One is that competition will eventually crack the software. They will replicate it and likely compete on price so margins could be threatened in the future. The second problem is price. The business reported revenue of under $20m last year but trades on a market cap of over $200m. At 70 times earnings, 46 times EBITDA and 10 times revenue, a lot of growth is already baked in.

Nevertheless, we've added Pro Medicus to our watch list and may take a more detailed look at the business in the future.

Jon Mills

Blue Sky Alternative Investments (ASX:BLA)

I normally keep my feet firmly on the ground, but I took a liking to Blue Sky Alternative Investments, an 'alternative investments' fund manager. Rather than investing its funds in stocks and bonds, Blue Sky invests in private equity and venture capital funds, hedge funds, private real estate and even 'real assets' such as water rights, water infrastructure and agribusiness.

Founded in 2006 with a mere $150k funds under management (FUM), the various funds managed by Blue Sky have generated average returns of 15% per year after fees since then, easily beating their average benchmark returns by around 10%. As a result, Blue Sky now boasts $1bn in FUM and hopes to double that figure by 2017.

Assuming its funds continue to generate superior returns, this shouldn't be a problem. Like all fund managers, however, declining fund performance and 'key person risk' are the greatest risks in this stock. The latter, however, is mitigated somewhat by the fact that management and members of the board own around one third of the company.

Unlike other fund managers such as Perpetual or Platinum which concentrate on stocks, the performance of Blue Sky's funds are unlikely to be influenced by market returns. To use industry jargon, this is because the returns of alternative assets such as private equity, real estate or even water rights are relatively 'uncorrelated' with the stock market.

So there could be opportunities to purchase Blue Sky at lower prices should the sharemarket decline and perhaps lead investors to (wrongly) assume that Blue Sky's FUM and earnings will fall with it. With a forward PER of 23 and little free cash flow, it's too expensive for us at the moment but its $240m market capitalisation means we'll keep a close eye on it.

The company also manages its recently launched listed investment company (LIC) Blue Sky Alternatives Access Fund (ASX:BAF). BAF invests in a portfolio (around 15) of the more than 30 different investment vehicles Blue Sky currently manages.

BigAir Group (ASX:BGL)

I was also impressed with BigAir, a small telco that owns a national fixed wireless network spanning all of Australia's capitals and 50 regional centres. It also has wholesale access to all fixed line networks operated by the major telcos such as Telstra and Optus.

The company's strategy is to concentrate on niche markets that are overlooked by the big telcos and hence aren't as competitive as the large corporate and government enterprise markets.

Its fixed wireless segment provides data services to 'middle-market' enterprises: businesses with between 25 and 1000 employees.

The company's community broadband segment is the largest provider of internet services to student accommodation, an area of the property market that has attracted increasing investment in recent years. In return for long-term contracts of five years or more, BigAir gets access to a building's infrastructure to provide WiFi to students, who usually have multiple devices that consume bucketloads of data via WiFi.

This segment is also now expanding into aged-care facilities and shopping centres, where it uses the signals given off by smartphones to provide data to shopping centre owners about such things as where shoppers walk within the centre and how long they spend in the different sections.

But BigAir is more than just a telco: it has a growing cloud infrastructure and managed IT services unit too. This segment manages data and applications for clients who no longer wish to spend the time and expense managing their own hardware.

The company's ability to supply services at low cost to niche markets is a competitive advantage that has allowed it cherry-pick customers from Telstra in areas such as in Armidale where Telstra previously had a monopoly.

However, while its network would be difficult to replicate, it wouldn't be too costly for any of the big telcos. Further, the risk is that the big telcos might try to avoid losing further customers to BigAir by lowering their prices. While this would have a material effect on BigAir's business, the resulting lower profits suffered by the big telcos would be relatively insignificant in terms of their wider businesses.

If it's able to avoid retaliation by the big telcos then the company has great potential to keep growing both internally and via acquisitions. However, with a price-earnings ratio of 19 and a free cash flow yield of 2%, there doesn't appear to be much margin of safety at the moment.