My first task in my role of helping to expand Intelligent Investor’s coverage of small companies was a rather good one. Based on the top picks from last year from Microequities Conference 2015, the event was a big success. Pro Medicus and Blue Sky Alternative Investments have both subsequently delivered big gains. So I was very much looking forward to this year’s event. Nor was I disappointed.
Because small companies are faster growing and more easily acquired than their larger peers, they have the potential for high returns. Yet with higher return comes higher risk. Small companies often have developing rather than established business models and are more dependent on key management than established businesses, which often run themselves (although the boards would never admit to that).
Past conferences have delivered big winners
Small caps offer higher return with higher risk
SMP, APD and SHM worth a further look
That’s why getting in front of management to see the 'whites of their eyes' is an essential part of small cap investing. So what better way to do that than the microEQUITIES 10th Rising Stars conference, where nine emerging companies presented their business case?
What follows are some snapshots and observations of what I consider to be the more interesting companies making presentations. Be advised that these have not been fully researched and are not formal recommendations. But if you’re interested in doing your own legwork you may be rewarded. Okay, here goes.
Smartpay is a New Zealand company that owns a third of the EFTPOS terminals across the ditch. These deliver a fixed monthly rental revenue stream from merchants, which the company is seeking to use to fund its entry into the Australian EFTPOS market. Smartpay also has an established position in the taxi payment industry.
Having held numerous senior roles at Customers Limited, Australia's largest independent ATM business, CEO Bradley Gerdis knows a thing or two about payments. That’s a good thing, because the bull case is largely based on execution of the Australian EFTPOS roll out.
Smartpay currently has just 1% of the 800,000 strong Australian EFTPOS market, offering 3-4 year contracts to merchants at an average cost of $45 per month.
As Smartpay must fund the upfront payment of the terminals, the growth path is initially capital intensive. But each terminal is paid off in 6-8 months and every 1,000 terminals adds $500,000 to revenue. Due to a fixed cost structure, much of that additional revenue should fall powerfully to the bottom line. With a market cap of $31m (and an enterprise value of $54m after adding A$23m in net debt), at current prices strong growth could render Smartpay cheap.
It’s also an interesting time for the industry. The rise of alternative payment methods such as Apple Pay entrenches the EFTPOS network as the dominant gateway into the banking system. And unlike its existing NZ business, Smartpay is positioned to take a slice of the 1-2% bank acquiring fee in Australia due to legislation changes in early 2015. This adds a transactional revenue stream to its existing rental business.
However, it’s not all beer and skittles. Most of Australia's EFTPOS terminals are currently supplied by the banks. Switching providers does not offer huge benefits to a merchant, which leads to sticky customers for the incumbents and growth difficulties for new entrants. So Smartpay must target the pockets of the market where the banks can’t or won’t play.
Furthermore, Commonwealth Bank is slowly changing the banks’ reputation for slow, cumbersome innovation with its Albert terminal, an early hit with retailers. Business customers that use Albert receive same day settlement, a service that Smartpay cannot match. That’s a potential chink in the new entrant’s armour.
APN Property is a commercial property fund manager with $2.1 billion under management. The company was founded in 1996 and has grown to manage 15 funds, the most successful of which includes the $1.2 billion APN AREIT fund and the $265 million Industria REIT capped fund.
Funds management is a good business due to its scalability, operating leverage and low capital intensity. Apart from a few desks, staff to sit at them, computers and seed capital for new funds, these businesses have no need for retained capital. But APN Property does, co-investing $97.3m (at December 2015) in its own funds. That’s significant in relation to its $160m market cap.
The question is whether APN Property should be valued as a REIT or a fund manager. For a while the market couldn’t decide, which is why the company traded close to its NTA backing, ascribing little value to the $2.1b funds management business. After backing out the co-investments and cash, there’s a case that the funds management business is cheap, despite performing strongly over the last year.
Despite the corporate mantra of ‘not shooting the lights out’, APN Property has been doing exactly that. Falling interest rates have supported property values, boosting performance fee revenue for the funds management business and book value revaluations of the co-investments.
This is in sharp contrast to the post-GFC period where performance fees were scarce and property writedowns featured regularly, highlighting the importance of interest rates for this business. Interested investors need to consider what the funds management business is worth if conditions do normalise, whatever that means in this environment.
Shriro Holdings (ASX:SHM)
Shriro is a distributor that owns or has exclusive Australasian distribution rights for a number of household brands, including Casio, G-Shock watches and Pioneer. The business dates back 80 years and CEO Mike Westrup has been at the helm for nearly 25 of them.
With such rich history, it’s a wonder why the company only released three years of financial results before its June 2015 listing. That said, there’s plenty to like about this business. The model is capital light and features decent returns on capital and high market share in a number of product lines.
Shriro counts all the major retails as customers with the largest being Harvey Norman at 16% of total revenue. It’s worth keeping an eye on housing construction as Shriro derives 46% of total sales from kitchen appliances such as cooktops, ovens and sinks and taps.
Shriro beat its IPO profit forecasts by 24% with better gross margins and operating expenses than expected, but the share price remains 19% below the $1 listing price. Management will tell you that’s down to concerns over the company’s exposure to the building market. Fair enough, but it is widely known that management also sought to offload shares out of escrow, and the poorly handled sale spooked a market already fearful of the next disastrous IPO.
A cursory look suggests Shriro is cheap with a PER of around nine. The company may not have a strong growth profile, but a rerating is possible if management can regain the market’s trust and the price realigns with the business’s fundamentals.