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Stunning results from this technology star highlight the potential for investment outperformance on AIM 

dotdigital Group plc (LON:DOTD) has rapidly become one of our small cap favourites and the latest results certainly didn’t disappoint.

Founded in 1999 as a web design agency, dotdigital has developed a globally compelling product suite for email and digital marketing.

Having grown significantly since admission to AIM in 2011, when it’s market capitalisation was only £19m, its marketing automation platform is now used by over 70,000 marketers in 156 countries worldwide, empowering global marketers to achieve outstanding results. Global expansion and an expanding range of products  has seen revenues grow eleven fold over the last 8 years and the market capitalisation hit an historic high of £339m in July 2019, when the share price stood at 114p.

The group’s expansion has been boosted by it partnering with many of the leading ecommerce platforms including Magento (now part of Adobe), Microsoft Dynamics 365, Salesforce and Shopify.

Results for the year ending 30 June 2019 were stunning, with revenues rising 19% to £51.3m, including organic growth of +15%, and adjusted operating profit up 25% to £11.8m.

33% growth in adjusted earnings per share to 3.88p was even more impressive and materially ahead of consensus market expectations of 3.4p.

The group acquired Comapi in November 2017 which specialises in ‘live chat’ and has built a software platform that allows clients to communicate directly with their customers via email, SMS and social messaging apps. The Comapi technology has now been fully integrated with dotdigital’s platform, with 19% of the group’s customers using more than one channel, helping to grow average revenue per user 14% to £966 per month.

The all-important recurring revenue as a percentage of total revenue increased to 86% thereby offering excellent visibility into the future.

The key partnerships have also been strengthened with revenue through Magento up 27% to £11.8m.

Despite the ongoing impact of GDPR, revenue from the EMEA region delivered double digit growth, but more distant overseas markets were the star performers. Having initially struggled to progress in the US, the group now appears to have found its feet with revenue in this key geography rising 27% to $9.0m. The APAC region was even better, reporting revenue growth of 83% to AUS$3.8m.

dotdigital comments how innovation is at the core of everything and they are committed to the continuous evolution of the technology, reflected in the considerable investment in the period. Despite this, excellent operating cash inflow of £12.3m still resulted in free cash flow of £6.3m, boosting year end cash to £19.3m.

The outlook was extremely encouraging with the first quarter of the current 2019/20 financial year starting well.

The house broker commented how “there are few companies we can point to which consistently deliver 15% organic growth, PBT margins over 25%, and reliable cash conversion” reiterating their target price of 135p, 37% above the current share price.

Having held the shares for several years and remaining enthusiastic buyers, we would echo their comments.

To discover other exciting investment opportunities on AIM please contact Chris or Stephen at small cap investment specialists Fundamental Asset Management by calling 01923 713890 or emailing [email protected] 

 

 

 


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AIM – the Good, the Bad and the Ugly

Investing in the shares of qualifying AIM companies can attract 100% relief from inheritance tax and is a proven tax planning method, avoiding the costs associated with a trust, or the risks associated with gifts. It’s also been a rather good investment strategy to follow, as long as you know what you are doing!

Fundamental Asset Management’s AIM portfolios can also be accessed through many leading adviser wrap platforms, including Transact, Standard Life Elevate and Nucleus, making it a viable tax planning solution for advisers who don’t want the adminstrative burden of administering assets on multiple platforms.

Supported by extensive in-house research and due diligence, we have successfully managed AIM portfolios for Inheritance Tax planning purposes since 2004, delivering outstanding growth, well ahead of mainstream funds and stock market indices. We have also helped families save large amounts of Inheritance Tax in the process.

However, it hasn’t all been plain sailing and over this period we have experienced everything that AIM has to offer, from the highs of AB Dynamics, whose shares have risen over 2500% since listing six years ago, to the lows of Patisserie Holdings, a café chain worth £400m which succumbed to a massive fraud and disappeared overnight.

We have seen it all, from the boom times of 2007, when AIM had nearly 1700 companies, to the depths of the financial crisis, which saw many investors abandon AIM entirely.

Come and join us on 2nd October 2019 at the Landmark Hotel, London (www.landmarklondon.co.uk) to find out what investing in AIM for Inheritance Tax planning purposes is really all about.

Numbers are limited so please RSVP by emailing [email protected] to reserve your place at this FREE event.
Alternatively, please call 01923 713890.

Venue: Landmark Hotel. 222 Marylebone Rd, Marylebone, London NW1 6JQ


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Crowdfunding continues to thrive, but the valuations look crazy – better value on AIM?

The latest news that leading UK based crowdfunding platform Seedrs raised a further £4.5m in a new funding round has highlighted the appeal of rapidly growing, early stage companies to UK investors, at least relative to the duller offerings on the UK stock market.

However, while there is no doubting the growth appeal of early stage businesses, we struggle to understand the high valuations many of these are achieving on the crowdfunding platforms when raising new money. In many cases money is being raised based on a mere idea, rather than a viable business. We fear this investing bubble will ultimately see small private investors lose out significantly, not simply through business failures, but as these cash consuming start-ups are subsequently forced to raise money at far more modest valuations.

A prime example of the valuation folly on crowd funding sites was recently illustrated by WeSwap, the online peer-to-peer travel money platform.

Back in November 2018 WeSwap was meeting prospective investors with a view to listing on AIM but failed to attract interest at the desired valuation. Admittedly it wasn’t a great time to list with stock markets going through one of their periodic sell-offs, nevertheless, the proposed valuation of more than £40m for a loss making business in a highly competitive arena looked crazy to us.

In 2018, WeSwap generated modest revenues of just over £1.5m with losses over £2.5m. As of June 2019, it had over 500,000 users who had exchanged more than £255m.

Fast forward 7 months and WeSwap raised a further £2.5m on Seedrs at a pre-money valuation of an eye-popping £41.6m.

Comparison can be made to AIM listed Ramsdens (LON:RFX), the diversified, financial services provider and retailer, which has its own thriving foreign currency exchange business.

For its last financial year ending March 2019 Ramsdens grew revenue 17% to £46.8m and underlying profit before tax was up 4% to £6.7m. Its foreign currency business alone served 705,000 customers, exchanging £496m of currency and generating gross ‘profit’ of £11.6m. It also rewarded shareholders with an appetising dividend of 7.2p per share, equating to a yield of 3.7% at the current share price.

We acknowledge that Ramsdens may not be growing as rapidly as WeSwap, however, unlike WeSwap it is demonstrating an ability to grow while generating profits and cash.

Many investors seem fixated that online offerings like WeSwap represent the only route to investment success. Yet the success of many online businesses is dependent on spending huge sums on marketing, much of it swelling the coffers of Google and Facebook. Contrastingly, while a High Street based business like Ramsdens addresses a much smaller potential customer base from its individual sites, its multi-faceted offering, of which foreign currency is just one element, is a beneficiary of falling rental costs.

Backers of crowd funded businesses will ultimately require an exit and a stock market listing, notably AIM, is one such route for this. Yet UK stock market investors seem very reluctant to overpay for loss-making, early stage businesses, addressing relatively small markets. It’s very different in the US, where the market is so much larger and the potential rewards thereby much greater.

While valuation concerns persist with many AIM companies, they look relative bargains compared to their peers on crowdfunding sites. Furthermore, as Sterling is set to languish over Brexit we expect to see overseas buyers keeping a close eye on modestly valued UK listed companies.

August saw our AIM portfolio holding Sanderson Group (LON:SND) snapped-up by a US based acquirer and we expect to see more over opportunistic moves of this type over the coming months.

If you are interested in benefiting from our expertise investing in AIM and smaller quoted companies, please speak Chris or Stephen on 01923 713890 or email [email protected]


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Office of Tax Simplification Inheritance Tax Review – second report: what does it really mean for AIM?

The Office of Tax Simplification (‘OTS’) published its long-awaited review on reforming Inheritance Tax. A first report released in November 2018 dealt with the administration of estates while the latest report focuses on how Inheritance Tax could be made “easier to understand and more intuitive and simpler to operate”.

The stand-out headlines in the latest report were recommendations to reduce the seven year rule for gifting assets to five years and to increase the lifetime gift allowance from the current £3,000 to something more meaningful.

The press has also been keen to jump on a mention in the report of Business Property Relief (‘BPR’) and whether the treatment of AIM shares is within the policy intent of BPR.

Paragraph 5.19 of the report states:
…in relation to third party investors in AIM traded shares, BPR is not necessary to prevent the business from being broken up or sold in order to fund the payment of Inheritance Tax. This raises a question about whether it is within the policy intent of BPR to extend the relief to such shares, in particular where they are no longer held by the family or individuals originally owning the business.

Firstly, it should be emphasised that this was only an ‘observation’ and no further reference was made to AIM in the report in the conclusions or recommendations. However, in our opinion the report makes a reasonable observation regarding AIM.

BPR has never been wholly relevant to AIM in terms of preventing a business from being broken up or sold in order to fund the payment of Inheritance Tax. The relief in respect of smaller listed growth companies, is surely in place to attract third party investment and there are indications that the Treasury has always considered it thus. This is backed up by paragraph 5.18 of the report which states:

The OTS notes that the government’s response to the Patient Capital Review consultation published in November 2017 stated the government’s commitment to protecting the important role that BPR plays in supporting family owned businesses and growth investment in AIM and other growth markets. In correspondence and meetings, the OTS has heard evidence of its importance in meeting that objective.

To reiterate, contrary to what has been suggested by some of the more sensationalist headlines in the mainstream press, the OTS report has not recommended the removal of BPR on AIM. 

However, the OTS report has recommended that estates should not benefit from Capital Gains Tax dying with the deceased if the same assets in the estate are also benefitting from an IHT relief or exemption. In this regard Recommendation 5 on page 44 states:

Where a relief or exemption from Inheritance Tax applies, the government should consider removing the capital gains uplift and instead provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died.

The Treasury has said it will respond to the report in due course and consider its recommendations.

Last year’s Patient Capital Review highlighted a huge gap in funding in the UK for smaller growth companies and the removal of BPR on AIM will only exacerbate this, therefore we remain cautiously optimistic that radical changes are unlikely.

I think it’s worth reflecting that AIM as a viable Inheritance Tax planning option would not exist at all if the investment credentials didn’t stack-up in the first place.

Our AIM for Inheritance Tax portfolios have materially outperformed leading stock market indices for many years due to the compelling growth characteristics of the companies in which we invest, which just so happen to be accompanied by an attractive tax benefit for UK shareholders.

Successful AIM companies like RWS Holdings, AB Dynamics and many others have not seen their share prices rise due to the weight of demand from those investing for IHT planning purposes, they have risen based on the performance of the underlying businesses.

The great benefit of AIM is that it is market where share registers are dominated by family, founders and senior management.

Studies from Credit Suisse, Boston Consulting Group and Bain & Company have highlighted how superior growth and returns have been a feature of family and insider-controlled companies.

The great risk with a tax change of the type feared is if it pushes executive founders to sell early and exit the business, thereby depriving it of a valuable asset. For example, both RWS Holdings and AB Dynamics have benefited from the ongoing involvement of founder shareholders; Andrew Brode, Exec Chairman of RWS, has not sold a share since the business listed on AIM in 2003.

You can find out more about our high performing AIM portfolio service from the link here


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Results season offers plenty of encouragement for our AIM portfolios

Results and trading updates over the past few weeks from our AIM universe of companies have been generally encouraging, with growing profits and cash generation supporting investment in the business and raised dividends. Here is a brief summary of the highlights from some.

Tristel (LON: TSTL), the manufacturer of infection prevention and contamination control products, announced the regulatory approval of its Duo High-Level disinfectant product in China. Duo is a hand-held dispenser which applies Tristel’s powerful chlorine dioxide chemistry as a foam to the surface of medical devices.

Frustrated by the length of time it is taking to gain regulatory approvals in the United States, Tristel is placing greater emphasis on China where it proposes to sell Duo through its own sales force. Our associates Investor’s Champion provide in-depth coverage of Tristel here.

Remaining in the medical sector, AIM portfolio company EMIS Group (LON:EMIS) announced decent results for the year ended 31 December 2018, growing revenues across all key segments and raising its dividend 10%. Having had a good look at the business we sense that new Chief Exec Andy Thorburn is looking to make more of the group’s fantastic position in the market and deploy the excellent cash flow to greater effect. Post results it announced the sale of its non-core Specialist & Care segment for £14.0m.

Adept Technology Group (LON: ADT), formerly Adept Telecom, has grown into of the UK’s leading providers of managed IT services. The trading update for the year ending 31 March 2019 confirmed a 13% rise in revenues and underlying EBITDA, in line with expectations. The full year dividend was lifted 12% to 9.80p. We like the recurring revenue attributes of this business from its sticky customer base, which results in lots of delightful cash being generated.

The share price of Smart Metering Systems (LON: SMS), the leading installer and manager of electric and gas meters, has been on a bit of a roller-coaster ride over the past few months. The UK government’s mandated smart meter programme requires all UK households and small businesses to be offered a smart meter by the end of 2020 and SMS will be a prime beneficiary of this huge change. Needles  to say this substantial government initiative has had a few problems.

There are approximately 53 million gas and electricity meters in the UK and, as of the end of December 2018, there were 14.9 million smart and advanced meters installed in homes and businesses across the country. SMS now has agreements with twelve of the independent energy suppliers, equivalent to a potential 8 million meter points highlighting the potential for its business.

While the domestic smart meter exchange may be extended into 2023, SMS will still be a long-term winner, thereafter generating reliable, index-linked returns from its vast portfolio of meter assets. The financial statements and high level of debt taken on to support the acquisition of meter assets take some understanding, however, the operating cash flow hints at the future potential.

Anexo Group (LON: ANX), which only arrived on AIM in June 2018, issued a promising set of results for the year ended 31 December 2018. Anexo is a specialist integrated credit hire and legal services business targeting the impecunious not at fault motorist, who does not have the financial means or access to a replacement vehicle, notably motorbike riders and motorbike couriers. Anexo provides customers with an end-to-end service including the provision of Credit Hire vehicles, assistance with repair and recovery, and claims management services.

This could be a fascinating business to follow as it endeavours to settle the large number of outstanding cases on its books and increase the cash recoveries. With a growing number of in-house litigators it’s looking promising, if little understood by the investment community. You can read an in-depth commentary on Anexo Group here from our associates Investor’s Champion here.

Away from AIM and returning to the main UK market, general portfolio holding Games Workshop (LON:GAW), the creator of fantasy miniatures, including Warhammer, confirmed that sales and profits have continued to climb, with pre-tax profit for the year ending 2 June 2019 rising 7% to £80m. Shareholders are rewarded with both a rising share price and lifted dividend – what more can one ask for!

As usual, there is plenty of variety from the stock market and some great companies to invest in. Please contact Chris or Stephen to find out more about our specialist investment services, including the high performing AIM for Inheritance Tax planning service, which has now been running for more than 15 years.


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Looking for ISA bargains ?

With the end of the tax year fast approaching, many investors will be looking to use their ISA allowance. Here is our brief introduction to some potentially interesting ISA bargains.

AIM shares have only been permissible investments in ISAs since August 2013, but since then they have proved a very popular choice, notably for those investing with an eye on potential inheritance tax savings.

AIM had a difficult 2018 and despite a strong opening to 2019, many excellent smaller companies are trading at modest valuations, offering compelling dividend yields and decent growth prospects.

Chris Boxall and Stephen Drabwell, co-founders of Fundamental Asset Management, would be delighted to discuss the investment opportunities on AIM through our bespoke AIM portfolio service. Please email [email protected] or call 01923 713890.

Our recent Blog commented on Redde (LON:REDD), a substantial business where the dividend yield had risen to more than 11%. While the shares have rallied marginally since our original Blog, the forecast yield is still over 10%.

The share price of Fulcrum Utility Services (LON:FCRM), an independent energy and multi-utility infrastructure and services provider, has been extremely weak over the past few months. Fulcrum’s primary business is the design and installation of utility services from single site properties to large complex multi-site projects. It also owns and operates gas and electrical assets that connect properties to the main UK gas and electricity networks.

Fulcrum has delivered consistent earnings growth over the past 4 years and in 2018 acquired the Dunamis Group, an electrical infrastructure services company. Unfortunately, the Dunamis business has experienced some Brexit induced contracts delays which has accelerated the share price decline. While the Dunamis business is made up of larger, lower margin projects, it’s operating in a very dynamic market with a notable opportunity in the area of electrical vehicle charging.

This week’s trading update provided some reassurance that bsuiness was not as bad as many believed it to be. The modest earnings multiple of 9x current year earnings falling to 8x for the year ending March 2020 and a forecast dividend yield of 6.3% means Fulcrum warrants a closer look for ISA investors.

The Property Franchise Group (LON:TPFG), one of the UK’s largest property franchises, has seen its share price pulled down principally due to fears surrounding the impact of the tenant fee ban on its business. The ban is due to be introduced on 1st June 2019 with the impact on group revenue less than originally anticipated.

TPFG was founded in 1986 and encompasses a diverse portfolio of longstanding high-street brands and a hybrid, no sale no fee agency, called EweMove.

The lion’s share of group revenue is made up of service fees (royalties) charged to franchisees, principally relating to lettings business. Therefore, this is a business which generates relatively stable revenues, high operating margins and returns on equity and excellent cash flow. With modest capital expenditure requirements, the attractive cash flow is able to support a generous dividend, with the yield just over 6.5 per cent at the current share price.

Fundamental AIM for Inheritance Tax planning portfolios may hold shares in the companies mentioned in this article.

Our associates Investor’s Champion publish in-depth research reports on many exciting AIM companies.


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Inheritance tax planning AIM favourite yielding 11% – what’s the catch?

The share price of AIM quoted Redde (LON:REDD), the provider of accident management services and an inheritance tax planning AIM favourite, has been in the doldrums ever since the announcement of its interim results at the end of February 2019. Recent news of its failure to secure the renewal of a sizeable contract has also pulled the shares down further to 4 year lows, this has also seen the forecast dividend yield rise to 11 per cent, but is this compelling return sustainable?

At first glance the interim results for the 6 months ending 31 December 2018 were actually pretty good with revenue up 14% to £291m and pre-tax profit up 7.2% to £21.3m. An interim dividend of 5.50p, equivalent to a yield of 5.5 per cent, highlighted the inheritance tax planning appeal of this AIM company.  However, cash flow wasn’t quite as rosy as usual, with claims taking longer to settle and debtor days rising to 109 from 105 previously. Reported net debt at 31 December 2018 had also risen to £41.2m from £8.5m at 30 June 2018, however in mitigation, this relates to asset backed finance leases, rather than bank debt, so is fairly low risk. The Group increased its car fleet 27% to meet increased hire days which meant finance leases rose.

It’s worth noting that the business doesn’t have any bank borrowings, reflected in the finance costs which only encompass interest on finance leases and bank facility fees; the latter for a facility which isn’t even used.

Management cautioned that growth for the remainder of the second half would not have the beneficial effect experienced last year from the “Beast from the East” – Redde was a beneficiary of the terrible weather.

While the interim results tempered investors’ enthusiasm for the shares, it was the contract renewal announcement which really accelerated the selling.

The failure to secure the renewal of a hire and repair contract with a large insurer won’t have any immediate effect for the current financial year ending June 2019 but will impact 2020. Management now expects a net reduction in sales of approximately £111.9m (representing 18.2 per cent. of consensus expectations) and a reduction in adjusted operating profits of approximately £4.7m (representing 8.7 per cent. of consensus expectations).

Thankfully the pipeline of new business remains encouraging with a number of live prospects, and management remains hopeful it can fill the void.

The stated £4.7m reduction in operating profits on sales of £111.9m suggests the lost contract was at lower margins than the majority of the Group’s business.

At the current share price of 105p the shares trade at an estimated 8.2x revised earnings estimates of 12.8p for the financial year ending June 2020. This looks a very modest rating for a business which will remain highly cash generative and should therefore be able to support the dividend.

Having consistently raised its dividend every year for the past 6 years, the dividend is now forecast to remain flat at 11.7p, moving the forecast dividend yield to approximately 11% at the current share price. That looks appealing to patient, long term inheritance tax planning investors, looking out for some extra income.

There will be concerns that the failure to renew the contract could be the start of other problems, however Redde is well diversified across contracts large and small, regularly winning and losing contracts with insurers. As at 30 June 2018, the most significant five customers represented 23% (2017: 25%) of receivables. That implies an acceptable level of customer concentration.

While the car fleet has grown materially, they have the flexibility to trim this back at short notice.

Hargreaves Lansdown’s reporting of a claimed JPMorgan target price of 11p (rather than 111p!) wasn’t terribly helpful for the share price either – we suggest HL should pay closer attention to their reporting!

Directors have shown their confidence in the business by snapping up £185,000 of shares in aggregate.

Fundamental AIM for Inheritance Tax planning portfolios hold shares in Redde


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AIM needs more newcomers

A recent update from our associates Investor’s Champion highlighted how February 2019 was yet another poor month for new arrivals on AIM, with only 1 proper new arrival and 7 more departures. AIM certainly needs to be re-energised!

While the quality of companies on AIM has improved considerably over the 15 years we have been investing in AIM for Inheritance Tax planning purposes, we are becoming concerned by the shortage of suitably attractive new arrivals.

AIM’s reduced appeal to many high growth businesses is countered by its evident attraction to the legal and professional services sector. Of the 7 new arrivals in December 2018, which was AIM’s best month for IPOs in a long time, one of the newcomers (finnCap Group) was a corporate broker and two (Manolete Partners and Litigation Capital Management) were providers of litigation funding solutions. While profitable businesses, they are unlikely to set investor’s pulses racing in the same way a fast growing technology company might, although we quite like the look of Manolete! The litigation funders join several legal services groups already enjoying life on AIM.

Investor’s Champion pointed out that, as AIM has struggled, its rival Nasdaq First North, which encompasses junior markets across the Nordic region, has started to attract a growing number of small technology companies. Many companies on First North also carry similar attractions for Inheritance Tax planning purposes to those on AIM. First North welcomed 2 newcomers in February, one a video game development studio, the other a cloud-based software group, just the sort of innovative high growth businesses needed on AIM. Should the flow of attractive newcomers to First North continue, it could become a viable market for those with an eye on mitigating potential inheritance tax.

AIM may soon have another rival to contend with in the rejuvenated Nex Exchange, where Oliver Hemsley, the founder of UK stockbroker Numis Securities, is looking to take control and inject new capital into Nex, which will also be given a new name. Nex could find some willing supporters in those investing for Inheritance Tax planning purposes.

Thankfully there remains a large pool of attractive AIM companies in which to invest, it would simply be nice for this pool to grow, rather than shrink, as has been the case for the past few months.


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Why we invested in Patisserie Holdings

Patisserie Holdings (AIM:CAKE), is a UK branded café and casual dining group offering cakes, pastries, snacks, meals and hot and cold drinks from over 200 stores in the UK.

It currently operates under five different brands – Patisserie Valerie, Druckers – Vienna Patisserie, Philpotts, Baker & Spice and Flour Power City.

The largest and best-known brand, Patisserie Valerie, represented 75% of Group turnover and 80% of Group operating profit in the last reported 6 month period ending 31 March 2018.

For the last full year ending 30 September 2017, the Group had sales of £114m and pre-tax profit of £20.1m, having generated operating cash of a similar of a similar amount. In every practical sense, it therefore looked in great shape.

– Background

Patisserie Valerie was first opened in Frith Street in London’s Soho in 1926 by Belgian born Madam Valerie. During the Second World War the Frith Street premises were bombed by the Luftwaffe and Madam Valerie subsequently set up shop around the corner in Old Compton Street where her legacy continues to this day in the Group’s Soho branch.

But enough of the romantic past!

– AIM admission

Patisserie Holdings PLC, the holding company of the Group, was admitted to AIM on 14 May 2014 at a share price of 170p.

£32m was raised by the company for the purpose of paying down senior debt (£21.9m) and shareholder loans (£10.9m). Total borrowings prior to admission were £33.2m.

£46.5m was also raised by selling shareholders of which Executive Chairman Luke Johnson received £23.6m, Chief Executive Paul May £5m and Finance Director Chris Marsh £1.45m.

These were the only Executive Directors with the Non-Executives:
Lee Ginsberg – former FD of Domino’s Pizza
James Horler – ex Frankie & Benny’s and La Tasca restaurants

The Board has the same composition today and, given the rapid expansion since IPO, seems to have needed bulking up!

At the time of Admission the Group had 138 stores.

The Executive Directors oversaw a period of growth from 8 stores in 2006, suggesting they initially had a fairly hands-on involvement from relatively humble beginnings.

The Group’s main bakery in Birmingham, its only freehold site, is also the head office.

All the stores are leased.

– Why we invested

Unless the valuation looks very compelling, we are generally reluctant IPO investors, preferring to see how new AIM arrivals develop in the public eye. Having had a good look, we first invested in CAKE in December 2016, attracted for the following principal reasons:

Growing sector
A business that is simple to understand, follow and monitor
Retail roll-out self-funded from internally generated cash flow
Attractive operating margins 16%+
Attractive Return on Equity 15%+
Highly cash generative
Growing dividend distribution – interim dividend was raised 20%
Strong net cash position and zero debt
Experienced senior management who had a material stake in the business, despite selling down at IPO
UK domiciled
Clean financial statements with an absence of adjustments

In summary, we invested in what we considered was a relatively simple, well-run, cash rich business, overseen by highly regarded sector specialists, operating in a very vibrant sector, that was easy to understand.

We like investing in companies where senior managers are large shareholders and have grown with the business. Luke Johnson and Paul May both come with excellent reputations in the sector and, despite selling down, retained material equity stakes.

We were slightly wary of Mr Johnson’s multiple directorships, but reassured that, with a 37% stake in a sizeable business he would hopefully be keeping a close eye on things.

– What has happened

On 10 October the Company announced that the board of directors of the had been notified of significant, and potentially fraudulent, accounting irregularities and therefore a potential material mis-statement of the Company’s accounts. This had significantly impacted the Company’s cash position and may lead to a material change in its overall financial position.

On 11 October they announced that, without an immediate injection of capital, there is no scope for the business to continue trading in its current form.
Chris Marsh, the Chief Financial Officer, has been suspended from his role and was subsequently arrested by police, although then released on bail.

– Recent Director option sales

In July 2018, Chief Executive Paul May and Finance Director Chris Marsh exercised options and immediately sold shares for a combined value of £5.26m. While they were both sizeable transactions, Mr May still held 4.54m shares, representing a sizeable stake with a value of approx. £20m.

Option exercises followed by share sales by senior managers are a regular part of the stock market and AIM and we are particularly wary if this results in the said managers having little or no stake afterwards. This was not the case here, although Finance Director Chris Marsh, who is considerably younger than Johnson and May, has only ever held a relatively small stake in this business.


– Cash flow was the real attraction

We aren’t big on earnings numbers or the mythical EBITDA so often quoted by analysts. Cash flow is our focus and the real appeal of CAKE to us.

In the 6-month period to 31 March 2018 claimed operating cash flow of £14.6m in the period, was up £2.9m or 25% (2017: £11.7m). There was nothing untoward on the balance sheet to suggest any unusual movements.

£2.7m of this cash was used to make income tax payments and £5m invested in capital expenditure, leaving free cash flows of £6.8m (2015: £4.9m). Of the £4.4m, £2.9m was invested in new stores and £1.5m in refurbishment of the existing estate or additional bakery or fleet facilities. Normalised Free Cash Flow for the 6 months, excluding new store investment, was therefore £7.7m.

The business is apparently well-funded with zero debt and claimed net cash at the end of the first half of £28.8m.

– Any clues in the cash flow?

Hindsight is a wonderful friend to the investor and, looking at things afresh, cash flow post IPO may have been a little too rosy, however, glorious cash is an attribute of a business such as this.

In the period prior to IPO, when the group was opening 15 sites per annum, capital expenditure represented approximately 58% of operating cash flow and 10% of turnover. For the period ending 30 Sept 2017, when the group opened 20 sites, cash flow represented 36% of operating cash flow and 7.6% of turnover.
Capital expenditure for the year ending September 2017 was in line with the prior year which may be viewed as mildly surprising given the ongoing maintenance requirements of a larger estate. However, allowing for lease expiries the net increase in the store estate was only 15.

Finance expenses of £36,000 in the period suggested the Group was using an overdraft facility on occasions.

– Low level of finance income

The single orange flag which may have suggested that something unusual was going on was the low level of Finance income for a business that claimed such significant cash reserves at its accounting period end.

Finance income for the year ending 30 Sept 2017 was only £44,000 whereas the Group stated period end cash was £21.5m.

However, rapidly growing businesses of this nature, which are collecting small amounts of cash on a daily basis and periodically paying out large sums to contractors can experience wide swings in cash flow, necessitating cash be available at short notice. Furthermore, deposit rates have been extremely low over the past few years.

– Wage inflation

We were concerned about the impact of wage inflation but the Group appeared to be taking this in its stride.

While inflation on food costs was high, management commented how they had benefited from a number of contract renegotiations, and in some cases switched suppliers to mitigate inflationary pressures. This, along with production efficiencies from investment in their bakeries helped them maintain a gross margin of just below 78%.

Management commented that ongoing labour inflation was built into budgets and is being absorbed as the group continues to grow.

– Too many pies….

At the time of AIM admission Luke Johnson was a Director or Partner in more than 50 companies and limited partnerships, including some high profile names. However, he was not a Director of many of Patisserie Holdings’ key operating subsidiaries, notably Stonebeach Limited, through which Patisserie Valerie trades, where Messrs May and Marsh were Directors.

Companies House currently lists him as Director and Partner in 33 companies and Partnerships although the list excludes Elegant Hotels PLC (see below), where he also a Director. Another list indicates he is a Director or Partner of 40 companies or LLPs.

Of significance, since June 2015 Mr Johnson has been Executive Chairman of Brighton Pier Group, which owns and trades Brighton Palace Pier, as well as twelve premium bars and six indoor mini golf sites. This business had a very active period this year.

In May 2017 he was also appointed Non-Executive Director of AIM listed, Elegant Hotels Group. However, the influential advisory firm ISS urged shareholders to oppose his election to the Group, on the grounds he is already on the boards of two other listed companies.

He stepped down from the Board of Arden Partners (AIM: ARDN), the AIM listed institutional stockbroker in May 2018.

He also has a controlled function in Risk Capital Partners LLP an FCA regulated firm.

Mr Johnson also has an interest in Gail’s Bakery (a trading name of Gail’s Ltd) and there was rumour of a combination of this business with CAKE. Gail’s Ltd is ultimately owned by Bread Holdings Ltd in which Luke Johnson’s Risk Capital Partners II LP and RCP Co-Investment LP have a combined controlling stake.
Surprisingly, financial statements have never been filed for either of these 2 LPs whose ultimate ownership seems to be hidden behind an extensive web of Limited Partnerships.

Mr Johnson also writes a regular column for the Sunday Times.

Paul May is involved with FD Chris Marsh in another business called Christian Lewis Performance and Classic cars, a company which appeared to be technically insolvent at 31 May 2017.

With due regard to current events, it now seems clear that Mr Johnson needs to have more focus in his business interests and extract himself from a number of executive and non-excutive roles….for his own financial well-being and that of his fellow shareholders!

 

We are absolutely staggered how a profitable, cash generative business of this nature could have collapsed so dramatically and suddenly. We will issue an update when we know more.  

 


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The key to AIM success

Chris Boxall, co-founder of AIM specialist Fundamental Asset Management, writes in this week’s Investors Chronicle.

The article ‘The key to Aim success’ suggests how the AIM Admission Document should be essential reading for any investor in AIM companies, yet large parts of this vital document are often ignored.

The disastrous performance of Conviviality (CVR) and Accrol Group Holdings (ACRL), suggest many investors – both large and small – missed the warning signs in the admission documents of both these companies that may have prevented a substantial loss of capital.

Subscribers to Investors Chronicle can read the article by visiting the link here

Be wary of Buy and Build!
We are increasingly wary of the so-called ‘Buy and Build’ strategies adopted by some companies on AIM, led by corporate managers with little real equity participation; Conviviality being one such example of this. Many of these businesses seem to address low growth markets and are struggling to make real progress, flattering their reported returns through large ongoing exceptional items and restructuring costs, with signs of trouble often reflected in poor cash flow. To quote Warren Buffett, ‘Only when the tide goes out do you discover who’s been swimming naked.’ On this measure Conviviality could be likened to a nudist colony!