Volvere - Unexciting but Undervalued

http://www.volvere.co.uk/


There are a large number of investment and other financial services companies on the London Stock Exchange, that tend to be overlooked by the market due to relatively uninteresting business models causing a lack of general market interest. However, that does not mean that these companies lack the capability of being good value for the right kind of investors. Volvere (LSE:VLE) is a company that broadly fits that category through its strategy to purchase stakes in underperforming businesses, re-vitalise them, and then to seek an exit strategy. The strategy has worked well to date, yet the company is valued at a marked discount to its net asset value (NAV) and investor interest is low. Volvere is currently trading at 325p/share, and with 4.16m shares in issue, the market cap stands at £13.5m.


As is always the case with illiquid companies, technical analysis is limited, especially in terms of helping to choose entry and exit points, hence investors have to fall back onto fundamental analysis. However, as per the chart above, there are some points to note. The most important is that the share price has been trending sideways for an extensive period of time, and there is a slight underlying uptrend beneath that. If the share price can break out of the range, and through 340p (for more than one week), then the long-term outlook is highly positive from a technical viewpoint. The share price has struggled to gain traction over the past few years on the back of low liquidity though, so there is a risk that liquidity could decline again should news flow dry up. The spread is not great currently, at between 315p - 335p depending upon volumes. That is a risk that has to be appreciated when investing in any illiquid company, so Volvere is no exception on that front.

The shareholder register is dominated by a small number of large shareholders currently. The top three institutional holdings are all through nominee accounts and total to over 21% of the shares in issue (Hargreave Hale, State Street and FG). Given that the two core directors of the company are part of the same family (Jonathan Lander = CEO, Nicholas Lander = COO), it is reassuring that investors will likely be respected through these institutions. That is made more important because the two Landers hold ~37% of shares between them. Having such large holdings is usually a double-edged sword. On one hand, the directors are very well incentivised - after all, the quickest way to become wealthier is to grow the company's market cap so that their stakes are worth more. In addition, they will need to seek an exit route, which could well end up being a disposal of investments and a return of cash at some point down the line. On the other hand, they could remunerate themselves too highly and have little incentive to please shareholders. In this scenario, it seems that the former scenario is more likely, especially since the group's track record is respectable and because the directors carry significant experience.

Fundamentally, Volvere offers investors a slightly different twist when it comes to investing in businesses because they do that for you, but not quite in the same way as an investment fund. Volvere is a company that uses its cash resources to purchase companies that are finding it difficult to access funding, or who are performing poorly. Once purchased, they complete a thorough assessment of the business, and implement a wide range of changes (often including office rationalisation and strategy changes) to try and turn the business around. That process often involves providing further access to funding whilst the transformation takes place, and is either through equity or debt. Once the business has been transformed into a healthier financial position, Volvere proceeds to seek an exit for that investment, where they will try to derive a profit. It's as simple as that.

The company has had very commendable success on that front over the years. The most recent success revolved around a circa 45% stake that Volvere acquired in Interactive Prospect Targeting Ltd, a private company. The total investment into IPT was £1.45m and IPT returned £2.75m pre-disposal and a further £0.9m during the disposal, giving an impressive internal rate of return of 160% given the short timeframe it was conducted over. The exit was through the sale of the stake back to IPTs management. A second equally impressive turnaround was of SIRA Certification in 2009, during the height of the financial crisis - the company managed to sell their stake for £8.6m, which was multiples of the initial purchase price and once again it was an example of management delivering excellent returns.

Currently the company has three investments:
- 100% of Sira Defence
- 80% of Shire Foods
- 75% of JMP Consultants

The importance of each of those investments is actually negatively correlated to the percentages. JMP is by far the most prospective of the three, with Shire Foods the next most interesting, and Sira Defence relatively immaterial. Part of the problem that potential shareholders in Volvere have had over the past few years is that catalysts have been few and far between. Between 2011 and early 2013, there was little corporate action as the company was being highly selective in its acquisition targets. Ultimately, that meant a lack of news flow and a stagnant share price when most other shares were rallying as per the wider markets. Despite that, those businesses have now started to mature, with Shire and JMP both registering material improvements in their financial performance.

JMP was bought by the group in May 2013, which is surprising given how good a deal Volvere managed to work. Volvere only paid £0.42m to buy up a majority stake in a company with revenues many multiples higher, and that had a solid customer base (The equity interest has since been watered down to 75%). JMP Consultants is a 160+ staff business that provides consultancy work for the Transport, Planning and Engineering businesses. Unsurprisingly, the company has seen an uplift in trading as the economic cycle swings into their favour, but also as a result of office rationalisation (there are now 10 offices), the business has been placed on a much firmer footing. As a sign of the expansionary phase the company is going through, they have decided to purchase up a new office at the Cotton Exchange that should help them build scale. A couple of recent projects that JMP have worked on include the East Coast Main Line and creating an area travel plan for an area around King's Cross.

On that basis alone, the company is clearly worth £0.42m (especially since it shook off a pension deficit upon restructuring), but you only recognise how good a deal that was when looking at the financials. Revenue for the calendar year 2013 totalled £7.41m and underlying pre-tax profits were registered at £0.54m. However, that only covered the period from May through December, so the annualised implied run-rate comes out at just shy of £0.9m, which is a far better result. Furthermore, during the period, JMP declared a £0.45m dividend and repaid £0.4m in loans leaving Volvere's net cash investment to total just £0.51m. Whilst it is difficult to assess how recurring the revenues are, the company is expanding and should be able to tender for an increasing level of work, and that all points towards the investment being worth substantially more than Volvere paid. There is clear potential for the pre-tax profits to grow further over the next couple of years. Putting JMP on 8x pre-tax profits suggests a total value of £6.9m, which is unlikely to be expensive given JMP's robust position within the industry and improving prospects. That values Volvere's share at around £5.18m. Of course, if profit growth continues on its path towards £1.5m over the next few years, then the 75% stake would be worth considerably more - perhaps between £9m and £11.25m. The next set of financial results should help define the nature of the financial results under new management, but early signs are encouraging. Defining earnings sustainability is the key point.

The second company in Volvere's portfolio is Shire Foods - a food manufacturer specialising in pies and other pastry products. The company has wholesaler distribution throughout the UK and it sells products to both retailers and food service customers. The financial performance of Shire has continued to improve post-acquisition albeit at a slow rate in terms of the bottom-line. The food manufacturing business is highly competitive where there tends to be margin pressure, and that is likely to explain why pre-tax profits were only booked at £0.12m (vs £0.44m in losses) whilst revenues jumped from £6.2m to £8.5m in 2013. The targets of Volvere for Shire include further diversifying the customer base and growing market share.

However, as noted, the industry is highly competitive, hence these companies tend not to attract high valuations. Valuing the company as a multiple of profits is probably not the best method for Shire, since it has significant net assets of £4.75m. That said, the company is suggested to be heavily reliant on a few key customers, so any valuation would need to be dampened down. I reckon between £1.5m and £3.5m would be a fair valuation range for Shire assuming that Volvere can grow profits more materially this year (towards at least £0.35m) and reduce reliance on key customers. It is easy to see value being added to the Shire stake, but it will likely require perseverance given the sector of operation. Volvere is unlikely to be looking to offload the Shire holding for at least a couple of years as the return would probably not cover the total invested to date. JMP is an easier win on that front.

The third company is Sira Defence & Security, which in reality requires a major turnaround just to be able attribute any material value to it. The business is based on CCTV viewing software, which is an incredibly competitive and fragmented industry. Revenues for 2013 were lower at £0.18m (against £0.25m) with the company operating at breakeven. That is not a performance that really deserves value attributing to it since Volvere are only expecting a modest improvement this year. That said, Sira probably could be sold on as a bolt-on for another business in the industry for £0.1m+ given there may be synergies through resource duplication. In the pursuit of a conservative valuation, and accounting for the small amount of net liabilities, I've attributed a valuation of zero to Sira.

Evidently, there is potentially major value in JMP and a modest amount of value in Shire (although that is still material to the market cap). What changes the dynamic is the balance sheet of Volvere (excluding its investments). First off, the company is trading at a circa 19% discount to its Net Asset Value (NAV) as per the last set of results - that is usually the conventional method for valuing stocks such as these. The Chairman commented: "The Group has had another successful year, with the acquisition of JMP Consultants, the disposal of IPT and the continuing improvement in performance at Shire Goods. These have resulted in encouraging further growth in NAV to £4."

However, net asset values are not of much use if they include intangibles such as goodwill. In Volvere's case it doesn't, which makes it more impressive and provides solid backing for the share price at current levels. Taking into account the underlying investments and their contributions, Volvere made £16.14m in continuing revenues in 2013 and gross profits of £4.64m. That filtered down to 10.7p on a continuing basis. As mentioned before, that is not the correct or best way to value Volvere as the value is in the cash balance the company has, and the potential returns that could be made on the three investments. Whilst these three investments are owned, the underlying investment balance sheet shows current assets to be comfortably over three times liabilities.

So how can we value Volvere? The simplest way is to just look at the net asset value, which stood at £4, but whilst a ~19% disparity is significant, it is not unheard of as there are numerous funds and investment trusts trading at similar discounts to their net asset values. What is interesting is when you start to construct sum-of-parts valuations taking Volvere's cash and marketable securities number as the base. As per the final results, that stood at £12.2m and that compares very favourably to the £13.51m market cap - a highly impressive 90.3% of that figure. Essentially, if Volvere were to return all of that cash back to investors, it suggests that JMP, Shire and Sira are all valued at £1.31m and that is not remotely realistic.

Using a conservative set of numbers based on 2013 and the net percentages to Volvere, it's possible to derive a £5m valuation for the JMP stake, £0.8m for the Shire stake and £0.0m for the Sira stake. That suggests a base case valuation for Volvere of 433.0p/share, which is over 30% higher than the current share price and is in-line with potential technical price targets. Assuming further growth this year and next within the portfolio, those valuations can then be bumped up to £8m for JMP, £1.6m for Shire and £0.15m for Sira. That extrapolates towards a target of 528p, which is yet further ahead. There are risks with that on the Shire front given the industry of operation, but equally there is clear potential for JMP to greatly exceed the implied £10.7m (100%) used as a range between £9m to £11.3m range is fair based on £1.5m profit/year being sustainably achieved. Unfortunately, given the details in the accounts, it is not always particularly easy to figure out how likely that could be. In any case, the base valuations suggest favourable upside from current levels, notwithstanding the likelihood of further acquisitions.

Volvere has not historically paid dividends despite its large cash pile, but that is with good reason. Instead, the company opts for the more tax-efficient method of share buybacks to reduce the number of shares in issue. Indeed, the number of shares in issue has fallen by 1m to 4.16m currently, since September 2011. In 2013 alone Volvere stepped up buyback efforts as they purchased 559k shares for a total consideration of £1.62m. That lends credibility to the idea that management are offering investors an attractive proposition rather than just being 'in it for themselves'. That buyback consideration is more than a company of that size is likely to return in dividends, yet if it was paid as a dividend the share price would likely be much higher due to yield buying. Of course, there is one more point to cover with regards to the current economic recovery. Has the recovery removed opportunities to purchase businesses at attractive rates because lending is becoming slowly easier again? There is no doubt that it has been the case, and some of the low-hanging fruit has probably been removed, but the acquisition of JMP last year demonstrates that there is still very good value to be found, so that should not be too much of a problem. That is especially the case since it works both ways - it should become even easier for companies such as Volvere to sell business stakes at higher valuations, as appetite for acquisitions grows.

Volvere operates a business model that is not particularly exciting for retail investors, yet the company is trading both at a discount to NAV and likely sum-of-parts valuations. In addition, the cash balance that the company is able to deploy is substantial, and helps cover the vast majority of the current market cap - the JMP and Shire stakes are likely to mean an overall higher valuation than the market is currently attributing. However, Volvere is not a company to expect quick profits on (barring an investment disposal), so patience is essential, but those willing to be patient will probably receive a respectable return on their investment over the next couple of years. The main issue at the current point in time is the inability to trade large quantities of shares on the market without being persistent, and that lack of liquidity does represent a risk, albeit one that is small given the state of the balance sheet.

Ultimately, the management have appreciable experience and if JMP (in particular) is disposed of over the next 24 months at figures similar to those expected (and potentially higher), the share price and NAV will both jump and the disparity between the two figures would probably narrow. At the current point in time, Volvere is unexciting, but relatively low risk compared to the vast majority of companies on AIM and it appears undervalued. It's currently just a question of how quickly the catalysts will be forthcoming and that is not immediately clear, although the upside is potentially significant. No Rating.

3 comments:

  1. Well done to the competition winner!

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  2. Great review and volvere seems like a nice little earner if you can wait for a few years. The liquidity is shocking. No wonder you put no rating. My Watchlist has just grown to 27 companies!!!

    CraigJ

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  3. Any update on NWT?

    ReplyDelete