Ripe Opportunities - August 2023 Update
“Undervalued companies, mismanaged or overlooked, are ripe opportunities for intervention or takeover to realise their true value." ― Carl Icahn, activist investor
THE MONTH | Another short-term period where avoiding bad news was not enough to avoid broad-based declines in small “FIT” (Financials, Industrials and Technology) companies. Illiquidity cut both ways with the largest moves in our investments being on limited trading activity.
This report is later than usual and will be shortly followed by the September monthly and quarterly update.
STOCK PROFILES | Since our last monthly update we have profiled MedTech company MedAdvisor (MDR) and battery technology company Redflow (RFX) in our weekly SmallTalk updates for investors.
OUTLOOK | We have been a bit repetitive in these difficult markets for microcaps in declaring that businesses not valued by investors would ultimately be acquired by industry or financial buyers. We have been seeing that playout a little lately - most significantly for the Fund via a bid for IT consulting business Cirrus Networks (CNW) that emerged mid-September; and also with an indicative offer from a financial buyer at the end of August for Energy One (EOL).
With reporting season delivering updated financials to scrutinise, we see it highly likely that there will be a lift in deal activity in the December quarter, with a push to line deals up before the summer holidays.
PORTFOLIO REVIEW
Cybersecurity tech company Archtis (AR9) reported 37% growth in revenue to $6.4m for a gross profit of $3.3m and a net loss of $8.2m with net operating cash outflow of $5m. It noted it has now won $17m of contracts with the Australian Department of Defence (DoD) and a $4m proof-of-concept contract awarded by DoD in June 2023 would mostly be recognised in FY24.
DIY security technology company Scout Security (SCT) bounced from one of the worst performers in July to one of the best in August (and subsequently in September slipped back the other way). There was little news, with financial results released that were pre-shadowed in the prior month by the June quarter cash flow statement. SCT did note that, following the end of the June quarter, it had launched its pilot program with US telco Lumen and expects to launch the smart security and control platform under Lumen’s brand in FY24, with recurring revenue to follow. Disclosure: Equitable’s Martin Pretty is a non-executive director of SCT.
Specialist cable maker Energy Technologies (EGY) is another that already provided its key financials with its June quarter cash flow statement release in July. It reiterated it had grown revenue 24% to $15.5m in FY23 and booked a $5.2m impairment charge on intangibles and inventory “to prepare the business for its fresh start in operations under this increase in utilisation”. EGY said “sales still remain strong, with the company having a healthy order book in place, as underpinned by it announcing its first project win in excess of $1m”. It also subsequently raised $2.6m from a convertible note that is convertible at $0.08 a share, compared to $0.042 at the end of August 2023.
Security monitoring company Intelligent Monitoring (IMB) finally eased off a little in August after rallying in June and July, having executed a company-changing deal to acquire ADT’s Australian security monitoring business. It completed the ADT deal in early August and reported its FY23 financials at the end of the month. Revenue in FY23 grew 42% to $32.9m, adjusted EBITDA grew 49% to $5.4m but a net loss of $11.9m was booked, with >$7m in depreciation and amortisation and $5,4m in finance costs, as well as $3m in charges for impairment and business acquisition costs. IMB reiterated that, with the acquisition of ADT, pro forma EBITDA of $24.8m should grow to $28.9m for FY2024 or $31m annualised, given ADT was acquired on 1 August 2023.
Portfolio Changes
There was only one change to the Top Nine positions - the result of increasing our exposure to 8Common (8CO). Below that level, we did participate in a capital raising that we considered to be attractively priced, with free attaching options. More changes will be evident in the month of September as we manage the re-rating of CNW and participate in capital raisings.
REPORTING SEASON
(an extract from Small Talk on September 4, 2023)
The average share price performance over August for stocks in our “FIT” universe was -1.3%. The market cap weighted average for the top 100 stocks was -1.66%. These numbers are not indicative of a particularly disappointing ASX reporting season when considered in the context of the US market, where the average Russell 1000 (top 1,000) stock fell 3.6% in August, according to Bespoke.
For those ASX listings with consensus earnings forecasts, there were slightly more “beats” than “misses” - 28% vs. 23,% according to Bell Potter, but 49% delivered as expected. Looking at large caps, Wilsons found a range of companies benefiting from cost disinflation and cost-out programs - at the same time that others are still facing cost pressures, particularly in labour intensive businesses or those reliant on renting space.
We crunched the numbers on the changes in analysts’ forecasts over August and found that among the top 100, consensus estimates for the current year fell 0.4% at the revenue line and -4% at the EPS line, using the market cap-weighted average. The figures are messier for our “FIT” universe as many smaller companies have stale estimates or, more often, no estimates at all, but for what it is worth the average revision was -4.9% at the revenue line but +3.2% at the EPS line.
We always think analysts’ earnings revisions for the year ahead tell us more about the impact of reporting season than the variation in reported numbers against consensus. Below we have charted the changes to consensus over the past month by company size and sector for our “FIT” universe, noting that less than half the companies in this universe have consensus EBITDA or EPS forecasts.
See the pdf for “What’s on Our Minds”
Applications to invest in Equitable Investors Dragonfly Fund can now be made online with Olivia123.
Twitter
Tech Valuations Report Q2 2023 | CB Insights
The valuation component of this year’s sotck-market rally may be ending | @KoyFinCharts
The incredible rise of unprofitable companies | @KoyFinCharts
SP500 Equity Risk premia at 20-year lows | @EquitOrr
Venture Firms Still Writing Small Checks Despite $271 Billion in ‘Dry Powder’ | The Information
Dragonfly Fund has the capability to "swap" shares in a company or companies for Dragonfly Fund units where Equitable Investors finds them attractive and suitable investments. If you have a stock in your bottom drawer that we might be able to do something with, please reach out. NOTE to date we have used this capability sparingly, rejecting all but a very small number of proposals, but we continue to seek favourable opportunities.
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