Time and Ignorance - April 2023 Update
"The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelope our future." - John Maynard Keynes
THE MONTH | There is very little we can write about the recent mark-to-market share price performance of our investments that is positive. On the flip-side, there has not been many recent negative developments within the businesses we are invested in. “The market” is not showing any interest in the smallest stocks. The value of trade in stocks in the S&P/ASX Emerging Companies index was down 38% year-on-year in the month of April to a monthly tally last seen three years ago. We think the decline in liquidity has been worse for companies not in the index.
SMALL TALK | Over the past month our weekly SmallTalk updates for investors (accessible here) profiled digital ad fraud mitigation company Adveritas (AV1), Intelligent Monitoring (IMB) and Medadvisor (MDR). You can also listen to our recent “Resilience” presentation here (or see the slides here)..
OUTLOOK | “... just in the last couple of years, I've had the realisation that with some of these stocks, nobody's ever going to care. Nobody is paying attention, nobody is doing the work, nobody cares what the company says. There's just nobody home.” - Greenlight Capital founder David Einhorn. We have cited Einhorn on this theme before and his comments ring true in the part of the market we focus on. As we said last month, our “True North” remains our understanding of the opportunities, capabilities and catalysts among our investments. With liquidity down, this looks like “private equity in public markets”. On the following pages we set out some charts that show not only where things are at now but also the strength with which small stocks in general have come out of past downturns.
PORTFOLIO REVIEW
Roughly one stock in the portfolio made share price gains for the month for every two that declined. The state of the market for the smallest listings is set out starkly in Figure 1, below. We do not have broad liquidity stats on hand for the “nano” and “micro” stocks that are not in any S&P/ASX indices but even the S&P/ASX Emerging Companies Index tells a story on liquidity, as set out in Figure 2.
Figure 1: The median performance of ASX stocks by size and industry over the past year (as of publication)
Source: GuruFocus
Figure 2: The monthly value of trade in the S&P/ASX Emerging Companies Index
Source: Iress
We continue to believe that ultimately we can distinguish our investments from “the market” through our bottom-up approach to investing in businesses where we see an opportunity to grow their valuation. But we also take solace at the macro level that historically small stocks have bounced back very strongly as set out in Figure 3, taken from our recent “Resilience” slide deck.
Figure 3: Smaller Stocks in Downturns
Monthly Movers
Intelligent Monitoring (IMB; +27% in April), Australia's largest independent security monitoring company, oversees more than 70,000 wholesale and direct connections. The most recent news from IMB was its quarterly cash flow update for the three months to the end of March: Positive operating cash flow of $181k in the quarter and $530k for the first nine months of FY23; $0.6m EBITDA in the month of March alone; guidance maintained for >$5.9m EBITDA for FY23. The elephant in the room with IMB is its debt position, created when it was named “Threat Protect”: Its net debt peaked at over $52m at the end of FY21. Capital raisings were undertaken after reaching that dire point, with $29m raised in 1H22 and another $8m in 2H22. At the end of the March quarter, IMB had $2.6m cash at hand and $28.4m debt drawn, mostly due September 30. IMB said it planned to refinance the debt with a new three-year facility by June 30, 2023. A “preferred debt partner” has been selected.
Embedded networks operator Locality Planning Energy (LPE; +24% in April) reported $2.5m operating cash flow for the March quarter. Its contracted customer base of 28,200 was unchanged but LPE said it had a further 3,200 customers at various stages in the contracting process. LPE said it is looking for complimentary acquisition targets. It expects a $5m loan it provided to Bundaberg Biohub to be repaid in the June quarter. LPE had $2.4m cash and $8m in unused financing facilities ($11.3m drawn, of which $9.2m is covered by the unwinding of LPE’s electricity hedge positions).
The most negative contributors to monthly fund performance were led by specialist cable maker Energy Technologies (EGY; -19% in April). While there was only $16k worth of EGY shares traded in April, the specialist cable maker had booked $4.4m in cash receipts for the March quarter, up 57% year-on-year. Its order book was “in excess” of $3m. EGY also reported that construction of the second factory at its Rosedale site has now completed and is awaiting the final concrete pour and permits associated with making it operational. EGY still burned $2m on operations, including a $0.7m increase in work-in-progress. It held $309k cash at the end of March with $2.7m in financing facilities available and a $375k grant payment pending.
Remote monitoring technology company Spectur (SP3; -20.5% in April) reported revenue of $5.3m over the nine months to March 31, 2023, excluding the contribution from recent acquisitions, up 20% year-on-year. Its annualised recurring revenue run rate also hit $5.3m. SP3 had $1.6m cash remaining, following the acquisition of 3CT and Spectur NZ, with $636k cash used in operating activities for the quarter. SP3 said its unweighted sales pipeline was $11.5m, or $5.2m weighted, “underpinning expectations of continuing growth into FY24”.
Portfolio Changes and the Recap Theme
The one change in the Top Nine was simply a result for a second consecutive month of cybersecurity company Archtis (AR9) and IMB swapping places based on share price movements rather than material trading activity. As mentioned in the last update, we participated in a capital raising for field services app maker Geo (NZX; GEO).
Since the end of April we have participated in a $9m capital raising for digital ad fraud protection software company Adveritas (AV1), which we profiled in SmallTalk here. With a strong group of cornerstone shareholders behind it, AV1 has until now managed its capital tightly and conducted small capital raisings anchored by its key backers - but having $3m cash in the bank at the end of the March quarter (plus $0.8m from non-executive director Mark McConnell that was approved by shareholders in April) wasn’t providing the market with confidence when it had burned $3.7m in the March quarter. AV1 has addressed this with the $9m capital raising, which it says allows it “to focus on its key objective of achieving cashflow breakeven.”
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“10k Words” - May 2023
Miserable IPO returns have been the story even though Kenvue got away with a 22% stag on day one of its US listing; a gap has opened between small and large stocks with the “jaws” notable in both price movements and valaution comparisons; in that context it is interesting to see how smaller stocks have outperformed historically coming out of market drawdowns; in Australia the industry survey looks negative but S&P/ASX EPS revisions haven’t really been notable; insolvency is on the rise as is US consumer credit card debt; and finally for whoever is advising the state fo Victoria, credit ratings do matter.
"Companies in the bellwether index reported earnings in line with estimates just over 3 per cent of the time… The overconfidence can be due to hubris, but there’s also miscalibration.” | AFR
“Over just two years, $NVDA stock tripled, then lost -70%, and now almost tripled again. During this time, the organisation itself has been stable & the product portfolio on plan. Yet we’ve seen massive narrative swings & financial forecast changes…” | @ecommerceshares
ASX: fifth-worst day this year for equities volume spells trouble | AFR
“Goldman Sachs 10,000 Small Businesses Voices found 77% reporting they are concerned about their ability to access capital. The investment bank called it a “stunning shift” from one year ago, when 77% of respondents said they were confident in their ability to access capital.” | WSJ
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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