The Idea Bench
My current shortlist of public equity names of interest.
Welcome to Value Situations issue #7, and the sixth edition of the weekly quick ideas newsletter. In this week’s newsletter I share my current live ideas pipeline with readers.
Disclaimer
Value Situations is NOT investment advice and the author is not an investment advisor.
All content on this website and in the newsletter, and all other communication and correspondence from its author, is for informational and educational purposes only and should not in any circumstances, whether express or implied, be considered to be advice of an investment, legal or any other nature. Please carry out your own research and due diligence.
This week’s newsletter is a little different in that rather than analysing a particular situation or theme, I’m sharing what I call my “idea bench,” being my current shortlist of public equity names of most interest to me. I usually try to maintain five or so live ideas on the bench at any given time, from which I’ll select my next actionable target idea, similar to the Total Produce/Dole write-up.
The names on the idea bench all meet my key criteria for an idea to be of interest (as I’ve outlined previously) and possess the following characteristics:
Upside of 50%-100%+
Clear downside protection
Asymmetric return/risk profile
European or US-listed stocks, typically under-followed or out-of-favour for various reasons
Again I’m not necessarily looking for the best quality, high ROIC compounders as most names fitting this description seem fairly priced and are well covered among the investment community, meaning there’s little differentiated insight or edge to be had in looking at them.
Rather, my shortlist of potential targets comprises names where there is a real possibility of mis-pricing. The current live ideas on the bench are as follows:
Atos SE (ATO)
Avon Protection Plc (AVON)
Kape Technologies Plc (KAPE)
Vertu Motors Plc (VTU)
Next Investment Memo Idea – to be revealed next week
One caveat here is that while these names meet my key criteria for further investigation, I haven’t done the real detailed work on them yet (with the exception of #5), so I may end up passing on some or all of them once I delve in further. But you have to first turn over the rocks to find something of value.
And so a quick outline of each situation is set out below.
Atos SE (ATO; Market Cap €4.4bn)
Atos is a French multinational IT consulting and services firm that has had a rough 2021 so far. The stock is down ~47% YTD and at ~€40/share is trading at its lowest level since 2012. The price decline this year is attributable to accounting irregularities disclosed in April followed by disappointing revised guidance for FY21 earlier this month that was significantly off previous expectations. Furthermore, the business is exposed to legacy IT outsourcing services which weighs on sentiment around the stock.
My initial sense is that the stock may be mispriced, particularly as it is now valued at just 3x LTM EBITDA (leverage is ~2x) vs. its longer-term average of 5x-6x, while peer Cap Gemini trades at ~14x. So Atos is trading at a distressed valuaton despite management disclosing that the irregularities are not material (relating to ~11% of revenues) and setting out a plan to rectify this issue. Additionally, the company has sticky contracted revenues with French government departments and other large corporates which should see it’s earnings power beyond the current year rebound. Also interestingly, Atos has been the subject of takeover rumours historically from Thales and Orange SA, two large French caps who are also customers of Atos.
So I think this is an interesting situation, with the hallmarks of an overreaction to temporary, short-term issues.
Avon Protection Plc (AVON; Market Cap: £757m)
Avon Protection is a UK-listed manufacturer of military and first responder protection equipment, such as ballistic helmets, body armour and respirator masks. The shares are down ~30% YTD (and ~47% since all-time highs last December) due to contract delays with the US Department of Defence (Avon is a supplier to the US and UK government defence departments and NATO). There have been positive trading updates since, as revenue grew at double digits in H1 FY21, while the contract delays may only impact current year trading and are expected to be rectified by FY22.
Avon is a recognised market leader across many of its product lines, with an entrenched supply relationship into the US and UK armed forces. It’s also clearly a high-quality business, with some very attractive investment characteristics - it has a growing order book ($157m at H1 March FY21, or ~75% of FY20 revenues) providing strong revenue and earnings visibility, negligible debt (just $13m net debt excluding leases), strong cash conversion of ~85% and robust returns on capital, at ~23%. In terms of valuation, Avon currently trades at 15x EBITDA, vs. ~20x+ prior to the contract delays being disclosed.
With the contract issues seeming temporary, the share price decline appears to be an overreaction reflecting investor disappointment over the current year outlook while the longer-term growth trajectory of the business remains intact. Avon therefore appears to be the type of mispriced situation that I am on the look out for.
KAPE Technologies Plc (KAPE; Market Cap: £672m)
Kape Technologies is a UK-listed cybersecurity software company focused on digital privacy and protection for consumers.
It’s shares are up ~60% YTD, reflecting impressive growth and the transformative acquisition of Webselense, an Israeli-headquartered consumer privacy and security platform, which was announced in March and well received by the market. While the share price has outperformed it’s FTSE AIM benchmark (+6.5% YTD) the stock still appears cheap at ~13x PF EBITDA compared with the private market valuations ascribed to comparable companies, which have been taken private in a range of 17x – 24x. Notably, UK-listed peer Avast Plc is currently the subject of a takeover bid from Norton LifeLock (formerly Symantec) at an implied valuation of ~18x-20x. Applying a similar multiple to Kape would imply 50%+ upside from the current share price.
Certainly Kape would seem to qualify for a higher multiple, being a fast-growing software business (H1 FY21 revenues +60% YoY) that has transitioned to a SaaS model with strong customer retention rates. Despite these positives, the stock divides opinion for a couple of reasons. Firstly there is a question over governance and control, given that billionaire founder Teddy Sagi (also the founder of PlayTech Plc) owns 60% of Kape, and has a chequered past having been previously convicted of bribery and fraud in Israel. Secondly, Kape has been a serial acquirer and its financial reporting is somewhat complicated (as with many software companies), perhaps resulting in Kape being put in the “too hard” pile by many investors.
My initial sense is that Kape is being built for a big exit – as with PlayTech, Sagi has a track record in building and exiting businesses and creating significant wealth along the way, while the consumer cybersecurity space itself is consolidating among a number of listed players and PE acquirers. I see Kape being put in play at some point given these dynamics.
Vertu Motors Plc (VTU; Market Cap: £152m)
Vertu Motors is a UK-listed car dealer, that sells new and used cars and provides related aftersales services to private and commercial customers across the UK. It is the fifth largest retailer in the UK and operates across 149 dealerships with key marques including Ford, Honda, Vauxhall, Hyundai and Nissan.
Vertu’s shares are up ~30% YTD, comfortably ahead of the FTSE AIM market’s 6.5% return over the same period, but again Vertu appears extremely cheap across a variety of metrics at just 0.07x EV/sales, ~4x LTM EBITDA and ~0.5x EV/IC. This discount to IC is interesting given that Vertu comes with significant asset backing as it owns its dealerships’ real estate, which is carried at historic cost of ~£229m on the balance sheet (equating to 150% of its market cap), while net debt is just £4.5m (ignoring IFRS 16 leases). Furthermore, Vertu generated record FCF in FY21 (February year-end) of £48m implying a ~30% FCF yield on the current EV.
Vertu delivered impressive results in FY21, with revenues of £2.5bn (-22% vs. PY) in what was an extremely challenging year due to COVID lockdowns and the closure of sales showrooms. The business benefited from the boom in demand for used cars as less people relied on public transport, and given the global shortage of semiconductor chips halting new car production. Furthermore, the company has evolved with an online and omni-channel sales model, which has helped to further drive growth.
What I think makes Vertu interesting is that it is a resilient and well-managed business in a fragmented market, and the combination of its real estate-backed balance sheet, negligible debt and strong free cash generation make it an obvious takeover target given how cheap it is. And we know how attractive UK businesses that own their own real estate are to PE at the moment.
Furthermore, when one considers that US comps trade at much higher multiples (Carvana ~5x LTM sales and CarMax trades at 16x LTM EBITDA) there is the potential for meaningful re-rating here (yes, I acknowledge the US and UK car markets are very different and am not suggesting Vertu re-rates to these types of multiples, but its online sales channel is a growth story that directionally at least allows some comparison to US names).
Of course, there are perceived negatives for car dealers, principally autonomous driving, and the potential for less demand for cars in the future with reduced commutes and increased WFH trends. However, I believe autonomous driving is some way off from reality in the first instance, while demand for cars should hold up as cities re-open post-COVID and workers return to places of work, for reasons I’ve written about previously.
So in summary I think Vertu merits further investigation at this point.
Idea #5 – Next Investment Memo Idea
The final name on the idea bench is one that I’m currently preparing a long-form investment memo on and which I intend to publish next week. I won’t reveal any details for now, other than to say it’s a name that I see doing well in the post-COVID recovery environment and I believe it is a plausible takeover target given its particular investment attributes.
So that’s my current list of potential target ideas. Hopefully this has been of interest and I’d encourage readers to get in touch if they wish to share any thoughts or views on any of the above names. Also, if there’s a particular name from the list that you would like to see as as the subject of a future investment memo please do let me know.