Small Cap IPOs in the new issues wilderness

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Small Cap IPOs in the new issues wilderness

Despite the dearth of new issues, with potentially attractive investment opportunities coming from IPOs, Richard Gill, CFA, takes a look at two recently listed small cap firms.

As I wrote in last December’s edition of Master Investor Magazine, 2019 was a terrible year for new small cap companies joining the market. On AIM, there were only 23 new issues during the year, raising a piddling combined total of £489 million. That made it the worst year ever for the junior market, well off the 519 firms which joined in 2005 and the near £10 billion raised in 2006. But as we enter the final quarter of 2020, it looks (unsurprisingly) like this year could be the worst yet.

Up to the end of September, only 16 new companies had listed on AIM in the year to date, down from 20 at the same point in 2019, with funds raised down from £371 million to £227 million. It’s not all bad news for the capital markets however, with secondary issues holding up very well in the midst of the current pandemic. In the year to date, £3.72 billion has been raised by AIM listed companies from further share issues (placings, warrants etc.), already ahead of last year’s total of £3.35 billion.

Data source: London Stock Exchange

Despite the dearth of new issues, with potentially attractive investment opportunities coming from IPOs, let’s take a look at two recently listed small cap firms.

VARIOUS EATERIES

Hospitality was arguably the worst hit industry during the depths of the pandemic lockdown restrictions. Most restaurants, pubs and cafes in the UK were effectively shut for business for over three months, many seeing zero income if they didn’t offer a takeaway service. While most have now re-opened following the relaxation of government restrictions, they continue to see limitations on their ability to operate normally.

Reflecting this, recent figures from hospitality industry analysts CGA reported that like-for-like sales across Britain’s managed pub, bar and restaurant groups were down by 22.8% in the week to 28th September compared to the same week last year. Notably, sales were down by 8.2% compared to the previous week after new restrictions came in place, including the maligned 10pm curfew, table-only service and limits on group numbers.

With all that in mind, it seems an odd time for a restaurant company to be going public. But on 25th September Various Eateries (LON:VARE) did just that, joining AIM after it raised £25 million at a price of 73p per share and converted £23.9 million of debt into equity. The business was founded in 2014 by Hugh Osmond, the hospitality industry veteran who co-led the £18 million acquisition and market listing of dough ball purveyor PizzaExpress. During his eight years on the board the company became one of the UK’s largest casual dining restaurants, moving from a loss into annual profits of £38 million.

Various Eateries currently operates two core hospitality brands across ten locations. Coppa Club, with seven sites, is a multi-use, all-day concept that combines various elements including restaurant, terrace, café, lounge, bar and work spaces. The vision for Coppa Club is to provide a clubhouse style environment without annual membership fees, but which provides all the associated facilities. Prior to listing, the company also purchased two hotels and events businesses which complement Coppa Club’s two flagship locations at Sonning-on-Thames and Streatley.  

Tavolino, meanwhile (Italian for “small table”), is a restaurant aiming to address a perceived “gap in the market” for high quality Italian food at mid-market prices. I’m not quite sure that gap exists but given the recent closure of many Italian establishments (see below) it might just be getting bigger. The first Tavolino site was opened in Tower Bridge in July this year, with two more London sites, at the Royal Festival Hall and St. Katharine Docks, set to open shortly. These are currently operating under the old Strada brand, which the company acquired, with the sites expected to be converted to the Tavolino concept in the coming months.

A lot on their plate

In the company’s initial stock market statement Hugh Osmond gave an overall sense of optimism and opportunity for the business despite the challenges facing the restaurant industry. The overall strategy here is to create a major leisure group post lockdown by investing in the expansion of the Coppa Club and Tavolino brands. Management believe that there is potential demand to ultimately roll out over 50 Coppa Clubs across the UK, with three new sites planned by the end of 2021 and four in 2022. For Tavolino, potential for over 100 sites is seen, with a fourth site planned next year and three in 2022. Alongside these organic openings, the company will be targeting distressed sites in prime locations and also intends to identify complementary acquisitions of other restaurant brands.

On that last point, despite the overall pressures on the demand side of the industry there appear to be numerous opportunities on the supply side. Adding to an already oversupplied sector and customers getting bored of outdated chain brands, the pandemic restrictions have prompted many restaurants chains to appoint administrators and close many sites in recent months. These include the likes of Bella Italia, Carluccio’s, Prezzo, Zizzi and PizzaExpress, all competitors to the Tavolino brand. As well as providing possible acquisition opportunities for the group, the current environment should also see landlords keen to offer attractive rents to encourage occupancy on their sites.

Cook’s books

In terms of Various Eateries’ own trading, the historic financials have been a bit messy, reflecting an ongoing reorganisation over the past five years. This included closures and disposals of a substantial number of Strada sites and the opening of new Coppa Club and Tavolino sites. For the record, in the last financial year (to end-September 2019) the company made revenues of £25.6 million and a loss of just under £12 million. However, much of the losses were related to non-cash items such as depreciation and non-cash interest payments, with the net cash flow from operations being positive at £3.3 million. Total debt remaining after the recent equity conversion was £12.4 million, so adding in the net £23.2 million placing proceeds and the company is in a strong net cash position.

Unsurprisingly, the business is said to have seen significant disruption as a consequence of the forced closures during lockdown, with eight restaurants having now re-opened and the remainder expected to re-open at the end of the year. Encouragingly, Coppa Club delivered like-for-like sales growth of 2.1% up to the end of August and since re-opening the hotels have seen occupancy levels rise to c. 79.2% in August, with over 100 wedding bookings made across both sites for 2021.

Worth tipping?

There’s no doubt that management is one of Various Eateries’ key assets. Alongside Hugh Osmond on the board is Executive Chairman, Andy Bassadone. He founded Strada in 1999 before selling it for £56 million in 2005 and then, as CEO, oversaw its disposal a second time for £140 million in 2007. Also, Yishay Malkov, CEO, was Executive Operations Director of the Ivy Collection and helped develop the concept, opening c. 30 sites in four years. If anyone can build a successful business out of a recession then they can succeed in a boom. But while there are clear opportunities here the risks are just as obvious.

In terms of the valuation we don’t have much to go on with the historic numbers. But in the company’s admission document it provided an illustrative account of what annual EBITDA could be on a pro-forma basis. This analysis includes the eight sites that were fully trading in the last financial year and adds in the acquired hotels and other assumptions that reflect normalised trading. The result is a “normalised” historic EBITDA of £5.3 million. However, this doesn’t take into account any negative impact of the lockdown restrictions nor any new site openings.

On that basis, by my calculations the company currently trades on an enterprise value to EBITDA ratio of just over 9 times – round about fair value in my view given the overall trading environment. But for those investors with a long-term view and confidence in management’s ability to use the funds raised to build an eateries empire, the shares look worthy of a speculative punt.

INSPECS GROUP

A few weeks ago I was prescribed reading glasses for my dodgy left eye, which brings me on to this next company. Founded in 1988 by current CEO Robin Totterman, Inspecs Group (SPEC) is a designer, manufacturer and distributor of eyewear frames and optically advanced spectacle lenses to global retail chains. The business joined AIM back in February this year, raising £23.5 million for itself at 195p per share and also raising £70.5 million for selling shareholders.

Inspecs’ current product portfolio includes a broad range of frames, covering optical, sunglasses and safety glasses. These are mainly mid-market and entry-level priced products which address the largest segments of the eyewear market; however a high-end offering has recently been developed. The products are either branded under licence to customers or under the group’s own proprietary brands, or sold “OEM” – unbranded frames and private label frames produced on behalf of retail customers. Customers include the likes of global optical retailers (including Specsavers, National Vision, Grand Vision), global non-optical retailers (including TK Maxx, Costco, Superdry), independent opticians, web-based retailers and global distributors.

This is a truly international business, with offices in the UK, Portugal, Scandinavia, the US and China and manufacturing facilities in Vietnam, China, London and more recently, Italy. The firm’s distribution network covers over 80 countries, reaching approximately 30,000 points of sale. In 2019, Inspecs generated 24.9% of its revenue in the UK and 75.1% internationally. Also, the firm has a vertically integrated business model covering the design, manufacturing and distribution of eyewear frames and lenses, making it one of only a few companies capable of offering a one-stop shop solution to global retail chains.

Inspecs came to market with a three line growth strategy which is focussing on continuing to grow organically, further acquisitions and the expansion of the Vietnam manufacturing capacity from 4,300 square metres to 8,800 square metres. Growth is being targeted amidst the backdrop of a global eyewear market which was worth over $131 billion in 2019 and expected by analysts at Bizwit Research & Consultancy to grow at a CAGR of 7% from 2019 to 2025. The market is being driven by factors including an increased awareness of eye examinations; a growing number of ophthalmic disorders such as myopia (short-sightedness), presbyopia (long-sightedness) and hypermetropia among ageing populations; and improved prosperity in emerging markets leading to increased consumption of fashionable eyewear.

Life through a lens

Inspecs came to market with a strong track record, having grown revenues from $22.1 million in 2016 to $61.25 million in 2019. This performance was boosted by the 2017 acquisition of Killine Group, a designer, manufacturer and distributor of OEM eyewear frames, which brought together the vertically integrated business model. Over the same period, underlying EBITDA grew from $1.5 million to $13 million, with the business traditionally being strongly cash generative. In 2019 the net inflow from operations was $12.2 million versus pre-tax profits of $7.35 million, meaning that EBITDA is a justifiable measurement of performance.

However, growth was halted in the first half of the current financial year due to the Covid inspired restrictions worldwide. Revenues for the six months to June 2020 almost halved to $30. 4 million with the underlying EBITDA down from $6.6 million to just $0.7 million. While the reported pre-tax loss was $8.3 million, the cash outflow from operations was less pronounced at 2.4$ million.

On the positive side, construction work on the Vietnam plant was said to have made good progress and is expected to be ready for frame production shortly, with Inspec also launching a new B2B digital platform for trade customers in September. Trading in the second half is said to have started well, with a significant increase in the order book, which at the end of August was ahead of the same time last year. The company confirmed that current indications are that the second half will see a continued improvement in the business performance, with the operations now back to profitability at the EBITDA level.

Another recent highlight was the £2.4 million acquisition of Norville Group, a manufacturer of optically advanced spectacle lenses which had entered administration, which was completed in July. Based in Gloucester, Norville supplies optical retailers with complete spectacles, including well-known brands, and is considered to have the most advanced portfolio of spectacle lenses in the UK. Inspecs looks to have pulled off a cracking deal here, with the Norville business looking to be an excellent fit with the existing operations and expected to be earnings enhancing in the 2021 financial year. Also, the business came with £4.9 million of assets, including a £1.2 million freehold property.

Specs appeal

While the first half of this year interrupted Inspec’s long standing track record, I think investors can still consider this to be a growth stock. Analysts at Peel Hunt are looking for pre-tax profits to be $3.6 million for 2020 as a whole before getting back on the growth track in the following years. Current expectations are for pre-tax figures of $12.7 million in 2021 and $13.9 million in 2022.

Those forecasts put the shares on a forward price earnings multiple of around 18 times, which looks round about right for a growth business in the current environment. However, those figures don’t include the potential for any additional acquisitions to be done. With net cash as at 30th June 2020 of $10.5 million, the company is in a good position to make some decent bolt-on deals.

In terms of income, Inspec’s admission document stated that the company expected to pay a dividend for 2019 of c.$1.5 million. However, this was scrapped in light of the uncertainty created by the lockdown restrictions. Nevertheless, I would expect the policy to be reinstated in normal times, with the policy being to grow the payment in line with earnings over the medium term.


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