Back on the value trail, Sagentia (SAG) shares have been weak of late, mostly on the back of forex concerns due to the majority of earnings coming from overseas, principally the US. However, this is a high-margin, asset-rich business, which has received an approach in the past from its 32% shareholder and current chairman Martyn Ratcliffe. Earnings can be volatile, but Sagentia has proved itself adept at weathering the cycle. There appears to be significant value emerging at current prices.
Sagentia focuses on providing world-class R&D consulting services to external organisations across three vertical segments: medical devices, consumer markets and industrial products. The company works with clients to add value and technology innovation at any stage of the product development cycle – from needs and market analysis, through to product design and transfer to manufacture.
An established business with more than 25 years’ operating experience behind it, Sagentia is part of the “Cambridge Phenomenon” of high-tech businesses clustered around that city, but also operates out of Cambridge, USA, thus giving it an international reach. Its clients range from start-ups to multinational blue-chips, including Vodafone, Johnson & Johnson, PepsiCo and AstraZeneca.
Divisions…
The Medical division is the largest of the firm’s operating units and accounted for approximately 45% of group core business revenue in H1 2014. Within this, the Diagnostics and Surgical sub-sectors typically undertake large instrumentation development projects for corporate or well financed start-up organisations and accounted for the group’s top four customers by revenue. The Patient Care sub-sector was created by combining the Critical Care and Drug Delivery business units, two less established activities, into a single sub-sector in order to increase the scale of these operations. The global medical market continues to be dominated by North American companies and in 2013 approximately 82% of the revenue derived from Sagentia’s Medical customers was sourced from North America.
Financials…
For me, one of the key attractions of Sagentia is its strong and conservatively managed balance sheet. As at 30th June 2014, shareholders’ funds stood at £32.5 million, equivalent to 87 pence per share. Of this, net cash and equivalents accounted for £13.5 million. There is also a freehold property at Harston, which was recently valued by Savills as part of a refinancing. Under the assumptions used, including tenant covenant strength and market rents, the latest indicative valuation range for the building was between £12.9 million based on occupational tenancies, and £18 million under a sale and leaseback scenario.
It is therefore worth bearing in mind that cash and freehold property account for between £26.4 million (57.6%) and £31.5 million (68.8%) of the current market capitalisation of £45.8 million. It is also worth noting that the company made no alterations to the carrying value of the property on the balance sheet following this review.
Recent developments…
In July Sagentia finally began to put its cash pile to good use, initially through the acquisition of OTM Consulting Limited, an international technology management consultancy specialising in the oil, gas and alternative energy sectors. Expected to be earnings enhancing during the current financial year, this looks like a nice bolt-on acquisition for Sagentia. The energy sector is very capital intensive, and should therefore be a rather lucrative area for Sagentia.
The sector is also undergoing heavy investment in areas such as renewables, deep water drilling and fracking, which are expected to drive new areas of production to secure new energy sources for future demand needs. While the takeout multiple of 8.1 times appears rather full for a small consultancy business, Sagentia should be able to strip out overlapping bureaucracy and corporate costs right away, which should lower the effective multiple.
What’s it worth?
In order to gain a better understanding of how the underlying business is being valued, we can subtract the value of the freehold property at Harston based on the lower end of Savills’ valuation estimate (£12.9 million, or 34p per share). In addition to this, we also need to subtract net cash (£13.5 million, or 36p per share) to reveal an implied market value of £19.4 million, or 52p per share.
On this basis, the operating business is trading on an earnings multiple of just 8.5 times for the current year, falling to 8.2 times for FY15. What’s more, broker Numis forecasts net cash to rise to £16 million (43p per share) by the end of 2014, and then to £20.3 million (54p per share) by FY15.
Factoring these numbers in to our valuation, we can see that the underlying business is being potentially valued at just 5 times earnings for FY14, falling to just 3.7 for FY15 – and this is before any potential increases in the value of Harston (which has in any case been included at a conservative valuation).