Monday, April 14, 2014

Avesco Group Plc - Light & Sound



Avesco is a collection of businesses that provide audiovisual equipment and services to broadcasters, entertainment events, and corporate exhibits and conferences.

Creative Technology (CT)  provides high end equipment and bespoke services to live event broadcasters and for live entertainment shows (concerts, Vegas shows, etc).

A/V for these kinds of events – the Opening Ceremony of the Olympics, the World Cup Final and the Eurovision Song Contest – are reasonably mission-critical, and one might therefore suppose that CT’s technical expertise, quality of service, and custom solutions for clients with which it has had long term relationships represent consequential barriers to entry.

The growth strategy, such as it is, has been to leverage this reputation and skill set to expand into adjacent markets, notably the corporate event and trade show markets, particularly in the United States. Walmart, Google, Ford, Microsoft and, yes, Herbalife are longstanding and repeat clients, as are, for example, the Frankfurt, Paris, and Geneva Motor Shows.

I mentioned barriers to entry above but, strictly speaking, the competitive advantage belongs to the teams of people who generate the revenue and deliver the services, not to the corporate home. The team in CT Germany up and left to start their own shop at the end of 2012 and Avesco has been (and probably will continue to be) unable to regain the lost revenue stream there.

Full Service (FS) offers a broader range of services than CT’s A/V, in smaller project sizes (from £500 to £25,000), and almost entirely to the corporate sector. 

FS’ center of gravity is in the UK where its “MCL” brand operates a national branch network that executes local conferences and corporate events while, at the same time, offering clients “national coverage and international capability”. It enhances this strategy via long term partnerships with venues like Old Trafford (home of a mid-ranking football team in the midlands), The Brewery, the National Exhibition Centre, and some other locations.

FS also does work in the Netherlands as “JVR” – for example, A/V work for Novartis' Sales & Marketing meetings – and has expanded (as ”Action”) into the south of France and Barcelona, the former an established conference destination, the latter an up-and-coming one.

Broadcast Services (BS) is not more than the sum of its parts – Presteigne Charter and Fountain Studios. 

Presteigne Charter provides dry hire of broadcasting equipment and its revenue fluctuates according to the incidence of major sporting events in any given year. Even years see the Olympics, the World Cup, the Euros, and Commonwealth Games – and therefore good utilization of its rental assets; odd years see only the World Track and Field Championships and therefore result in poor utilization. Management experimented with adding a service component to this segment and found that it lost a lot of money. They scaled down the service offering and lost less money. They've now (end 2013) eliminated services altogether  and the segment should regain its health.

Fountain Studios is a 1 &1/4 acre, fully equipped studio facility in Wembley that is rented out to live TV shows such as Britain's Got Talent and The X-factor, for live televised concerts,  etc.

 That's the overview. Customer concentration is not an issue. The financials, scrubbed of extraordinary items, look like this:



The investment case turns on generating an accurate estimate of Creative Technology's maintenance capex. It seems to me that, of the £109m or so that Avesco has spent on PP&E since the beginning of 2008, some 45% of it has been for growth. 

Taking away growth capex, then, the economics of the business looks like this:


 



Common sense says that this collection of businesses, barring gross and consistent incompetence, should earn pre-tax returns on capital of at least 10% and probably a touch higher. Since Avesco employs £124 million in net operating assets, a run-rate pre-tax profit of £11.3 is not, I think, a wildly optimistic estimate of its earning power .

All of this is relevant because Avesco is trading at an enterprise value of £37m, or an EV/EBITDA multiple of 2x (trailing) and 1.6x (run-rate). If I'm more or less right about maintenance capex, then it is also trading at a price-to-earnings multiple of ~2x. One could liquidate the business and receive receive two, three or four times the market cap.

Why me, O Lord? Investors may have been more focused on the very large special dividend than on the business that remained, the financial statements are not pretty to look at, the bid/ask spread is typically off putting, and there's no way to know when the market (or, for that matter, management) will decide that 2x earnings is too low a price.

Disclosure: I am long Avesco and I might get longer in the future.  

edited to add the bit in italics 

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Maintenance capex

Focus in on the hire stock and compare what it cost to the revenue that it generates:


Buy a piece of equipment for £1 and it generates £1.50 in annual revenue, give or take. That relationship is consistent over time, except for 2013 for the reasons indicated in the main body of the post (CT Germany, for example). 

So, if the change in revenue between 2008 and 2013 has been £48.7, then it more or less follows that growth capex, the investment in hire stock to support that growth, has been £48.7 / 1.5 = £29.  And that represents a large share of the total £47 million in net capex between those dates. And that, in turn, suggests that maintenance capex (i.e.total capex less  growth capex) is a much lower figure than indicated by the cumulative D&A between those years.

A second angle from which to view it is to remove depreciation from both the nunerator and the denominator of the usual return on capital equation:

  
This is a portrait of a nicely profitable company reinvesting cash at attractive rates of return. The company's treatment of depreciation and amortization, however, does not give that impression.

The third and, I think, best way to look at it is intuitively: this is a business that, at bottom, rents out equipment. How likely is it that its business model is to buy a camera for £1 and to rent it out at below its cost? It seems improbable to me. If it recovers at least what it costs, then Avesco is worth at least its net asset value, which is £32 million. 

18 comments:

  1. Cheeky, yet awesome dig at United.

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  2. Interesting idea, took a quick peek at it. If you don't mind helping out an amateur a bit: how did you arrive at the 45% growth capex?

    Second, if this is such a great investment why did Taya just sell out 30% at a small premium to market?

    Third, the board doesn't really look like gods gift to minority shareholders. Also compensation for (ex-)directors is nothing to sneeze at. Just an observation. Curious about your thoughts. Keep blogging, excellent stuff!

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  3. I've added a bit on maintenance capex to the main body of the post.

    Gosh, I find it hard to care about what and when other shareholders buy and sell. Take that kind of concern to its natural conclusion and one would never buy securities on the cheap.

    If they're not crooks and they have no important incentive to artificially depress the share price, then price discovery will happen sooner or later.

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  4. Red, thanks for clarifying.

    Shouldn't growth CapEx be 48.7 / 1.5 = 32.5 instead? Which would be a much smaller part of total CapEx.

    Intuitively I get your explanation - the math doesn't make sense to me yet.Probably I'm overlooking something stupid.

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  5. Oh dear, I shouldn't post before my morning coffee. Just as you say and and also the increase in gross hire stock is ~44 not 109.

    So growth capex = ~30/47 = 67% and maintenance capex is 17/47 = 33%.

    Thanks for catching my error. I'll fix it accordingly.

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  6. Cool, makes sense now. Thanks for helping me out. One last question: how did you get from the ~33% growth capex to the 45% in your initial post?

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  7. I was making assumptions about pricing compression etc, which affects revenues and therefore asset turns and therefore the GCEX/MCEX split.

    Too finnicky to bother with, frankly. 30% GCEX will do the job well enough.

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  8. Thoughts on the LTIP entered into in Aug 07 and Jan 08? I see that of the 15% that they can issue under the LTIP over the next 10 years, 5% was granted under an Option Scheme to Executive Directors. They also made it so that the LTIP awards in Jan '11 would vest before the B&C Share Scheme in Feb 14, effectively diluting shareholders for an event that arguably had nothing to do with the performance of employees (litigation outcome).

    I'm personally worried about the passive outside minority investor (POMI) phenomenon that often arises for companies with such a small float? Seems to me the company is managed for the benefit of its original owners at the expense of public shareholders, hence £2.6m in emoluments to 4 executive directors for a company with a £20m market cap.

    I can't read the Company's articles of association (need to inspect physically at the registered office of the Company), but you presumably noticed Resolution 8 at the AGM passed, allowing the Directors to allot 33% of the current issued capital at 10p each.

    Also worth looking at the evolution of shares outstanding for the company.

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  9. OPMI risk is always there, yeah? The question is whether it is already priced in & my sense is that it is more than priced in here.

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  10. Even with another 33% dilutive hand-out to Directors at 10p?

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  11. Either that hand out is worth something or it's not. If it is worth something, my shares are undervalued; if it's not, then it makes no difference.

    I'm not under the illusion that Avesco is Judges Scientific. I just think Avesco's shares are worth more than 10p.

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  12. Say you get diluted an additional 33%. That means you have to achieve a 33% higher take-your-pick multiple to receive the same sterling amount. Let's use your c.2x EV / EBITDA. This now becomes c.3x. Still sounds cheap.

    But let's look at a listed peer like Vitec Group. Granted, only 10% of its revenue is sourced from comparable services offered by Avesco (they mainly manufacture the equipment), but largely driven by same macroeconomic variables as Avesco. Vitec is 3.5x the size of Avesco by way of revenue and profitability. It trades at c.5x, with a 3-6x through-the-cycle trading. Agree, Avesco still sounds cheap. Worth reading Vitec's annual for more information on the industry.

    As an aside, any thoughts why Herald Investment Mgt. would idly vote in favour of Resolution 8? You'd think being an active investor, they'd know better. I would certainly kick up a stink given what I think are excessive emoluments.

    And any thoughts on catalysts to crystallize the gap between fair value and the current seeming discount? Better trading in 2014 given the slate of sporting events?

    While I can appreciate second-guessing investors motives for buying and selling shares isn't the most instructive exercise, I still think it worthwhile to address the Taya buy-back. I see they got involved in Q1 2010 in just prior to the Celador litigation outcome, placing a 25-35p bid for Avesco which the Board summarily rejected for undervaluing the business.

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  13. Vitec's a good enough comp and 6x mid-cycle EBITDA sounds fair.

    Avesco a little different from my other position: they have reasonably well-defined price discovery paths whereas Avesco is more or less a cash alternative with a free option.

    I'd say this: there should be substantial FCF in 2015 as post WC inventory is sold down. That seems to me to be an opportune time for management to buy back some (more) shares.

    The problem with the LTIP is not it size but its structure, based on EBITDA rather than TSR.

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  14. Agree wholly on poor structuring of LTIP, but my earlier question still stands: why did presumably intelligent substantial minority holders like Herald consent to Resolution 8? If you trawl through the historic vote on the LTIP in 07 and 08 you'll see that while it passed, there was less unanimity. Corporate governanve at Avesco is rotten. And ripe for activism. Any idea what a blocking stake in the float would be?

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  15. Can't get anywhere near a blocking stake, but surely shareholders have a legitimate case against the fairness of such dilution? Need to refresh on legal precedent. Would be good to get hand on Articles of Association to see if they've waived certain pre-emption rights. Am still stunned that they can issue a whopping 33% at less than 10x the current share price, clearly to the benefit of Directors, beneficiaries of more than 66% of previous LTIPs.

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  16. Please forgive the fact that I just posted the comments below in your BFC thread!

    First of all, thanks very much for the idea. Very interesting indeed. I've enjoyed trying to work it out. I think I'm going to pass for now, though I'm conscious that interims will be out soon. I will take a look at those and reassess.

    Reasons:

    1) You've scrubbed the earnings numbers of extraordinary and exceptional items. But I think that there are so many of these that one can't really do that. Your valuation assumes that the accounts are clean from now on, and we just don't know what will happen next. Will more equipment be impaired? Will more teams defect? The full year report states that "we expect to incur more restructuring costs in the current year".

    2) Your assumption is for £12mln of CAPEX. Yet the full year report states they reduced CAPEX to £15.4mln in 2013 and "we plan to keep net investment at around this level". If this is true, it cuts £3mln off your numbers.

    3) I'm not quite sure where your run rate estimates come from. But assuming £134mln does not seem too conservative. Presumably 2012 was an epic year because of the Olympics. Assuming FY revenue only £9mln off this number seems optimistic. The company hints at pricing pressures: "There was also a drop in underlying revenue of 5%" and "margins have come under pressure as a number of major international customers have generally become more price sensitive". In that light, is 18% really the right margin number to assume? I have no idea but it doesn't feel massively conservative.

    4) Debt: The company has a lot of it. It's obviously a requirement of the business model because one cannot even hope to achieve adequate returns on equity without it. But, it makes me extremely uneasy when there is pricing pressure in the business, impairments of equipment have occurred, and the facility is up for refinance in 2015 in an environment where interest rate may rise somewhat.

    5) Management and Governance: This appears to be a company where management overpay themselves and aren't very good at what they do. Combine this with a bad business model, and you don't really want to be holding this for a long time.

    I found myself very excited by your write up, and I want to love the idea. But truth be told, this investment relies on a year or two of things going well, and the business being run efficiently for cash. But there has to be a strong likelihood that something else goes wrong, sucking up cash or even that management spend our FCF on some new venture that is average at best. In addition, I just don't think we have enough visibility on revenues and margins to be confident on forward EBIT projections.

    The interims may change a lot of the above, and I hope they do.

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  17. No worries, I've deleted the other.

    In random order:

    2) maintenance capex not capex

    3) why talk about 2012 nd extrapolate backwards when 2011 numbers are visible?

    4) premise is false. True ROIC (or unlevered ROE) is ~20%

    5) "a bad business model". I don't know where this is coming from since buying equipment and renting it out is a tried and tested business model across several industries. I'd be interested in hearing more about this.

    1) Not my thing but I get why people do this.

    This is a cheap stock but it's most definitely not the world's only cheap stock. I picked it because -- unlike some of my other positions -- it requires no brainpower,no monitoring, no follow up.

    Thanks for reading and for your detailed comments

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  18. UkvalueinvestmentMay 27, 2014 at 6:25 AM

    Maybe "bad business model" us extreme but:

    No barriers to entry or exit.
    Reliance on human capital (German team defected)
    Lumpy revenues
    Low margins

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