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And so the multiple potential bidders for spreadbetting form London Capital (LSE:LCG) walked away last week. The shares duly crashed and now trade at 30.5p valuing London at £16.2 million, a discount to net cash. Or is it? Just a few points from this sorry saga emerge and perhaps offer lessons elsewhere.
1. I called it right. It happens now and again. I tipped the stock at 52p as a buy on October 23rd 2012 (see here) and when the bid news came out I advised selling at 56p ( see here). Not a great return but lesson learned buy on the rumour sell on the news.
That is to say when the bid was announced the shares spiked to 56p – what was the upside then? Norra lot. What was the downside? As those who ignored my advice found out – a lot.
2.Is the net cash a reason to buy? Not as much as you think. I reckon net cash is now c£19 million. The company might just be trading at breakeven or a tad better or a tad worse as it has cut costs. But that cash pile is not growing. More importantly as a regulated entity it needs to keep an awful lot of that cash on deposit just to stick to FSA rules. That number is £11.4 million. So in fact net free cash is c£7 million. That is just under twice last year’s cashburn. I am sure cashburn is drastically down, London capital is not going bust but do not view this as a value investment.
3.Is this a good business? London Capital is well run but it operates in an appalling industry. There are in reality no barriers to entry. Anyone with money can get into the game. As such margins will never be great. Staff costs are high and fixed. And because some clients are always cleaned out you always need to spend heavily to get fresh meat into the mincer. Some companies do that via advertising (Cantor). Others do it by using an affiliate model (London Capital) but while that may pare direct ad costs it means a lower margin on every trade and higher fixed costs (staff). Whichever way you look at it, this is not a business you want to own.
4.Management. Former CEO Simon Denham stepped down last month. Denham was a seller of shares in the summer (good move). He still owns c14% of the equity. As he contemplates his next move you have to assume that at some stage he will sell his shares. There is an overhang – that has to cap the upside.
The new management team is unproven. It is all very well saying that the old guy was useless we are now under new management but the new guys do not always get it right. It is a bit of a gamble backing them.
5.But ultimately the issue is that in this industry volumes will rise if market volatility increases and investors have a bit of cash to punt. London capital can tweak its offering or change its management but if the macro picture does not change it will not make a decent profit. It is a cork on a wave. And none of us know whether that wave is heading in or out.
As such at 30.5p you are paying £16 million for free cash of £7 million. If the market picks up massively this year London might make a £1 million profit and so might just be almost fair value. If it gets worse it could lose £1 million. My forecast is break-even and that means that the stock is still expensive.
6. As a general question I might ask you to consider the question: “what earnings multiple do you place on an operationally geared business where the company has little power to influence volumes and no pricing power at all since there are no barriers to entry?” I tend to think that the answer is not greater than five which makes London Capital look expensive on any scenario.
Tom Winnifrith is half of the team behind t1ps.com during the 12 years when it delivered such stellar gains on its share t1ps. The other half is Steve Moore who quit t1ps on a matter of principle in October 2012. The two men are now replicating the t1ps success with a new product The Nifty Fifty, details of which you can find here – the next hot tip from which is due next week.
