I have bought tiny positions in each of these companies, because I want to be included in any discounted capital raising they may do. None of these companies are guaranteed to raise capital, and I’m not guaranteed to make money if they do, but I think overall there is a good chance they will raise capital at an attractive price.
Gentrack (ASX: GTK) is a decent company serving software to water utilities, power utilities and airports. Figures in this section are in NZD, its reporting currency.
In 2018, it had net profit margins over 13%, but in 2019 its result was ruined by a large write-down on a past acquisition. Even excluding that writedown, its results were weaker than the year before, with a hypothetical net profit margin around 8%. In its steady state, I reckon this business (which generated over $70 million recurring revenue last year) could easily produce profit of about $7 million each year.
I would say in this low interest rate environment, that means the business is worth somewhere between $70m and $140m, even assuming no growth. Once you factor in the fact that it likely will grow. If you’re buying this stock at around $120m I think the risk reward is very good indeed. Its current market capitalisation is around $140m NZD.
In the last financial year it had about $34 million in one-off revenue. Profit before depreciation, amortisation, acquisition related costs, revaluation of financial liabilities, impairment of goodwill and intangible assets, financing and tax (phew!) was only $24.8 million. Therefore, its accounts could temporarily look like a complete dumpster fire if two thirds of that one-off revenue dries up for only 12 months. I can’t be sure Gentrack would need to raise capital, but if it did, I think it is extremely likely to be at an attractive price, given the business looks like a survivor under my framework for evaluating opportunities in a pandemic.
Monash IVF (ASX: MVF) is an IVF provider assisting couples with reproduction, running antenatal ultrasound clinics and also doing blood tests that check for chromosomal abnormalities. Many of its services will be temporarily closed during the shut-down.
In the half year to December 2019, it earned $77 million in revenue at a profit margin of approximately 10%. It had $5 million in cash and a whopping $96 million in debt, not to mention another $24 million in short term liabilities. The business essentially was borrowing money to pay its dividend, and is a classic example of a business that is swimming naked when the tide runs out. I think it’s quite likely its bankers will expect it to raise capital, but at the moment it has simply said that “The Company is in discussions with its Financiers to secure an additional working capital facility and will update the market as appropriate.”
At present the business has an enterprise value of around $220 million, and it could be reasonably expected that, when things return to normal, it can generate $12m to $18m of profit in most years. I think that it would be worth around $150m at least, and I think a capital raising will likely be at a fairly steep discount to the current price. If we’re willing to assume the business can raise $100m, it seems likely it will live to fight another day, and, assuming that is used partially to pay off debt, I could see the market re-rating the stock on the reduction of risk.
Virtus Health (ASX: VRT) is another IVF provider I have bought as part of this strategy. It did about $15m last half and has $160m odd in net debt plus mountains of liabilities, particularly lease liabilities. As with other health providers, it will get some government support so it’s not clear if it will need to raise capital or not but its current enterprise value is only about 10 times its normalised earnings, so I suspect any capital raising would be very attractive to participate in.
Integral Diagnostics (ASX: IDX) is a radiology imaging businesses running clinics in both the community and at hospital sites. While it is an essential service, many of its sites will be closed during the shut-down.
In the last half year Integral did revenues of $132 million at profit margins of around 7.5%. It had $160m in debt and short term liabilities to boot, when it last reported. It may not need to raise, but I suspect there’s a good chance it will, especially given the current pricing is fairly generous and this company needs dry powder to grow by acquisition. An enterprise value of around $400m would make a raise attractively priced to my mind, though that would be a fairly steep discount of around 30% to the current price.
Hansen Technologies (ASX: HSN) is a roll up of various legacy software providers in billing and customer care solutions to the Energy, Telecommunications and Pay-TV industries. Since its software impacts the customer, it is very sticky, but it doesn’t have much organic growth. In the last half it made profirst of around $7.5 million off revenue of $144m, which is a net profit margin of about 5%.
Hansen has withdrawn guidance so it’s not clear what the impact on its business will be from coronavirus, but data out of the US suggests that Pay TV will not fare well in a recessionary environment since it is more expensive than and inferior to online streaming alternatives. In my opinion the only reason Pay TV even really exists in many instances is sports, which have largely been cancelled. Hansen’s free cash flow is stronger than its profits, and even that is after some discretionary spending, I suspect.
Hansen is trading well above where I would value it, as it has $180m worth of debt, plus payables of $20m and some fairly large lease liabilities. However, if there was a sufficient discount to the prevailing price, I would probably try to apply for shares and then flip them for a profit (which may not work out, of course). Hansen looks like a stack of melting ice-cubes to me, but its businesses are sufficiently enduring that I’d be happy enough to own shares for a short while for the right kind of discount to the market (perhaps around 20%). Personally, I only see the business as worth around $400m, which is about 40% below its current enterprise value.
Vista Group (ASX: VGL) is a provider of cinema management software currently reinvesting heavily into its products (at the expense of near-term profits). Not only that, but its growth engine, focussed on facilitating effective cinema advertising has proven bumpy over the last few years. Profit was down 10% to $10.8 million for the full year with debt of only about that figure. However, its free cashflow was very negative due to software development expenses and so it will probably need either more debt or to issue shares. I think it will probably opt for debt, but if it does issue shares I think it will be attractively priced given its enterprise value of about $190 million. I would probably pay around 20 times past year earnings for this company, though I note the cinema industry may face longer term challenges after this pandemic.
Class (ASX: CL1) is similar to Vista in that it is a software company investing heavily in software development at the moment. However, Class offers SMSF reporting software to accountants and so I doubt it will be so challenged by the pandemic as Vista is. In the six months to December it made $3 million profit in the last half. That said, its free cash flow was only $2m and it may have trouble growing much in the current settings. Previously the company had net cash but the ill-timed acquisition of NowInfinity for $25m leaves it in a net debt situation. I don’t think the company will raise capital to pay off debt (though it might), but I do think there is a chance it will look to make another acquisition and raise capital for that purpose.
Link Administration (ASX: LNK) does corporate administration services for companies, especially public companies, and owns an interest in the property clearing business PEXA. The company says:
“Link Group is appropriately capitalised and has adequate undrawn and committed credit facilities to support liquidity. The first refinance obligation on any portion of these facilities does not fall due until January 2022. As at 29 February 2020, Link Group had $126 million of cash and net debt of $773 million. Link Group’s leverage ratio was 2.6x (3.0x pro forma for Pepper European Services (PES)), excluding any cash benefit from a potential capital return from PEXA, which continues to experience strong growth with over $50 million in cash reserves. With annual debt servicing costs of approximately $20 million per annum, Link Group’s interest cover ratio is around 15 times Operating EBITDA”.
For this reason, it’s not clear to me that the company will have to raise capital, but when you consider its free cash flow was only about $22 million last half, I do think it is possible. My view is that any capital raising would be well supported, but I would just be looking to flip my shares for a profit, as I don’t really want to be a long term holder.
Sonic Healthcare (ASX: SHL) and Ramsay Healthcare (ASX: RHC) are both strong multinational healthcare businesses that have a lot of debt. Sonic has net debt of $2.3b and Ramsay has net debt of about $3b. Both companies will presumably enjoy government support and support from their lenders but given that their businesses will be at least interrupted by the pandemic, I would not rule out them raising capital. Again, I think these are decent to good investment grade businesses that will be well supported in markets and would probably look to flip my shares for a fast profit.