Today I want to follow up on something we looked at earlier in the week… as an example of why you need to be a little careful when buying shares on account of apparently good news.
Solid trading from AIM software tiddler
On Tuesday Penny Sleuth drew attention to an intriguing deal struck by IT consolidation company, Xploite (ticker: XPT). To remind you, it announced the sale of its Anix subsidiary for a net £28.5m. Given that Xploite closed its last financial year in October with net debt of £0.2m, this deal should leave it with a cash pile that exceeds its £21m market capitalisation. - Software specialist SciSys (ticker: SSY) continues its recovery as it reports good trading for the first half of the year and a positive long-term outlook.
- SciSys has recently reported new contracts with the BBC, the European Space Agency and the Environment Agency.
- The company continues to show healthy utilisation levels, a solid order book and a steady flow of repeat business from established clients. Dividend payments will be resumed this year.
And yet, despite this, the share price of Xploite has slipped back by more than 20%. This puzzles the Penny Sleuth! Why has the reaction not been more favourable?
Possibly the impact of the deal has simply been overlooked. But in fact there has been some quite hefty trading volume in Xploite’s shares so investors do seem to be forming a collective view. So let us look at the situation in a little more detail.
Looking beyond the headline figures
At the end of October, Xploite did indeed have net debt of just £0.2m. However, included within its balance sheet were long-term borrowings of £5.7m, short-term borrowings of £2.2m and cash of £7.7m. Given that Xploite had net current liabilities of £6.5m, the cash was clearly earmarked to pay immediate bills, rather than being available for long-term investment.
Since then there have been a few other significant changes. A further item in the end of year balance sheet was a deferred consideration for past acquisitions of £3.1m. This related to the October 2007 purchase of Itheon Limited, for which Xploite paid £3.5m at the time, with a further £3.5m contingent upon Itheon’s performance. According to the Annual Report £2.2m of that was paid in December with a further £970,000 payable at the end of this year. So that is £2.2m that has left Xploite’s bank account to which we must add the £3m that Xploite spent on the acquisition of Blue River Systems last December.
Even so Xploite should still have over £20m of cash and for a company with an avowed strategy of ‘acquiring, consolidating and developing innovative, high growth businesses in the IT services market place’, that is a pretty good position to be in.
One reason why the stock market does not get too excited by cash-rich companies is that they do not tend to stay cash-rich for very long. In rare cases the money, or some of it, is paid back to shareholders but more often the company spends it.
That is what Xploite intends to do. It wants to make more acquisitions and clearly thinks that the recession is a great time to be snapping up corporate bargains. Certainly I agree with this. Plenty of companies that made acquisitions when the economy was flying high are now wishing that they hadn’t, and it is good to find a company that is poised to make acquisitions at the low point of the economic cycle.
All eyes are on Xploite’s next deal
The question is whether it can find the right companies to buy and then add some value to them. To get a handle on this, I have been looking at Xploite’s history and it has certainly had an exciting ride since it launched on the stock market in 2001.
Then it was known as Offshore Telecom, and was a provider of satellite communications services for yachtsmen. Soon this business ran aground and the group transformed itself into a supplier of IT network solutions. In April 2003 the current chief executive Ian Smith took over and the company changed its name to Matrix Communications.
A number of IT companies were acquired in short order until in 2006 the distribution division was sold to Horizon Technology for £10.5m, the Integration business was sold to Calyx group for £40.5m and £10.5m was repaid to shareholders. This left the group only with its Fujin Technology subsidiary.
Fujin Technology briefly became the name of the quoted company until, after a management buy out of this division, it was changed yet again. Xploite is now the fourth name that this quoted company has had in just eight years, which must be a record. Anyway Xploite embarked upon a new acquisition strategy and seems to have created some value. This week’s sale of Anix delivered a cash profit of £10.5m and an internal rate of return of 39%, good going by any standards, and this now leaves Xploite with its cash pile and also a subsidiary called Storage Fusion.
The latter enables customers to identify and recover large areas of previously unutilised capacity within existing IT infrastructure and according, to Edison Research, has a ‘major strategic market opportunity.’
But it is the next deal that is going to move the shares one way or the other. I will be watching closely.
In the meantime, avoid jumping into shares just on the basis of positive news. You need to look a little closer. Tomorrow, the Penny Sleuth will show you how to avoid this and other expensive mistakes… and reveal five excellent shares to buy right now.
Good investing,
Tom Bulford
For The Penny Sleuth
P.P.S. If you want to follow the insights of a small company investor, and uncover the hidden gems of the stock market, find out more about The Penny Sleuth by clicking here.
