Friday, 28 December 2012

My investment non-mistakes in 2012: Part 2

Continued from Part 1:

4) Lo-Q - LOQ

Lo-Q is a company I liked from the first time I heard what their product was. As a big fan of theme parks and rollercoasters I'm aware of how terrible the whole queuing system is, no one wants to wait an hour or more for a one minute ride (One of my favourite memories is going to Universal Studios in the American off season and being able to ride this crazy thing over and over and over with almost no queue... bliss!). Lo-Q offer a product that theme park fans like me love and the theme parks love. You use their devices and virtually queue for a ride rather than physically, allowing you to go off and do something else (and importantly for the parks, potentially spend more money whilst you're not queuing) and when the time comes you just turn up to the ride and walk straight on. Theme parks love it too, as it brings not only an extra revenue stream from customers purchasing the devices but they also have more time in the park where they're not queuing when they can be buying other rides, food, toys etc. The model also has high barriers to entry as there will be switching costs and inertia for any new supplier who'd want to break in to the market.

As an investment, the company fell very much in to the GARP category for me - it was trading at only 15x earnings when I first bought at ~180p (it later fell to 150p in October 2011 and I bought some more) and the potential for further roll out of an already proven, profitable business seemed pretty obvious. I'd never heard of the product before and I like to think I've been to a fair few theme parks in my time so there was obviously huge scope for adding incremental parks. Also the company had been trialing a wrist-band for water park queuing, opening up a whole extra adjacent market. The company had a new CEO with a good track record and £6m of net cash on the balance sheet to comfortably support further expansion.

So, what did 2012 bring? Results in February showed revenue up ~20% although EPS was actually slightly down, largely due to the way they've accounted for the dilution for the new CEO's options (I believe the whole amount have effectively been issued up front) although going forward that should be the end of the dilution. Since then the company have been announcing contract wins left, right and centre and it's hard to see anything other than a really bright future here. Most recently, they've announced an acquisition of accesso plc to expand their overall ticketing empire.

The share price has responded by shooting up to as high as 389p (as of today) however I must admit I got out this year at an average of 333p. Whilst I still love this company and think it's got a bright future ahead of it the price was getting too racy for someone like me who likes owning companies at a hefty discount to easily identifiable value. At 15x earnings, I felt the company was hugely underpriced for the growth that seemed highly likely over the next five years or so and could have seen myself holding here for a very long period but given the huge run up in price I started feeling uncomfortable as we slowly entered the high 20's. Even now, the share trades at 35x 2011 EPS, although this will look better soon as 2012 figures are expected to put the current price on ~28x earnings.

Does this mean I think the shares are expensive? Actually, no, they may actually still be very cheap on a long time horizon as I think the growth here could be very rapid and erode those high multiples in a few years time. It's also a matter of opportunity costs - I think I can find other shares that also have similarly good growth prospects but trade on much lower multiples. Lower multiples reduce the downside risk from either short term (or indeed, long term) disappointing changes in the future and increase the potential upside from a re-rating, LOQ style. To carry on holding at high multiples I need a higher degree of certainty of the growth that LOQ can generate not just next year but over many years, something I'm not confident enough I can do.

Having said that, if I were more growth-orientated as an investor I'd definitely consider holding LOQ for the long term - I reckon investors who stick this away for years and years could well end up making me look foolish for selling so soon.

5) Indigovision - IND

Another rollercoaster of a share. I bought after a profit warning with impeccable timing at a bit under 300p back in 2011 - just before the full results came out and the price tanked even further to a low of 165p. Ouch. So, why did I buy? Well, my thesis was that a) this was probably a short term problem and the real earnings power of the company wasn't that affected in the long run and b) the strength of the balance sheet wasn't being factored in by the market, which had not only had £5m in cash (of which a lot appeared to be largely excess to working capital requirements) as well as £4m in deferred tax assets which get converted in to pure cash as the firm makes profits. These are obviously very significant in a market cap of about £23m (when I first bought).

I didn't add any further in 2011 as the price really tanked as a real drama erupted in the company no one saw coming. Besides the results being way worse than expected (even after the profit warning) the CEO tried to make a low-ball bid for the whole company backed by private equity which the board rejected. This then turned in to a bit of a spat between the CEO and the board, and full credit to the board, they held firm against the CEO and protected smaller shareholders from being taken out for a song. There was even some suggestion (bulletin boards love their rumours) that the CEO deliberately mis-managed the company to harm short term results in order to panic the market (which it did) in order to engineer his low-ball buy out. Even if this isn't true at all, the manner in which he cynically attempted to exploit the low share price for his own riches is very poor and it takes a lot of guts from the board to do the right thing here and say no to him.

After the old CEO got evicted, his second in command stepped up to the CEO role and got to work. Given I now felt the company had a good reason for the short term poor performance which had been removed (the old CEO's bad management) and the balance sheet strength still hadn't been factored in by the market I topped up at 337p and also at 368p. The company then put out an exceptionally bullish announcement which was way out of form compared to the previously reserved tones - talking of "matching market growth" which they also mentioned happened to be 20%+, as well as a special dividend of 70p to return a lot of that excess cash. Wow! The price rocketed up and I got a bit uncomfortable that too much of the valuation seemed to be based on this one statement. Given the company's past of rollercoasting between "It's all great!" and "Ahhhhhh profits are down!" I wasn't entirely convinced I could bank on suddenly getting high growth now so I sold half my stake at 530p. Naturally, the next statement seemed far more subdued and then the price shot down again.

IND seems inherently a bit unpredictable to me. There's a number of good private investors I pay a lot of attention to (particularly Paulypilot, who's been in the share for a long time and knows it well) who are still very bullish on the future and may well be right but the problem for me is I can't value the earnings too highly as I don't feel I can predict them very well. It's fine when my investment thesis only partly relied on earnings and was predominately about the balance sheet, but with the cash now paid out and the price still being higher ex-dividend any thesis now has to be based on earnings. The shares still look fairly cheap, at 11x 2013 forecasts, but I've sold out completely now as I don't know the company & the industry well enough to have a strong opinion about the company's future. Hopefully they'll nail it and I'll look a fool for having missed a great growth opportunity - if they can get anywhere near 20% consistently they're a huge bargain right now.

6) Debenhams - DEB

Debenhams is probably the fastest time I've gone from investigating a share to buying it. It's a well known company in the UK but because it had the stigma of being both a) retail and b) straddled with lots of debt from being private equity owned the price was insanely cheap for a company which is much bigger than I'd normally buy. At a P/E of 6 and paying a 6% dividend yield the price (54p when I bought) incorporated a lot of pessimism which felt really unfounded. Firstly, many years of earnings as well as a rights issue had paid off a large amount of the debt which had, for the past good few years, heavily burdened the company. Secondly, the company's earnings weren't forecast to fall off a cliff like the price implied and the company was expected to grow both revenues and profits. Unlike FCCN, DEB is a more diversified retailer and the specific fashion risk was low as they sell a range of brands rather than a specific one (like FCCN) - this is reflected in the earnings history, which is far more stable and predictable than you'd expect given the low PER at the time.

Long story short, the shares started rising and, well, didn't really stop. If there's a lesson here, it's that I sold too early - half at 81p and the rest at 100p - the shares went over 120p this year. Again, another baffling inefficient markets example as, whilst the results they announced this year were better than expected, they weren't exactly miles ahead. Why did they double? Well... I don't really know. Then again I don't really know why they were so cheap in the first place. I sold early mainly because I felt I had "better ideas" after the price rise. One of those "better ideas" being FCCN. D'oh.

OK, only four more winning shares to discuss for 2012 then I'm done! The gripping (!?) finale to come in the next few days and I'll post my full 2012 results on 1st January, then a look at my current portfolio and my favourites going in to 2013.

Disclosure: I own shares in FCCN

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