These comments are my own thoughts and should in no way be considered to be the thoughts of, or endorsed by, MPAC and its staff.
My essential proposition is that the business which has Turnover in excess of £50m should be able to make a Return on Sales of 6% ie £3m. On a PE of 5 this gives a value of £15m. The company also currently holds circa £25m of cash that it has not identified a proper requirement for (the company used the generic "organic growth and potential acquisitions" to validate holding onto it), and could if the business was operating efficiently be returned to shareholders. (The cash situation is a little complicated – see below).
A £15m business valuation + £25m in cash = £40m which is well above the current market capitalisation of £25m (ie cash). On top of this the company does seem able to grow revenue so at 6% return on sales the PBT should go up. 6% is itself a low number so good management should be able to move that up nearer to the 10% of a high performing business. (10% has been and continues to be a medium term target within the business). A PE of 5 is not a high rating, and if there was to be a consistent delivery of good performance this might itself get into double digits. So it is £15m+++
There was a company broker present at the meeting and like many brokers their advice to their client was very much along the lines of saying as little as possible for fear that something wrong might be said. Recognising that restraint I did feel Mr Steels did try to give me as full an answer as he felt able to. Given the broker felt the need to interject and give his answers to some of my questions I assume he felt Mr Steels was being too effusive on occasion.
My key takeaways are this;
1 – There has been a reasonably substantial reorganisation in the senior ranks over the last 18 months. There are a few important posts still to fill but going forward the team is in place, should now start delivering and management changes should no longer be used as a reason for underperformance.
2- The FD who had been the Financial Controller did a stint during the reorganisation stabilising the operations in the Netherlands. As such he has gained significant operational experience and contacts within the management in the Netherlands.
3 – The new structure, and in many cases new staff should see a closer working together between the OEM and Service side.
4 – Customer acquisition is ongoing and successful, the top line growth percentage should be double figures, though the nature of the business and the limited number of significant customers does mean that this growth can be lumpy.
5 – The Market Risborough site, in the books at £800k has the potential to be developed and if this goes through would be worth far more. It should be noted that the local council is currently opposing development and as such this is perhaps best viewed as only another factor that could get the valuation above £40m
6 – There were three sources of margin weakness in the first half of 2018.
(a) Cost overruns on two large contracts. One in the UK and one in the Canadian business.
(b) The relocation of operations in Canada led to downtime and inefficient running
(c) OEM requirements were misforecast so service engineers had to be transferred to helping OEM, causing some loss of margin on both sides.
These issues with the exception of the Canadian overrun have been resolved and so whilst it will impact 2018 figures there should be a noticeable margin improvement in 2019.
7- The Canadian project issue is not resolved and whilst management believe they have a route to completion it extends to H2 2019. I am concerned that the time delay and the fact that it is not yet, or indeed in the immediate future, due to be resolved may lead to litigation. Whilst MPAC believes it has behaved correctly litigation will have a cost and in any litigation there is a risk and it will not help ongoing business with that customer.
8- There were I believe two rationales given as to why MPAC should hold significant cash levels after the Molins sale;
(a) for operating requirements and
(b) to fund acquisitions which the company would be looking for.
They have used a few million for development and working capital flows, but there have been no acquisitions. I think this places MPAC in a difficult position. If it releases the cash it calls its previous action into question, if it does not release the cash the pressure on it grows to make an acquisition. Both of these provide problems.
There is also an actuarial pension deficit and should the company substantially reduce its cash reserves, without delivering positive results, the pension scheme trustees might look for additional funding.
Given the lack of positive results, without the cash I would expect a substantially lower share price for MPAC at the moment. As it is already a market cap minnow I am sure management would want to avoid this. If it starts paying a small dividend, you are faced with the question as to why not before and if it pays a larger special dividend it looks as though it should have done this sooner. If it buys back shares it has all of the above problems plus it reduces its already small shareholder base which I cannot see it wanting to.
If the company makes an acquisition there are issues.
- Most acquisitions do not work. This is even more of an issue when you recognise that some companies are good at acquisitions, making the success of the rest even more marginal. There is no reason to expect that MPAC is better than the average, though it may be.
- MPAC is very lowly rated, as such there is a risk that any acquisition will value the acquirer higher than MPAC. In the same way highly rated companies can acquire and rerate their acquistions up, lowly rated companies can acquire and effectively rerate the acquisitions down, destroying value very quickly.
- MPAC seems to be only just coming through a period of management change. Any acquisition will detract from the time the new management are focussing on the existing business, which is of itself not hitting the ball out of the park.
- A large acquisition will lead to potentially a higher focus on delivery from shareholders. If you take away the price support (the cash) you had better succeed.
- MPAC has yet to prove itself adept at juggling multiple balls and I would be concerned that the focus would be away from the existing business which has itself yet to deliver good results. I am also concerned that the increased pressure would not result in improved decision making and that the company will opt for a big acquisition which it is not well prepared to take on.
I am also concerned by some mis-thinking (which I shared in until I thought about it). The point was made (by the broker, not Mr Steels), that management had to spend the same amount of time on an acquisition largely regardless of size. On consideration this is not correct. If the group was to buy a small bolt on for its existing operation for a hundred thousand pounds it would need some legal Due Diligence for risk management and some work from the relevant country staff on products and customers, but I do not see why it would require significant time from the group CEO or FD. Maybe not even from the Business Development Director. I think that in reality there are bands and a £3m acquisition is not the same, as difficult, or as risky as a £10m acquisition.
As time goes by the pressure to do something increases and as such the decision criteria may decrease. Of course counter to this is the risk that management just sit on the cushion that the cash gives them and let this allow operations that are less than properly efficient.
Overall I think that management created a bit of a cross for themselves by holding back the cash at the start. That said that may have been under shareholder encouragement as I believe some shareholders see this as a marginal holding which they hold for treble or quit returns. Given where they are I do not envy them the decision as until they can drive real value in the existing business almost any avenue is open to being seen as a poor decision.
9-Whilst the company has a strong offering in the Cartoning, Case Packing and Palletising sections of the market its offering in primary packaging is less strong and an acquisition in this field could be a genuine strategic way forward. Alternatively MPAC may need to invest in this arm to create organic growth.
10 – There is a genuine expectation that 2019 will be substantially better than 2018. (Possible legal case excepted). There has been a significant order and many of the problems identified in or before 2018 have been addressed, setting the company up for the future. Whilst the company is second half weighted given all the H1 issues the results for 2018 will not be exciting, though hopefully H2 will improve on H1, nor will the H1 results in 2019 be that exciting so we will be looking for the release of the H2 2019 results, issued in March 2020 to see the real results of what has been done over the last year. The corollary to this is that most of the identified issues were internal and it is yet to be shown through results that internally the company has been really improved.
On balance I am pleased to say that following the meeting I do believe that there is a plan and the plan is being implemented.
Whilst it is only fair to consider that this is a longer cycle business with larger projects running over years I have yet to see real delivery on that plan though that is now forecast for 2019. If it happens the company is worth a lot more than it is valued at today.
Both a potential legal case and a potential acquisition could significantly divert management from delivering the 2019 results.
As such I am happy to have a holding but will be looking carefully for evidence of delivery as this could result in a significant upside. Alternatively should delivery not occur management and the company do not have the history that would allow me to continue holding on the assumption that they will get it right in the end. I would need to either sell or look for a catalyst event.