At the time of the end of December 2016 monthly review NCC was 6.2% of my portfolio.
I think that NCC remains in many cases a slightly misunderstood stock. And the closure of Domain Services – never a division I was a fan off (see previous write ups) is something that I welcome.
Being a little bit simplistic NCC has three parts;
The first of these is Escrow. And this I think is an under discussed business. Escrow is a cash cow with a current revenue growth rate (January 2017 trading update from November 2016 accounts) of 14% YOY. Because of the strength of the inherent business this revenue growth is replicated in a 14% EBITDA improvement. This is a low cost, low risk, potentially decent growth business that has year after year maintained its business dynamics and throws of cash with only a limited requirement for reinvestment. In the last full year this division made in excess of £20m and I believe this will be continued and can continue to grow. I see this business as being worth in excess of £200m on its own. In fact as an independent business it may be more successful than as a combined business. As a combined business means it does not get the same share of top management mind. Doesn’t get to utilise all its earnings and has the potential for conflicts of interest with some potential customers. I think this bit of the business is worth between 75p and 150p
The other side of the trading business is Assurance. In reality this breaks down into 3 sub sections,
-Testing systems and websites for customers
-Managing systems and sites for customers
-Tracking “bad guys” and possibly working with security services to be pre-emptive. There isn’t much stated on the activities of this part but I think there has been reference to this pre-emption activity and it gets mentioned by others.
This is the sexy part of the business but it is also the part of the business that is currently underperforming. The Group has made acquisitions that have not delivered as expected with some cancelled contracts, non renewals and delays in customers' implementation.
The company has been able to grow the Assurance business at the revenue level but the margin levels have not been held. With revenues increasing by 42% Operating Profits have remained static. This is genuinely poor and needs to be recognised as such. (Management do admit this and a number of senior staff have been changed in the poor performing sections). The problem with Assurance is to my mind 4 fold;
1 – Too many companies do not fully appreciate the value that NCC brings to the table. As such they are not prepared to pay full value for the service
2 – Because internet security is a “sexy” area of business there are many competitors or would be competitors so prices are for much of the market not set by NCC. They become a price taker
3 – Whilst NCC has a decent brand so do others. Acquisitions and take overs such as NCC conducts regularly are a chance for customers to review their arrangements and try someone else. I personally think NCC is routinely too optimistic on acquisitons. Perhaps not on a 3 – 5 year review but certainly on a 1 – 3 year. If you look back at previous forays not just the recent acquisitions there is a steady drum beat of acquisitions missing initial expectations.
4 – Because this is a sexy industry the number of skilled professionals is limited. Everyone wants a presence but few have the skills required. As such the NCC staff in this area are often very well paid and will continue to need to be or they go elsewhere. A few highly skilled staff with high wages is often followed up by lesser skilled staff also receiving wages at a higher level than the general market requires. Very few firms that claim to be a top tier payer for key staff admit to being only average for the rest.
The third area is Head Office. The jury at the half year is out on whether these are growing too fast. But they have increased from £1.8m at Nov 15 to £2.4m at Nov 16. A growth of 33%. Not a convincing demonstration of costs being under control. But given all the balls currently being juggled, including the closure of the failed foray into domain services I would hesitate to suggest they are out of control as yet.
My combined parts valuation for sections 2 and 3 is currently 125p to 220p
NCC clearly has realised that operationally it has not covered itself in glory and the Chairman is to step down at the end of the financial year in May. His head is the sacrifice required by institutional shareholders.
The CEO Rob Cotton has a significant personal holding and has bought more on recent weakness. And NCC has a history of not getting things right at the start. It’s initial foray into the US underperformed as did Its move into Germany. But after time they were corrected and a decent business has been delivered. I currently see no reason why this cannot be repeated. I may sell the shares I bought after the profit warning, which are just in +ve ground as it has had its oversold bounce and I want to keep within my risk parameters.
For the rest of my holding I have a target price of 300p to 350p. I expect the next set of results to be more positive than the November figures. I would review these targets if that is not so. Currently shares are trading around 200p ,which is concurrent with my low case valuation. As such they are not a screaming buy, there is no margin of safety, but I am holding them on a GARP thesis.