Numbers don’t add up at Alphameric

Think of a number, any number…

Judging by the numbers, Alphameric (ALM) a supplier of IT and TurfTV, a live horseracing channel, to betting shops is as financially strong as an Asian bank, highly profitable and dirt cheap but I’m still not going to add it to the Thrifty 30 model portfolio.

Investors’ are unsettled by the stake building of Joe Lewis, the activist investor who recently unseated the chairman of M & B and is suspected of manoeuvring with other shareholders to take control of the pub chain on the cheap. 

At last April’s Alphameric AGM, Lewis almost amassed enough support to force out the chief executive, Alan Morecombe, but in its recent full year results, the company announced Morecombe has gone anyway, despite having masterminded what looks like a successful new venture in TurfTV.

The Guardian speculates he was bowing to the inevitable. Since Lewis has increased his stake to 29.9%, just beneath the 30% that would trigger an automatic takeover bid, he probably had enough support to vote Morecombe out at this year’s AGM.

I tend to avoid situations like this, preferring companies that investors have forgotten about, which is difficult when there’s bid speculation is the papers, and companies that are so undervalued I should be able to sell them for at least 50% more in three years or so. If the speculation about Lewis is true, he’ll take the company private before I get the chance.

Even if Lewis fades into the background, Alphameric is still difficult to assess. On the face of it, the company is very cheap. Its price is ten times its average earnings over the last ten years. It also scores eight out of nine according to the F_Score, a measure of financial strength. Normally that combination is irresistible, but Alphameric’s history may invalidate its cheapness.

This chart tells some of the story:

It shows Alphameric’s operating profit (before exceptional items) for its IT business (Solutions) and TurfTV (a 50:50 joint venture with 31 racetracks called Amrac). Temporarily at least, TurfTV seems to have taken over from supplying IT to betting shops as the main source of profit, although its worth checking out Alphameric’s site if you’re a gambler, just to see how cunningly bookmakers deploy IT to keep you in the shop betting.

The fact that its future partly depends on a completely new business makes its past less relevant, a problem exacerbated by changes in Alphameric’s traditional software business. In 2002, it had four divisions, betting, logistics, retail and hospitality but it sold off retail in 2003, logistics in 2004 and hospitality in 2007 because these divisions didn’t have the scale to compete, especially during economic slowdowns.

Then there’s the goodwill. Goodwill is paid by a company when it buys other companies for more than the accounting value of their assets. If the acquired companies are sold, remaining goodwill must be written-off, resulting in a loss if the value of the write-off is greater than the money received from the sale. Essentially the write off is an admission that the company paid too much in the first place, something investors can generally ignore because goodwill is a sin of the past, and it’s future profits they’re interested in.

Alphameric made hefty losses on the sale of its retail and hospitality divisions, mostly because of goodwill. Although these figures are not included in the normalised earnings used to calculate the long-term PE, they probably should be if we are using it as a guide to future profits. Including them would reduce earnings, and make the company look more expensive.

None of this, the boardroom shenanigans, Alphameric’s past failures or its current strategy, mean it won’t make investors money. It’s just difficult to tell.

TurfTV looks like a stable earner, and the IT business has returned to profit, but there’s a twist in that tale too. Recent low profits aren’t just the result of recession. The introduction of TurfTV made Alphameric a competitor of some of its biggest customers, who own a rival broadcaster, SIS.

Coral, Ladbrokes and William Hill, took Amrac to court alleging some of its exclusive licences to broadcast horse racing were in contravention of competition law. They lost, and TurfTV is now in over 10,000 betting shops, but the relationship between Alphameric and its customers was tested, and whether there was any lasting damage remains to be seen.

The problem with Alphameric is it’s a well established company with a long history of earnings that on closer examination looks a bit like a new venture born of a company with a chequered past. We can speculate about its future potential, but I don’t feel confident enough to include it in my rather more dull, but worthy, bevy  of companies.

The current Thrifty 30 portfolio