RM revisited

Never let the story get in the way of good facts

Nearly two weeks ago I profiled Thrifty 30 constituent RM (RM-) but quickly realised that some of the figures I’d quoted were wrong. I  published the correction you can see at the top of the article, finished off a blog about Titon, and then returned to RM to reconsider whether I was right to retain it in the portfolio.

As I pondered RM again, I felt more and more disconcerted. I had miscalculated the two financial statistics I lean on most heavily; the ten year price earnings ratio and Piotroski’s F_Score.

I quoted a 10y PE of 12, because the formula in my recently re-jigged spread sheet erroneously pointed to just seven years of earnings, and an F_Score of seven out of nine because I had incorrectly transcribed the total assets figure from RM’s accounts. In fact RM’s PE is nearly 15, and it’s F_Score only four out of nine. That makes RM look more expensive, and financially weaker than it did, although many of its F_Score failures are extremely marginal. They may not be significant.

As it happens I’m receiving another sharp lesson in accuracy, courtesy of the Open University. The course is the opening module of what, cobbled together with lots more modules, might become a maths degree.

Unit one of module one is most definitely stuff you learned at school, and although it’s easy, or perhaps because it’s easy, I’ve got most of the first eleven exercises I’ve attempted wrong, or partially wrong. I seem to be accomplished at misreading questions, confusing addition signs with multiplication signs, and calculating how many jewellery boxes a craftswoman makes in 48 days instead of how long it takes her to make 48 jewellery boxes.

The point is, when you think you know the answer, you often forget the question in the rush to complete the assignment.

I fear this applies to financial analysis as much as it does to calculations of how much fuel is required on a round-trip between Perth Glasgow and Edinburgh.

Humiliating though my mathematical errors are, the far nastier conclusion I’ve come to is I rushed the maths because I had already decided to hold on to RM. As a former teacher, who used to work for an educational publisher, whose children use RM Maths, who knows many, many teachers, and has a lifelong interest in education I let the story, the undoubted benefits of IT in education, take precedence over the analysis.

Since that’s the opposite of what I’m hoping to achieve, a fulsome confession seems appropriate.

I ejected RM from the portfolio earlier this afternoon at just under 168p, the bid price plus 25% of the spread, my way of simulating a sale price since you rarely achieve the mid-price quoted by the stock exchange but usually do better than the bid. I added RM to the portfolio a year ago at 161p so it’s made us a little money including a dividend of about £8.50 in July, and another of about £32.10, which will be paid on 4 Feb.

One number I got right, is RM’s return on equity, which has been consistently over 20% in recent years. But I think I may have misinterpreted that figure. There are two things about RM’s return on equity we need to establish; whether it’s sustainable, and how much of it is due to leverage.

Not much, on the face of it as RM only has £11.5m in long-term debt, which is under 6% of the value of all its assets. Add in the money it owes customers and suppliers and it’s £12m pension deficit and total liabilities are 68% of total assets (another way of saying that is the company’s assets are worth three times its equity – see the blue bars on the chart). If RM were funded completely by equity, its return on equity would be the same as its return on assets, a more mundane 8%. It also has £25m in non-cancellable operating lease payments (rent for office space) to make over the next five years, which do not appear on the balance sheet.

Although RM entered the 2000’s earning more than 20% return on equity, it wasn’t able to achieve it in 2002, 2003, and 2004.

The trouble is RM faced similar problems in the first half of the decade to those it faces today, namely the end of big infrastructure projects to re-equip our schools and devolution of IT procurement to schools.

History may not repeat itself. As I mentioned in the blog RM has growth opportunities in the US, a bigger market which for once is behind ours, and it’s more diversified owning significant businesses in classroom resources, and marking and assessment.

I think, because of the leverage it employs, RM is tuned to perform when school, and particularly IT, budgets are expanding. But leverage works both ways, depressing profit when a company is going through difficulties. That fact alone excludes RM from the ‘buy and hold forever’ category, in which I may previously have absent-mindedly placed it.

I would hold the shares if they were obviously cheap, but on fifteen times ten year earnings, they aren’t.

-

Make the past your crystal ball

@GeoffGannon says “Make the past your crystal ball”, Warren Buffett does.

Watch Pesto’s excellent explanation of the banks’ role in the financial crisis before it disappears from iPlayer tomorrow.

In Memoriam: Sunny Day Investor, a rare and illuminating UK value investing blogger, has quit, and removed his blog from the ‘net.

UK Value Investor, on the other hands, has had a makeover.

Still room in portfolio for RM

CORRECTION. Due to a glitch in my spreadsheet some of the figures in the blog below are incorrect. RM’s 10 year PE is 14, not 12, and and net profit has grown about 3% a year over the last 10 years and 7% a year over the last five years, not 20%. This makes RM look more expensive and less desirable than I figured and I will post a revised and corrected blog when I have had a rethink. Sorry for the errors.

feast and famine

Managers at RM (RM-) must be wondering what they must do to impress investors. A third consecutive year of record profit ended in September, and the company has maintained or increased the dividend every year since it floated in 1994. It’s share price is no higher than it was in 2005 and last year it temporarily fell to a five-year low.

That short-lived scare may turn out to be a salutary tale for short-term investors. RM’s price dived when the new government cancelled Building Schools for The Future, funding to modernise Britain’s classrooms, but revived when it confirmed that school budgets will increase modesty in real terms.

RM manufactures, designs, and supplies computers (like the robust RM One) and related technology, networks (RM Community Connect 4), learning platforms (Kaleidos), and administration systems (Integris), to schools and local authorities mainly in the UK. It has two newer divisions:

1. Classroom resources: software, music resources, art supplies, and teaching and learning aids for special needs.
2. Assessment and data: testing, marking, and analysis for examinations boards like ACCA and the International Baccalaureate.

13% of turnover now comes from relatively new business abroad, mainly the US and Australia.

I like RM. As a former teacher with an interest in technology, I think our future wealth and happiness is dependent on our investment in education now and IT can help. I also believe the most successful companies look after all their customers and staff as well as shareholders. So the fact that RM trumpets surveys showing growing customer and employee satisfaction enthuses me.

But RM’s up against formidable competition in some areas, for example the big computer manufacturers, and the cold-hard figures are mixed. Since 2005, RM has prospered from sustained government spending on schools. A return on equity of 20% or more is very good, but growth seems to come in waves and the expansion of the past five or six years was preceded by five years of (relative) famine, which was preceded by earlier years of feasting.

In the 90′s RM helped put computers and networks in schools, but by 2001 the schools were switching from buying hardware to making better use of it, forcing RM to diversify. A second wave of government investment followed with the BSF, but now the company says its Learning Technology business, its biggest division by revenue, will be subdued for some time. Meanwhile, it should benefit from existing BSF projects, which will take years to complete.

Despite its recent profitability, overall shareholder wealth has only grown by an average of 7% a year since 2001. Since 2005 it’s grown at a healthier 11%. Since RM has increased net profit by about 20% a year and, other things being equal, net profit is either distributed as dividends or retained as assets in the business, I’d expect shareholder wealth (the cumulative dividend per share added to net asset value per share) to increase roughly in tandem. All other things aren’t equal though, and I suspect the company’s pension fund is gobbling up some of the difference. It’s deficit has widened from £3.3m in £2007 to £12.4m in 2010.

Whether its pension liability will continue to impinge on shareholder wealth is imponderable. It depends on actuarial assumptions about mortality, interest rates, inflation and future salaries, and the performance of stock markets. The outlook for the business is also uncertain. RM would like us to believe it is sufficiently diversified in terms of products and geographies to suffer less in subdued times, but that too remains to be seen. In the US, a potential growth market, RM is much smaller, the market is much bigger, and US public schools are less-well kitted out than out than ours.

The cynic in me fears RM is changing its financial year end in 2011, effectively lengthening the year by two months, so the figures won’t look so bad next year. But I think education is still a long-term growth market and the shares are not expensive, so I’m keeping RM in the Thrifty 30 for at least another year.

The company is largely financed by customers and suppliers, bank debt is only 5.8% of total assets, and although that figure has risen slightly since last year an F_Score of 7 indicates RM’s in good financial health.

At 12 times average earnings it’s not in bargain territory, but I still think the shares are cheap.

-

Thrifty 30 updates

The Thrifty 30 portfolio (updated 4 Jan)

Model army manufacturer Games Workshop blames itself for falling sales, not the bad weather

Dry cleaner Johnson Service should meet expectations, although it was affected by weather.

And auto engineer Ricardo reports signs of recovery in all its markets.

Making room for RM

Not so IT

As any parent knows, school has changed since our day. Yes kids still refuse to wear coats even though it’s minus five degrees outside, but the roofs have tiles on them, kids loosen their straps so their rucksacks hang around their bottoms instead of knotting stumpy ties, and parents are more involved, whether or not we want to be.

Every day ‘Parent Mail’ reminds us about grey uniforms, disco fundraisers, and money for school trips. Dinner money has gone, replaced by the ‘cashless catering card’, a euphemism for giving kids a blank cheque to buy expensive fizzy drinks and bacon butties. Needless to say the card needs more topping up than a kettle on busy day at a building site.

But the barrage of email and top-ups is just an inkling of the technological change in the classrooms and offices of schools and colleges in the last two decades. These days teachers use interactive white-boards instead of overhead projectors, or chalk. Administrators employ School management software and students and teachers organise their work and collaborate using Learning platforms that promise to replace the homework diary and school report.

In the UK, RM (RM) has been at the forefront of these changes. It started out in the 1970’s as an electronics distributor to computer hobbyists and, as Research Machines, designed computers for schools. The first was the RM-3807 in 1977.

In the 1990s, it diversified into networks and then curriculum software, programmes that teach and test students. Since 2003, it’s diversified again into into administering and marking examinations for exam boards and government departments, and, most surprisingly perhaps, traditional classroom resources, not all of which boot up, or even need to be plugged in.

The reason for this seems clear just by looking at the segmental report in the notes to the accounts. Learning Technologies, by far its biggest division by revenue, makes less than double the profit of its much smaller Education Resources division (click table for full-sized version).

Learning Technologies is closest to the original RM, supplying IT infrastructure to schools and whole authorities, here and thanks to the acquisition of Computrac in 2008, in the south east of the United States. It’s a reliable, low-margin business, divisional profit is about 4% of divisional revenues compared to about 10% for Educational Resources and Assessment and Data Services, the third and smallest division.

Surprisingly, the one activity that seems resistant to computers is learning itself and the growth in learning resources has not come from IT. Light box, RM’s curriculum software, is in long-term decline and contributed only £9.4m of the division’s £63m revenues. The two acquisitions RM made in 2009, art and craft supplier Pisces Art, and furniture maker Isis Concepts perhaps shows where management’s priorities lie.

Once RM’s IT expertise was its biggest asset but as technology has matured and competition has increased, its entrenched position in UK schools has become a channel through which it can market almost any educational product or service. Whether or not this means, as the company foresees, growth in all areas of its business, remains to be seen.

So far it’s done a reasonable job since competition from other computer hardware sellers forced it to diversify. The chart shows the percentage change in RM’s profits and financial strength since 2000, the negative axis just shows that profits fell and then recovered after 2003 (the company didn’t make a loss). Meanwhile its financial strength hasn’t declined markedly although it stepped tentatively into long-term debt in 2009, borrowing about £8m (5% of total assets) to finance its acquisitions. It’s raised its dividend every year since it floated in 1994, except in 2003 when it paid the same dividend as the year before.

The shares cost twelve times average earnings over the last ten years, which looks cheap for a company with a record as consistent as RM’s. But RM looks more like a mundane supplier of equipment to  UK schools these days, than a flashy IT company, and schools are increasingly well equipped with IT anyway, which is why the company is looking towards America’s apparently less well endowed classrooms for growth. It also seems likely that funding for schools will suffer as the next government cuts spending on public services.

Nevertheless I think RM is a solid company, at a cheapish price, with a toehold in some promising markets. The extraordinary turn around at Educational Development International has shown there is money to be made in assessment and marking, and it may well be a good time to buy shares in RM when expectations are low. I’ve added it to the Thrifty 30 model portfolio.

-

Invincible markets theory

Quoting Benjamin Graham, Jason Zweig says markets may be inefficient but they are still invincible.

Rumours of Europe’s decline are overdone, says Paul Krugman.

Saj Karsan says Apple and RIM are great companies, but that doesn’t make them great investments.

The newspaper business is bizarre, says Robert Peston, and he spent two decades working in it.

The Economist answers Malthusians. We’re not breeding like rabbits anymore.

Doesn’t she scrub up well.