Total Systems is a value conundrum
Posted on September 15, 2009 by Richard Beddard
Filed Under Companies |
In practice:
Full fat spread
As if producing ‘total systems’ weren’t enough, Total Systems’ (TTS) main product is called, Ultima (brochure - pdf). It’s software that administers polices for insurers and brokers so they can issue quotations, manage renewals, and settle claims.
From the case studies on its website, customers like Dixons, which uses Ultima for its infamous Coverplan warranties, Denplan, the dental health plan provider, and Civil Service Healthcare (I reckon you can guess what it does), say it reduces costs, increases efficiency and makes it easier to comply with regulations.
On the face of it, the company looks a good fit for the Thrifty 30. The shares are cheap, about nine times average earnings over the last ten years, and in the year to 31 March (see the annual report) the company was financially strong, scoring seven out of nine on the F_Score.
Here’s a back of the fag packet calculation that shows just how cheap the shares are, and just how strong its finances were. If we take its current assets (about £4.8m, including cash of £3.4m) and deduct all of its liabilities (£1.2m) we get £3.6m, more than its tiny market capitalisation of £2.8m.
Total Systems is very close to being a fabled Ben Graham ‘net net’, where the price of a company is less than two-thirds of its net working capital per share (or current assets minus total liabilities).
In other words the stockmarket values Total Systems at less than the value of its most liquid assets, ignoring, for example, the property it owns, even after taking away everything it owes.
Last year Total Systems was profitable, had no debt, and owned its own premises. It sounds about as thrifty as you can get, even though it will make a loss in the first half of this year.
But, and as you can see it’s a big but, the shares are awfully illiquid. Total System’s normal market size is just £270, which means that anyone wishing to buy more than £270 worth of shares (i.e. virtually everybody), might have to pay more than the quoted price.
Worse, the spread, the difference between the price you pay for the shares and the price you can sell them for is a cavernous 7p.
Using the mid-price, or yesterdays close, as most websites and computer databases do, to calculate value or returns is bogus.
At an offer (buying) price of 30p, a holding in Total Systems is worth 23% less immediately after you’ve bought it, because you can only sell at the bid price of 23p. The bid price must rise 30% just to break-even. To make a 50% return on 30p, you’d need to sell at 45p, a bid price 96% higher than the 23p the shares would have fetched at the time of purchase.
Usually the spread is so small, it’s irrelevant, but not in the case of Total Systems.
Although a broker might negotiate a better price, and the fact that the cost of trading the shares is one of the factors making them so cheap, psychologically it’s a difficult deal to do.
There has to be a time when it would be worth it, though, or shares like Total Systems would never recover. That point must be when the shares look cheap even after the cost of the spread.
My criteria for an absolute bargain is a long-term PE of 10 or lower. Feeding the offer price of 30p, the price we must actually pay, into the formula, Total Systems’ PE comes out a shade above 10p.
The offer price would only have to fall a penny to 29p to qualify as a bargain.
Using Graham’s ‘net net’ measure it would have to fall to 23p, though, and for safety’s sake, I think I’ll adopt Graham’s measure this time.
Even then, I might want to reassure myself that Total Systems is recruiting new customers. For years its been competing against the trend for companies to commission software from low-cost developers in countries like India and it’s used the same two case studies in its last three annual reports (Dixons and Denplan). A new contract with Capita seems to have taken longer than expected to produce revenues, suggesting that its current losses may be symptomatic of something more serious than a temporary recession.
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Confident results from Thrifty 30 member Haynes Publishing (HYNS), albeit buoyed by one off accounting profits and a cheaper dollar.
In theory:
The fallacy of earnings per share
Tim du Toit, discovers that measures of value, like price earnings ratios, work best when combined with measures of financial strength, like the Z-score…
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Monevator’s mate is lost in Neverland. Too scared to commit when the market’s going down, and too scared to commit when it’s going up again. He needs to grow up, or become a passive investor.
Steve Le Compte’s best guess is that value and momentum strategies work best, especially via low cost funds.
Novelist Max Barry says the ultimate risk is the risk of ruin. Hat tip: The Big Picture.
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Did you watch Love of Money (BBC2) on the anniversary of Lehman’s collapse? If not, you can watch it on iPlayer, or read this executive summary: Lehman failed because it borrowed too much.
I’m on a list of 33 Twitter Users the Motley Fool says it’s worth following.
The recession is over, confirms the Daily Mash, and the BBC is dismantling Robert Peston.
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