This article reviews the interims results of the surveillance company Petards and discusses the recent changes in the shareholding structure and management after Water Hall’s Tender Offer
The Petards Group plc designs and provides electronic and security systems. The company’s customers are in central and local government, the commercial sector and are mainly in the United Kingdom, but are increasingly coming from abroad. Petards shares are listed on the AIM Market in London under the Bloomberg Ticker PEG:LN
Revenues fell 19.7% during the 6 months ended 30th June 2010 to £5.3m from £6.6m for the equivalent period last year.
Gross margins increased from 30% to 41%, due to a more favourable mix of sales. However, this did not prevent profit before tax falling by half, from £242,000 in H1 last year to £115,000 for H1 2010.
The bottom line showed that earnings per share fell from 0.04p to 0.02p. It is worth noting that the first half of last year represented only 23% of the full year earnings for 2009, as the business is weighted towards the second half of the year.
Net debt at the end of June 2010 stood at £1.9m, which was barely changed from the level 12 months ago. There was in fact a net cash outflow of £0.9m from operating activities during H1 2010. Management drew attention to a cash inflow of £1m being taken prematurely into H2 2009. As this was previously made clear in the release of the 2009 yearly numbers, we are happy with the explanation. Adjusting for this would give a revised cash inflow of £0.1m during H1 2010, which is a little disappointing, as we had thought that cashflow and the elimination of the balance sheet deficit should have been management’s top priority. We commended management’s efforts last year to re-establish the financial health of the business, but we were concerned that their major issue this year has a trivial consolidation of the shares in issue and feel that management may have taken their eyes of the ball in these economically difficult times.
The net assets and shareholders’ funds at 30th June 2010 showed a small deficit of -£0.25m. Six months earlier this was -£0.29m, whereas at 30th June 2009 these figure stood at -£1.14. So, although there was a small surplus in the last 6 months, it is nonetheless going in the right direction and it is possible that the balance sheet deficit will be eliminated completely by 31st December 2010.
The company stated that revenues from defence and emergency services are lower. This was well flagged beforehand and will probably be unlikely to improve in the UK given the Government’s austerity measures in the public sector. Revenues from overseas were up from £0.8m to £1.4m and now represent 26% of sales. This was due to the sales of the company’s EyeTrain products.
On issuing the interim results Tim Wightman, Petard’s Chairman, gave an outlook for the company and said that they “expect results for the second half to be slightly weaker than in the first half…. although revenue should be higher, margins are expected to be lower”. He added that they “anticipate a significant order intake in the balance of the year which will provide a good base from which to build for 2011.”
Petards won another new customer in the first half. This was the Spanish train building subsidiary of Vossloh AG. Furthermore, they stated at 22nd September 2010 that the pipeline of opportunities for rail business was strong.
We are pleased that the company continues to diversify its earnings internationally and that it is taking steps to minimize the effects of the UK Government’s austerity measures, which have an impact on the funds available to Petards’ customers in the Defence and Police Forces. Petards Blue Chip client list will help see them through these tough times, but the size of the UK government’s predicament should not be underestimated.
We note also the political trend worldwide to build new train networks in Turkey, Saudi Arabia and Italy, with positive statements on high-speed trains being issued by the Obama Administration, Deutsche Bahn and the Californian Governor Arnold Schwarzenegger, among others. The major beneficiaries of these include the train manufacturing operations of Alstom, Bombardier and CAF of Spain, all of which are listed among Petard’s customers. On issuing the 2009 results Petards’ management stated that their pipeline of sales opportunities across their business continued to increase and that they were confident that the markets in which they operated would continue to expand. This could only be good for Petards’ EyeTrain digital CCTV systems. Moreover the recent addition of Vossloh as a customer is another nice coup for Petards. Vossloh comprises two divisions: rail infrastructure division and motive power & components division. The former division is one of the world leaders in rail fasteners and has a strong position in switches. The latter division builds locomotives and suburban trains, as well as manufacturing electrical components for light rail vehicles. Vossoh are particularly excited about building their first complete train, which will be introduced in early 2011 on Mallorca. It is currently being built at Vossloh’s Valencia plant in Spain.
NEW SHAREHOLDING STRUCTURE and NEW DIRECTOR
On 19th May 2010 Petards announced a Capital Reorganisation to consolidate the huge number of shares in issue. The proposal which was to swap one new consolidated Ordinary Share for each 10,000 Existing Ordinary Shares and then sub-divide these into 100 New Ordinary Shares and 9,900 Deferred Shares. We wrote about this at the time and rejected management’s argument that the Petards were hindered in their fundraising possibilities by the current capital structure. Even more surprising to us was the timing of the reorganisation as we thought that management’s priority would have been to continue find new income streams, as they had done over the previous 18 months.
On 21st May Water Hall announced that they had been increasing their investment in Petards Group, through market purchase. Then on 27th May 2010 they made a Tender Offer at a tender price of 0.7 pence per share to increase their holding to just under 30% of Petards issued shares. This was a premium of 27.27 % over the closing mid-market price of 0.55 pence per Petards Share on the day before the Tender Offer was made. Water Hall achieved their target to acquire all the Petards Shares it needed to reach 29.99% of the issued ordinary share capital of Petards and subsequently used their shareholding to veto management’s special resolution to consolidate the shares of the company on 24th June 2010.
Water Hall’s owner Mr. Abbullah does not have the skills to manage a security firm like Petards and it is unlikely that he wants to make a full-blown takeover offer for Petards. Water Hall itself is a maturing landfill company in the UK which has become a cash shell. Nowadays Water Hall has two financial investments: Petards and Lloyds TSB. Water Hall’s Tender Offer has succeeded in getting them a large chunk of Petards shares cheaply and it appears that Petards Board made the mistake of not buying the Petards shares themselves and let disgruntled shareholders play into the hands of Mr. Abdullah’s corporate raid.
Looking forward Water Hall has effectively been permitted to acquire a blocking stake without paying full price for the shares. The status quo will be frustrating for the existing board to pass any special restructuring resolutions, but may well benefit existing shareholders, if Water Hall presses for shareholder value to be realised as soon as possible.
As at 16th September 2010 the major shareholders in the company were: Water Hall Group plc with 29.99%, Mr. P. Doherty with 15.7% and Gartmore Investments with 6.5%
Petards announced that Mr. Abdullah has been appointed as a non-executive director to the Board with effect from 30th September 2010. The Chairman Tim Wightman welcomed Mr. Abdullah to the Petards’ Board and stated that he looked forward to working with him in developing the Group’s potential, citing in particular his contacts in the Middle East and in Saudi Arabia.
WHAT ARE PETARDS SHARES WORTH?
Since Petards sold off its loss-making computer services division in 2007, its deficit had been decreasing by about £0.4m every 6 months. The interims to 30th June 2010 showed however that the turnaround had slowed to a trickle. Nevertheless, the balance sheet deficit at 30th June 2010 was down to only £0.25 m. Net Debt which had also been falling by £0.5m every 6 months was little changed over the 12 months to 30th June 2010 when it closed at £1.9m. As the terms of the £1.45m bank loan were extended early in 2010 through to December 2012, this has relieved the business from any immediate financing uncertainties.
On the basis of the Chairman’s outlook as at 22nd September 2010 we are assuming sales of £14m and £15m for the full years 2010 and 2011 and EPS of 0.065p and 0.08p for 2010 and 2011. That would represent a forward PE of 8.46 times 2010 earnings and 6.88 times 2011. Net profit should be about £0.4 and £0.5m for 2010 and 2011 respectively. Assuming full cash conversion, this would be a lot less than the £1m generated in free cashflow in recent years, but it will be another step in the right direction and the market should react favourably once it sees that the balance sheet deficit has been completely eradicated.
Based on the estimated EPS numbers for 2010 and 2011 and assuming modest growth rate of 5% thereafter we arrive at a valuation of 0.60p per share for Petards. This valuation is 9% above the current 0.55p offer price. The Chairman’s pessimistic statement for the rest of 2010 has resulted in us revising all our numbers downward. This can be largely attributed to the UK government’s austerity measures which continue to affect businesses dependent on the public sector, especially the defence services. However, the Chairman does indicate that the pipeline of opportunities for the rail business is strong and that another significant customer in that industry, i.e. Vossloh, has been won. This potential is not fully reflected in our numbers and we look forward to seeing how Petard’s order book will progress in the second half of 2010.