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Tern – Cryptosoft update and a clarification from yours truly

By Nigel Somerville, the Deputy Sheriff of AIM | Friday 11 December 2015

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

AIM-listed Tern plc (TERN) released an update on the progress of its flagship investment Cryptosoft yesterday morning. I’m not entirely sure why it bothered, given that only £26,000 of sales is reported in something of a jam tomorrow statement.

More on that below, but first a clarification of my own: in my last piece on Tern I wondered why it was that institutional investor Hargreave Hale had managed to go from a bit under 10% of the company to under 5% with no RNS being triggered for the 9, 8, 7 and 6% thresholds. AIM rules appeared to me to suggest that RNSs should have been triggered but, with thanks and a hat tip to Duck and Dive, that looks to have been incorrect.

There are two sets of rules which appear to apply – AIM Rules and the Disclosure and Transparency Rules (DTR) of the FCA. AIM rules appear to place an obligation on the company to report significant shareholder transactions which cross each 1% threshold above 3%, but as far as I can see this is only if the company is itself notified of such transactions. Meanwhile under the DTR rules, it appears that institutional holders such as Hargreave Hale (HH) in respect of, for example, unit trust holdings, are only obliged to report the crossing of the 5%, 10% and subsequent 1% thresholds above that. No doubt Duck and Dive will correct me once again if I've still got that wrong!

So it seems that HH was not obliged to report its dealings to Tern, and if it did not then Tern had no responsibility to report those dealings to the market. It leaves AIM Rule 17 looking a bit pointless: why should some holders be exempted from reporting when others are not?  Compliance therefore appears to be a waste of time: I’m sure that everyone would agree that they would prefer that Angus Forrest and his team at Tern spent their time seeing that investee companies such as Cryptosoft were successful instead of checking up on selective (and therefore useless) AIM rules. ‘Shill’ landed one on the nose: I guess that if you are going to dish it out you have to be prepared to take it too. Point taken: I was wrong.

Now, back to the statement yesterday. It read very much to me as though little in the way of sales had thus far been achieved, and that the rest of the statement was something of an attempt to massage down expectations. At yesterday’s close of 12.5p Tern had a market capitalisation of £7 million (not to mention a boat-load of confetti to be issued when director loans are converted at prices a very long way south of the current share price). One contract for £26,000 seems very small beer in the face of that, especially if one bears in mind that Tern only has a 75% beneficial entitlement to sale proceeds if and when Cryptosoft is eventually sold (although with the structure of the funding packages being in the form of loans one would expect Tern to get its money back there on top). But an eventual sale price would have to be pretty juicy before Tern’s shareholders saw something to justify the current share price.

Of more concern is that Tern has, it seems, decided that it will need to pump another £500,000 into Cryptosoft. Now it could be that this is because there is such a vast stack of orders on the way that servicing the increased business requires additional investment. Or it could be that this was always planned (in which case why announce this additional funding now, and not as part of the last funding package announced in March of this year?) Or it just could be that cold hard cash has not been coming in to Cryptosoft at anything like the rate originally envisaged.

At the end of September Tern told the market that top sales opportunities have been selected to focus sales activity in the next four months. Two and a bit months on we are being told that larger contracts with multinationals take time to convert. Perhaps four months was a bit ambitious, although the previously stated time-frame does not end until the end of January. In the meantime, I rather doubt that an odd contract for £26,000 is quite what the bulls had in mind – that won’t keep the lights on for terribly long.

The lecture on how much longer it takes to get contracts out of larger companies is, perhaps, telling. It hardly suggests that the big boys are falling over themselves to get to the front of the Cryptosoft queue. The worry would be whether Cryptosoft and/or Tern run out of cash before the contracts roll in – as appears to have happened at Angus Forrest’s and fellow Tern director Bruce Leith’s previous AIM-listed vehicle, Digital Learning Marketplace (DLM).

Looking at the share price action, we see that the shares closed down 24% (according to ADVFN), at first sight suggesting that the market was less than impressed with yesterday’s statement.  But a bit more detail on the share price shows that ahead of the RNS the shares had been rising sharply – from 11.5p at the open on Monday to a close of 16.5p on Weds. That is a gain of 35%, with the bulk of it on Weds (13.5p to 16.5p = 22%). So set in context, yesterday’s drop looks simply to have been a case of giving up the gains of Monday-Wednesday. One might wonder whether the rise was triggered by a few people who were then rather disappointed by the contents of yesterday’s RNS.

Going back to the HH stake, I have warned pretty much all year that this represented a huge overhang. I don’t in all honesty think Tern will make enough out of Cryptosoft to justify its fully diluted market capitalisation, and I have thought the same all year. So it is hats off to HH for some very shrewd trading – or perhaps it is just sighs of relief round at HH towers. Meanwhile, at 12.5p, we are a long way down from the peak which headed towards 30p over the summer.

Will it go up or down from here? On the one hand I am still convinced that the company is very overvalued. Unless there is a big change in the magnitude and frequency of cash generative contracts for Cryptosoft then I fear that the shares may continue the recent slide.

But in fairness one might also take the view that since HH are (or are almost) completely out, and having represented a persistent stock overhang, the balance of supply and demand might work in favour of the bulls once HH stop selling. So perhaps there is the possibility of a bounce.

In the longer term, however, it is delivery of a profitable business which matters. It may seem odd, but I rather hope that it works out for shareholders and I will be pleased to offer my congratulations if Tern manages to sell Cryptosoft for the sort of price which might justify the current market valuation of Tern. It could happen, I suppose.

But it seems to me that there is the most incredible amount of hope in the current share price.  The persistent selling by HH from a position of about 20% around a year ago would suggest that I am not alone.

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    Aye, Nigel, the distinction is drawn between those who buy/sell shares which they beneficially own (3% then 1% thresholds) and those who do so as an intermediary for the benefit of investors in their unit trusts or other managed products (5%, 10% then 1% thresholds).

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