By Cynical Bear | Thursday 29 December 2016
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.
I wasn’t writing for Shareprophets a year ago but I called Nektan (NKTN) as my bear pick of the year on 14 January and it has played out as I envisaged with the share price dropping from its 31 December 2015 price of 130p to 32p today – a drop of 75%; but I think there’s still some way to go as I sense matters are coming to a head.
My articles over the course of the year can be seen HERE but the short version of the bear case for this online casino games supplier is that it has an unsustainable cost base for a business of its size, although reduced now to about £340,000 per month. It has funded its life since IPO in late 2014 by a plethora of equity raises and convertible debt issuances and has managed to amass close to £11 million of said convertible debt which converts at much higher levels than the current share price, so let’s just call it debt. It should be noted for balance that the debt doesn’t fall due until 2020 but Nektan does need to find the 10% coupon on the debt.
To put those costs in context, in the latest numbers, the interims to 31 December 2015, it generated revenue of £1.6 million and gross profit of £1.1 million; however, once one deducts marketing and affiliate costs, the business generated a loss of about £700,000 before one even gets to the significant administrative expenses.
There are a number of other more recent warning signs, namely, the lack of recent news particularly about any significant customer wins. This is in contrast to start of the year when it gave strong indications of the possibility of a huge customer that would drive the business to break-even. It was never heard of again.
In fact, there has been no news at all, other than the sale of their own-brand gaming sites in August for £1.75 million, since the 1 July pre-close trading update.
Another major red flag is the delay in releasing the year end numbers. They are due by 31 December, however, they were released much earlier last year in mid-October.
As the share price has plummeted throughout the year, it has become harder to raise funds with the amounts reducing over time, the most recent amount of £1.75 million being raised by selling a profitable part of the business, rather than by a debt or equity raise.
On the basis of the lack of news, I think it is safe to assume that the business is still not at break-even; accordingly, one wonders how it is going to satisfy the going concern test in its accounts as historically there has been a six-monthly cash outflow of about £5 million. That should be reduced going forward but I would be surprised if it didn’t need to find at least £3 million from somewhere in 2017 and probably more.
There is limited liquidity in the stock so death spiral funding is ruled out so what are the other options? Could it find a friendly buyer for its Respin JV share in the US? Could it raise further convertible debt or place at a heavy discount? The latter would lead to significant dilution considering the current market capitalisation has dropped to just under £8 million.
I don’t think any option is easy unless Nektan is showing real progress in its underlying business but now that it has sold off its profitable brands, it has made that more difficult for itself (in return for the short-term cash).
I’m taking a bit of a gamble in putting this up before the year-end numbers come out this week in case there is some positive news but I have seen no evidence to change my view of the challenges this business faces and with debt of over £10 million today, I see limited value in the equity today.
An investor here may think that after a 75% drop, there’s some value here as it can’t go any lower but it’s a sell for me all day long. If you’re not in here, the brave among you may look to sell the shares with extended settlement and buy back once the results come out this week although one could get into difficulties if it goes into suspension pending the release of the results.
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