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Tern – Interims and ramptastic prospect of dividends (what with?)

By Nigel Somerville, the Deputy Sheriff of AIM | Tuesday 26 July 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.

AIM-listed jam-tomorrow investment company Tern plc (TERN) released its interims to June 30 2016 this morning. Once again the company has to be commended on the speed with which it gets its numbers out. As expected there is a large paper profit, no cash and the promise of future dividends despite a lack of cash and hefty retained losses. As to the profit…..

The merger between Cryptosoft and US-based Device Authority earlier this year, with the UK outfit becoming the new home and taking the name of the American one is the source of a large paper profit. But as Cynical Bear pointed out at the time the valuation was agreed between two parties which would want to get a high valuation (see HERE), and he thought the whole thing smelt a bit Worthington-esque.

The resulting uplift in NAV for Tern was remarkable, taking the value of its holding to £7.1 million. But that value, as indicated, was based on a merger price agreed by parties happy to push up the number. What the market value might be is another matter, but perhaps not entirely relevant until significant sales are announced – something which has been lacking thus far.

We might celebrate the paper gain at Device Authority, tempered as it is by the nature of the transaction, but the only open market exit thus far achieved has been the insolvency of Flexiant, on which Tern has made a 100% loss. Funnily enough there is no mention of that in the interims.

One might hope for better from its second roll of the dice there, after the company bought some assets out of administration. I’m not holding my breath, but maybe we will see a rabbit pulled from the hat.

We are told that Device Authority has seen commercial contracts increasing in number and size. Well I guess that two contracts for a tenner would be an increase on one contract for a fiver! But we’ve not yet seen the all-important sales and contracts of a size which would merit an RNS. Perhaps they’ll come in the end, but we seem to have been waiting a long time for that.

The company gives us a paragraph on Use of Distributable Profits which indicates an intention to pay dividends, reinvest part of the cash and up to 10% to incentivise and reward management.

That’s all very well, but having finished the period with net current assets of just £32,220 (the accompanying statement points to current assets of £140,069 as opposed to net current assets), and cold hard cash in the bank of only £5,172 that is just laughable.

There is also the small matter that even in the wake of a hefty revaluation of Cryptosoft/Device Authority there remain retained losses of £4.4 million.

The company recently raised (before expenses) £525,000 in a placing at 8p, but with a net cash outflow in the first half of £273,284 even after raising £1.1 million in new equity the direction of travel is clearly still one of cash consumption, not cash-generation and paying dividends. It all feels like a bit of a ramparoonie.

Perhaps that explains the less than exuberant response of the market in marking the shares lower (by 3% last seen) on the numbers.

The company ended the period with 71.9 million shares in issue. The interims calculate basic earnings per share on a weighted average number of shares in issue of 69.4 million. I’m told that this is perfectly correct, but one might note that the calculation of fully diluted earnings per share uses a figure of 70.3 million shares. That seems rather low in the face of 3.25 million options noted in the FY15 accounts, although since they are exercisable at prices higher than the current share price one might understand why they might be ignored. But what about convertible loans? What about warrants?

In the FY15 accounts we see that there were 1.3 million warrants outstanding, exercisable at prices of between 2p-4p (see Note 16). None, so far, have been exercised since then.

Turning now to Note 15 to the FY15 accounts we see convertible loans of £15,000 convertible into 0.74 million shares, £41,500 convertible into 3.3 million shares, £55,500 convertible into 4.4 million shares and a £50,000 loan convertible into 4m shares was under dispute as the company had repaid the money.

The disputed loan convertible into 4 million shares (at just 1.25p) remains a bit of a mystery, although an RNS HERE appears to suggest that it is indeed valid.

Since 2015 year-end we have seen none of that debt converted (at prices of up to 2.016p) and so even ignoring the disputed £50,000 it seems to me that there are around 8.5 million shares queueing up to be issued. I’m sure that the fully diluted figure of 70.3 million shares is perfectly proper, but it seems to me to be a tad misleading, given that the company ended H1 2016 with 71.9 million shares in issue and debt convertible into a further 8.5 million shares (and perhaps another 4 million from the disputed £50,000 – an update on that would be welcome) and 1.3 million warrants which all suggests to me a potential total of around 85.7 million shares at period end (or 89.7 million if we count the disputed £50,000 loan).

And that is before adding in those 3.25 million out-of-the-money options,  another 250,000 options granted during the period (also out of the money) and the placing the other day of a further 6.6 million shares. I make that potentially around 96 million bits of confetti.

As ever, one might want to tread carefully with Tern’s numbers.

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