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First Derivatives shares surge on interims but 11 points you may wish to consider

By Tom Winnifrith, The Sheriff of AIM | Tuesday 6 November 2018

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.

As I write, shares in First Derivatives (FDP) the company floated via a fraudulent IPO and which has overstated its earnings by c50% for each of the past three years, are surging. Interims have gone down well and the stock is up 160p ( c5%) at £34.10. But hang on Henry… here are 11 points you may wish to consider before buying

1. The company says it was profitable yet net debt rose sharply to £24.2 million (£16.2 million). First says that the $53.8 million Kx  transaction will be paid out of existing debt facilities but there is no mention of what those facilities are at the moment. I remain convinced that an equity raise to fund Kx (and the cash First continues to spend on its “interesting” Venture Capital investments) is where it is heading.

2. Management has split out gross margin between software and consulting – I’m not sure this proves anything. Total gross margin was basically flat at 42% and managed services gross margin down 5%. This allows First to state that software margins are up by 8% at 84%.

3. R&D still surprisingly low for a “software” business at £4.9 million – natch most of this (£3.8 million) was capitalised and not charged against underlying Pre-tax profits which were roughly double that.

4. Overall costs rising faster than sales, so EBITDA margin was down by 1% to 17%. Reported PBT still very low at £7.6 million. Knock off the capitalised R&D and add back amortization of past capitalised R&D and that number falls to £5.6 million.

The market cap is c£900 million so on a standard tax charge you’d be paying an annualised PE of c100 if R&D was – as it should be – all charged against the P&L.  That is a mighty high PE.

5. Today saw confirmation that it is loaning and investing significant monies (relative to its cash resources) in the small, loss-making, cash-guzzling start-ups. Now £15.3 million has been splashed across 13 companies. Remember the scale of this was broadly denied by the sell-side.  How many “sales” does First make to companies in its investment portfolio? That is not disclosed.

6. Long-term trade and other receivables now at £9.8 million (H1 18: £2.7 million)! Why is that? Who is so tardy in paying? Short term trade receivables also advanced by 10% to £58 million – on its own that is more than three months of sales.

7. First has only £8.7 million in fixed assets. The rest of its assets are intangible. So will this asset base support its intended higher debt as security for the Kx acquisition?

8. You will have noted that though profits went up what is reported as free cash flow went down again.

9. These results contain no real information on what Kx adds to the mix.

10. Why was First being paid more than its share of earnings before and why is Kx Non-Controlling Interest (NCI) now receiving more than 35% of ALL dividends being paid by the group?

11. Why does Kx NCI receive dividends after they have disposed of their interest? When was this agreed to? How are the $12 million future dividends calculated for as yet unearned profits up to three years in the future. Who exercised the NCI put? FDP or NCI? Who are the principals in the NCI?

That is enough for now. Anyone paying a real PE of 100 for this crock is tonto.  The real issue is the lousy cash generation and all those opaque investments and other deals. One day this pack of cards will collapse. Still a sell.

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