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By Tom Winnifrith, The Sheriff of AIM | Thursday 8 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.
I hinted at the short case for Accesso Technology (ACSO) a few weeks ago HERE. What follows is a far, far more detailed proposition as to why this stock is grotesquely overvalued. At 1,880p, the market cap is £512 million...
1. The true growth of this business is paltry, at best: I estimate growth of around 3.9% in H1 2018, far below the company’s claimed 47%
2. At least two accounting tricks were employed in 2017 to boost earnings: These tricks may have represented circa 80% of 2017’s net income
3. Customer concentration may be much worse than people think: Over 30% of the company’s revenues stem from a single declining customer
4. Cash flows: Not healthy, capitalisation has increased sharply since the implementation of the company’s current management LTIP
5. Management incentives have been purely based on the share price: This perhaps explains much of the behaviour
6. Departure of the CEO seems suspicious: He left with 1 year to go of his five year LTIP, leaving half the stock award on the table – Why?
6 (part 2). The Exec Chairman and CFO sold half of their shares, in the spring of this year: The CEO departs immediately after two transformational acquisitions, other execs sell stock in size
7. The valuation is astounding: I call it down by 50%... for starters
A bit of history:
1. Growth is much lower than the headline figure
The first problem with this company is the growth profile. The company recently released its H1 2018 numbers: sell side analysts crowed with delight at the “47% underlying revenue growth” and journalists tipped the stock as a “spectacular growth” stock. The fact of the matter is that the company’s true like-for-like revenue growth was, perhaps only 3.9%! Given the valuation of the company, at 40x forward earnings, and the growth expectations, low single digit would be bad for management’s ESOP. How can there be such a massive disparity?
Well, management has done a great job of hiding the reality by reporting a non-IFRS defined measure of performance: “underlying revenue growth”. Here’s an excerpt from the earnings release (19th September 2018):
The company had been booking some of its revenues on a gross market value (“GMV”) basis and IFRS15 compelled a change. If IFRS15 had been applied to H1 2017’s figures, the “underlying revenue growth” would have been 47%, management exclaimed. The timing of this change was convenient to Accesso as it has helped to obfuscate the real picture.
The claim of 47% “underlying revenue growth” is clearly defined in a way that ignores the effects of two transformational acquisitions made during 2017. It is not a like-for-like number. As investors, we want to see how the underlying businesses of Accesso are growing. To help explain why, consider this extreme example:
What would the “underlying revenue growth” be in this example? Well, according to Accesso’s management team, it would be infinite. I don’t care about Accesso’s weird definition of growth. I want to understand Accesso’s true like-for-like growth, so that we can see what the businesses are really doing. To get to that to picture we have to do two things:
Here’s how to adjust the H1 ’17 numbers. The following sentence is pertinent:
Given that FY2017 reported revenue was $133.4 million we can calculate that TE2 and Ingresso generated a combined $15.3 million of sales during 2017 before they were acquired:
(Total revenues including a full year of Ingresso and TE2) – (Reported Revenues) = (Revenues of Ingresso and TE2 prior to acquisition)
$148.7 million - $133.4 million = $15.3 million
Therefore, adding $15.3m to the H1 2017 reported revenue figure provides you with a view of the combined entity’s revenue generation in that period.
The second is to the H1 2018 figure, which we have to increase to take it back to the IAS18 standard under which 2017’s numbers were reported. Fortunately, deeper in the notes of the H1 ‘18 earnings (page 8), Accesso make the following clarification:
“If reporting under IAS 18 for the period [H1 2018], revenue would have been $9.9 million higher, and operating proﬁt $1.6 million lower. There was no material impact on the Group's interim statement of cash flows for the six-month period ended 30 June 2018.”
So, to make a like for like comparison, one has to adjust the H1 ‘18 revenue figure upwards by $9.9 million. This provides the following picture:
This implies Accesso grew by 3.9% in H1 2018 on a true like-for-like basis, not 47% as the management claim. It has been suggested by the sell side gophers that TE2 had a particularly strong performance in the final three weeks prior to its acquisition. The implication here is that much of the 2017 revenue it booked in advance of being purchased by Accesso actually happened in the final three weeks prior to acquisition – i.e. in July, and therefore the second half of the year. In this case, the true like for like growth number may be a little higher than 3.9% , but the scenario is unlikely in the extreme. It is common practice to sandbag sales as soon as you have agreed an acquisition. Both parties, the buyer and seller, are compelled to do so: The buyer (Accesso) wants to see the sales booked after the acquisition, because that’s good for their reported numbers. The seller (TE2 executives) also wants to see sales booked after the acquisition closes, because that helps them achieve their earn out. Here’s how the conversation will have gone immediately after the papers were signed:
Accesso guy: “Hey man, I see you have a load of invoices you are about to send out. That revenue will be booked in the three weeks prior to us acquiring your business.”
TE2 guy: “Yeah. What of it?”
Accesso guy: “Well… you could always just stick them in the top drawer and wait a couple weeks to send them out.”
TE2 guy: “Why would I do that?”
Accesso guy: “It won’t affect the purchase price, but it will help you achieve your earn out. Also, you want to cosy up to your new bosses ,right? Well, stick ‘em in the***ing drawer then, son.”
The core business was already slowing in 2017. By “core”, I mean the Accesso that existed before the acquisition of Ingresso and TE2. It looks to me like revenue growth crashed to only c2% in 2017. Accesso reported the following numbers:
2016 reported revenues: $102.5 million
2017 reported revenues: $133.4 million
Growth of core business, before acquisitions = 2%
2017 without acquisitions: $104.8 million
No wonder management was keen to make acquisitions. I appreciate that’s all a bit complicated, so here’s a couple of pictures to explain what I mean:
The above chart shows how management presents the revenue growth, explaining the impact of IFRS15. However, this fails to adjust for the fact that Accesso made two very large acquisitions during 2017.
As can be seen above, when you incorporate the two acquisitions, the growth from H1 2017 to H1 2018, on a true like-for-like basis is only 3.9%. This is devastating to the investment case.
Either the core business (pre-acquisitions) has gone into sharp decline, or the acquisitions went ex growth in H1 2018. I’m not sure which would be worse: the two acquisitions were very fast growth companies before they were acquired… Has Accesso screwed them up, or was it spoofed into buying them? The market needs to wake up to this.
2. Accounting tricks to improve 2017’s financials
As mentioned above, Accesso made two acquisitions during 2017 and I think each offered an opportunity to gloss up the numbers.
Acquisition number 1: Ingresso Group Limited (Summary of the trick)
Agree a high price for the acquisition with a large contingent element based on stretch targets. Then account for the entire purchase price in the balance sheet, including a liability for the contingent payment. Given the stretch financial target is not met, book the unpaid contingent consideration through the income statement, thus inflating earnings.
Ingresso Group Limited – A little background
Just to set the scene, here are a couple of charts of Ingresso’s performance before acquisition. This company had kind of come from nowhere, but was growing at an extreme rate. Revenues went bananas in the past three years. It’s worth noting that these revenues were booked on gross market value basis. It’s a ticketing company, so this means booking the entire value of the ticket as revenue.
This explosion of growth came shortly after it became part of a Dutch travel magnate’s empire (BCD), who made a major investment in the company in 2013. Prior to that, it looked like a doggy start up (in fact, it was the rebirth of a group called Seatem which went bust a few years prior). Perhaps it had benefited from its inclusion in the BCD empire, hence the top line growth. Gross margins were stable, and the massive increase in volumes clearly pushed the company into profitability.
Onto the trick…
From the 2017 FY accounts of Accesso, page 54:
“The earn out, payable in 2018, is based on the financial performance of Ingresso for the year ended 31 December 2017 exceeding its financial performance in 2016. It is payable in cash and secured by a floating charge on the assets of Ingresso.
“The full earn out was not achieved, resulting in a credit to the Consolidated and company statement of comprehensive income of $3.2 million. The Group's statement of financial position includes a liability in relation to the earn out of $9.1 million. Under IFRS 3, consideration payable to employees of the acquired company is compensation expense, rather than deferred consideration. The Group’s income statement contains $1.0 million of compensation expense due to this treatment within administrative expenses, and $0.2 million of interest expense related to this treatment. “
This means that the $9.24 million reported operating profit for Accesso in 2017FY was inclusive of a $3.3 million “credit” relating to a reversal of the Ingresso earn out, the acquisition it made in the same year. So… just to really sledge-hammer this point... a third of the company’s operating profit in 2017 resulted directly from the non-achievement of financial goals of an acquisition undertaken that same year. Magic.
Acquisition number 2: “TE2” (Summary of the trick)
Make an adjustment to the acquired company’s balance sheet, attributing a large chunk of the value to acquired intangibles, rather than booking it as goodwill.This compels the creation of a deferred tax liability (“DTL”), as these new intangibles will not qualify for a tax shield when amortised. Calculate the DTL based on the historic tax rate of 40% (which was indeed the tax rate at acquisition but not at the time the accounts were stated). Then, in the same set of accounts, reduce the DTL by applying the new (thanks to The great Donald Trump) US tax rate of 21%, taking the tax gain to net income, and boosting EPS.
“In July 2017, the Group announced the acquisition of Blazer and Flip Flops Inc (TE2). The cash element of the acquisition costs (net of cash acquired) was $69.2m and was funded via an underwritten vendor and cash placing, raising gross proceeds of $75.6 million.”
“Founded in 2013 by its management team led by CEO Scott Sahadi, COO Ray Atkin and Head of Technology Josh Bass, TE2 is based in San Diego, California and Orlando, Florida and has approximately 69 employees. TE2 has a growing customer base consisting of several leading theme park and leisure operators, with notable customers including Cedar Fair Entertainment, SeaWorld Parks & Resorts, Merlin Entertainments, and Carnival Corporation.”
…currently derives the majority of its revenues from professional services…
This is all to be found on page 55 of the Annual Report. Accesso adjusted the TE2 balance sheet to include $22.6 million of intangibles, attributed to the technology and customer relationships. This compelled the creation of a deferred tax liability as the intangibles would not qualify for any tax shield. This was calculated as $11.5 million, equal to 40% of the created intangibles. 40% was the US corporate tax rate at the time of the acquisition, but not a the time the accounts were drawn up. The Trump administration reduced the US corporate tax rate to 21%. Accesso booked the difference between the tax liability at 40% and 21% through the income statement.
From Page 50 of the FY17 accounts:
“Tax rates in the UK will reduce from 19% to 17% with effect from 1 April 2020. Tax rates in the US will reduce from 35% to 21%, before state taxes, with effect from 1 January 2018. As both rate changes have been substantively enacted at the balance sheet date, deferred tax assets and liabilities have been measured at a rate of 17% and 21% plus state taxes in the UK and US, respectively (2016: 17% and 40%, respectively).”
It looks like this represented just under half of the company’s reported NPAT. In fairness to Accesso, when it reports its “adjusted” net income, it backs out the effects of these two tricks, but adds in all the amortisation of acquired intangibles, which is a true cost to the business and so should not be adjusted for. How can one reasonably argue that just because an intangible has been acquired rather than capitalised internally, it should not form part of the company’s calculation of operating costs?
The table above highlights that over $7.7 million of the total $9.9 million reported net income stemmed directly from these two tricks.
3. Customer Concentration
I understand, from sell side gopher research, that the group’s major customers are the large theme park operating groups. It currently serves seven of the top 10 globally. Again from sell side research, I understand that, in total, the group services circa 60 theme park operators and the following are included within this:
In the context of this list of leading brands, one would not expect to see a high degree of customer concentration, or dependency
Customer concentration is very high – From the financial accounts:
“Major customers - The Group has entered into agreements with theme parks, theme park groups, and attractions to operate its technology in single or multiple theme parks or attractions within the theme park group.
The majority of the ultimate revenue of the business is derived from guest rentals of the Group’s virtual queuing technology or tickets purchased by guests via the Group’s ecommerce technology, but no single guest forms a significant proportion of the revenue of the Group. However, the ability to generate guest rentals or ticket related revenue is fully dependant on the Group maintaining and developing agreements with theme parks or attraction owners to operate its technology.
The customers of one of the park operators with which the Group has a contractual relationship accounts for $44.8 million of Group revenue for 2017 (2016: $51.3 million). “
So a third of the revenues come from one client (likely Six Flags), and that client declined by about 13% from 2016 to ’17.
4. Cash flows and balance sheet
The cash flows are not healthy. For starters, they are very seasonal, which is to be expected given the industry it operates in. The capitalisation of intangibles has grown markedly since 2014, which coincides with the new management LTIP.
Also, 2017 saw a very large benefit to its operating cash flows from growth in Ingresso, which holds customer cash. The gross market value of those transactions are a benefit to Operating Cash Flows (OCF) for as long as they sit on account. Growth is great for cash flows in that business, and this contributed about $12 million to OCF during 2017. Naturally, this reversed in H1 2018, which is seasonally weak. This led to negative OCF (despite growing capitalization), and VERY negative Free cash Flows (FCF).
The calculation of OCF starts with the net income. Given this was inflated by the reversal of the contingent consideration, OCF saw a benefit from the same. The OCF was effectively inflated by the structure of the acquisition.
And the cash flows in 2017 were further helped by some “option cash”. From the 2017FY accounts:
“Our closing net cash balance of $12.5 million (2016 net debt: $3.4 million), includes balances of approximately $5.5 million in respect of cash paid back to the Group by the sellers of TE2 to make payments to employees in lieu of a pre-acquisition option scheme over a three year period.”
But surely those cash flows weren’t reported as operating cash flows? Well, they were in the headline number as this excerpt shows:
That’s a really important chart because it actually explains what was really going on with this company’s cash flows. If you use $21.3 million for the OCF figure, then FCF was about 60% lower. And that’s before we put in any adjustment for the accounting tricks.
As of December 2017:
“The facility is at an agreed rate of 140 basis points above LIBOR at a borrowing to EBITDA ratio of less than 1.5 times, rising to a maximum 190 basis points if the borrowing to EBITDA ratio is greater than 2.25 times. It provides an additional accordion mechanism allowing for a further $10m relating to future acquisitions, and includes a commitment interest on undrawn funds of 35% of the relevant interest rates above.”
I wonder what the actual covenant is on that facility. Surely there must be one if they have levers for increasing the rate. As of the end of 2017:
“Our closing net cash balance of $12.5m (2016 net debt: $3.4m), includes balances of approximately $5.5m in respect of cash paid back to the Group by the sellers of TE2 to make payments to employees in lieu of a pre-acquisition option scheme over a three year period. In addition, cash balances totaling approximately $11.0m are held by the Group to make near term settlements to venue operators in respect of the Ingresso platform.”
So, that means the closing cash balance could be described as negative, and that was going into the bleak part of the year for cash flows. If I were an exec at that firm, I’d probably have thought about selling a few shares. The company reported a net debt position of $11.6 million as of H1 ’18. I’d like to come back to this chart again.
You see how it all falls off the bottom at the right? That’s because cash flows have been terrible in H1 2018. I don’t find that surprising at all given my analysis of 2017. Also, as a ticketing business, growth is great for cash flows. When there’s no growth, it’s not so good for cash flows and it’s terrible when revenues are in decline…
Perhaps therefore, the cash flows provide further evidence of a lack of topline growth. Had I been an executive of this company, and had I seen the trading conditions, say, half way through the H1 period, in April, I might have been tempted to let a few shares go…
5. Management incentive structure
A new LTIP was put in place in March 2014, which coincides with the growth in the propensity to capitalise intangibles. If you can’t be bothered to read all the blurb in the 2017FY accounts, the summary is that the performance criteria for receiving the LTIP were entirely based on the share price. All of these LTIPs appear to have been awarded, but not all are yet exercisable.
As can be seen, not all of the LTIP awards have become exercisable, with the remainder due in March 2019. I think that an incentive structure like this is blunt and risks compelling the wrong behaviour.
6. The CEO leaves and other Execs sell stock
Steve Brown was with the company for 10 years, until April 2018 when he left. He doesn’t seem to have been leaving for another job – see his Linkedin page. He seems to have been doing reasonably well.
- 2017: Base of $385,000, bonus of $480,000 plus share based payments…
And he had 634,000 shares.
He must have had good reason to leave, because it looks to me like he walked away from a large stock award.
The next screen shot is another extract from the 2017 FY accounts. I read this as suggesting that he was due to receive a further 70,000 shares in March of 2019. So, he had to work less than a year and he’d pull in another $2 million… That doubles his take from the LTIP, which he’d been working up to for the last 4 years.
So, why not wait another year? He may well have had personal reasons to leave the company. On the other hand, stepping down from the board frees him up to sell his stock without any disclosure, and he had a lot of stock: 634,000 shares. Given that the company had only recently made two large, transformational acquisitions, it seems strange not to bed those in and profit from their impact on earnings.
And on 6th April 2018, the Executive Chairman and CFO announce the sale of half their stock:
For me, the combination of the CEO departure and the sizable share sales is worrying. Since these events, the company has reported its H1 2018 results and I’ve shown that growth was actually pretty crummy. Added to this interesting series of events is the loss of Amazon as a major customer.
In February 2018, Amazon Tickets announced its intention to close its UK ticketing venture as you can see HERE
Ingresso had been the supplier of the back end for this venture and so Amazon was listed as a banner customer at the time of the acquisition by Accesso:
“It counts Lastminute.com, Cirque du Soleil, Amazon tickets (UK) and Yplan among its international partner base.”
I understand that this was indeed a “major customer” for Ingresso and it was therefore a “big blow” to lose the service. Indeed, sell side analysts have justified Accesso’s lack of pro forma growth by putting it in the context of losing a “high revenue” customer.
Fine. What’s odd is the lack of disclosure about this loss of customer ahead of the executive share sales I mentioned earlier.
Let’s recap the order of events:
March 2017: Accesso buys Ingresso (Amazon highlighted as major customer)
February 2018: Amazon announce intention to exit the UK market
February 2018: Accesso announce planned departure of long term CEO
April 2018: Exec Chair and CFO sell half their stock
September 2018: H1 results released showing collapse in pro forma growth, obfuscated by the claim of “47% underlying revenue growth”
I know what you’re thinking: “When did Accesso announce the loss of Amazon and the impact on the company’s revenues?” Er... it didn’t announce it.
Question 1: The folk who bought the stock off the executives… Did they know the pro forma growth in the first half was going to be single digits, owing in part to the loss of Amazon as a major customer?
Question 2: Did the executives who sold the stock benefit from material information that had not been disclosed to the public?
7. The valuation
Given the lack of clarity over its true earnings power and growth profile, valuation is arbitrary. However, clearly the following consensus multiples are beyond bonkers even after the precipitous recent decline in the stock.
23x Forward P/E (130x trailing!)
13.5x Forward EV/EBITDA
4.5x Forward EV/Sales
For this enterprise, with a single digit growth profile, a track record of earnings manipulation, rubbish cash flows, and "interesting" share sales? You is 'avin' a bubble!
Now you may ask "How does this stuff even happen? If this was all for real, it would have been picked up already. Can a company valued at £512 million avoid serious analysis? Surely the sell side gophers would have noticed. Er ... this is London’s AIM Casino, the wild west of investing, where low disclosure standards meet bad tax incentives and an ill-informed retail investor herd and a badly advised institutional bunch of monkeys. And of course a company doing lots of M&A needs paid City advisors. Why would any sell side analyst jeopardise such lucrative corporate work by doing his or her job properly?
In short - sell!
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