Stockwatch: A minnow destined for great things?

by Edmond Jackson from interactive investor |

This small-cap had soared, but price weakness offers a buying opportunity, argues our stock picker.

If an alleged "growth stock" falls over 20% in response to underlying results, this must surely negate the label? Aren't growth companies meant to beat expectations and, if ramping up investment, shouldn't the market respect this by was of a mark-up in response?

Maybe that's also reflective of bull market sentiment, where the current situation - especially for small caps - is more complex. AIM-listed Beeks Financial Cloud (LSE:BKS), a niche provider of computing and connectivity for financial markets, has just seen its stock drop over 20% to 95p in response to interim results.

Revenue jumped 36% rise to £3.5 million with underlying pre-tax profit up 46% to £410,000 (percentage advances being easier from a low base, mind), but the outlook statement cautioned how underlying pre-tax profit growth of about 25%, for the financial year to end-June, will be lower than previously guided, due to investment.

In fairness, the stock had been chased up to 127p pre-results but the reaction still shows wariness of a capitalisation around 46 million.  

I drew attention last September at 114p as a long-term 'speculative buy' given early-stage parallels going back as far as 20 years with what used to be called Royalblue financial systems – a small cap financial systems group that became FTSE 250-listed Fidessa Group (LSE:FDSA), ultimately bought by Ireland-based Ion for £1.5 billion following a competitive bid situation with Swiss firm Temenos.

That stock always traded on exotic price/earnings (PE) multiples above 30 times, versus annual earnings growth in a zero to 20% range, and doubled in its last listed year despite a modest 9% growth projected. 

Merits attention again after the drop in share price Beeks is evolving financial systems somewhat similarly for traders, according to the modern "cloud" convention which offers major scope as trading firms switch to this format.

The company offers a self-service portal enabling clients to build their own cloud infrastructure. It says,

"we believe gives the group competitive advantage for deployment against our peers."

I cautioned about no margin of safety in the stock and its chart already showing three material drops over 20% in nine months, but that Beeks' marketing/technology had long-term upside.

The stock rose to 144p then succumbed to Q4 2018 market weakness in a sense of "risk-off", hence the latest fall may relate to a sentiment shift after stocks have soared in the New Year. Traders are more sensitive to any shift in profit expectations as global economic data; not yet a bear market psychology but certainly an edgy one.

Yet broadly the reasons for regarding this stock as a speculative tuck-away remain and, since I suggested buying on bouts of weakness, it is timely to take another look.

Beeks Financial Cloud Group        
year ended 30 Jun 2015 2016 2017 2018
         
Turnover (£ million) 1.34 2.68 3.97 5.58
IFRS3 pre-tax profit (£m) 0.42 0.15 -0.76 0.75
Normalised pre-tax profit (£m) 0.42 0.27 -0.03 1.20
Operating margin (%) 31.8 10.6   16.1
IFRS3 earnings/share (p) 0.62 0.29 -1.55 2.26
Normalised earnings/share (p) 0.62 0.52 -0.22 2.27
Price/earnings multiple (x)       44.1
Cash flow/share (p) 1.26 1.71 1.08 1.33
Dividend per share (p)       0.30
Net tangible assets per share (p)       7.87

Source: Company REFS  Past performance is not a guide to future performance

Operational development going to plan

The number of institutional clients is up consistently from 170 to 210 over 12 months to end-December 2018, versus 192 last June, as if this key objective to grow the institutional base is intact. Signing a first Tier 1 client (implying a global investment bank) is said to represent a major milestone, "a key reason for the IPO" and further such opportunities have been identified.

Beeks' data centres on the Singapore Exchange, Asia's leading international multi-asset exchange, and InterXion in London became revenue generating and are said to be on track to reach break-even within 12 months. A first South American deployment, the B3 exchange in Brazil, is being planned in response to client demand, with revenues expected by the end of this year. A "wait and see" approach is being taken to China, until there is more favourable regulation, having established a small team in Shanghai.

Chief asset classes involved are equities, fixed income and cryptocurrencies - whose market has continued to expand despite bitcoin's de-rating from $20,000 at end-2017 to a $3,500 to $4,000 range.

Thus, Beeks serves banks, brokers, hedge funds, crypto traders and exchanges, its average entry level new institutional customer contract value having doubled from £900 a month to £1,825 (from year-end reference points). Good progress is vital when the market cap may currently be at least five times prospective annual sales.

The majority of client signings are expected to continue to arise in Beeks' (current) second-half year, and a strategic focus on Asia is hoped to be replicated in South America, though such expansion is coming with costs of investment in platform infrastructure and increased depreciation/amortisation charges. At least it's building on a strong market position, rather than investment required just to stand still against competition. Such is a "capital growth" view where deferring financial returns enhances longer-term value.

In which case, why pay a dividend?

The financial year to end-June 2018 showed a move into profit (£747,000 pre-tax, or £1.2 million underlying) on revenues up 41% to £5.6 million and curiously there was a maiden dividend of 0.3p despite net cash generated from operations down 28% to £448,000.

The cash flow statement showed £1.5 million applied for investment after £4.4 million had been raised by issuing shares, hence net cash of £2.1 million at the financial year-end underwrote dividends (for now).

Encouragingly, the interim cash flow statement shows net cash from operations turned around from £630,000 absorbed to £620,000 generated, due to a higher profit and depreciation charge added back. There was also a £664,000 reduction in trade payables during H1 2017.

Thus, the board's declared "progressive" dividend policy – with a maiden interim payout of 0.2p per share - can be seen as a discipline for good cash management, though in context of investment, up 70% to £648,000 (comparing first-half years), makes little sense to me while Beeks has ample opportunities to scale its business. Surely better to retain cash for this investment phase unless institutional owners are stubbornly fixated on dividends.

Some extent of competitive moat

As Beeks' infrastructure evolves with continued investment, so does the challenge to replicate it given its type of services and exchanges occupied. Post-results, collaboration was announced with BeQuant, a cryptocurrency exchange based in London and Malta. Beeks will host BeQuant's matching engine in London within its network, although this seemed more like a trade announcement than financial boost.

I may be stretching hopes at this stage but can see potential for Beeks as a preferred supplier quite the same as Fidessa achieved - fund managers such as Lindsell Train used its systems and also held stock through periods of volatility - all the way through to eventual takeover. 

Reliable projections are a tall order right now, although it is possible to envisage annual earnings growth with a very rough 20% baseline (is my recollection of Royalbue evolving into Fidessa) given Beeks' modest size and potential to scale up its operations.

News of any further Tier 1 institutional clients would likely boost the sense of preferred supplier, hence confidence in the stock. Speculative indeed, but worth a look with the post-flotation party subsided: Long-term buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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