Two small-cap stocks that attract a lot of interest from private investors are Watchstone Group (LSE: WTG) – formerly known as Quindell (LSE: QPP) – and Bango (LSE: BGO).
Investors in both companies believe they have the potential to deliver big long-term rewards. But there are concerns. In today’s article I’ll ask whether the price is right to buy Watchstone and Bango.
Bango
Bango stock rose by as much as 13% this morning after the group said that its deal with Microsoft has been extended to include Windows 10. The change means that customers buying software apps and content from the Windows Store on Windows 10 devices can now charge the cost to their mobile phone bill.
Today’s update didn’t include any information about Bango’s recent trading performance. The group recently raised £11m cash through a placing of new shares, but I’m afraid the outlook isn’t that bright.
Bango’s latest interim results, which cover the first half of 2015, focus on a metric called End User Spend (EUS). This is the amount of money customers using the firm’s billing services spend.
The problem for investors is that EUS isn’t necessarily a good indicator of Bango’s growth. EUS rose by 72% to £18.45m during the first half of 2015. However, Bango’s revenue, once pass-through payments to digital merchants are stripped out, fell from £1.4m to £1.1m.
Gross profit fell from £0.7m to £0.6m and Bango reported an operating loss of £2.8m for the first half of 2015. Even if EUS continues to rise, I find it difficult to see how this business is going to gain sufficient scale to generate a worthwhile profit.
In the meantime, Bango shares trade on a price/sales ratio of about 30. That seems much too high to me, given Bango’s falling sales and mounting losses.
Watchstone Group
After selling its legal services business, Quindell’s new management renamed the group Watchstone.
The group recently completed a cash return of 90p per share. According to the latest management update, this leaves Watchstone with about £90m of cash. The group also has £55m of cash in escrow accounts and may be entitled to a further £39.6m of conditional payments relating to the legal services sale.
As I write, Watchstone’s market capitalisation is £146m. Stripping out £90m of available cash values the firm’s continuing operations at £56m. Is this an attractive valuation? Let’s see.
Watchstone’s continuing operations generated revenues of £35.3m during the first half of last year, down by 16% from £42m for the same period in 2014. Gross profit fell by 38% from £16.6m to £10.3m during the same period, and Watchstone reported an operating loss of £35m for the first half of 2015.
In my view, Watchstone’s operations only look cheap if the firm can reverse its sales decline and turn a profit. Forecasts from Watchstone’s house broker suggest this is unlikely in 2016. Although full-year revenue is expected to rise from £68.7m in 2015 to £75m in 2016, a loss of 68.5p per share is expected for 2016.
Watchstone’s new chief executive, Indro Mukerjee, is expected to issue a strategy update early this year. I would be tempted to wait until then before considering an investment.
