These companies could be set to bounce back.
There are always recovery plays among small caps that look enticing, but of course they are somewhat risky. Here are two plays where, for different reasons, the risks seem to be offset by other factors that make them attractive prospects.
Iomart
Iomart (LSE: IOM), the data centre and web-hosting specialist, posted its latest set of interim results last month. They were very encouraging, with a return to profitability. Revenues for the six months to 30 September 2009 rose 47% to £8.4m. Pre-tax profits were £0.5m against a loss of £0.7m in the same period last year.
For the year ended 31 March 2009, it made a loss of £1.2m on revenues of £11.8m. Nevertheless, it still paid out its first dividend since 2006 -- 0.3p a share. There was no interim dividend, but brokers are forecasting a similar 0.3p payout for the current year.
However, these results told only part of a good story. On July 2008, Iomart raised £20m from the sale of its online business directory service Ufindus to BT (LSE: BT-A). It used some of this money to buy RapidSwitch in May for £5m, thereby expanding its data storage operations and gaining a host of clients, ranging from small firms to large companies.
Consensus estimates are that Iomart will produce a full-year profit of £0.7m for the year ending 31 March 2010, with revenues hitting around £18m.
Demand for data storage and hosted services is continually expanding. With the acquisition of Rapidswitch, Iomart bought a lot more capacity and now it needs to drive more business in order to raise utilisation rates that are currently in the high twenties.
Small and medium-sized businesses represent 50-60% of its revenues and my only concern is that the prevailing economic conditions may hit growth. However, Iomart doesn't seem to have been greatly affected by recent events. Management said they had "hit budgets every month for the last 18 months. There was no credit crunch effect to our business. There are two economies in the UK: the traditional economy and the online economy, and the online economy is thriving."
Bad debts have been next to zero, due in part to the fact that cash payment is given up front for two of the businesses -- Easyspace and Rapidswitch.
Iomart could also make an attractive acquisition target itself for any providers seeking to gain a foothold in the UK market.
Looking further ahead, consensus estimates for the year ending 31 March 2011 are for pre-tax profits of £2.1m, putting the company on a forward P/E ratio of 22. On the face of it this looks expensive, unless you factor in the growth rate. The shares currently stand at 45p.
Media Square
Last week, Media Square (LSE: MSQ) released results for the six months to 31 August 2009. They weren't good. Revenue was down 25% at £24.3m with pre-tax losses widening from £1m to £3.2m.
Media Square has been affected by the downturn and reduced expenditure from clients. However, it's in the final phase of a three-year cost-cutting and a rationalisation programme has just taken place. The second half of the financial year is expected to benefit from this reduced cost base, taking the company to break even.
The shares dipped below 5p in April but have since recovered their current level of 14.75p.
Media Square has been much in the news of late because of a power struggle taking place at the company between active shareholders and the management. Among its investors are:
- Bob Morton, who controls Seraffina Holdings, Hawk Investment Holdings and Retro Grand Ltd. He holds 9% of the shares, acquiring them in October 2009 for an average price of around 16p.
- Peter Lynch of Prime Active Capital. He owns 21.5% of the company and was blocked by the board earlier in the year from becoming a director of the company.
Media Square's Executive Chairman is Roger Parry. He took the reins in mid-2007 and has helped turn the company around cutting costs and rationalising the business. He is due to step down in January 2010 and has recruited a new Chief Executive.
Net debt at £15.5m as of 31 August is a concern, but the company has stated that it expects a couple of disposals to help reduce this before its year end.
According to Parry, the strategy going forward will be for the business to deliver an operating margin of 10-15%. If this is achieved it should deliver operating profits of £5-7m within 2-3 years.
Of the two, I think it is certainly the riskier play but it appears to be over the worst.
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