2 investment disasters to avoid after today’s news

Roland Head explains why he believes investors should steer clear of these troubled firms.

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Shares in satellite broadband firm Avanti Communications (LSE: AVN) rose by as much as 20% this morning, after the company announced a €10.7m contract win alongside a rather worrying finance update.

Avanti has won a two-year deal worth “up to €10.7m” to provide broadband in rural Africa. This could add up to $6m per year to Avanti’s revenue. However, given that the company’s operations generated a cash loss of $45.9m during the first half of this year, I’m not sure this contract win is big enough to be worth celebrating.

Indeed, today’s update suggests to me that Avanti has serious financial problems. The group’s cash balance has fallen from $162m at the end of December 2015 to just $57m.

Avanti announced today that to address “near-term liquidity needs” it will use $32.25m of new three-year bonds to make the October interest payment on its existing bonds, instead of using cash. So far, 60% of the firm’s bondholders have agreed to this measure. In my view they would only do so if they though that forcing Avanti to pay in cash would lead to a default or prevent the firm from operating normally.

Lossmaking Avanti says it’s now working on “a long-term funding solution”. Shareholders are hoping for a takeover offer, but in my view this is unlikely before a refinancing deal is agreed.

Investors looking for a bargain shouldn’t be tempted by the shares’ discount to book value. This is based on Avanti’s interim accounts, since when cash has fallen dramatically. Taking into account today’s announcement, I suspect that Avanti’s next accounts will show that the value of the firm’s assets is almost completely wiped out by its borrowings.

What’s more, any refinancing solution may well involve giving bondholders a big slice of equity in Avanti. In my view, Avanti’s financial distress means that the shares are a strong sell. I’d certainly use today’s gains as a selling opportunity.

This firm has lots of cash

Watchstone Group (LSE: WTG) — the company formerly known as Quindell — reported its interim results today. Underlying revenue rose by 10.7% to £31.9m, while the group’s underlying EBITDA loss was reduced from £13.8m to £6.9m.

The group’s cash balance at the end of August was £89.3m, or about 191p per share. Watchstone also has a further £50m of cash in escrow that relates to the sale of its professional services business to Australian firm Slater & Gordon. Watchstone hopes this will be released at the end of the warranty period in November. If it’s released, then Watchstone plans another £1 per share return to shareholders.

That’s the good news.

The bad news is that the firm’s cash balance is gradually being eroded by the poor performance of its operating businesses. Today’s results show that Watchstone’s four businesses are all either lossmaking or only marginally profitable. Growth appears uncertain too.

Watchstone’s share price is being supported by the firm’s large cash balance. But what this tells me is that the market thinks the group’s underlying businesses aren’t worth much. Watchstone is also the subject of a Quindell-era Serious Fraud Office investigation, which could lead to cash penalties.

In my view, Watchstone shares carry a lot of risk. I think there are far better growth opportunities elsewhere in today’s market.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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