04 June 2015
By Maynard Paton
Today I’m owning up to the second of two new investments I’ve made during the last few months.
I say ‘owning up’ because this second share has so far been a complete disaster. Indeed, what I thought could have been a ‘perfect stock’ has instead rewarded me with a 37% paper loss :-(
The company in question is World Careers Network (WOR), an obscure AIM-quoted business that develops and sells recruitment software for major employers.
I purchased the shares during February and March 2015 at an average price of 320p including all costs. The bid price now is 200p and the holding currently represents about 3% of my portfolio.
When I bought, I was convinced this £24m firm offered all the hallmarks of a successful investment. Alongside claims of supplying “world-class technology”, other attractions included a blue-chip client list, generous margins, a cash-flush balance sheet, respectable sales growth and a long-time founder/entrepreneur at the helm. Furthermore, a possible P/E of just 7 suggested the shares were a bargain.
However, events have since not gone my way as I will explain in a moment. And I dare say some investors would have never touched WOR in the first place due to its humungous bid-offer spread and dominant 80%-plus family ownership.
At A Glance
- Developer of recruitment software for major employers
- Accounts generally blessed with high margins, robust cash flow and substantial net funds
- Dominant founder leadership appears focused on the longer term
This man from M&S uses WOR to hire 35,000 people a year
World Careers Network (WOR) was established during 1995 when Charles Hipps spotted the potential for employers to recruit university graduates through the Internet.
During the group’s early days, WOR’s clients were provided with website-design, online-advertising and applicant-tracking services. The product suite has since evolved into a comprehensive recruitment system that can even handle open days, fitness tests and contract production, as well as the usual CV storage and interview scheduling.
WOR’s software is used by large employers, and clients include retailers such as John Lewis, banks such as HSBC, government departments such as HMRC and universities such as Birmingham.
Perhaps the best explanation of WOR’s software is contained within this video, which sees the recruitment manager of Marks & Spencer no less explain why his employer uses WOR.
The man from M&S says the retailer recruits about 35,000 people from more than 200,000 job applications every year — the administration for which is handled by a WOR product. The M&S man reckons WOR’s system allows his group to recruit people within three days of posting the job advert.
Anyway, the video is certainly worth 5m58s of your time.
(A second video featuring WOR founder Charles Hipps is worth a watch, too.)
I must admit to not having any special insight into WOR’s software or competitive position. For what it is worth, the firm claims its “broad experience, award-winning functionality and best-in-class service” all differentiate it from the competition.
I noted in particular that the 2014 annual report claimed: “Strong market positions in a number of sectors, compelling value propositions, world-class technology and functionality, and long-term client relationships, provide a solid foundation to take advantage of the opportunities and navigate the challenges in a very dynamic market place.”
All I can say is that if WOR can persuade the recruitment manager of M&S to use its product — and for him to provide a video testimonial as well — then it’s fair to assume the service is reasonably good.
You can find full details of WOR’s software for yourself on the group’s website.
Respectable growth progress, a static dividend and an awful spread
WOR joined AIM during March 2000 and that year saw revenue of just £208k produce an £85k operating loss. The dotcom crash then created further losses during 2001 and 2002, but by 2003 revenue had reached £1.8m to deliver a £115k operating profit.
The respectable progress continued through to 2008, by which time revenue had reached £5.2m and operating profits had breached £1m. WOR did suffer in the banking crash, however, when certain clients went bust or merged to push profits down to about £600k.
The subsequent recovery is detailed in the table below:
|Year to 31 July||2010||2011||2012||2013||2014|
|Operating profit (£k)||557||1,130||1,933||1,758||2,431|
|Finance income (£k)||28||36||48||86||44|
|Pre-tax profit (£k)||585||1,166||1,981||1,844||2,475|
|Earnings per share (p)||5.65||13.83||19.46||18.34||25.25|
|Dividend per share (p)||3.50||3.50||3.50||3.50||3.50|
Just so you know, WOR’s quoted history has not involved any acquisitions and has not involved any reporting of exceptional items.
I must admit that WOR has been very tight with its dividend payments. A maiden 1p per share payout was declared in 2004, which was followed by a 2.5p per share handout for 2005. But from 2006 onwards, shareholders have received only a static 3.5p per share dividend — which in 2014 was seven times covered by earnings.
(Following WOR’s recent bad news, I now understand why the firm kept its dividend cover so high!)
The shares joined AIM at 110p and the tech bubble instantly pushed the price to 450p. By 2003, though, the price had fallen to less than 50p. Earlier this year, buyers — including me! — had to pay more than 300p for their shares.
I should state that this share has always suffered an awful spread — right now it’s an enormous 200-275p. Clearly that spread is going to affect my future returns.
At the time of my purchases, I imagined the spread would narrow over time as the company would progress well, its market cap would increase and more investors would become interested in the stock.
But such a narrowing may now take somewhat longer than I first thought…
Surprise! Profits have just collapsed by 71%!
Interim results issued during April contained a bombshell.
WOR admitted its first-half revenue had dropped 16% to £3.5m following “delays in the sales of online tests” combined with “a significant decline in the value of a major contract”.
Operating profits in turn collapsed 71% to £287k as the group continued to invest “in the resources required” to generate overseas sales and to further enhance its products.
The rest of the 2015 financial year may witness a small improvement though:
“We expect to see some recovery in sales and profitability in the second half of the year, as major new contracts come fully online and delays in the sales of online tests, albeit at a lower level, are made good.”
But overall, profits for 2015 are likely to be substantially lower than those generated during 2014:
“However we do expect profits to continue at significantly lower levels than last year as we make further substantial investments in the business particularly in the areas of sales, marketing, product development, delivery and customer success, all of which are aimed at generating future long term growth.”
Past results had been cautious, too… and yet profits then soared
I have to say, April’s interim results were a real shock. True, WOR’s preceding 2014 annual results had hinted at rising costs (my bold):
“During the current year we expect to make significant ongoing investments in our capabilities across the board: in sales & marketing, in the size of our delivery team, in customer support and satisfaction, in our own processes and management capabilities and in our software solutions.”
But then again, WOR had clearly hinted at something similar during 2013 (my bold):
“Whilst these investments inevitably increase our cost base they ensure we are in a position to take advantage of new opportunities. At the same time a competitive market, unsettled economic climate and the increased scale of some of our projects make growth less predictable and more erratic which taken together make the maintenance of our current level of profitability unlikely”.
…only for operating profits then to jump 23%.
WOR’s 2011 results had offered some caution, too:
“We are hopeful that ongoing revenues from projects delivered in 2010/11 and the completion of implementations started in 2010/11 should provide a certain level of momentum in 2011/12. However greater dependence on implementation revenue and the increased scale of some of our implementations is likely to make growth less smooth and more erratic. A highly competitive market and an extremely unsettled economic environment make it difficult to assess prospects for the coming year.“
…only for operating profits then to surge 71%.
So I’d happily assumed WOR’s managers were once again hoping to under-promise and over-deliver… but I was caught out.
He owns 72% and has never sold a share
An important attraction to WOR for me is the ongoing executive presence of the group’s founder.
The aforementioned Charles Hipps continues to run WOR as chairman and chief executive — and impressively, never sold a share at the group’s flotation and has never sold a share since. I feel that shows a remarkable commitment to the business.
Mr Hipps boasts a 72%/£13m shareholding and other members of the Hipps family control a further 13%/£2m.
I would not say Mr Hipps is underpaid for running a business that has delivered a maximum annual profit of £2.4m. During 2012, 2013 and 2014, he took home an annual salary and bonus of £300k-plus.
However, his pay prior to 2011 was very modest and I’m pleased he holds no options. Mr Hipps has recently turned — or will soon turn — 50, so I expect he could be leading WOR for some time to come.
Assisting Mr Hipps are two other executives, one of whom has served as technical director since the flotation (WOR’s operations director was appointed in 2009). Both men do not receive extravagant pay, but have options representing 2% of the share count. Total outstanding options represent 4.6% of the share count.
The last few years had seen the cash pile double
One unusual feature about WOR’s accounts is that they are presented in the ye olde UK GAAP format. (AIM rule 19 allows companies that have no subsidiary companies to publish their books in this way — Bioventix does the same).
Irrespective of the accounting convention applied, it’s plain to see WOR offers some great numbers — or at least it did before the nasty interim results!
In particular, operating margins were a mighty 28% during 2014 and had topped 15% during eight of the preceding ten years. When I bought WOR shares, I had presumed such consistently high levels of profitability indicated the business enjoyed some sort of competitive advantage.
The superior margins also contributed to some attractive return on equity calculations. During 2014 for example, average net assets of £7.4m generated after-tax profits of £1.9m — a return of 26%. The same annual calculation has dropped below 15% only once since 2004.
When I decided to buy, I’d also seen no problems within WOR’s cash flow:
|Year to 31 July||2010||2011||2012||2013||2014|
|Operating profit (£k)||557||1,130||1,933||1,758||2,431|
|Depreciation and amortisation (£k)||90||84||105||100||88|
|Cash capital expenditure (£k)||(78)||(114)||(94)||(71)||(96)|
|Working-capital movement (£k)||(180)||351||590||(679)||(196)|
|Net cash (£k)||3,389||4,479||6,516||6,726||8,171|
During the last five years for instance, total cash capital expenditure had been covered entirely by the depreciation and amortisation charged against headline profits. Meanwhile, aggregate working-capital movements had led to a relatively small outflow of cash.
The robust cash generation meant WOR’s bank balance had more than doubled to £8m between 2010 and 2014. I deemed almost all of that money to be surplus to requirements.
I also noted the books carried no freeholds, no debt and no defined-benefit pension obligations.
These valuation sums have since become redundant
Prior to April’s interim results, I had believed WOR could sustain its 2014 operating profit of £2.4m and earnings of close to 26p per share.
When I bought, I calculated WOR’s enterprise value (EV) to be 214p per share — that is, my 320p purchase price less my 106p per share estimate of surplus cash. Dividing that EV by my 26p per share earnings guess gave a P/E of about 8.
(Perhaps being a little greedy, I’d also calculated that doubling the second-half figures for 2014 would produce earnings of approximately 30p per share. You see, I had noted that, for nine of the last 13 years, annual profits had been more than double the preceding H2 result. Anyway, the underlying P/E on that earnings calculation was 7.)
For a business that was blessed with superior accounts, loyal management and a respectable track record, I had felt that a single-digit P/E rating was just too low — and could offer notable upside possibilities… assuming profits could sustain their upward momentum!
Here’s where I went wrong
What I hadn’t appreciated with this business was its dependence on sizeable contracts and the resale of third-party tests.
Past annual reports had referred to initial “implementation fees”, which by their very nature can be somewhat haphazard. But there were also mentions of “ongoing service fees” from existing clients, which I’d hoped would lead to some predictability to the top line. A long list of clients on WOR’s website suggested a good spread of income, too.
As it turned out, it was the renewal of a major contract — at a price much less than before — that helped cause profits to dive.
Clearly the customer in question has decided to scale back its involvement with WOR — perhaps due to finding a replacement product or perhaps because it simply no longer needs as comprehensive a service.
Whatever the reason, other WOR clients could obviously act in a smiler manner and hurt profits even further.
Blaming the lack of third-party test sales was interesting. Such revenue had never been mentioned in WOR’s annual reports and it had never crossed my mind to wonder whether the firm was in any way dependent on selling outside services.
Still, as investors, we live and learn and any third-party dependence is perhaps something to add to our checklists for the future.
And here’s another reason for things going wrong
I guess the other risk with WOR is dominant executive Charles Hipps turns the business into a personal fiefdom that one day leads to a de-listing.
I suppose I am more relaxed about this risk than most other investors. For a start, WOR has already been quoted for 15 years and I feel if the boss was ever going to do the dirty on shareholders, he’d have done so by now.
I don’t know for sure with WOR, but my research into family-dominated firms suggests a stock-market quotation offers:
- Greater transparency and reassurance for customers and suppliers;
- Operational benefits and greater financial discipline from the additional reporting;
- The opportunity for smaller family shareholders to dispose of their investments, and;
- The ability to raise funds through further share issues or to motivate staff with share options (although many family firms I have come across do neither!)
I trust one of those reasons will keep WOR on the stock market for some time to come.
A worthwhile gain could involve a very protracted wait
So now I am stuck holding a load of WOR shares with a quoted spread of 200-275p. Based on the depressed interim results, I have to admit the current price does not look like a bargain.
But I am hopeful earnings can recover within the next few years. During 2010 for instance, first-half profits sank to £161k — only to have cleared £1m by 2012. I would obviously welcome a similar rebound! Trouble is, that may only get the share price back to where I bought in.
My over-riding investing belief is that a collection of companies that offer a mix of respectable track records, asset-rich balance sheets, attractive margins, decent cash generation, loyal management, high insider ownership and lowly valuations can generally deliver worthwhile long-term returns to shareholders.
Such stock-picking won’t work every time, however, and I’ve suffered an unpleasant shock with WOR. Nonetheless, I am happy to hang on here and ride out this setback — although the wait to enjoy a worthwhile gain could now become very protracted indeed :-(
Until next time, I wish you happy and profitable investing!
Disclosure: Maynard owns shares in World Careers Network.