Fears that this company may need to raise fresh equity to finance its rapid expansion have seen its shares drop like a stone. But the sell-off has been overdone – which means this is a great buying opportunity.
Vanco (Aim:VAN)
Vanco, a leading virtual network operator (VNO) has, like Vantis, been unfairly treated by the City due to fears over gearing. Since hitting a high of 540p back in April 2007, the shares have dropped like a stone as fund managers have fretted that the company will need to raise fresh equity to finance its rapid expansion. This is certainly a risk, but I believe the sell-off has been overdone, providing another good – although high-risk – buying opportunity. Let me explain.
Being a VNO, Vanco does not possess its own network. It instead rents capacity from major telecoms groups, such as AT&T. It adds value by offering outsourcing services worldwide to its enterprise clients, such as Avis, Siemens, British Airways, Ford, Lloyds TSB and Pilkington. Its fully managed network agreements tend to be for three to five years, and generate high retention rates and predictable revenues. Moreover, its asset-light model has been a roaring success, with the orderbook leaping to £421m as at the end of October 2007, from £327m in July 2006.
But the major factor spooking analysts has been that although contracts are profitable, they tend to suck in cash at the start, and only later release funds as deals mature. So due to the firm’s astronomical growth, average net debt has risen to around £70m from £43m two years ago. In theory, this trend should soon start to reverse as the firm reaches a tipping point where its older contracts generate more free cash flow than its newer ones consume. Even so, in these stressful times, nervous institutions have decided bale out.
I think this danger has been overplayed, particularly given that the group has an existing five-year, £100m banking facility that should prove sufficient. And after so much public scrutiny, I’m sure the board will do everything it can to avoid a rights issue. This might simply mean renegotiating more favourable payment terms with suppliers and customers, or even possibly toning down its future growth rates.
Another concern for investors has been Vanco’s much-criticised revenue recognition policy. But I expect a more conservative treatment to be adopted in the January year-end accounts, which should improve sentiment and transparency.
Finally, at the last trading update in November, the board encouragingly said that “the markets in which we operate remain buoyant and we have not experienced any change due to the global credit squeeze. We remain confident that trading for the year will be in line with expectations”.
In relation to the numbers, Goldmans Sachs has a price target of 345p on the stock, and is forecasting 2007 sales and adjusted earnings per share of £227m and 24.2p respectively, increasing to £260m and 28.4p in 2008. As such – trading on a lowly p/e ratio of 6.8 – Vantis looks good value to the more adventurous investor. Indeed, three directors seem to think so as well, with each recently picking up shares at between 136p and 155p.
Recommendation: speculative BUY at 172p (market cap £110m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments