City investors often say that the reason they do not invest in small companies is that they simply cannot buy a sufficient amount of shares. They say that they need to be able to buy enough to justify the work of assessing the company in the first place and monitoring it thereafter. And they need to hold enough shares to make a real difference to the performance of their multi-million pound investment portfolios.
That’s fair enough. But the irony is that these big investors then buy the shares later on when the company has grown larger, and they miss out on the early years of its growth.
This leaves an opening for individuals who are happy to hold just a few hundred pounds worth of a share. And it’s one of the main reasons why small companies can be such a good opportunity for private investors.
In my opinion, the size factor seems to be the only thing holding back the share price of one small company operating in a fast-growing industry. This is Netdimensions (LON:NETD), a small but successful software provider for learning management systems. According to sector experts Bersin and Associates, this market grew by 9.9% in 2010 to become worth over $1bn worldwide. And it is expected to expand at a similar rate again this year!
How ‘e-learning’ became a billion-dollar industry
Learning management systems provide the framework for ‘e-learning’, a new business that would not have been possible without the internet. As we all discover, the need to learn and be examined does not end when we leave school.
And while children are still taught by the teacher in the classroom, that type of personal attention is an expensive luxury for mature students. Bringing busy people from far and wide to sit in a classroom for a few hours is an inefficient use of time and money. It is far better to distribute learning modules over the internet, allowing users to study and take the exams in their own time.
Arguably, this leads to in-depth understanding of a subject being replaced by learning by rote, box-ticking and multiple choice exams. But interestingly, these are the precise skills many of the courses seek to teach!
For example, customers of NetDimensions include Cathay Pacific, whose staff are expected to learn various safety critical procedures, and ING Bank, whose staff require compliance training. Online learning delivery is ideal for such things. It also has advantages beyond the mere delivery of training courses. Through the internet, it is possible to monitor the response of staff and see how they engage with the training material. It is also possible to analyse the results, leading to better training programmes and the identification of strengths and weaknesses in staff skills.
NetDimensions has eight million high paying users
Although the business is still relatively new, NetDimensions has been around since 2004 and already has 900 clients and approximately eight million end users. For a small business, its global reach is impressive, with other clients including the Chicago Police Department, Delphi Automotive, Fuji Xerox and Travelex.
As reflects a company that has its origins in Hong Kong, it has a presence in China – and this will be a focus of its marketing efforts this year. With two small but seemingly successful acquisitions under its belt, NetDimensions has been quietly piecing together a larger business.
But its efforts have barely been recognised on the stock market. A striking feature is its large cash balance. At the end of 2010, NetDimensions held $6m of net cash, which has since been reduced to about $5.87m through the buy-back of 325,000 shares.
Deducting this from today’s stock market capitalisation of £6.46m, we get a value of about £2.9m attributed to the trading business. But this trading business is expected to achieve sales this year of nearly £7m and to record an operating profit of £0.85m.
With a good base of recurring income, conservative accounting principles, a high and rising cash position and plenty of opportunities for future growth, NetDimensions looks undeniably cheap.
As broker Arden Partners observes, a similar company, Learn.com, was acquired last September for $125m, a price that valued it at four times sales. A similar take-over price for NetDimensions – and in a consolidating industry, a bid is not out of the question – would value the shares at over £1.
NetDimensions may not have the excitement factor that I look for in Red Hot Penny Shares, and trading volumes are slim. But for evidence that there can be some real value in small companies, you could hardly find a better example.
Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd.
• This article was first published in Tom Bulford’s twice-weekly small-cap investment email
The Penny Sleuth.