Northamber reminds us why deep value is so difficult #NAR

Northamber reminds us why deep value is so difficult #NAR

Deep value investors along with some regular bystanders have been pulling their hair out for years when it comes to Northamber (latest share price 28p, market cap £8 million).

The tech distributor has been loss-making since 2011, and Friday’s interim results suggested that FY June 2019 will be no different.

Background

To understand the lack of strategic change, we must look no further than the Chairman, who is also the founder of the company and 63% shareholder. He has been managing the business since the 1970s.

PC distribution just isn’t what it used to be. Generating a margin in this supply chain has never been more difficult, and Northamber hasn’t generated results that can justify, from an economic point of view, the continuation of its activities. As a middleman whose primary assets are its relationships with a range of different suppliers and customers, and a warehouse, its bargaining power is extremely limited.

Typically, its gross margin has hovered around the 7-8% mark. The Chairman has been keen to improve this in recent years, and made progress in H1 2019 as this ratio improved to 8.4%.

Results falling short

This still left the company £500k short of covering its distribution costs and overhead. Gross profits of £2 million in H1 2019 were actually £400k lower than the result in H1 2018.

The company blamed breach of contract by a supplier for damaging sales, which were down by a remarkable 24% in total, as lower-margin activities were discontinued. And today’s outlook statement, as usual, provided no cause for optimism.

Wasted resources

My impression of the Chairman is that he is just too close to the company to reach the conclusion which many financial observers would think is obvious: it ought to shut down and put its assets to a more productive use.

At the end of FY 2010, just before the business fell into losses, it had a net asset value (NAV) per share of 88.5p, or £26 million. Its assets, both then and now, are entirely tangible and it should not be so difficult to convert them to cash.

Since FY 2010, it has paid out c. 4.75p per share in dividends (my calculation) but cumulative losses have served to drag NAV per share down to 62p, or £17 million.

This “official” NAV very likely understates the true value of the company’s assets. The balance sheet includes PPE of £7.8 million, and within this figure are two freehold properties which together could be worth in the region of £13 million (that’s according to an old estimate by Professor Glen Arnold).

This means that if the operating business was managed down or disposed of in such a way as to recover book value from the current assets, then an additional boost from the disposal of the non-current assets could generate a total realisation in the region of £22 million for shareholders.

That is the dream, but for many years now it has remained a fantasy.

A faint glimmer of hope

There is one solitary piece of evidence I can find to suggest that the Chairman might be about to change course. In August 2018, the company returned £225k to shareholders via the purchase of shares at 28p. This was the first buyback since 2011. It was followed up by another nibble in November at 29p.

Perhaps the Chairman has realised that its better to use assets productively rather than tie them up in loss-making ventures? It’s too soon to say.

If Northamber had been liquidated in July 2011 (after the business model had broken) and the assets had been reinvested in a FTSE All-Share ETF with dividends reinvested, then by now they would have generated a 67% return, before taxes and fees.

Putting it another way, £25 million as of mid-2011 could now be worth £41 million (before taxes and fees), instead of being worth just £17 million on a reported basis.

Even better, achieving that 67% return would have required negligible (let’s call it zero) effort by the Chairman or any other shareholders who chose to go down that route.

I still expect Northamber to be liquidated some day and to generate a handsome return for investors when that change in direction is announced. The problem is that we could still be waiting in 2031. And meanwhile, the FTSE continues to grind higher on a total return basis.

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