Under the Radar Report looks at making money from growth and value. We’ve made big returns from Zip Co and Afterpay Touch, but most of our success has come from Small Cap value stocks, some of which include Clover, Infomedia and Tassal. Here we look at whether Small Cap Stock Servcorp can survive against the WeWork onslaught. If it can, there could be big money to be made. Its octogenarian founder certainly hopes so.
SMALL CAP STOCKS ARE ABOUT GROWTH
One of the reasons I like Small Caps is because the share market is all about growth. If you’re not growing, why are you buying? And in Small Caps, it is self evident that you can get supercharged growth because there is much bigger operating leverage.
Small Caps are often the avenue where ASX investors get access to new, innovative technologies that make a difference to the world, which can pleasantly provide a big boost to their bank balances. You only have to look at hot stocks like “buy now pay later” small cap Zip Co (Z1P) and its bigger brother Afterpay Touch (APT) to see what can happen when companies tick the growth box.
SMALL CAP STOCK RETURNS 10 FOLD
Zip Co (Z1P) has increased four fold for our subscribers since we first covered it; while Afterpay Touch (APT), has returned a phenomenal 10 fold for Under the Radar Report's subscribers.
The fact that we took profits too early is a good indicator that growth isn’t everything. Getting off the band wagon is essential when it comes to profiting from stocks that have little prospect in the near term of being profitable, let alone paying dividends.
UNDER THE RADAR REPORT PRIMARILY HUNTS FOR SMALL CAP VALUE
We are primarily looking for value in small caps and many more of our successes have been in this area. We’ve made big money from turnarounds in the past, for example small cap Clover Corp (CLV), Infomedia (IFM), and Tassal (TGR) have all delivered more than four times our original purchase price. There is some risk, but big reward.
The risk is that operations continue to deteriorate while management is performing triage. But if you get your timing right, the bad news is in the price. When this happens and operations start to improve, you get the double whammy effect of improving earnings and improving sentiment (multiple expansion). This is what delivers you big returns from many value plays, of which the vast majority are Small Caps.
SERVCORP (SRV) A SERVICED OFFICES VERSION OF JACK AND THE BEANSTALK
Which brings me to the serviced office manager Servcorp (SRV), which is in the fight of its life. This is a solid, if boring business, which makes money from leasing large offices and sub-dividing them. Having started a business myself, we were one of the sub-tenants of someone doing exactly that. It’s not rocket science. It’s simply space arbitrage, which has nothing to do with technology, let alone astronauts, and has been going on since the dawn of capitalism. The bottom line, you would have thought, is whether or not the rent has been paid.
WEWORK, ONE OF THE GREAT UNICORNS OF OUR TIME
Then we come to that great Unicorn playing havoc with Servcorp’s business model: WeWork (now renamed The We Company). The company was founded in 2010 by Adam Neumann and Miguel McKelvey and is spending billions of dollars becoming a version of WeWorld with its cult like following. But basically it does the same thing as Servcorp, just at a lower price (which means its occupancy levels are close to 100%). If you are generating sales and you are a WeWork tenant, you are the exception. It is start-up central.
The company is private, but based on the US$8bn (A$11.4bn) plus it has so far raised, WeWork is worth just shy of US$50bn. The company doubled its revenue from US$886m in 2017 to $1.8bn in 2018, producing a net loss (wait for it) of US$1.9bn.
One important factor is the company’s major backer include the Japanese based Softbank’s Vision Fund, as well as Saudi Arabia’s sovereign wealth fund.
CAN SMALL CAP SERVCORP SURVIVE?
Against this giant is little Small Cap Servcorp and its charismatic leader and 51% owner, the octogenarian globe trotting fitness fanatic Alf Moufarrige. The company now has a market valuation close to $300m and is bleeding cash (although it had a lot to start with). Servcorp’s shares have drifted slowly downwards alongside WeWork’s ever climbing investment.
Servcorp operates its business in over 50 cities across 24 countries, which include Australia, New Zealand, Asia, USA, Europe and Middle East (no wonder Moufarrige globe trots). These days the stock trades on a low double digit PE and a forecast dividend yield of close to 5%.
New developments have piqued our interest. The first is that two of Moufarrige’s children, Marcus and Taine, who worked at senior levels in the business (Taine was also a director) have left effective at the end of December, which is presumably a reaction to WeWork and the desire for operational savings.
Any savings won’t come through fully until FY20. In the meantime refurbishment investment programs may reduce returns. In the first half of fiscal 2019 there was an impairment of assets and goodwill of almost $19m, as well as restructuring costs of $2m. The company’s cash balance has reduced to $72m, but we believe that Servcorp will maintain its annual dividends of 16 cents a year.
FIDELITY IS INCREASING ITS STAKE
Another point of interest is a slow increase in Fidelity’s position as a substantial shareholder, which crept up from just over 5% to just over 6% last month. Fidelity has been investing much earlier than most institutional funds in a number of the big tech firms and we would not be surprised to see it on the WeWork register after its much anticipated US float. This IPO could have an illuminating effect on the value difference between WeWork and Servcorp.
Amongst the hype about the Unicorns such as WeWork, Uber and Lyft, at some point investors might realise that there are financial realities (losses can’t continue forever) and there are existing mundane businesses that fulfil the same role that some think need to be reinvented.