Wednesday, 20 June 2007

"Seeing through the Tracing Paper"

20th June 07
"Seeing through the Tracing Paper"
Olde Holway SYSTEMHOUSE headline from the mid-1990s!

My posting on 16th June (below) on Microgen and Trace seems to have caused some controversy. If my comments were construed as giving support to the MBO team - that was NOT my intention. The thrust of my argument (with which I know some disagree!) is that shareholder value cannot come from acquisition and the resultant cost cutting ALONE. Shareholders will reward companies that show organic growth because it is likely to be more sustainable than profits growth which mainly or solely comes from cost engineering. Personally I have always supported the 'blended' organic/inorganic approach and would cite Sage, Capita and Axon as some of the best examples of the genre. Ie strong organic model with strategic M&A to get them into new geographies, technologies or allied markets. But never venturing too far from their "core".

Turning to Trace, I too can find things to criticise. Indeed, I seem to have criticised Trace's performance continually for more years than I care to remember! I select this quote from the 1998 Holway Report "Trace Computers has hardly been our favourite company. Always confident of the future, always swinging from revival to slump to recovery". I could have used the same statement in every year since. So what's the point in inventing a new one.

It's amazing to report that Trace had lower revenues in its last financial year than it had in 1991! Prior to the current bid activity it had a lower share price than it did in its IPO at 125p in 1989! Trace was one of those almost unique companies whose share price fell by a third in the year to Apr 2000 - when just being involved in anything to do with IT guaranteed massive share price rises.

Many of you will know my abhorrence of the practice of capitalising software development - although this argument has become somewhat tougher with the advent of IFRS. Trace now has £2.5m of capitalised software development on its Balance Sheet (at Nov 06) In that six month period they made operating profits of £444K. But they also capitalised a further £385K of software (£285K nett of £100K amortisation). In other words profits would have looked somewhat meagre without this!

On the other hand Trace recorded a 9.5% increase on revenues from continuing operations. All of this seems to be organic. In today's market, that's not bad at all. But, I remind you that Trace has been here many times before..."Always confident of the future, always swinging from revival to slump to recovery".

What will happen now in the Microgen-Trace tussle?
Will the Tulip MBO team increase their bid? If so they would have to raise it to 200p for Katie Pott's irrevocables to fall away. Would Microgen then be prepared to top that? At least if they then "No bid" they would be sitting on a sizable gain on the c26% of Trace shares they have already secured.
On the other hand, Tulip have also secured a significant % of irrevocables of their own which include a standstill arrangement prohibiting these shareholders from selling their shares for a 12 month period regardless of a higher external offer. Does Microgen really want to be the majority shareholder in another small quoted company for a significant period? How messy is that going to be?

Anyway, some people are very happy. I had an email from a Trace shareholder, unconnected with both Microgen and Tulip, who thought the whole bidding war was great and hoped it would go on!

Now what would be even better would be someone taking similar bid interest in Microgen.

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