Conexus Newsletter October 2011

29.11.11

Introduction
 
This news letter is designed to provide Investors with information that is relevant to the valuation of the portfolio intra-quarter. This is as a result of significant events that have occurred since the last fact sheet.
 
Features:
·         Possibility of further capital raising by South Point
·         Possible sale of the interest in Rowbow/Daly’s
·         Recent release of results for Poynting.
 
South Point
 
A considerable amount of work is taking place at South Point. While the company has shown significant growth of the property portfolio over the last few years and has more than doubled the beds to the current 8,695, this has caused a vacancy factor. The expectation has been that the student market is insatiable but what also becomes apparent is there is a price ceiling of affordability for students. Furthermore, the market for student demand needs to be sub divided, for example a NSFAS (National Student Financial Assistance Scheme) student’s affordability ceiling is very different to a post graduate bursary student. If this market analysis takes place the graph below assumes a current target market for South Point of 110,000 students. This implies that the long term investment case remains in place.
 
 
The market circumstances, current South Point occupancy of 75% (July2001) and the implementation of a new management structure have caused a re-look at the South Point model. The period of consolidation  remains in place and a review of the property portfolio is underway with decisions being taken to sell inefficient buildings in order reduce capital and gearing. This will take time but will improve the portfolio of properties going forward.
 
With the occupancy below 90% and the recent portfolio growth, the business is over geared. It is expected that the Board of Directors at the meeting of 28 October will decide to embark on a further capital raising exercise. This capital will be raised from the current shareholders probably based on a combined rights issue and convertible debt.
 
While Douglas Investments continue to believe in the South Point investment case, Conexus is over-exposed to South Point. It would therefore not be prudent for Conexus to invest further funds. However, Investors may wish to pursue this investment in light of their overall portfolio (beyond Conexus only) to avoid being diluted. Douglas Investments will facilitate Conexus Investors to follow these rights by allowing the injection of further funds.
 
Rowbow / Dalys
 
Investors should be aware that we are currently in negotiations on the sale of Conexus’ shareholding of Rowbow, the holding company of Daly Credit Corporation. To date we have managed to increase the Conexus shareholding to 62% having purchased an additional 32% from Bill Daly in September. The underlying performance of the business has started to generate significant profitability which has facilitated the possible sale of the combined shareholding to a third party. If this is concluded, Conexus Investors will receive an IRR of > 30%.
 
Douglas Investments will communicate further when and if these transactions are concluded.
 
Poynting Results Year Ended 30 June 2011
 
Attached is a summary of the annual results of Poynting since being listed. The results released on the 30th September show a marked improvement – see the financial analysis attached as appendix A. We think there is still more to come and that the company is on a much better footing.
 
Below is an article that might be of interest and is a good simple analysis.
 
Published on www.smallcaps.co.za  on Friday, 30 September 2011 08:00 | Written by Keith McLachlan | 
 
Micro cap, Poynting Holdings (POY), released results late yesterday. The Group designs, manufactures and sells antenna and telecommunications products to the cellular, wireless data and defence markets and holds a large amount of intellectual property (IP) inhouse with its strong R&D team.  Poynting's commercial products are used in cellular and 3G end-user equipment, as well as wireless data networks employing WiFi, iBurst and WiMAX technologies, while its defence products tend to individually made to order and sold to various OEMs.
That said, POY has been through a fairly tough time and reported a large loss in FY 09 driven by the operating leverage in its manufacturing leg that is susceptible to lower volumes and the strong ZAR. The Group realigned its overheads to its normalized volumes in FY 10 and felt some nice revenue growth that saw the Group basically break-even in this financial year.
 
The latest FY 11 results show POY revenue rising further by c.7% (revenue from Continuing Operations actually increased by 22% over this same period) and the Group's HEPS rose 10% to 3.28cps (FY 10: 2.97cps). The Group has discontinued its continually loss-making Base Station Equipment Division and, once this Division's results are excluded, the HEPS from Continuing Operations actually rose significantly by 68% to 5.72cps (FY 10: 3.39cps).
 
Cash flows were slighlyt down, yet positive and saw the Group generate R4.6m in cash flow from operating activities (FY 10: R6.4m) that resulted in a net cash position being reached at year end of around R2.6m (FY 10: R0.9m).
 
What I like about Poyntings is a multitude of factors:
 
1.Margins on original IP is a lot like miners' margins in the resource sector and will always be higher than the resellers of the products. This is reflected by POY's ability to achieve an incredibly high ROE, once it fully monetizes its IP and manages its manufacturing risk properly. If the Group doesn't do this, then its low share price makes it a good acquisition target for someone seeking access to that IP. Either way, shareholders can win.
 
2.Owning the IP you are selling, of course, is also a very good barrier to entry into your market.
 
3.POY is a bit of a ZAR hedge, given its export capability. Recent ZAR weakness should benefit the Group.
 
4.POY is one of the only two defence expenditure proxies on the JSE (the other one that I know about is a division of Ansys - share code "ANS").
 
5.For a Group that is rich in intangible IP, the Group's tangible NAV per share is 25c, which is more than double the current share price of 11c! Crazy... At 11c (or even the highest offer of 15c), you are buying tangible assets at a discount and getting very valuable IP absolutely free!
 
Now, I do own some shares in POY, so I am talking my book. Also, POY is a real micro cap with a shocking bidding spread and the low liquidity of its share in the market to match this status. Also, a relatively technical reportable irregularity concerning lack of manufacturing licenses for making weapons/arms was noted by the auditors (though, subsequently resolved to POY's benefit). So, its not like this share does not come with a healthy dose of risk...
 
Still, c.56% discount to TNAV on an IP play... Very tempting indeed.
 
In conclusion, POY directors indicate that they "The Defence Division is expected to show continued revenue growth and profits in 2012. This Division currently has a stronger order book than at the same point last year and has a healthy number of proposals and opportunities in the pipeline ... The Commercial Division is starting to re-invest in product development again after some severe reduction on spending in this area for the past two years. Good opportunities are becoming apparent in the area of cellular coverage driven by the high growth in cellular data products both locally and internationally. We envisage increased growth in cellular product sales. Our drive to combine cellular products with installations in South Africa is proving popular. The Commercial Division is also forming a close relationship with a BEE partner to start providing innovative coverage solutions to cellular service providers. This offering has been well received and we hope to expand this business in future."
 
Should you have any questions, or wish to discuss any of the Conexus Investments in more detail, please do not hesitate to contact us.