Zoo Digital share price has risen from 9p to 60p in less than a year. But their market valuation rose from less than £4m to £45m, due to the increase in share outstanding from 32m to 73m.
So, is Zoo Digital market valuation justified?
Let’s find out.
Share Price: £0.60 (down 2%)
Market Capitalisation: £45m.
Looking at their interim result it was like love at first sight, but that quickly faded away when I scroll to their financial statement.
First, they reported revenue rising by 63% to $12.7m (H1 2016: $7.8m), (I immediately assumed profits would beat expectations).
Then, they mentioned most of the revenue came from their new dubbing division, but that division was new and lots of costs were included. It helps to lower its gross margin to 63% from 75%. Management promised to lower costs through efficiency.
Next, onto their financial statements.
Zoo Digital reported an operating profit of $413k, which was ONLY $100k higher than last year. But net profit was much lower at $85k, compared to $677k last year, due to conversion loan note expenses and exchange losses from borrowing.
P.S. No wonder they didn’t include net profit in their key financial highlights!
Then, something didn’t smell right when it came to their trade receivables.
Zoo Digital’s trade and other receivables
We don’t have the details but can only speculate from what was given from their interim accounts.
Sales growth of 62% was partly down to the near doubling of trade and other receivables. The $3.4m increase in receivables has boosted Zoo Digital sales by 70%.
Some would speculate about prepayments, but data isn’t available. Historically, prepayments have accounted for 1 0% of total receivables.
And this has caused their cash flow statement to report a NEGATIVE net cash from operation of $1.85m (up from $19k). It mostly came from receivables cash outflow of $3.34m, up from last year cash outflow of $1.2m.
Despite raising a net share issue capital of $3m, their cash balance at year-end saw a net increase of $115k to $722k.
The company has managed to capitalised debt of £1.1m ($1.45m) and reduced net debt to $3.9m from $6.2m. (See a brief fundraising details below)
Details of their recent fundraising and Conversion of Debt
Zoo Digital has recently raised funds to support growth and extend the terms of their existing loans. The terms are as follows:
1). It raised gross funds of approximately £2.58 million, through a Placing and Subscription comprising the issue of 28,611,111 New Ordinary Shares at 9 pence. (when the share price was around 13 pence)
2). They further issued 12,222,223 New Ordinary Shares at 9 pence per New Ordinary Share to extend the terms of its outstanding CLN1 and CLN2 by a period of three years.
3). Stuart Green (the CEO) bought nearly 7m shares as he is part of the holder of CLN.
4). Share outstanding rose to 73m shares from 32m. So, be careful of dilution.
This isn’t the first-time Zoo Digital saw their share price spike towards 70 pence per share. Previously this happened after the financial crisis (2009 to 2011).
Chart One: Zoo Digital’s share price chart
That story behind was down to Zoo Digital getting sales and making a profit from their software division while their media production was underperforming.
As soon as their software division starts to fall in sales, investors sold off their holding, which collapsed their share price by 70-75% as it traded around 10 pence per share. And four years later, we got another share price spike.
That’s a brief history of Zoo Digital’s share price.
Zoo Digital Divisions
So, what has caused the recent spike in share price?
To answer this question, I present their sales and profit charts of their two divisions.
Chart two: Divisional Sales
Chart three: Divisional Profit
From both these charts, Zoo Digital has experienced a reversal of fortune from software to media production. Their software was once a growing division and generated over $3m in profits. Now, it is dragging the business down with its losses.
Zoo Digital’s media division is now a hot item as profits soar to $3m.
P.S. The above is quoted in USD.
And investors are optimistic about Zoo Digital media division boom.
The Impact of Corporate Costs on Zoo Digital
For small publicly-listed companies like Zoo Digital, the impact of being listed and staying listed is far from the minds of investors and shareholders.
Instead, they focus too much attention on sales and profits without this cost has a profound impact on earnings.
The chart below provides us with some insight.
Chart four: Zoo Digital PLC costs affecting profitability
For a small business like Zoo Digital, the cost of being a publicly-listed company is the difference between reporting a profit or a loss.
That is evident if you assess it over a period of time.
Since 2009, Zoo Digital paid $13.3m in corporate cost, but accumulated turnover generated is $71m. That is equal to 18% of all sales just to be recognised as a publicly-listed business.
Basically, Zoo Digital needs to earn an 18% (before corporate expenses) operating margin to break even.
Now, onto some fundamentals.
Historically, Zoo Digital has been a poor business as it struggles to consistently produce a profit.
Chart five: Zoo Digital Basic Fundamentals
Putting It All Together
Zoo Digital’s results was a big disappointment because I was expecting a beat on profits. Now, they need to perform in the second half of the year.
My worry is after capitalising debt and reducing net debt to $3.9m, through raising net funds close to $3m. There is STILL a possibility they need to raise further financing because cash balance amounts to $722k. Unless they can convert their “excessive” receivables into cash.
Today, the share price responded lower by 2% reflecting the poor profit generation. Their excessive trade receivable is a concern, but we need details.
On a market capitalisation of £42m, which was once valued less than £4m eight months ago, I think Zoo’s share price has risen too fast.
The risk of further fundraising and a decline in gross margin could see the company correct by 30% or more.
And given the history of Zoo’s share price correlation with their operational performance, I see the outlook looking less bright than I expected.
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The above analysis is based on my opinion and nobody else. It does not constitute professional investment advice. Data is correct on at the time of availability. I don’t hold the company’s shares unless stated.