NCC Group: A few thoughts at half year

Full disclosure up front, I am long on NCC. I have been so for many years. NCC is currently one of my top 5 holdings. NCC recently released it’s half year results for the period ended 30th November 2015.

Highlights (according to management) were:

– revenue increase of 50%, of which organic growth 17%

– adjusted operating profit up  26%.

– adjusted pre tax profit up 24%.

However GAAP Operating Profit was in fact down 22% and GAAP post tax profit was down 28%.

Now before going on to give my opinion on the differences and what I see the real position of NCC as being I think it is worth covering three particular issues.

1) NCC is good at putting its numbers out clearly.  You do not have to look hard to understand what is in “Adjusted” numbers and as such a individual can make a proper consideration of NCC’s numbers

2) NCC does regard itself as being a lot better than many in what it “Adjusts” for.  I have been in some correspondence over the years with NCC on the accounting treatments and a consistent theme is whatever you think of NCC we are much better than certain of our comparators.

3) With the acquisition of Fox IT NCC is in a significant change process.  Going forward next year’s numbers are going to be significantly different from this year’s.  The Fox transaction happened on 27th November 2015.

That said here is my reconciliation of GAAP to Management;

Reconciling GAAP to Management Figures6 months ended 30th November 2015 £000’s6 months ended 30th November 2014 £000’s6 months ended 31st May 2015 £000’s
UK GAAP8,59311,06911,540
Amortisation of intangibles (1)2,2518841,323
Share based payments (2)696338653
Acquisition Related Costs (3)2,58302,387
Revision to Estimates of Contingent Consideration (4)(2,992)00
Intangible Asset Write down (5)4,06800
Restructuring Costs (6)49700
IT claim  (7)0158(1,957)
Management Adjusted Figures15,69612,44913,945

(1) I have no problem with management’s reversal of Amortisation of Intangibles.  I would agree that if the business is being well run the intangibles do not denigrate.  To cover genuine denigration you have impairment reviews and Asset write downs (5).  So for my figures I am happy to write this back.

(2) I think stripping out share based payments is completely wrong and fundamentally misleading.  Share Based Payments are both a very real cost and a very expensive one.  Not only has the company given away part of what I owned, they have done so at a price lower than I thought it was worth.  If a share trades today at £1, if I hold it, it is because I think it will be worth more in the future.  Otherwise I should take the £1 and do something else with it.  Share based payments not only give away what I already have but at a cheap price.

(3) Acquisition Related Costs.  This to my mind is nuanced.  These are real costs and if they were capitalised I would accept them onto the balance sheet and not worry about the amortisation, but I would worry about impairment.  As it is taking them out in year 1, so they are not being matched to the ongoing revenue stream seems to me to be less than perfect.  However as a fundamental position all activities and costs incurred should be used to judge managements performance and if they choose to expense it then I will reflect that in my judgement of performance.   However these are related to the Fox IT acquisition so I will not expense them now, but in the 12 month figure when 6 months of the Fox revenue is being reflected.

(4) As with item 3 above, all costs or savings need to be recognised somewhere or as with item 1 be available for review.  As management have taken it in this period, so will I.  But at 50% in this period and 100% in the year.

(5) A write down of Intangible Assets is a fundamental cost.  Money was paid and the asset is not worth what was paid.  I absolutely do not agree with management’s treatment on this and I add this back for judgement on the period.  You cannot say that the mistake was made in a prior period so you do not count it for judging this one.  It’s akin to saying an acquisition was made last year so do not count the revenues this. Madness

(6)  Restructuring costs.  If NCC bought one business every 10 – 15 years I might accept this.  But given the ongoing acquisition strategy this is a real genuine and recognisable cost.

(7) I do not get why this is out of the ordinary.  Contracts are entered into all the time and both the good and bad parts are a normal part of a business.

So my reconciliation of UK GAAP to My Judgement figures are;

Reconciling GAAP to JC Figures6 months ended 30th November 2015 £000’s6 months ended 30th November 2014 £000’s6 months ended 31st May 2015 £000’s
UK GAAP8,59311,06911,540
Amortisation of intangibles (1)2,2518841,323
Acquisition related costs (3)2,58302,387
Revision of contingent consideration (4)(1,496)00
My Adjusted Figures11,93111,95315,250

Effectively from my perspective there has been no real improvement.  Revenue has undoubtedly increased at 50% but so to my mind has the underlying cost.  You also need to accept Management’s assurances that second half year performance will be stronger than the first half as this six months is noticeably worse than the six that preceded it.

However in judging the situation there are three further factors that I include;

(1) NCC is undergoing significant change.  The acquisition of Accumuli and Fox will both for the May 2016 and half year November 2016 produce significantly different results from the ones shown here.  I believe with significant upside potential.

(2)  In my experience NCC has a history of short term blah.  By this I mean that results after a big change, acquisitions in europe or the US or the beginning of the Domain Services business have underwhelmed.  But management have been able to move through this and generate a significantly better business, time after time.  It may be rose tinted spectacles but I see no reason not to believe the poor short term comparatives as being a repeat of this history.

(3) I do see the Fox acquisition as being more than adding business.  NCC currently has 3 divisions, Escrow – a brilliant growable cash cow, that has funded the growth of the rest of the business and paid for many of the mistakes that have been made along the way.  Domain Services – currently a waste of time and effort that looses money and when I do a DCF calcualtion I end up valuing as worth £0.  Assurance – the sexy cybersecurity arm.  Fox is going to be labelled under Assurance but I see it as almost the establishment of a fourth line of business.  I feel Assurance has been very much about checking the systems that a business has, Fox and Accumuli are more orientated to managing the systems for a customer. I recognise that there is an overlap between old and new Assurance but I would not be surprised to see NCC at a future date report as 4 rather then 3 business lines and as such the Fox acquisition on top of the Accumuli acquisition is exciting.

I therefore intend to hold my NCC shares for the current time but will look to reassess on future news.

 

A special thank you to Jonathan Curry for sharing and if you wish to follow his twitter account @jpsc01

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