Insights into the challenges and triumphs of UK Smaller Companies

Please be aware that the accuracy of machine-generated transcripts, such as those utilised in our video interviews, may fluctuate based on factors like audio quality, subject matter complexity, and individual speaker enunciation. Consequently, these transcripts are unlikely to achieve 100% accuracy. However, it is important to note that, at FundCalibre, we do not consider the correction of automatically-generated captions to be an effective or proportionate use of resources.

Given the inherent limitations of machine-generated transcription, we strongly advise against relying solely on this transcript when consuming our video content. Instead, we encourage you to use the transcript in conjunction with the accompanying video to ensure a more comprehensive and accurate understanding of the topic.

Hi, I’m Joss Murphy, research analyst at FundCalibre. Today I’ve been joined by Paul Marriage, manager of the Tellworth UK Smaller Companies fund. How are you, Paul?

[00:12] Thanks, Joss.

Great to hear. Paul, last year you were genuinely optimistic on the sector with M&A and a healthy IPO market, yet we didn’t really see the recovery in smaller companies that many maybe thought, why is that?

[00:30] So what we didn’t see is a big 20- 30% year. What we did actually see was a pretty, you know, a good small cap fund made you seven plus percent last year. So yeah, it’s ahead of cash. It’s not the blowout year that you’d expect from small cap. And to some extent, small cap needs to do that blowout year fairly soon to remind people what it could do. Obviously 2022 was a pretty tough year for people, so actually quite okay recovery in the end, not a bad asset class to have been in on a 12 month view. And these, you know, January – December you could argue is an arbitrary period, but looking at it in a calendar year, it wasn’t actually a bad year. But you make two interesting points at the beginning. I think you’re talking about M&A and IPOs.

So IPOs just didn’t happen. And there’s one IPO tried to come that that, you know, that looked like it might make it in the kind of mid cap space that was cap payments, that, that fell flat on its face was a bit of disaster. Probably coshed much enthusiasm for other IPOs for the rest of last year. I think we will see IPOs again this year, although M&A are conversely just accelerated. In fact, you know, M&A became the big theme going into Q4. And, and this is a great sort of background to the market in general because if you think about what M&A means in UK small cap, it means that there’s people who aren’t in the UK market – so they’re not market operators, they’re not fund managers like me looking and, and buying and selling shares – these are people outside the market saying, these UK listed companies are too cheap, so we’re going to come in from outside – trade buyers, private equity – buy them, take them private, grow them out outside the market. So M&A has really come back and it just highlights how much value there is in the UK market. We don’t mind M&A, there’s plenty of opportunities out there, plenty of companies. So, so we don’t see it as a bad thing, we see it as a good thing because it is showing people the inherent value we have in our marketplace.

And Paul, if interest rates fall, could this help UK smaller companies recover?

[02:15] I don’t think the interest rate UK smaller companies thing is … it’s a sentiment thing. Yeah. So interest rates fall, people get more positive on equities. Most of the stocks we invest in have pretty strong balance sheet so we’re not really looking at a scenario where a fall in rates suddenly makes a heavily indebted company in a much better place. We don’t really invest in those. So I think, you know, there is a perception that smaller companies have weak balance sheets and that’s not really the case these days. May been the case a long time ago, but small companies that that, that, you know, surviving, thriving, small company generally not bring go generally <inaudible> more flexibility, less interest costs, you know, more cash to spend on, you know, growing the business perhaps. But I wouldn’t say it’s a big binary call. It’s a big sentiment thing for wider markets.

Certainly makes sense. For the past couple of years, a lot of UK companies have struggled with higher input costs and strained supply chains. Are these pressures over and is the outlook for profit margins better now?

[03:13] Well, you are absolutely right. There’s a big supply chain input cost shock as we came out of covid. But also due to a whole range of things like, you know, shipping costs went through the roof, you know, issues in the Panama Canal, et cetera, et cetera. So companies had to adjust really, really quickly then to changes they’d never seen before. And then we saw a kind of reversal of all of those and normalisation, supply chains pretty much fully reopening in 2023, companies no longer saying, you know, we’ve got an issue, we can’t get this product out the door because we’re missing this component and it’s stuck somewhere, or it’s not being made, or the people making it can’t find components to make it. So that supply chains, we’ve gone away. So, so no longer a big issue.

I think the experience of 2022 did make companies think a lot about how and where they make stuff. And probably was a healthy reassessment of supply chains to make themselves more capable of coping with input cost volatility, probably here to stay but also in some ways thinking about, well, where was the best place to, to make stuff and the components and, and that probably meant for most companies bringing things a bit closer to home.

And can you share with us a couple of your best ideas at the moment?

[04:26] Yeah, I think, you know, one of the big things I said right up front is UK small cap offers plenty of value. We are not a value fund, we’re a UK small cap fund. So we’re trying to find, you know, good stock ideas in the 100 to 500 million area. We’re not micro cap, we’re not mid-cap, we’re right there. So, so really in there I’ve got, there’s a couple of things that really stand out to me. And one, one of them has been particularly interesting lately because of a transaction in the media sector.

The very back end of last year, a business called GlobalData [PLC] which is the large data provider – imagine like a Bloomberg or a Reuters type business selling mainly into corporate, so not into financial market players, but into pharmaceutical companies and stuff – that’s a very entrepreneurial business led by guy called Mike Danson. And he did a clever deal where he brought private equity in to buy a stake in one of his divisions. And that was done a multiple of 22 times EBITDA.

We’re actually invested in GlobalData, so we benefited from the share price to positive share price reaction. But there he was saying to the market, look, an external investor is valuing a decent chunk of my business at nearly my whole market cap. And this made us think about what else we own.

So we own something called Wilmington [Plc]. Wilmington is another media stock. It’s a provider of data and services and training into the legal and compliance markets. Whether we like it or not, the legal and compliance markets are big and growing globally. Wilmington’s a leader in that space. Wilmington as net cash <inaudible> actually GlobalData <inaudible> and one of the things about the deal was the transaction was going to wipe out the debt – that was an interest sensitive company, referring to what we were saying earlier – whereas Wilmington, niche leader in that training space, net cash of 30+ million and trading on eight times EV/EBITDA, the GlobalData deal done on 22 times. So for me, you know, Wilmington is a really good example of a great market leading UK business. Strong balance sheet, no interest rate worries, but just trading on the wrong multiples by some margin. So I think that’s a really great way to trade it. It’s done very well for us. It made a good sensible acquisition the other day. So I really think Wilmington is a great example of how what’s happening in the wider sector, that’s a UK small cap that stands out as a value opportunity for us, but also it’s a leader in the niche. I really like this combo of really good quality leading companies that are offering fantastic value.

And that leads me nicely onto something different. You know, Wilmington Media, a little less tangible, Gooch & Housego [(UK) Ltd], hi-tech engineering business makes stuff. Gooch & Housego’s history is about leadership in something called a Q-switch. You use a Q-switch to change the wave of a laser. Don’t ask any more questions, I’m no physicist!

But the world leader in, in Q-switches and that was a great business over the last 30, 40 years. And over time Q-switches have become a little bit more common, probably a little bit more challenging to make cheaply in the UK and a bit more competition. So Gooch & Housego have taken all that photonics IP, which is, you know, the technology around the movement of light, which they’re very strong in and expanded into a number of different areas, you know, in in medical and defence. And they’ve really broadened the business out. They haven’t, that hasn’t been a seamless process without a few, quite a few bumps in the road, frankly. New CEO came in last year, had a really good look at it and said, look, Gooch & Housego is a great IP-rich business, we could do some things a bit better. And we need to focus on just making the business a little bit more focused, a little bit more looking at what the end client really wants. A little less blue sky R&D, a little more delivery.

Now Gooch & Housego makes kind of 10% margins on 80-90 million of sales today. He thinks they can make towards 20% margins and see those sales grow. So at the moment people are valuing those, that 10% margin for a really IP-rich business, let’s say 10, 11 times feels a bit low. Imagine it was a 20% margin business, growing at five-ten top line. You know that a hundred million of sales make <inaudible> ,that’s going to value that at least <inaudible> times. So your market cap 150 today, future market cap 300, 400, that wouldn’t seem unreasonable to me. So I think Gooch & Housego is a great opportunity to buy IP Rich UK business, leads in lots of attractive niches exposed to a whole load of exciting things like AI … you know, the chips behind AI, Gooch & Housego supply into the machines that make those chips. You know, they have the best quality kits. So the best maker in the world wants to come to Gooch & Housego in Somerset, buy that kit, put it into their machines. All sorts of really interesting markets, undersea cables for data, a really broad range of exposures there into all sorts of exciting things are going on in the world.

Classic example of a UK small cap which really undervalued, but really, really IP rich, a really well managed business, new management team are really grasping that. So a bit of a management story, bit of a margin growth story. So yeah, Wilmington, Gooch & Housego I think are really good examples. And that there’s, you know, there’s dozens of Wilmingtons and Gooch & Housegos, we’ve got 40 odd of them in our fund. So they’re not, they’re not super difficult to find and I think it’s just a really, really exciting time to be looking to buy more of those kind of companies.

Well Paul, thank you very much for your time.

[09:20] Thanks very much for your time.

If you would like to find out more about the TM Tellworth UK Smaller Companies fund, please visit FundCalibre.com. Thank you.