Hi Reece

Excellent research note. What is your view on how the Sydney lockdown will affect the business? From memory the Melbourne lockdown was a significant problem for SP3 and I wonder if we will see something similar with Sydney lockdown and border closures, given the last quarterly noted the following:

Planned installation of the first phase of Surf Life Saving solutions in NSW and WA is expected to lead to further growth during the year and, pending COVID restrictions, Spectur plans to market this safety and warning offering intensively. 

FY21 started in challenging times. COVID-19 related lockdowns and associated circumstances were affecting customer confidence and the building and construction sector was depressed. 

Nikman

Hey Reece,

Just wanted to reach out and say your report on SP3 is great, in particular you think about valuation in the micro cap space exactly like I do; conservative assumptions on what could this business look like in a few years and what is the upside vs downside to that level. To often I think people overcomplicate valuation in the micro caps, the businesses are too small and volatile to model out traditionally.

I don't own SP3 but must admit the quarterly caught my eye and I spoke with the MD last night and came away impressed with his vision for the company over the next couple of years. I think holders will do well and I may become one at some point! 

@Storge

Firstly, thanks for taking the time to put some numbers together on SP3. I would just like to address a few things included in your number crunching.

1. The shares outstanding

You have kept the share count at 106.3m, which is fine assuming the company doesn't raise capital. (I personally think they will, but I completely understand someone's calculations that they won't need to). The issue moving forward is that there are currently 6.5 million total options outstanding, with call prices ranging from 5 cents to 9 cents (off the top of my head). We can assume atleast 3 million are in the money right now and will be exercised, raising the share count.

The change in shares outstanding will obviously affect the valuation measures you have applied in this case.

2. Company is not yet profitable and cash flow negative. So can only really use a revenue multiple.

I personally disagree with this statement. I think the most important focus for companies that are CF negative is becoming CF positive, and hence the measure to value these companies would be from free cash flow generation. In my analysis, I used an FCF-yield, which compares the level of cash flow to the price (or market cap) of the company.

*I've taken the following excerpt from the research report on SP3;

*The focus here is based on the free-cash flow generation, particularly given the company is currently not generating self-sustaining profits. For me, I think this type of ‘speculative’ investment would require a FCF yield of something between 6-10%, given a 3 year investment horizon.

I used to sit and think, how do I value cash flow negative companies given that I can't apply a P/E ratio or EV/EBITDA multiple because the company doesn't generate any form of earnings yet......

I think the use of an FCF Yield, or FCF generation is a super important way to value such companies and it is a more thorough way of valuing the company, given a certain level of risk.(I.e a risker investment commands a higher level of FCF yield).

The issue with valuing companies on a revenue multiple is that its a mere guess to what the market will apply to this company. For example, if you change the mutiple to 4 x revenue instead of the 3 x you applied, we get a valuation of 0.22 cents. This is a 33% difference from the 16 cent result you had.

I don't mean to criticise this measure by any stretch, more point out its flaws. I personally would never part with my money in the form of an investment on the basis of a revenue multiple.

Again, thanks for taking the time to put your thoughts on the value for this company!