Formjet* – Initiate Coverage: Speculative Buy at 0.525p with a 1.5p target

Penny share growth opportunities are seldom so compelling. Formjet offers limited downside and two chances of generating significant upside. We have conservatively estimated a present break-up value of £2 million for the business, and that must limit the downside risk. The upside could, however, be far greater if the company’s new CEO Andrew Monk is able to use it as an acquisition vehicle and we expect Monk to make his first move within months.

Ignoring the £2.95 million or so of tax losses that could also have a potential value, the assets include an eight year world-wide licence to distribute Ability Software International (ASI). Its products include practical and substantially lower cost alternatives to Windows Office and should be attractive to cost conscious users, reluctant to perpetually and expensively upgrade for marginal increased functionality. The market for low cost office software could be substantial and Formjet seems set for strong organic growth. Much of the restructuring is complete and our forecast of modest operating profits in 2010 is derived from cautious sales growth assumptions, which could well be exceeded if the company manages to secure any of the major distribution deals we believe that it is negotiating.

The CEO since September, Andrew Monk, is a major shareholder and after 25 years of working in the stockmarket is ‘well connected’. He has moved quickly to ensure that Ability can deliver organic profits growth but his strategic goal is to use Formjet Plc as the acquisition platform to take advantage of the opportunities created by the uncertain economic and stockmarket environment. We believe that he is working on a twin track strategy of looking both at bolt-on deals to complement Ability but also at larger deals outside the Software sector which can be funded with Formjet paper and would almost certainly constitute a reverse takeover. On the basis of Ability alone we regard the shares as materially undervalued while Monk’s M&A strategy has the potential to move Formjet into a new league. We initiate our coverage at 0.525p with a BUY recommendation and a price target of 1.5p.

Background

Formjet floated on AIM in 2004 at 7.25p and with an initial market capitalisation of £4.75 million. The strategy was to build a business based on the distribution of ‘white label’ software via alternative routes to the IT market, such as supermarket chain Tesco as well as dedicated IT retailers. The two principal brands for distribution were Panda and Ability.

Despite some success Formjet never achieved the critical mass needed to support its corporate overhead and therefore failed to deliver bottom line returns. A number of attempts were made to achieve scale by acquisition but these ended in failure. In July 2009, the company announced that it had agreed to sell the license to distribute its Panda product in UK and Ireland back to the license owners Panda Security S.L. The licence’s revenues of £1.65 million accounted for 46.5% of Formjet’s December 2008 turnover. Formjet received £0.5 million on completion and will receive another £0.5 million on the first anniversary of completion and a further £0.2 million on 31st December 2010 with a final earnout related payment of up to £125,000 due on 31st December 2011.


In July, Formjet also raised £250,000 by placing shares at 0.25p – with Mr Monk taking 80% of the placing.



Monk only started work in September 2009 and he and new FD Peter Joy have agreed to accept a nominal £100 per month salary each, which is likely to continue until the company has grown to a size where it can afford to pay them market rates. The company published a trading update on 23rd December in which it stated that it had written off a loan of £397,418 made to a Dutch company – ASI Benelux – and there were indications that equally dramatic actions have been taken within the Ability business. However, we believe that Ability should generate sufficient profits and cash to almost cover corporate costs during 2010. In November 2009, Formjet announced that it had secured an extension to its Ability distribution license taking it out to September 2018.

Operations

The product mix has been restructured to focus on higher margin own label software. The core business remains the distribution of Ability Office as well as competitively priced alternative, ‘white label’ software products, but with a suitable slimmed down administration overhead. Since disposing of the distribution licence for Panda anti-virus security software in July 09, the continuing products are ASI and BeAnywhere.

Ability (ASI) is a highly functional suite of Business Software comprising nine titles, which include fully comprehensive office and graphics suites, a business plan development application, small business accounting, and staff records management (word, spreadsheets, presentations, etc). These products are compatible with Microsoft Office packages and can be purchased for a much lower license fee – typically Ability products retail at around 20% of the cost of standard Microsoft packages.

A newer product, the marketing of which has started only recently, is a remote computer access tool called BeAnywhere – a USB memory stick sized device which allows users to access up to 3 computers from anywhere in the World. The product has been updated to suit Windows 7 and retails for around £35 against comparible products such as GotomyPC and PCanywhere which cost from £110 to £240 per year. The distribution channels are well formed, including partnerships with Tesco, Asda, Dell, Sainsbury, Amazon, Dixons, Currys and PC World. Formjet also distributes via a TV shopping channel.

In order to scale up the distribution network, the company is seeking to develop arrangements with original equipment manufacturers of computer notebooks such that they pre-install Formjet’s software (notably Ability) on their products. The OEM would be able to sell on added functionality at a minimal incremental cost to itself while Formjet would achieve volume sales with no distribution costs. Recently Ability Home Office has started to be installed as standard on Fizzbooks – a version of the Intel Classmate Mini-Notebook – and this should increase the numbers of Ability users rapidly. Moreover, Notebooks are being provided to the reseller channels as part of the 3GMobile offering and are being bundled with ASI Ability Office. The launch of the Intel Atom processor and its adoption into the new breed of cost-effective sub-notebooks has resulted in Ability Office being supplied with thousands of machines, significantly improving the brand awareness and providing further credibility to the entire product range. Microsoft are increasingly selling updates and software via the internet and not in boxes through their traditional retail outlets and the ASI product range is ideally placed to fill the resulting shortage of products felt by these retailers.

Andrew Monk
As significant as the disposal of the Panda licence is the arrival of Andrew Monk as CEO in September 2009. After investing £200,000 at 0.25p a share, he is the largest single shareholder, with around 23% of the equity. Since graduating from Oriel College, Oxford Mr Monk has enjoyed a successful career in the City spanning more than 25 years. He was a founder and Joint CEO of the stockbroker Oriel Securities Limited during its initial four year build up period. Early investors in Oriel made a return of around 2000%. More recently he was CEO of AIM listed stockbroker, Blue Oar, now called Astaire. He has an extensive institutional and corporate contact list.

As the recovery phase draws to a conclusion, Mr Monk’s attention will be focused increasingly on the group’s strategic development. Currently, he is only taking a nominal salary of £1,200 per year and as a shareholder is keen to generate capital growth. The group’s new name of Third Quad Capital relates to the fact that this is Monk’s third business venture and that there is a Third Quad in Oriel College, Oxford.

Current Trading
The results for the 12 months to December 31st 2009 showed the extent of the corporate developments at Formjet, but are not a useful guide to the underlying business going forward. Turnover was £1.83 million, about £869,000 of which was from continuing operations. The operating loss was £1.995 million, of which £1.3 million related to exceptional items. The cost reduction programme is expected to produce £500,000 savings during 2010. As part of the restructuring, a particularly prudent approach has been taken to accounting policies and, as a result, a loan to a Benelux Distributor of ASI Software amounting to nearly £400,000 was written-off.

However, we believe that Ability will generate a modest operating profit in calendar 2010, which will almost cover Plc costs and, if it can sign some bulk OEM contracts for Ability or if BeAnywhere gains major market traction, the risks to our forecasts are very much on the upside. As a result of the July placing and the first instalments of the proceeds from the Panda disposal, Formjet leaves 2009 with a strong net cash position, which we estimate to be £315,000 and this will be boosted by a subsequent receipt from Panda of, potentially, a further £125,000 in 2011.

Management
Since the disposal of Panda there are 12 employees.

Chief Executive Officer, Andrew Monk joined Formjet on 1st September 2009 after a successful stock broking career spanning 25 years. In that time he has built up strong relationships with many major UK institutions. He was employed by Hoare Govett ABN AMRO for 11 years before starting up Oriel Securities from scratch as Joint CEO, and which, under his leadership, eventually employed nearly 100 people and had a valuation of approximately £40 million. Andrew later became CEO of Blue Oar, where he successfully turned around its UK securities operations and its private client division as well as starting an asset management division. During his period as CEO, Blue Oar made three successful acquisitions.

Finance Director, Peter Joy joined Formjet in February 2010 having spent the last twenty years as Finance Director of stockbroker Astaire & Partners and latterly as Finance Director of Astaire Group PLC which was previously Blue Oar. Currently Peter has no shares in Formjet.

Non-Executive Chairman, Lyndon Chapman commenced his career joining Cadbury Schweppes as a management trainee. Following a successful career with Cadbury he moved into the SME arena and has held many directorships; Dean Corporation (Lupus Capital), Envesta as non executive before becoming Executive Chairman, leaving Envesta in 2004.

Major Shareholders

Number of shares in issue 350.15m Free Float 43.09%

Those owning more than 3% are:

Andrew Monk	22.85%
Chase Nominees	12.39%
The Bank of New York	9.18 %
SF T1ps Smaller Companies Growth Fund	7.61 %
TD Waterhouse Nominees	4.88%
Barclayshare Nominees	4.82%
Giltspur Nominees	4.75%

SWOT Analysis

Strengths

The assets include an eight year licence for the Ability Office software titles, which are a practical and substantially lower cost alterative to Windows Office.



Andrew Monk is a major shareholder and after 25 years working in the stockmarket is ‘well connected’. He is focused on delivering both organic growth and growth by acquisitions. His track-record and contacts could include a potentially paradigm changing acquisition.



Following the sale of Panda, Formjet will have net cash, which should reach £0.5 million when all Panda proceeds are received. Formjet also owns the freehold to its premises in West Sussex and we believe that the sale of these premises should, after the repayment of associated loans, boost the net cash position by around £400,000.

Weaknesses
Historically Formjet has been loss making with disappointing growth. The company has a track record of spending money on abortive acquisitions and investor perception is not positive.

In July 2009, the Panda licence was sold back to Panda Security. It had accounted for 46.5% of calendar 2008’s turnover – the remaining Ability business needs to scale up if it is to achieve critical mass.


Although Ability is compatible with Microsoft Office, many IT professionals appear reluctant to adopt it for usage. The speed at which it gains acceptance is beyond Formjet’s control and is in part determined by its – as yet unproven – ability to secure large scale pre-installation deals with OEMs.

Formjet’s small market capitalisation means that even a modest transaction undertaken by Monk would almost certainly constitute a reverse acquisition under AIM rules – which will be costly and potentially time consuming.

Although the Ability licence has been extended until 2018 there is no guarantee that it will be extended thereafter – although there is no reason why it should not. Nonetheless, there are question marks over long term revenue visibility.

Opportunities
Ability Office should be attractive to cost conscious users reluctant to perpetually and expensively upgrade software for marginal increased functionality. If larger OEM Bundle deals can be secured and/or if BeAnywhere gains some traction the risks to our sales forecasts are very much on the upside.

Ability Office should generate sufficient operating profits to almost cover Plc costs during 2010, leaving Formjet well placed to use its growing cashpile for corporate transactions.

The uncertain economic environment does provide opportunities for a purchaser with both cash and listed paper to make both strategic bolt-on acquisitions in the same space as Ability, or to make larger non-related acquisitions using Formjet and its listed paper as the platform.

Threats
Formjet is trying to sell bulk products into markets with dominant established players. It has a clear price advantage over the established brands but gaining acceptance of its product in a market which is marked by inertia may take longer than expected, or may not happen at all.

The growth strategy is dependent on acquisitions and these will be driven almost entirely by Andrew Monk and hence the company is heavily dependent on this one man.

Forecasts and Valuation

The finals for 2009 showed that despite the difficult economic environment, tighter credit control produced a strong improvement in debtor collections as trade and other receivables were reduced by 30% from £1,250,528 to £875,881. The Head Office property is in the balance sheet valued at £870,342 and is for sale, but could be marked down for a quicker disposal, if necessary. Annual cost savings of £500,000 are forecast to be achieved from the restructuring and will make an impact in the first half of 2010.

Our assumptions for 2010 are of a 44% increase in underlying revenues thanks to a new sales focus within Ability – we do not assume major OEM sales are secured and if they are that will push sales ahead of our forecasts. We have also assumed some margin improvement as a result of a changed sales mix. The cash proceeds from the Panda licence disposal and the share placing in July mean that there are no cash concerns for the group.

Year Ended 31 December, £ 000		2007	2008	2009	2010E
Continuing Revenue		3,663	3,592	869	1,250
Discontinued				954
Total		3,663	3,592	1,823	1,250
Sales Growth (%)			(2)	(49)	(31)
Cost of Sales		(1,283)	(1,652)	(703)	(350)
Exceptional					0
Gross Profit		2,380	1,940	1,120	900
Margin (%)		65	54	61	72
Admin		(2,421)	(2,791)	(1,835)	(1,000)
Exchange Rate Gain		0	39	0	0
Exceptional			(519)	(1,280)	0
Operating Profit		(41)	(1,370)	(1,995)	(100)
Profit on Sale Panda		0	0	538	0
Finance Income		22	7	1	0
Finance Cost		(50)	(400)	(35)	(50)
Profit Before Tax		(69)	(1,403)	(1,492)	(150)
Loss Before Tax Include Except.		(69)	(1,403)	(2,030)	(150)
Tax		0	0	0	0
PAT		(69)	(1,403)	(1,492)	(150)
EPS (p)		(0.053)	(0.779)	(0.497)	(0.043)
No. Shares (000)		129,773	180,153	300,153	350,153

Assumptions
Margin improvement due to changes in the product
Sales do not assume OEM deals
Lower costs from restructuring

Our valuation is based on a sum of the parts basis. Underpinning the stock are the tangible assets plus the cash set to be received from Panda over the next two years plus the property and plant on the balance sheet of £913,000, which mainly consist of a freehold property with a £285,000 mortgage. That gives tangible net asset backing of a total of £2.2 million or 0.63p per share.

In addition, there are the world-wide exclusive distribution rights for ASI which run until 30th September 2018. We believe that at an operating level Ability should, in 2010, deliver an underlying profit of around £350,000 and valuing it on a multiple of six we ascribe to it a value of £2.1 million or 0.6p per share.

And then there is a management premium. There is no guarantee that Andrew Monk will pull off a major corporate transaction but there is a possibility and to this we attach a modest risk weighted value, which gives us a sum of the parts target price of 1.5p. At 0.575p the downside risk is minimal given the tangible net asset backing of 0.63p while there is clear upside risk to our valuation both from the potential that Ability might materially exceed our forecasts and/or from the ability of Andrew Monk to deliver a transformational acquisition. At 0.525p we initiate our coverage with a stance of buy and a 1.5p target price.

Forecast Table

Year to 31st Dec	Sales (£000)	Pre-Tax Profit (£000)	Opperating Profit (£000)	Earnings Per Share p	Dividends Per Share p	P/E Ratio	Yield %
2007A	3,663	(69)	(41)	(0.05)	0	N/A	0
2008A	3,592	(845)	(1,370)	(0.34)	0	N/A	0
2009A	1,823	(1,492)	(1,995#)	(0.50)	0	N/A	0
2010 E	1,250	(150)	(100)	(0.04)	0	N/A	0

#Including exceptionals and after the disposal of Panda.

*Formjet is a corporate client of RSH the ultimate owner of this website. The SF t1ps Smaller Companies Growth Fund, which is managed by another RSH subsidiary owns shares in Formjet.