Staffline Group (lon:staf)
Staffline – Some Big Share Price Movements, Why?

Staffline have been on my radar for a while now, each time I look at it I think is this the end of the bad news, Have a look at the case study?

Yet each time there is a sort of mini recovery in the share price as some new action, change of focus or fund raising is announced followed by more big bad news.

This time the bad news is poor trading figures, an overstatement of 2018 profits by around £4m and the departure of the CFO.

Underlying profits are expected to be down from £39m in 2018 to around £10m in 2019.

The Board expects year end net debt to be approximately £50 to £55 million, in line with current market expectations. Staffline maintains a constructive relationship with its lenders and consequently the Board does not anticipate any covenant issues over the year end. Furthermore, the Company is considering certain strategic options which may significantly reduce net debt during H1 2020.

So there is some concern that the company may simply run out of money, in August 2019 the auditors PriceWaterhouseCooper resigned, it is hard to know if there is anything that a shareholder should infer from this though.

The half year results were significantly worse than I had expected, so where does this leave the share price?

The underlying earnings for the full year 2018 were affected massively by adjusting for the Minimum Wage payments, £15m and Reorganisation Costs of £10.6m but the half yearly adjustments for 2018 were roughly half of those 2019, £4.5m rather than £9M.

Debt is much higher that I was expecting, at the time of the placement, net debt was expected to be 2x EBITDA by 31 December 2020. So how has it gone from £63m to £89m?

The Board expects net debt to be c2x EBITDA at the year-end benefiting from the proceeds ofthe equity capital raise and trading in the second half of the year.

The board expects the Group to deliver full year adjusted operating profit (being profits before interest, tax and non-underlying charges) of approximately £20m.

Just how much this adjustment will be is of course unknown, but the current market cap of the company is about £82m so surely we are looking at a P/E of between 4 and 8 at the moment.

Recruitment profit has fallen a bit per branch, down to 7.2% from 7.8% so the overall increase is a result of acquisitions, and People Plus sales have dropped bringing the margins down from 39% to 22%.

Given this I see a strong possibility of a strong share price rise, but the recent share volumes suggest that the price will stagnate again within a few days, once the excitement generated by this announcement dies down, I am also seeing 4% spreads.

So is the company a takeover target, either by a big competitor, or from its larger shareholders?

HRnet Group currently holds 29.9% of the company, this is surely deliberate as they bought 11.7 million shares at a premium to the market price after the recapitalisation, around 190p when the quoted price was around 150p.

They are an Asian recruitment company with revenue of S$428m which is roughly £248m so it would not be an easy to fund offer. However they may make an offer if they had assurances that some of the other larger shareholders would not accept the offer, there are other shareholders with 13.7% (Octopus), 8.5% (Invesco) and 7.3%(L&G).

For someone like Reed or Randstad this may appear to be a cheap way to acquire a lot of business and lose a competitor.

Either I am completely wrong and am misunderstanding the company or the market of this is a bit of a bargain. My main worry is that the group has borrowed to expand and this has left it with a significant amount of debt possibly along with a drop in revenue per branch.

There is a trading update for the six months ended 30 June 2019 scheduled for Tuesday, 17/Sep/2019 and I am expecting an acceptable
set of results as there was downbeat trading update in May.

Staffline shares generally have very low trading volumes and as described in previous commentaries the company has been through a very rough patch.

Adjusting for the share issue, the current price of 156p is roughly equivalent to 346p and the last time that the share price was around there was March 2013.

Year ending 2013 saw revenue of £416m and an operating profit of £13m.

On Monday (15th) there is a vote to approve a massive share issue, the share issue itself appears to be fully subscribed if it is approved and will be admitted on the 16th.

The placing will raise £34 million by placing approximately 122% of the Company's existing issued share capital at 100p per share.

On Friday the market closed at 107p per share, down from the 800p to 1200p range that it has been trading at over the last couple of years but up from the low of 85p.

Post issue this gives an adjusted range of 360p-504p.

The reason for the issue was three fold, not paying wages during “change for work hours”, about £15m wiping out the genuine profits for the year, costs associated with changing part of the training division and borrowing to buy other agencies.

2019-2020 is predicted to be a difficult year and I find reasons to believe that the profits could be similar to 2016, and the “change for work hours” really is a one off exceptional cost.

So the real question is the demand for temporary staff, especially from the better payers such as the car industry, still there or does the group have too many branches?

I mentioned in an earlier commentary that I was surprised by the market taking the price up to 140p after announcing that a share issue would be needed by without a price.

Those who bought in at 85p will have done well but had the shares been priced at 50p it would of course been a different matter.

I waited until the circumstances were very clear and have bought in at a bit over 100p, so my gains (hopefully) will be less than those who bought at 85p but I may not be tied in for so long as someone who bought at 140p.

If I am right and the price creeps back to 200p well under the adjusted 360p value then the returns will be good and the risk of loss relatively low.

As expected Staffline have just announced a share issue at 100p, although at £41m it is a bit higher than the £37m proposed about 10 days ago.

After the disastrous announcement on the 17th of June that the company had a £15m bill for unwaged wages due to underpaying the minimum wage, a poor trading year and a proposed £37m share issue the share price dropped from about 250p to 100p.

I expected it to stay at around this level or drop even further yet it rallied to nearly 150p dropping to only 120p when the share issue was announced.

I was really surprised to see retail investors buying in to a company that had such a difficult future and knowing that a share issue was about to be announced.

I get that there may be a long term price growth as for most of the last 5 years the price was around 1000p but a doubling or trippling of the number of shares was clearly on the cards. So post share issue price growth is pretty unclear

Much of the net debt increase was due to £50m being spent on acquisitions, and reducing this debt along with the unexpected £15m wage bill is the reason for the proposed share dilution.

I am not at all sure that I like to notion of incurring debt and then doing a share issue to raise funds to pay it off.

With no 2018 final dividend and none proposed for 2019 and 2020 a lot is being asked of existing and new shareholders, C Pullen’s salary has risen from £295K to £325K and M Watts’s from £180K to £220K but at least they waived a 40% of salary bonus and there is some commitment to the share offer.

Director                Intended Participation
John Crabtree, Chairman £25,000
Chris Pullen, CEO      £100,000
Mike Watts, CFO         £18,000
Ed Barker, Non-Exec     £10,000
Tracy Lewis, Non-Exec  £100,000
                 Total £253,000

Clearly the top level management has lost control, but there is still a profitable business so I would be surprised if the share issue is not approved and taken up.

I have been watching Staffline since the announcement that they were going to suspend publication of the 2018 accounts.

Most of the issues haven’t changed since the previous commentary except the cost of meeting minimum wage requirements the reason for delaying publication.

The amount that has to be paid to workers has gone from £4.4m to £7.9m to £15.1m, this includes £0.5m in advisor fees and £1.8m extended audit procedures. It expected that none of these costs can be recovered from the companies that the agency staff were working for.

Along with other exceptional costs this means that the total exceptional charges for 2018 will be £32.6m.

No matter how you try to arrange these numbers, the fact is the £14.5m in back wages will have to be paid in cash and reasonably quickly.

A trading update in March said that the Group expects to report net debt of c.£63m (unaudited) as at 31 December 2018. Add in the £15m in back wages and an expectation of only a small profit in 2018 and things look pretty unhealthy.

Recognising this the company is now discussing raising £37m by a share issue, £30m being a non public placing and £7m being an open offer.

The current share price 170p gives a current market cap of £47.5m, so getting close to a 1 share for every 1.2 shares held.

That it got this far is worrying, I understand that when the minimum wage came in there was confusion over whether getting changed was counted as work time.

I don’t understand how such a bill came about covering such a long time span though, it’s almost as if nobody wanted to confront the issue.

The share price is now 129p so the market cap is now £36m, less than the proposed isssue amount.

StaffLine shares were suspended on at the end of Jan 2019, something that always makes investors nervous and restored in early March.

At the time the reason wasn’t entirely clear and at the time of writing there is still some uncertainty. The key outstanding matter in finalising the results relates to the Group's historical compliance with National Minimum Wage Regulations 2015.

Given that the company is a recruitment agency it seems likely that is going to cover an area that other companies have also been found to be handling incorrectly but this could be over 3 or 4 years. The company appears to be putting aside £7.9 million to cover this, whether this is enough or like banks PPI costs it will escalate I have no way of knowing.

As the 2018 accounts due to be published at the end of Jan are still awaiting the results of this investigation so looking at the numbers is difficult.

The expected $1bn revenue for 2018 is double that of 2014 (£503 million) and more than double 2010 (£206 million) and underlying profit has roughly grown at the same rate as have dividends, reported profits are similar but slightly less at £24 million in 2017, 2014 (£10.5 million) and 2010 (£7.5 million)

So why the panic drop from 800p to 300p?

The company was reporting net debt of £63 million at the end of 2018 up from £16.5 million at the end of 2017 along with £23.5 in exceptional costs for 2018, so it seems 2018 may be a less profitable year than 2017.

Reading the trading update the Board now expects the Group to deliver adjusted EBIT in the range of £23 million to £28 million for the financial year ending 31 December 2019.

Then looking at the 2017 annual report and the difference between underlying profits and reported profits this seems to be saying that 2019 will not be a great year, there is too much uncertainty in the updates to be more specific.

So has the bubble burst for the group, has it grown to fast?