How splendid raising capital by a rights issue instead of shares to friends in investment houses ... this is surely a winner.

Stock to Watch: The Innovation Group
By Edmond Jackson | Fri, 09/12/2011 - 00:00

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

A compelling aspect of stockpicking is that no matter how bad the business news, there is always some company somewhere, able to prosper. Industries change and technology drives fresh demand. You still need to pay attention to the economic outlook and apply tests for value, but turning a blind eye to shares will mean missed opportunities.

So it is interesting to note how the 6 December prelims (to end-September) from the Innovation Group (TIG), a FTSE SmallCap provider of outsourcing services and software to the global insurance industry, delivered a 54% advance in adjusted pre-tax profit to 15.1 million on revenue up 9% to 175.9 million. Operating cash inflow jumped 119% to 16.9 million. Management says the group is "positioned for continued growth in 2012".

The city consensus as shown by Company REFS expects normalised pre-tax profit to rise about 20% in the current financial year, for a similar rate of earnings growth, compared with a forward price-earnings multiple (P/E) of 15 times with the shares at 18p. A legacy of 940 million shares in issue means it doesn't take much price movement to affect the P/E, even for a firm capitalised at 170 million. There is also no dividend, having only been a fleeting payout of 0.45p a share for the 2007/08 year, which was axed to 0.05p then eliminated. So there are a couple of issues in TIG's financial profile telling you there is some history here.

Yet the outlook message is: "We feel strongly that we have now moved from being a turnaround business to a business delivering sustainable and profitable growth." One broker report after meeting the management post-results cites a revenue pipeline more than twice improved, year-on-year, and the software element increasing, hence better margins.

"Top-down" it looks as if insurance companies will need to continue deriving economies from outsourcing; the group's revenues comprise 152.8 million "business process outsourcing" and 23.1 million software. TIG's Insurer Claims version 7.0 software is described as well-received and expected to build revenue through 2012. Yet the 2008 financial crisis and its aftermath showed how care is needed towards the insurance industry lest the eurozone debt crisis spirals. Profits were hit by "financial turbulence and customer contract delays" despite good progress extending the brand internationally. This coincided with TIG needing to make its own changes towards better efficiency: while 2007/08 revenues grew 27% near 140 million, a 3.8 million pre-tax loss prompted a restructuring also changes among principal board members.

The company also needed beefing up financially to be able to meet the requirements of large insurance companies. TIG's large number of shares issued partly results from untimely offers: after the price dropped from a 30p range to low single figures with the 2008 financial crisis, in May 2009 TIG needed to raise 5 million via a placing at 8p a share and at end-2009 a further 21 million via a placing/offer at 10p.

At least this has helped put the balance sheet in a pretty strong position: at end-September debt was a low 10.4 million, if mainly short term, and outweighed by 43.1 million cash such that the net interest charge was 0.3 million against 10.1 million operating profit. Within 107.9 million net assets, 94.2 million represent goodwill and intangibles, although this is fairly typical of a business involved in software and acquisitions.

Customers are well diversified across global insurance markets, fleet and lease management firms, also in financial services. TIG is not directly exposed to consumers cutting back (renewing) insurance policies because they can't afford them during a recession. Nor should motor insurance reduce unless people are willing to break the law. Accidents and claims will continue and are probably less sensitive to the economy. So TIG's services have an essential aspect, dealing with over five million claims a year.

So this company ought to be reasonably recession resilient now it is restructured and the new management has shown what it can deliver. It is going to need a European catastrophe affecting the wider world to knock this company now, but in a stagnant environment it can prosper.

Brokers have remained supportive despite the post-summer price drop, and following prelims Panmure Gordon has upgraded its 2011/12 earnings per share target from 1.4p to 1.5p also its target share price from 27p to 29p. Given this implies a P/E multiple over 19 times I suspect it will be difficult to achieve in the 2012 environment, although TIG's risk/reward profile looks to weigh on the upside.

There may also be takeover prospects in the current time window before TIG's earnings track record gets better established and its shares return to the dividend list. A profile of operational momentum, good cash generation and aspects of earnings dependability ought to be attractive to an industry buyer.

With the results, a 13 million acquisition of Claims Services Australia was announced, providing similar outsourced motor and property claims management services for Australian insurers. This being the leading specialist outsourced claims management company in Australia, it is hoped that synergies will arise with TIG's current operation by offering insurers the benefit of a broader service offering also sales volume to the target's infrastructure. This kind of acquisition is likely to typify future deals, to enhance earnings.

The overall sense of a relatively attractive share is affirmed by some substantial trades on the prevailing offer price of 18p on 7 December: 1.8 million shares and four other trades of just less than one million shares each. There has not been any directors' buying as the shares retreated from 23p, although the chief executive owns nearly 2.6 million shares, the chairman 1.2 million and the finance director 0.7 million.

In conclusion TIG cannot be described as a truly defensive share while black clouds of the eurozone crisis hang over, but if a major storm can be avoided then it is one to follow in the weak economic environment.

For more information see www.innovation-group.com, and for more stocks to watch visit Edmond's archive.

StockMarketWire.com
Innovation Group has signed a major contract with Lloyds Banking Group for its market leading claims scoping solution Innovation Symbility.

The new contract, which is for an initial period of five years, will be charged on a transactional basis and will contribute about £7m to Innovation Group revenues over the term with volumes expected to be fully ramped by Q1 2014.

The Board of Innovation Group (LSE: TIG.L) notes the recent press speculation and confirms that it is in advanced discussions with The Carlyle Group (“Carlyle”), at 40 pence per share in cash, which may or may not lead to an offer being made for the Company.

This announcement is not an announcement of a firm intention to make an offer under Rule 2.7 of the City Code on Takeovers and Mergers (the “Code”). A further announcement may be made shortly and will be made as appropriate. However, there can be no certainty that an offer will be made, nor as to the terms on which any offer will be made.

This announcement is made without Carlyle’s consent.