Scantech Limited (ASX: SCD): a cautionary tale

Scantech is an Australian company that provides on-line real-time measurement technology for bulk materials. Their equipment is primarily used in the cement, coal and minerals industries. Scantech’s equipment can analyse the quality of the materials and can help companies with the blending, grading and sorting of those materials. Examples of their products can be found on their website and include Coalscan and Geoscan. Scantech describes itself as the world leader in this industry in the annual report.

The company is a microcap, Scantech has a market cap of just $9.9m AUD.

Unfortunately this will not be a post about a wonderful little company that is very cheap. I just revisited the company last night when reviewing my watchlist and became more and more appalled as I read how minority shareholders are being treated here. I do think the situation provides a good cautionary tale, also for myself, so I decided to spend a bit of time to write this post and describe what is taking place here.

You can find all the documents referred to in this article on the ASX website: http://www.asx.com.au/asx/statistics/announcements.do?by=asxCode&asxCode=scd&timeframe=Y&year=2015

Insider ownership

A good place to start in this case is the insider ownership of Scantech. Below are the members of the Board of Directors and their shareholdings in the company at the end of fiscal 2014. The total number of shares outstanding at that time was 17.56 million.

  • D.J. Lindeberg: 3,588,301 shares
  • P.D. Pedler: 728,885 shares
  • L.C. Brett: 827,476 shares
  • D.C. Brown: 55,000 shares

At the end of fiscal 2014 insiders owned 29.6% of the outstanding shares.

Large cash balance, discount to BV

The second thing that is relevant is that the company has a large amount of cash on the balance sheet. As of June 30, 2015 the company had $7.5 million in cash. There was also $2.0m of debt, but that still leaves a net cash position of $5.5m. That’s about 56% of the market cap. Scantech trades at just 74% of June 30, 2015 book value.

Reasonable results & NAV growth

Scantech has had some pretty big swings in profitability over the last six fiscal years.

Profit (loss) after tax:

  • 2015: $0.97m
  • 2014: ($0.27m)
  • 2013: $3.12m
  • 2012: $1.70m
  • 2011: $0.08m
  • 2010: $0.44m

This is a graph of the development of NAV per share over the years:

Scantech NAV per share

Overall I think this shows a reasonably positive picture.

What could also be an important development for the company is the steadily rising services revenue. As the number of installations using Scantech products rises, the revenue generated in servicing these installations also rises. This is significant, because it could dampen the cyclical nature of the industries to which Scantech is linked.

This is the services revenue of the last six years:

  • 2015: $7.25m
  • 2014: $6.03m
  • 2013: $5.22m
  • 2012: $4.52m
  • 2011: $4.2m
  • 2010: $3.7m

Scantech’s product sales show a much lumpier picture and seem closely linked to the cyclical swings of the mining industry.

The Proposed Delisting

On August 14, 2015 the company called a General Meeting to let shareholders vote on 2 resolutions:

  • The delisting of Scantech’s shares from the ASX
  • The on-market buyback of 15% of the company’s shares

The reasons for the proposed delisting include the very low liquidity of the shares and the abuse by competitors of the publicly traded status of the company. On this second reason: the company describes a fake takeover proposal it received last year from a company in Singapore. Scantech says this caused them problems in winning contracts as competitors pointed to the “fact” that Scantech was involved in a takeover battle.

After delisting Scantech plans to set up a “Low Volume Financial Market”. Shareholders would still be able to trade via this facility, but it should be obvious that this is not a good option for many shareholders. You will probably not be able to access this market through your current broker. Of course the company would also no longer be subject to the rules that apply to an ASX listing and shareholders would lose that protection as well.

I don’t like the delisting proposal. As a board member you have a fiduciary duty to all your shareholders. I don’t see how this delisting benefits smaller shareholders. These shareholders might not represent many shares, but these are real people and there a few hundred of them. In my opinion it would have been much fairer to these shareholders to first make a tender offer that gives shareholders a reasonable price for their shares. I think that price is well above today’s price levels. Other options could have been to first pay-out a large special dividend or for management to buy out all the other shareholders.

The 10% Share Buyback

The delisting seems bad enough of itself, but Scantech management managed to do even worse. On August 21 Scantech mailed a letter to shareholders announcing the General Meeting in which they also announced it is currently conducting an on-market buyback of 10% of the issued shares. The company didn’t need approval for this 10% buyback. Note: this is not the proposed buyback of 15% of the shares for which the company is seeking approval.

I guess this is not illegal, but I think it should be. This buyback is just taking advantage of the forced selling and capitulation of existing shareholders caused by the delisting proposal. In the letter the intention of the buyback is explained as “an opportunity for shareholders to realise their investment in the Company”. That’s one way to explain it.

Another way to explain might be to say that this buyback allows management to increase their stake in the company by taking advantage of the forced selling at depressed prices and thereby also increasing the chance that the delisting proposal itself is passed. If I have read it correctly, only 50% of the shareholder votes are required for the delisting to be approved. At the end of fiscal 2014 management already owned almost 30% of the shares.

On August 28 Scantech announced it had repurchased 674,023 shares at an average price of $0.51. They also announced that the buyback will be extended to 11 September.

Conclusion

This post serves more of a warning, primarily to myself, because I’ve looked pretty hard at Scantech a couple of times and could easily have been a shareholder today. I need to be a bit more reluctant to invest in the most illiquid stocks with high insider ownership in markets such as the ASX and also AIM in London. You’re just not well protected as a minority shareholder there and in my opinion it is much too easy for a company to delist there. In Singapore for example, minorities seem better off as a company seeking to delist needs to make a reasonable exit offer to shareholders. In the US there’s usually an active market on the pink sheets when a company delists.

As a minority you can get in a situation where the incentives cause management to screw you when a company’s business improves and to let you suffer when business stagnates or deteriorates. Heads you don’t win, tails you lose. This is not a situation you want to be in, so the upside must be pretty dramatic to compensate for these risks and you should also have strong indications that management is friendly towards minority shareholders.

My guess is Scantech will start paying a dividend (or pay a large special dividend) once the company has delisted. People forced to sell today will not see anything of this money. Perhaps management will think of other ways of extracting money from the company in the future.

Disclosure: NO POSITION in Scantech.

Posted in Australian stocks, Small caps.

NeverLoseMoney

Author of ValueInvestingBlog.net. Private investor.

5 Comments

  1. Good article. This happened to me once with a company whose name I have forgotten….it did start out as Yates, and then eventually became known as Mark Sensing. Anyhow, no chance of a dividend as most of the profits were consumed by extremely high wages paid to the family employees.

  2. Thank you for the write up as usual. Very interesting.

    “In Singapore for example, minorities seem better off as a company seeking to delist needs to make a reasonable exit offer to shareholders.”

    What are your thoughts on ‘delisting plays’ or investing in companies with a high chance of delisting on the SGX? I would love to be able to find case examples of such scenarios.

    • I have no idea whether this is an attractive area to invest. It seems to me that many of those companies will try to make a low exit offer to shareholders or otherwise move to Catalist if possible. On the other hand companies that are at risk of being delisted might be trading at very depressed prices.

    • I think it is a lot better than in many of the other markets I also invest in, like Hong Kong. But I do think you need to be aware of special situations like delisting rules. The question is “bad” compared to what? Perhaps governance is not up to the standards of large cap companies in the US. But there are plenty of examples of terrible behavior by management in the US as well, especially among small, unlisted companies.

      It just comes down to evaluating the insiders at individual companies and making a judgment. If they are dishonest people or if the wrong incentives are in place the rules are not going to protect you anyway.

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