Is it time to plug into Ellies?

There is hope for plenty of work when the new TV broadcast technology comes into operation

The stock exchange performance of former stock market darling Ellies Holdings could be likened to the travails of President Jacob Zuma; both saw a pocket of glory in the run up to the 2010 Soccer World Cup and both since then have been on the skids.

As SA’s largest installer of DStv systems and having a well-known electrical accessories brand, Ellies rode the World Cup to its advantage and used its rising share price to move into the (then) hot sector of power infrastructure by acquiring Megatron Federal for R180m in 2008. In hindsight, this was a bad move as Ellies could not support the vast working capital demands of the infrastructure division.

The success of the World Cup, the profits from infrastructure and a “juicy” deal during the Eskom power supply crisis brought super profits. The parastatal paid companies a success fee for every megawatt saved from the grid.

Eskom soon cottoned on to the fat profits companies were making off the first phase of the residential energy efficiency programme (REPP) and phase 2 saw much greater competition and keener margins. But it postponed phase 2 of the REPP in late 2013 and the “kicker” that Ellies had been hoping for in its FY14 results failed to materialise.

The wheels started to come off the Ellies bus shortly thereafter. The first profit warning was issued in December 2013. Several more profit warnings and weak earnings ensued and by the end of 2014 Ellies was trading at around 120c, a rapid descent from its 700c a year prior.

Plunging profits and weakness in its infrastructure division brought a cash crunch at Ellies, with rising debt, soaring inventories and working capital issues. Ellies made its first rights issue in late 2014 to raise R115m and a second to raise R180m in mid-2015, both at 110c/share.

The proceeds were used to repay debt and provide working capital for the business. At the time of the second rights issue, Ellies announced plans to split into two units — Ellies Consumer and Ellies Infrastructure.

That process has been going for on a year. The main reason for the delay is that management wants both counters to be listed on the JSE’s main board, but at present their profitability and size only make them suitable for Alt-X status. That would not go down well with certain institutional shareholders who have no mandate to own Alt-X counters.

With the share price hovering at a new low in the 60c range at the time of writing, and having raised more than R300m of new equity at 110c/share, Ellies has “burnt” shareholders who followed their rights.

With a tangible net asset value of 130c/share at the time of its improved interim results for the six months to October 2015, one could argue there is recovery value in Ellies. But that does not paint the whole picture.

Having cleaned the decks at the infrastructure division and with the core consumer division chugging along, first-half 2015 results showed a smaller HEPS loss. But challenges remain; infrastructure continues to need capital and separation of the two operating units will probably require Ellies Infrastructure to seek further capital on its listing. This is a risk.

Ellies Consumer is probably the business to be in after the separation. It’s a solid operation and has potential to expand its product base. The long-delayed digital terrestrial transmission migration will put new television reception aerials and set-top boxes in millions of homes to continue to receive the SABC channels. This is Ellies’ bread and butter, and government plans to spend billions to subsidise this process. This will provide years of potential work for Ellies.

But 2016 will be another financially tough year. The split needs to occur and investors will need to see the terms and conditions of the listings and ascertain if there is any further cash call; I fear there will be.

Existing Ellies shareholders who have endured the share price collapse have little choice but to hang on. The real money to be made in Ellies will be for new investors plunging in on signs of recovery and the separate listings. I advise “caveat emptor”.

The proceeds were used to repay debt and provide working capital for the business