The Investment Column: Snap up Thus as acquisition hopes bolster prospects

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The Independent Online

Our view: Buy

Share price: 131p (+3p)

In the words of Bill Allan, the chief executive of the telecoms provider Thus, the company is "very prudent and conservative". That prudence resulted in a better cash performance than analysts had expected in the year to March, as the Glasgow-based Thus rapidly improved the cash profile of Your Communications, which it acquired during the year.

Thus also performed well at the revenue and earnings lines. However, it is the integration of Your Communications and Legend, which has yielded annual cost savings of £25m, where investors should perhaps focus. Thus has not only bulked up its customer base and improved the operating performance of those small-fry companies, it has done so without weakening its balance sheet. As its financial performance improves, investors should expect Thus to continue to add small competitors to its stable. If it chooses well, acquisitions should accelerate its drive towards an inaugural net profit.

Despite the improvement of its balance sheet, investors have yet to get excited. Thus's shares have lagged its UK fixed-line rivals by about 18 per cent over the past year, despite the travails of Cable & Wireless. Its share price has been inhibited by fears of competition in the broadband internet market, where Thus operates under the Demon brand.

With revenues forecast to improve to between £520m and £540m this year, from £372m in fiscal 2006, Thus needs to maintain its margin profile. The company benefits from strong margins in its broadband business, where the price war has yet to impact on its profitability. It gets almost one-quarter of its revenues from its internet unit, meaning the impact of competition in the small-business market could prove disastrous. Yet Thus also points to its strong pipeline in managed services contracts, which could drive improvement in its margins.

Thus shares have yet to factor in the sale of its Dutch internet business to KPN at a higher-than-expected price. Despite the lack of excitement at the financial improvement, longer-term investors might think about buying the stock on the prospect of further acquisition activity or even an offer for the business.

Leisure & Gaming

Our view: Buy

Share price: 136.5p (unch)

Since Leisure & Gaming was created two years ago to tap into the online gaming craze, it has unveiled a spate of acquisitions: VIP, a US sports-betting and casino business, Nine.com, another US sports book, and English Harbour, a US internet casino operator. Yesterday the fast-growing company snapped up Betshop, in a £32m deal to branch out into Europe.

L&G listed as a cash shell on AIM in September 2004, and bills itself as a consolidator of smaller online gaming firms. That means it has become a new force in the competitive online gambling world, with strong sports betting and casino brands. The business generates a lot of cash and is well-placed for further deals.

L&G's maiden results showed proforma net win up 32 per cent to $80.9m (£44m) and proforma pre-tax profits of $13.2m, assuming the acquisitions had been made at the start of last year. For this year, analysts expect organic growth of about 24 per cents. The key risk for investors are attempts by US politicians to clamp down on online gambling. While similar attempts have failed in the past, and the current anti-gambling initiatives are unlikely to get passed, the issue will hang over the industry at least until autumn. While its shares could be hit by US regulation fears in the short term, they should do well in the longer term as the appetite for online gambling shows few signs of fading.

Celtic

Our view: Avoid

Share price: 28.5p (unch)

There are 158 mining companies to choose from on AIM, and among the new kids on the block Celtic Resources is something of a veteran, having been listed since April 1996.

Yesterday's results were disappointing, showing a decline from pre-tax profits of $5.7m in 2004 to a loss of $263,000 last year. The company blamed a 39.6 per cent jump in operating costs, on top of a $1.3m loss on foreign exchange.

Celtic operates two gold mines in Kazakhstan and has strategic investments in two other listed companies, Victoria Oil & Gas and Eureka Mining. Gold production climbed 14.9 per cent in the past year, and with a cash injection of $80m from the sale of a 50 per cent interest in the Nezhdaninskoye gold mine in Russia, the company's financial security looks solid. But with so many other mining stocks to choose from it is difficult to recommend buying the shares.

If demand for gold keeps growing, Celtic looks like it's worth a punt, with secure funding and good prospects for increased production in Kazakhstan. However, costs are not going to come down overnight and, for the time being, there are more exciting opportunities for small-cap mining investors.

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