High profile for image makers

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The Independent Online
BUSINESS in Britain is being transformed by specialisation, as companies focus on what they do best and contract out non-core activities. This process is spurring dramatic growth in some unlikely areas.

The two companies featured here are specialists in direct marketing and display services respectively. Skilful implementation of the latest technology is enabling them to gain share in strongly growing markets, helping profits to soar. They represent an interesting way for in- vestors to take advantage of the contracting-out trend.

Colleagues, at 205p, is a Bath-based group that helps blue-chip companies exploit direct marketing more effectively. It does this by focusing on every aspect of the activity - from design to printing to database management and response analysis - to do it better and cheaper than even giant companies can. Further benefits come from bulk buying, with Colleagues expecting to handle more than a billion inserts this year.

The results of the formula are explosively profitable, because a lower break-even point per insert or mailing encourages the group's clients to increase their direct-marketing budgets. When the shares were floated at 115p in March, the chairman and founder, 41-year-old James Robson, made no secret of his belief that the group was absurdly underrated on a historical price-earnings ratio of 12.1.

Apart from general malaise in the new-issue market, investors may have been influenced by the unfamiliarity of the business and the fact that more than 70 per cent of 1994 profits came from one customer, Sun Life. Common sense says that is good reason for caution. But the reliance on Sun Life is, in a way, a tribute to the power of Colleagues' business. Since Sun first became a customer, its annual direct-marketing spend has risen more than tenfold to an expected pounds 20m this year, with its proportional contribution set to fall. A more positive interpretation would focus on the potential of the group to build up other blue-chip accounts, such as Barclaycard, Eagle Star and Frizzell, in the same way.

Analysts' forecasts for calendar 1995 profits are pitched at pounds 4m-plus, against pounds 3m achieved for 1994 - itself nearly 10 times the profits reported for 1990. My impression is that trading is buoyant and that expectations may be revised upwards after interim figures are reported in the autumn. On a prospective p/e in the mid-teens, with excellent prospects of further growth, the shares look attractive.

Photobition is another recently floated company, which services the display industry. Its chairman and chief executive, Eddie Marchbanks, describes its business as anything to do with images used for display purposes, typically in museums, retail environments or airports. Founded 27 years ago as a photographic laboratory, the group now has a much broader base. A hiatus came in 1990 with acquisition by the quoted marketing services group FKB. That went bust, leaving Photobition to be bought back by its management, just in time for a recession that forced many rivals into bankruptcy.

In the past four years, the group has grown from two businesses to nine,while profits have roughly quintupled. Promotional spending tends to rise late in the economic cycle, with a general advance in spend becoming noticeable about nine months ago. Levels of activity are described as very buoyant.

The impact of new technology is creating a virtuous circle of growth. Not only is capital spending at high levels - around pounds l.5m in the past 12 months - but the group has formed a subsidiary, Colour by Colour, which began trading last September, handling sales of electronic imaging hardware. Another subsidiary, Scan Display, which makes display systems, is growing fast.

In a fragmented industry, smaller rivals find it hard to fund implementation of the latest technology, which is creating acquisition opportunities for Photobition. Any deals are likely to be earnings-enhancing with a strong probability of action before the end of the current financial year next March. Even without such deals, analysts are looking for profits to rise to pounds 3.2m for a prospective p/e of around 11 at 227p, falling further the following year, if profits continue to rise to a tentatively forecast pounds 3.6m. The share price has already advanced 50 per cent since flotation, but the best should be still to come.

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