Investment Column: Smiths News faces structural challenges

NetPlay TV; Zoo Digital


Our view: Sell

Share price: 88.75p (+2.25p)

Smiths News is a company steeped in history, as it never fails to point out. It traces its "distinguished heritage" back 200 years to Henry William Smith and his paper round. Yet it operates in an industry facing as significant a structural change as at any time since Mr Smith trudged round bringing news to the neighbourhood.

Smiths News split off from the famous WH Smith Group in 2006 to focus on the business of wholesaling newspapers and magazines around the UK. Yet shortly after the demerger, the company faced the prospect of increased pressure on the media industry during the downturn.

Yesterday, it announced results for the six months to 28 February and revealed that a cost-cutting programme had seen the group lift profits, yet this came on declining revenues, with management blaming the fall in newspaper and magazine sales. Revenues from the latter are down almost 10 per cent.

Pre-tax profits rose 22 per cent from a year earlier to £18.7m, while revenues fell 5 per cent to £872.3m. The cost-cutting strategy introduced by management took out £11m from the first six months, with a further £9m to come by the end of the year.

But there is only so much cost cutting management can do before it hits the bone. Chief executive Mark Cashmore said yesterday that it had identified "clear acquisition targets in our preferred sectors" in a bid to reverse falling sales. Yet the diversification strategy remains shrouded in uncertainty and seeking deals is a route studded with pitfalls if it is not properly executed.

The group's debt is perfectly manageable and investors should have been pleased after the dividend was lifted. But again, the headwinds remain, with analysts pointing to the decline in print media, changing consumer habits and the rise of digital media. Profits also sank 12.4 per cent at its book wholesaler Bertrams. Management have performed ably so far, but we are not convinced that the shares will increase in the near term.

NetPlay TV

Our view: Hold

Share price: 8.88p (+0.13p)

Despite its name, NetPlay TV is not limited to offering gambling games solely to those high rollers playing in front of their living room telly. With brands including SuperCasino and Challenge Jackpot, it also offers punters the opportunity to place bets on games including roulette and bingo on their mobile and over the internet.

And NetPlay is having success in converting the players who come on board through the television to playing on other platforms. Yesterday, it published a first-quarter update which showed another strong performance, and which was met with some enthusiasm among analysts.

In particular, it said the mobile business was improving. A fifth of SuperCasino players joined via its iPhone application in the past three months. Management is also confident that the opening of the Italian online casino market will see the group expand beyond the UK. The update marked the latest step in the company's rehabilitation. It left us hopeful, but we would still wait to see further signs of progress before buying in.

Zoo Digital

Our view: Hold

Share price: 44p (-7p)

Zoo Digital licenses out software to adapt media to different formats and languages, specialising in things such as the authoring of DVD discs and the translation of DVD menus and websites. Yesterday's trading update suggested that demand for its services was holding up well, with profitability for the year to March expected to be in line with market hopes.

The company also revealed that its year-end cash balance stood at $600,000, which, taken in together with its bank overdraft facilities, leaves Zoo in good financial health. The slight negative was news that organisational changes at a major customer had triggered a short-term slowdown of orders, and had thus had an adverse impact on revenues. However, on the upside, Zoo added that "demand from the division most affected" by these changes was now increasing and it expected "further revenue recovery going forward".

Overall, then, the update was reassuring, and argues firmly against a "sell" stance. But, with the shares trading on an enterprise multiple of nearly 11 times FinnCap's estimates for 2011, we would wait until the preliminary results later this year before wading in.

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