Frontier Smart Profit Warning: Share Price Halved

Frontier Smart Profit Warning: Shares in digital audio specialists Frontier Smart Technologies (LON:FST) halved today as it cites several factors for a reduction in revenues and profits. The share price immediately reacted:

This has been really a latest in a long series of declines for this company. Checking back through the history is fairly illuminating. Last year there was another Frontier Smart profit warning and the share price was 90p at this point. So today’s fall caps a rapid decline. The market cap is now just above £4m, which is fairly negligible as far as valuations go and is among the smallest we have covered here.

Going back further, we can see that perhaps Frontier Smart is perhaps a template of what happens when businesses do not work out. It was originally part of a larger group called Toumaz. They divested a healthcare business which was burning through cash to leave the current one. This also looks to be doing the same.

The valuation of the group then was some might call, ‘blue sky’, which attributes an incredible amount of value onto the potential of the company, in effect, paying for future earnings today. This can be seen in the previous share prices, reaching a peak of near 750p a decade ago, this was still trading well above 100p last year.

What did the Frontier Smart profit warning say?

The warning comes in a trading update RNS. Despite the small size of the company, it is actually fairly detailed and much better than others we could mention.

We start off by recapping the previous years objectives (maximising cashflows and establishing new business). The bad bit hits:

However, a review of current trading and market conditions has identified three factors which are expected to have an adverse impact on the Group’s trading performance in the current financial year:

– an increase in competitive pressures in Digital Radio;

– continued weak sales of the Group’s legacy Smart Audio hardware products; and

– the ramp-up timing of the new Smart Audio/IoT licensing business.

As a result, the Board now expects to report for the full year:

– sales of approximately US$36.6 million;

– an Adjusted EBITDA1 loss of no worse than US$0.9 million; and

– a Trading EBITDA2 loss of no worse than US$1.5 million.

Due to the seasonality of the Group’s business, the Board anticipates an H1 2019 Trading EBITDA loss of US$2.2 million followed by a return to EBITDA profitability in the second half, as was the case in the last financial year.

Some specific details here, but it does not sound good. Without referencing what previously happened we have to look back ourselves: 2018 revenue was $41.8m, adjusted EBITDA was $1.380m, trading loss of $3.280m.

On the first two items this looks bad, and the second improvement conditional on a marked pickup in H2 when momentum seems to be downward.

There is a note about cash:

As at 30 April 2019, the Group’s gross cash position was US$2.6 million (net debt of US$3.9 million). Frontier is reviewing its plans for mitigation and the Board is confident that the business will return to Trading EBITDA profitability in the second half of 2019 and for the full year 2020.

As far as I can make out this is also slightly down, a year ago the cash was at $3.8m and loans seem to have stayed the same.

The Business

Frontier describe themselves as pioneers in the supply of software and hardware for Digital radio. They are also leveraging their position to move into the much newer Smart Radio space (devices which are connected to the Internet).

This seems to be a very exciting space to be operating in if your products can gain a foothold. Sadly for Frontier it seems that this has not occurred. Digital Radio was heralded as the future when it arrived. It offered a myriad of benefits to the consumer such as clearer reception, a greater choice of channels and a greater transmission of information. Sadly, for whatever reasons there have been little advances in the technology over the past decade. A quick browse of Argos shows that the DAB radios for sale are more or less the same as the ones on sale about 10 years ago, and at the same price. That is bad news for companies like Frontier, as the market can quickly get saturated. For example, I have a Panasonic DAB radio purchased around 2004, and there is no compelling reason at all for me to upgrade it.

Smart Radios are definitely in a better place, with genuine functionality being seen in the new devices such as Google Home and Alexa. There also appears to be a greater drive in technology here, with many syncing with phones and gaining video screens. It is here where a good opportunity lies, but at present it seems that Frontier are being cut out of this. Their Smart Division remains loss making. In not so many words, companies such as Google and Amazon are spending incredible amounts on their products. What are the chances that a small company like Frontier has something they have missed? It’s possible, but not likely.

If there was something good to say about the business, it is that after a period of huge cash burn, the rate is declining:

We could make the point that depreciation and amortisation are not cash expenses. In fact due to the cash burning nature of the company cashflow has been negative for many years, but has started to improve. It was positive in 2017 and only negative in 2018 due to working capital movements.

However, the balance sheet does not look pretty at all. Previous years have seen assets go out of the company as divisions have been sold and capitalised assets depreciated. Shareholder equity has plummeted along with the share price. Needless to say there have been no dividends.

The most worrying aspect is debt. From the accounts we can see this:

It goes without saying that this is relatively expensive, although it has been refinanced last year. The company seems hemmed in on both sides of the agreement. No mentions are made on a potential covenant breach. However, one can assume that Clydesdale will not be happy about further deterioration. It also seems unlikely that they will extend the loan any further. There does not seem much to secure the loan on. Net tangible assets of the business are small, and there is less than £400k worth of PPE on the balance sheet.

Is the Frontier Smart profit warning a buying opportunity?

It does seem that this is in last chance saloon. The previous years of Frontier characterised by cash burns are simply over and the business needs to start generating some cash. With another trading loss predicted for this year, it is hard to see the situation getting any better. This threatens to utilise the remaining cash position.

The business to me seems heavily operationally geared. They spend a huge amount on research and development every year with nothing to show for it. Whilst the markets Frontier are operating in seem exciting to start with, on further thinking perhaps they are not. As mentioned previously, Digital Radio is mature. But crucially as we can see here, is actually the best part of the business:

At this point, one may wonder why they are bothering, or can afford to bother with the Smart division. As they have mentioned in the report, they have suffered because the likes of Google and Amazon are simply selling their devices without use of any Frontier technology as they are doing it themselves. Given the price wars surrounding these things it seems very unlikely that anyone else will get a look in.

So clearly there is a division of this business that is worth well in excess of the £4m market cap. That’s even if we assume that these revenues may decline as DAB radio is succeeded by wireless devices. But it seems unlikely that divesting will occur, or even if the company wants to. In their trading update they are already talking about developing positions in other Smart verticals such as hospitality. Which is a reasonable enough move, but requires more R&D dollars, money that doesn’t seem to be around.

The combined figures for both divisions make the overall company look like a basketcase. But the Digitial Radio division appears good and there may be a turnaround story in there yet. 2/5.

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