Delcam PLC

Report updated: 7th July 2004

BACKGROUND

Delcam came to the market in 1997, raising £2 million at 260p. A CADCAM specialist it had already spent two decades cementing its reputation in the business of developing and licensing its advanced software. It must be said that the company looked a real class act, as, supported by a network of subsidiary companies joint ventures and distribution agreements, sales had grown consistently - at expanding gross margins - and had enabled the company to be one of the top ten global players in its field, with 60% of revenues emanating from overseas.

Switch now to the summer of 2004, and start with the recent news that US industry analysts had voted Delcam as the number one supplier in its field in the United States. If, like Rip Van Winkle, you had slept for seven years and wakened up to this news, you would be making haste to call your broker with a song in your heart. But it would not last very long when you found out that today the shares are just 245p.

A poor company? Absolutely not. A poor investment? Read on.

The early perception of investment quality was marred only by the year-on-year cost of constant development expenditure, and the perception was that even that, whilst it constituted a drogue on the P&L, lit the path which would lead to a prosperous future. However no assessment of Delcam is possible without recognising that this figure runs regularly at a sum equivalent to more than a quarter of sales.

Another problem was that the company was already a mature business, not a concept stock - it had to make its way in the real world and not the more clement investment environment of future promise and breathless expectation(the latter nearly always disappointed). And the first thing to understand here is that the company is, and must be, totally sales-orientated, for the primal thrust of the annual earnings stream is derived from the sale of its permanent licenses. To be sure there are maintenance agreements, mostly taken up, which provide a growing strand of recurrent income. There are revenues too to be derived from installation and from training. And whilst customers with maintenance agreements get software upgrades as part of the deal, others do not; and of course Delcam prospers by the sale of additional or new product to client companies expanding their own operations, or engaging in activities of increasing sophistication. But on the first day of January in any given year Delcam has to conquer the world.

And what a world. Remember the sudden weakness in the Far East which blew carefully prepared projections so smithereens? Remember Russian devaluation? Note also how companies in the United Kingdom have had to live with the unexpected strength of sterling; and are now having to cope with dollar weakness.

FINANCIAL CONSEQUENCES

To be blunt, the combination of the features listed above has, by administering regular shocks to the body corporate, robbed Delcam of its growth cachet in its public career to date, the nadir perhaps being that of a near £1 million restructuring charge.

But incapacity is one thing, ill health another - and Delcam has never suffered from that. Indeed, taken in isolation, the figures of the three years would grace 80% or more of the total AIM offering - a pattern of rising earnings and dividends culminating in December 2003 sales of over £20 million, a gross margin of £14 million, a pre-tax profit of £1.3 million and earnings per share of over 20p. A vigorous cash flow has extinguished the trifling borrowings.

Trouble is that the earnings figure replicated that of December 2000.

THE INVESTMENT CASE NOW

Whilst the company still relies as to about 60% of its sales from the automobile and อากาศยาน sectors combined, customer numbers approaching the 10,000 mark, and revenues which emanate as to about 20% from the United Kingdom, 20% from the United States, 20% from the Far East and the bulk of the balance from Continental Europe, point to a fine degree of stability - and a deservedly high reputation. Some growth prospects lie in the perception of how the awesome accumulated expertise can be packaged so as to be adapted by hitherto lagging activities - a striking example of this is the way in which Delcam has impacted the world of jewellery design and manufacture. There are strong footholds in the packaging and toy manufacturing sectors too. A bit unexpectedly to the layman are the connections with shoe design, and contacts with Nike in the USA are now breeding downstream sales in the countries where the footwear is actually manufactured. A major opportunity currently being pursued is that of working with the developers of precision measuring equipment, opening, often, another avenue into tool rooms round the world where Delcam is already represented - as well as those where it is not.

Does the foregoing add up to an investment case? Maybe not, but it is a bloody good place to start.

Delcam is capitalised at £15 million. The shares sell at twelve-times earnings, a figure which may waft gently back into a single-figure multiple when the 2004 earnings are eventually tabled. Ditto, a yield of 1.5% may ratchet up to something closer to 2%. (The interim results will be along shortly).

Some will think that dollar earners may be cherished again as they once were.

Delcam may be in for a period of secular growth. And if conditions do worsen, this is where gravitas speedily replaces glamour as an object of investment desire - and note that the strengths, including that of financial strength, would make an excellent platform from which to acquire complementary businesses if the price were right, almost certainly with the object of transforming the enlarged group - the collegiate-type board tends not to fiddle around very much.

But that is for the unknown future. Right now, seeking to undertake the task of ploughing your savings into fertile soil, in addition to the foregoing, you might note that in 2003, a year by no means untypical, development expenditure outstripped the pre-tax profits by a ratio of almost four to one.

Now that is a first class British business - and there are little enough of them.

Courtesy of Alternative Markets Review (AMR) - www.amreview.co.uk