A Portfolio of AIM Shares (3): Murgitroyd Group PLC and RWS Holdings PLC

AIM Stock: Murgitroyd Group PLC

Thomas Edison, holder of 1.093 patents, with the phonograph, courtesy Wikipedia

Murgitroyd Group PLC, based in Glasgow, was founded as a firm of lawyers by Ian Murgitroyd in 1975 and floated on the Alternative Investment Market (AIM) in 2001. The firm provides patent and trademark services in Europe on behalf of companies around the world - USA, Japan and other non-European states. Ian Murgitroyd is Executive Chairman and his son, Edward, who runs the American offices, is Deputy Executive Chairman. Between them they hold one-third of Murgitroyd's shares.

Shares in Murgitroyd are currently free of Inheritance Tax, the company has a 'free float' of 60% of its shares and the bid to offer spread for its shares is 4%. It is valued by the stock market at 45 million pounds. 

Murgitroyd has a good trading record and it is almost free of debt. It is the largest firm of patent and trademark lawyers in the UK. Murgitroyd's staff of 240 includes PhD Patent Attorneys with expertise in engineering, life sciences, healthcare, energy, emerging/alternative technology, electronics and software as well as Trademark Attorneys experienced in the consumer goods, fashion, food and entertainment industries. 

The Group has grown by opening branches in the UK, Ireland, France, Germany, Italy and Finland, sales offices in the United States and by the acquisition of law firms in the UK. By client location, 55% of its revenues of 36 million pounds is sourced from the UK, 24% from the USA and six European countries account for a further 11%. The number of patent and trademark applications in Europe continues to grow: 

	2011 annual increase	2012 annual increase
European Patent office	+  3%	+  6%
EC Trademark office	+  8%	+  3%

The company relies on its reputation, technical skills and 'relationships' with companies. 

Murgitroyd has been an outstanding long-term investment, although it only regained its pre-crisis share price very recently:

Courtesy Yahoo, click to enlarge

 

Murgitroyd has an excellent trading and financial record:

1. Earnings per share have increased by 20% per annum cumulatively in the last 10 years.

2. Net margins are running at more than 12%.

3. The historical return on equity is 15% and rising, as the return on retained earnings is 22%.

4. The Group has reduced net debt from over 8 million pounds in 2008 to less than 3 million pounds. Net debt now represents 12% of equity.

5. Over the past five years, net operating cash flow of 11.6 million pounds has covered the dividend 2.4 times.

However, 2013 has seen just a 4% increase in pre-tax profit on 2012 and the firm declared a 4% increase in the dividend. The Chairman notes that competition is fierce and there is a downward pressure on fees. To help counter this trend, Murgitroyd is using more lower cost paralegal staff to do the work of attorneys. The Board remains optimistic that the company will maintain its 'steady growth'.

At the present bid price of 520p, Murgotroyd is trading on a PE ratio of 13 and yields 2.4%. My valuation model values the company at around 560p.* However, this assumes an upturn in trading which may not occur. *Assumptions: eps growth 10%, equity per share growth 9%, return on equity 15%, average PE ratio 14.5, dividend payout 34% of eps, all discounted for the years 2014-2018 at 10.8% (3.8% SLXX yield + 2% operating risk + 5% margin of safety).

The cautious investor will note:

1. Although a firm's reputation is important, the barriers to entry in the legal profession, even one as specialised as patent and trademark law, are low.

2. Murgitroyd's growth is currently centred on the United States, which is a notoriously competitive market.

3.  The company has offered no assessment of the impact that the new, proposed, European Union Patent might have on its business. The proposal would dramatically reduce the number of European  countries requiring separate patents.

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AIM Stock: RWS Holdings PLC

Martin Luther translated the Bible into German, courtesy Wikipedia

Now let's look at another name in patent services.

Buckinghamshire-based RWS claims to be the world’s leading provider of patent translations. RWS is also one of Europe’s largest providers of intellectual property support services and it has a technical, legal and financial translation service.

2012 revenues of 69 million pounds were derived from patent translation (63%), commercial translation (23%) and patent information (10%), largely via its PatBase online programme.

By customer location, 2012 revenues were 63% sourced from Continental Europe, 24% from Asia and the USA and 13% from the UK. RWS has companies in the UK, Japan, Germany, France, Switzerland, the USA and China. Over half its billings are in the Euro.

RWS listed on AIM in November 2011. The Executive Chairman and leader of the management buyout of RWS, Andrew Brode, holds almost 43% of RWS's outstanding shares. This leaves a 'free float' of 57%. RWS is currently eligible for 100% business relief for inheritance tax.

The company has an excellent trading record since floatation:

1. Earnings per share have increased by a compound 15% p.a. and the dividend by 17% p.a.

2. Equity per share has increased by 22% p.a.

3. The historical return on equity is 21% and 25% on earnings retained in the business. The net margin is, at 25%, unusually high even for a service business.

4. RWS held 21-million pounds net cash, or about 9% of its 325 million pound market capitalization, at end March 2013.

5. Operating cash flow, net of capital expenditure, for the 5 years 2008-12 covered the dividend paid 1.6 times. This left 26 million pounds for acquisitions.

RWS' share price has almost quadrupled in the 10 years since flotation. In the past five years, RWS shares (in blue) are well ahead of Murgitroyd (in green), which drinks from the same stream.

Graph courtesy Yahoo, click to enlarge

The Chairman explains RWS's growth strategy in the 2012 Annual Report:

"Our strategy is focused upon organic growth complemented by deploying the Group’s substantial cash holdings for selective acquisitions, providing they can be demonstrated to enhance shareholder value. Organic growth is driven by increases in the worldwide patent filing activities of existing and potential multinational clients, the growing demand for language services and the Group’s ability to increase its market share by winning new clients attracted by its leading position and reputation, in an otherwise fragmented sector." 

Recent acquisitions include:  

1. inovia Holdings Pty Limited, acquired for $29 million September 2013. inovia, based in the USA, is a leading provider of web-based international patent filing solutions. A key aspect of the inovia transaction for RWS is the ability of the inovia filing service to generate translation revenues. From March 2012, when RWS took a first stake in the company, inovia began to direct translation orders to RWS resulting in sales in excess of £1 million. The company reports that "This level of activity has accelerated since 30 September 2012."

2. PharmaQuest Ltd, acquired for 2.3 million pounds in May 2013. PharmaQuest specialises in providing high quality translation and linguistic validation of patient reported outcome measures resulting from clinical trials conducted globally. RWS believes this is the only translation company in the world that specialises in this area.

 

While both acquisitions are said to be earnings enhancing, no further financial justification is given for their purchase.

At the current offer price of 770p, RWS trades on an historical PE ratio of 25 and yields 2.3%. The forecast for 2013 would reduce the PE ratio to 22 and increase the dividend yield to 2.4%. My valuation model values RWS at around 650p a share.* In the last 12 months, RWS shares have traded at an 806p high this August and at a 525p low last December.*Assumptions: Eps growth 15%, equity per share growth 10%, ROE of 21%, average PE ratio 18, dividend payout 60% of eps, discount rate of 10.8% (SLXX 3.8% + 2% operating risk + 5% margin of safety.

While recent acquisitions should add to growth, and management's ability to add complementary businesses has proven to be successful, doubts remain:

 

1. With 90% of revenues derived from translation, RWS's business is vulnerable to computer-aided translations. It is not hard to foresee that, at some point, translators will use computer programmes to do the basic translation that will only require revision by a professional. This would lower the cost and so the revenue of translation firms such as RWS.

 

2. If the European Union Patent ever sees the light of day, this will significantly reduce the requirement for patent translation. The standard languages will be limited to English, French and German. And this is RWS's main market. RWS recognises the risk, but believes that opposition from within the EU (especially Poland, Italy and Spain) will scupper the plan.