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Investment Manager’s Report

‘The focus of the market is likely to play to DSM’s favour’

Judith MacKenzie, lead manager of DSM, reviews performance and portfolio activity and concludes with an upbeat outlook on why DSM should provide non-index correlated returns, with value creation playing out in a maturing portfolio.

As we have written about many times before - strategic investing takes time, requires catalysts to be exercised, and outcomes tend not to be correlated to wider markets. Negative sentiment has not been the friend of smaller UK companies over the last two years. This has made it even more important for the DSM philosophy and style to be adhered to. We believe that the coming months and years could lend themselves to our style of stock-picking, value orientated investing, as the absence of ‘free money’ and the importance of cash flows returns to investors’ minds.

DSM builds and helps realise value in UK small companies. DSM is focused, long term, and the managers unlock value by executing on specific catalysts driven by company management. We are able to do this by concentrating on a focused portfolio (12-18 positions) and taking between 3-25% of the underlying equity, awarding us a seat at the table.

We focus on companies under £150m market capitalisations as they tend to be overlooked by investors, therefore providing pricing anomalies. We are engaged investors. We like investing in companies which, whilst solid, might be underperforming their potential and are overlooked by the market. We invest where we see the opportunity for constructive corporate engagement to unlock improved sustainable returns for all stakeholders.

This style is likely to lead to periods of NAV per share performance that is quite different to the wider market. Out of the 70 months of DSM’s life for instance, the performance has been 1st or 2nd quartile for over 30 months, whilst 4th quartile for 21. We realise there is still significant ground to make up from the early years of the Company. However, we think that recent performance should allow the current and potential investor to understand the journey of our underlying portfolio, and how it is reaching maturity with some significant catalysts playing out within it. We highlight these later in the report.

Since inception, we have undertaken a multitude of constructive engagements, these include board improvements, engaging on operational improvements, M&A, disposals, and helping to guide strategic direction. More specifically, in the last 12 months we have engaged with management teams in the following capacities (this list is a sample and just an example of some of what goes on behind the scenes):

►     AdEPT Technology Group, invested in 2020 when revenues were £34m and EBITDA £7.8m. Based on the last full year accounts, revenues were £68m and EBITDA £11.9m. We worked with management and other shareholders to deliver atrade exit during 2022/23. In Feb 2023 the company achieved a successful exitto WaveNet (a Macquarie backed company) at a 75% premium to our holding value pre-announcement.

►     New Chairman at Synectics. Succession and appropriate handover period. DSM managers were involved in interview process and selection.

►     Attended DigitalBox board meetings in a monitoring capacity.

►     Engaged with a number of investees on next steps and strategic realisations and approaches both for exit and M&A.

►     Engaged with new position Journeo and its shareholders regarding the appointment of a new NED.

►     Catalysed new FD appointment at Norman Broadbent.

►     Continued active engagement in a non-executive capacity at Real Good Food.

We know that constructive corporate engagement can unlock value because we can see the results in our portfolio, (see tables on pages 12 and 14 for an illustration of the catalysts in play to date, and where we believe value will be found in our Top 10 positions).

Good ESG practice has always been core to the DSM investment ethos. We probably didn’t realise how well we were doing it. We have now become more diligent in ensuring accurate reporting of ESG credentials within the portfolio, and we include some key metrics below.

Over the period, we have conducted 24 engagements with 13 companies on various ESG issues such as board independence, climate change and ESG disclosures. Four of the engagements are resolved, while the rest are ongoing. All of this stewardship activity is logged in an Engagement Tracker to monitor the companies’ progress and performance, as well as manage escalations. We voted on 160 shareholder resolutions, whereby 9% of votes were against management recommendations. All of the votes against management were due to changes in capital structure.

A summary of our voting at General Meetings for the year is below (unless otherwise stated all meetings are Annual General Meetings):

We decided not to ‘outsource’ ESG, as this is an important part of our diligence and monitoring process. We as managers need to be accountable. Therefore, we have created our own ‘scorecard’ for companies, which considers that one-size-does not fit all. We are pragmatic but lack patience where we see behaviours that are not acceptable socially, corporately, or environmentally. Often, we are engaging with our investees on how to improve their reporting and disclosures.

The added benefit of our integrated approach is that an investee that reports well on all matters ESG should pique the attention of new shareholders, drive more efficient returns on equity, and over time achieve a better rating. 

Performance and portfolio activity

The year ending February 2023 represented a depressing and volatile period for equity investors, particularly those investing in small UK businesses. The macro issues are well known and don’t need reiteration here. We believe that the time where cheap money was available has gone, inflation hasn’t stabilised and hence the ‘tool’ of interest rates to balance the economy hasn’t played out yet. Hence, this is a good time for a value orientated stock-picker in an overlooked market. The UK market now looks cheaper on relative terms than it has done for most of our careers. 

Below we include a slide from our recent investor presentation which summarises the outlook and reporting from the top 10 positions in the portfolio over the reporting year, and our expectations for 2023.

The Top 3 Contributors:

Centaur Media saw its share price rise by 23.9% in the period and contributed 2.3% to performance. Centaur is certainly coming of age – having weathered Covid well, we had been concerned about potential negative macro influences that could affect this media orientated business. However, given the levers it had to pull from an operational perspective, we have been reassured to see the continued resilience in the business. This was in part due to the unique aspects of its brands and offerings – The Lawyer being the predominant title for the legal profession, and the growth of the ‘Mini MBA’ continuing to buck the trend of a relatively stagnant wider marketing industry. Upgrades and a special dividend have buoyed the share price, but we still believe there is significant latent value here and as the company delivers on its MAP-23 margin plan, it will have a double-digit free cash flow yield and a single digit PE. 

Ramsdens saw its share price up by 21.8% in the period and contributed 1.4% to performance. This was a reflection of trading improving to close to pre-Covid levels, the articulation of a refreshed new store opening program, and the results of a revitalised online jewellery offering. In the thick of Covid, Ramsdens was one of DSM’s worst hit investments – store closures put the business strategy on ice. However, we believe that this management team is one of the strongest and most manoeuvrable in the portfolio, and they used their time well. After only modest spend on the online jewellery site and a revamp of FX, the opening up of Covid restrictions evidenced an improvement in jewellery sales. The group recently reported in a trading update that jewellery retail gross profit increased by over 20% on the prior year, reflecting further growth both in store and online. Meanwhile FX has returned to c.70% of pre-Covid and the loan book has improved to £9.7m.

Synectics saw its share price up by 18.2% in the period and contributed 1.5% to performance. This was a recognition of good order intake and new contract wins which included the most recent Saudi pipeline surveillance contract for £3.5m. The analyst forecasts are underpinned by this contract’s strength and therefore look to an EBITDA of £4.3m in 2023, implying an EV/EBITDA multiple of sub 5x. Next year (2024) this drops to sub 4x, delivering a 10% free cash flow yield. Clearly the market is cynical on delivery of this, however, confidence from management and the arrival of a new chair has begun to attract attention to a company that has been overlooked by the market.

Top 3 Detractors:

FireAngel saw its share price down by 26.9% in the period and detracted 3.3% from performance. We often describe this company as the one in the portfolio that is notorious for finding the banana skin to slip on.  Although our confidence in management’s ability to execute was heightened through the last 18 months as the gross margin delivery plan was delivered, this has been further hampered recently by macro headwinds. Although demand is strong and the barriers to entry are significant, we are ensuring management focus on the execution of getting product out the door.  The recent Techem contract news illustrates the strength of the IP and the market leading advantage of FireAngel.  This has yet to translate to shareholder value. Ultimately, we believe that FireAngel should be part of a much larger entity, who could benefit from the IP, the dominant market position and regulatory growth in the market.

DigitalBox saw its share price down by 42.3% in the period and detracted 4.0% from performance. After a stellar first half of the year, trading deteriorated in the second half as a result of wider ad spend headwinds. Regardless, the group still delivered a strong performance, owed to the lean operating model centred around the Graphene Ad-Stack and core titles Entertainment Daily, The Daily Mash, The Tab, and now, The Poke. While strategic progress has been relatively slow due to the valuations of media businesses through 2021 and the first half 2022, expectations of the vendors of private businesses are now reducing and there is greater opportunity for Digitalbox management to deploy capital. Buying sub-scale assets is a proven strategy in public markets but requires patience. Management is also proving their track record here with The Tab paying itself back in less than a year. The Poke, acquired at the end of 2022, will add to the group’s depth in satirical content which generates strong yields, and we believe this can generate similar payback to The Tab. Overall, we remain positive on the group’s prospects. While they can be subject to algorithm changes on the social media platforms, they have proven adept at navigating these in the past and a healthy net cash balance sheet provides comfort and opportunity in a market currently facing headwinds.

Tactus, a private holding, saw the value of its C shares written down by 34.9% in the period, detracting 1.8% from performance. While near term trading is difficult, Tactus retains a strong market position in the PC gaming space which is one of the fastest growing forms of digital entertainment globally. It also has an established market position through supply of its own and third-party branded PCs to the consumer, enterprise, and education sectors. Tactus experienced difficulties through 2022, mostly driven by a weaker consumer environment and significant de-stocking of all retail channels following buoyant Covid trading. There were also fewer new product releases through the year which often provide a catalyst for upgrade and replacement cycles. While earnings were significantly lower, operating cash generation was very strong as the company was able to prioritise inventory sell through and to reduce overall levels of working capital. Consumer appetite should return as attitudes adjust to a higher cost of living through 2023, and Tactus has significant untapped opportunity in the B2B space where they have added headcount and are significantly under penetrated versus peers. While the write down is disappointing, this should be taken in the context of the total investment and returns to date. Of a total investment of £1.9m across equity and loan notes, DSM has realised a total of £1.4m. The loan notes were fully redeemed less than four months after our investment, returning 13% in total, including the redemption premium and arrangement fee. The equity element disposed of at the same time returned over 3.6x our cost. Overall, DSM has recouped 75% of its total cost of investment to date yet retains over 84% of its equity stake.

Activity in the period

Four new investments were made in the period: Norman Broadbent, TheWorks, Inspecs, and OnTheMarket, and we topped up modestly in another three positions. This incurred a spend of £6.3m. Meanwhile, an outright disposal was made in one company, Venture Life, where we had lost confidence in management’s capabilities re capital deployment and controls. 

Alongside this transaction we took profits in four others, realising £5.2m in total, at a realised gain of £852,000. Net cash at the period end was 3.9% of net assets, before the proceeds of AdEPT Technology which, received post period end, will add c£2.48m to cash.


In terms of our outlook, we focus on where we are on the value creation journey with our portfolio. The table below highlights where we believe value creation is likely to be derived within our top 10 holdings over the course of the next 12-24 months.

As you can see, there is a clear pathway to value realisation, or an identification of where the market has undervalued companies, across the portfolio.

Despite what we think will be volatile markets over the coming 12 months, we believe the catalysts put in place by management within this portfolio should provide non-index correlated returns, with value creation playing out in a maturing portfolio. More generally, we think the focus of the market is likely to play to DSM’s favour. Higher inflation isn’t great for larger monolithic companies but favours smaller companies that can grow faster than inflation. As the cost of capital increases, there will be investor focus on real assets and real earnings (cash) – which is a feature of the DSM portfolio where the majority of positions hold cash on the balance sheet. Capital allocation, buybacks and self-help are features of the DSM portfolio, as is the focus on organic growth versus M&A. We believe the market headwinds could in fact be DSM tailwinds once combined with the strategic catalysts playing out in the portfolio.

Judith MacKenzie

Head of Downing Fund Managers and partner of Downing LLP

5 May 2023

Judith MacKenzie, Head of Downing Fund Managers
Judith MacKenzie, Head of Downing Fund Managers

The Investment Manager’s Report was originally published in the DSM Report & Accounts for the full year to 28 February 2023. View the full accounts here.

Risk warnings

Opinions expressed represent the views of the fund manager at the time of publication, are subject to change, and should not be interpreted as investment advice. Please note that past performance is not a reliable indicator of future results. Capital is at risk.  

This document is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. Downing does not offer investment or tax advice or make recommendations regarding investments. This document contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Downing LLP as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. Downing is authorised and regulated by the Financial Conduct Authority (Firm Reference No. 545025). Registered in England No. OC341575. Registered Office: St Magnus House, 3 Lower Thames Street, London EC3R 6HD.