Description

MICE Group can be bought for 5x three year out earnings on a somewhat levered capital structure, and could thus reasonably be expected to triple over the next 2-3 years with relatively little downside risk. Poor working capital management turned what was previously a negative working capital business into a cash-consuming pig. New management was brought on after the last reported half with a clear mandate to improve working capital and margins, but their improvements have yet to be reflected in reported results. With relative ease we believe the new management team can release capital tied up in bloated receivables and skinny payables to pay down debt, and refocus on higher-margin business to bring the company up to industry standard margins and working capital levels.

Background
All numbers in this report are GBP unless otherwise specified, the numbers at the top are in USD.
MICE essentially has two businesses. The first and most attractive business is the Integrated Marketing Services (IMS) business. This business puts together point of sale displays to facilitate merchandising efforts in various venues. The largest venue is trade shows, exhibitions, conferences, etc. – events where MICEs customers want to introduce a product to their customers so as to maximize the branding experience. As an example, Toyota might hire MICE to help them launch a new model. MICE would design an attractive and dramatic environment to display the new model. MICE would build a platform to put the car on at the show, design a lighting scheme, and put up audio visual equipment (plasma screens, etc.) to run multimedia presentations that MICE designs. This business is all about creativity. Clients put down money upfront for these services.
MICE also performs these services for retail clients. An example might be designing a display to help Coach promote a new line of handbags in its U.S. stores. Basically, MICE makes artsy fartsy displays to make products look better than they’ll look when you get them home, the essence of successful marketing. I encourage you to check out some of their work at their Web site, http://www.micegroup.co.uk, it’s one of the finer examples of commercial over-specialization I’ve seen. MICE also performs other value-added marketing services such as niche marketing campaigns, incentive program design (e.g. to motivate salespeople to push a new product), market research, and sales promotions (e.g. direct mail programs). MICE never really goes head-to-head with any of the big ad firms with any of these products, and in fact gets some outsourcing business from them.
The second business is Manufacturing and Fabrication (M&F). This is essentially the same product as IMS without any of the creative aspects like design, consulting, etc. A typical client for this business might be a retailer who says, “I want a spiffy shelving system for my shoe stores, and this is how I want it to look.” Already it should be apparent why this is an inferior business relative to IMS. In this case MICE essentially becomes a carpenter, not a marketing firm – MICE gets to inject none of the creative equity that makes their services value-added. Furthermore, the primary customers for M&F services are retailers. Retailers are genetically superior buyers and thus stretch out payables as long as possible, making this business inordinately working capital intensive. Typical payment terms in this business brings cash to MICE 125 days after performing the work.

The UK
MICE got where it is today because the founder and former chairman and CEO, being an aggressive entrepreneur type, was bent on achieving growth at all costs. Several manufacturing facilities were rolled into the company until manufacturing capacity far exceeded the requirements of the IMS business. In order to cover the massive overhead of the manufacturing facilities the old management filled the capacity with low margin, working capital intensive M&F business. So, in the last three years DSOs have ballooned from 46 days to 83 days, and diluted EBITDA margins from 10% to under 8%.
The UK manufacturing centers were subsequently consolidated from a peak of 23 to 7 today. Retail revenue growth in the UK was reigned in, and new management has begun the work of slowly dialing down receivables terms of the retail business where possible and culling out bad business where necessary. Management does not believe they will kill revenue as any lost M&F revenue should be replaced with higher value IMS revenue.

The Other Divisions
MICE also has mainland European (International) and North American businesses. Both are run extraordinarily well and are models for the UK business. Europe has 8-9% EBITDA margins and 55 day DSOs versus the UK’s 104 days. Europe can probably grow revenues in the low single digits for the foreseeable future. North America is an upstart capable of producing 10-12% EBITDA margins and also has 55 day DSOs. Management believes higher margins are possible in North America due to its fresh new manufacturing infrastructure with no legacy problems, and the lower occupancy costs relative to Europe. North America is a high-growth upstart (growing 37% yoy in FY2005), and can easily reach $100 mill of revenue within the next year or two. Interestingly, MICE does no business in Asia other than an insignificant JV. They are certainly interested, either through a green start or an acquisition, but not until the debt is paid down.

Management
If you get a chance I highly recommend speaking with the North American CEO, Paul Mullen – he is after all the main value driver for MICE over the long-term. Paul is one of the more extraordinary public company executives we’ve met. His compensation structure speaks for itself. He effectively owns a 5% equity interest in the North American business. He started the division in 2001. His compensation works as follows: 7 years after startup the average of the previous two years’ net income is multiplied by 5% then capitalized at some multiple (won’t say what multiple) and is paid out to him in either cash or MEG stock. The time frame works perfectly for us because he is incentivized to max out margins over the next few years. He runs a very tight ship – salespeople are incentivized on gross profit instead of revenue, all employees follow several important metrics like utilization. He is also one of the rare CEOs that is immersed in all aspects of his business. He can simultaneously tell you about the smallest new order at any of the plants and quote you the rent on a storage facility in Irvine.
The new CEO, for an advertising guy, is comparatively hell-bent on working capital management and margins – the fact that he even talks about it, we believe, is promising. The new CFO likely has erotic dreams involving 10 day DSOs. The DSO levels in Europe and North America, which were relatively insulated from the UK madness, is testimony to the diametric philosophies those CEOs have to the former CEOs way of running the company.

Why we believe we’ve very likely bottom-ticked it
With UK retail revenue growth brought in, the capital consumption and margin contraction has certainly come to a screeching halt. That is what has weighed most heavily on the stock on the long ride down from £1.50 to its present level over the last few years. Otherwise, the company is larger and has much higher earnings power than it was when the stock was at £1.50. The major risk to our thesis I believe is fallout from the slump in UK retail sales. Management is certain that this will not weigh on results over the next year as 1H results have yet to be reported and they have near 100% visibility on 2H revenue. Lastly, we are on the cusp of realizing value from a non-core asset that could pay down about 20% of the debt. The asset is a management contract/lease for a zoo and an aquarium in London – go figure. Management believes it is worth £10-15 mill pre-tax (I’m assuming £7 mill after-tax, or 4p/share or 12% of the stock price), and they will likely sell it in the next 3-6 months.
Keep in mind that this business was once working capital negative. Since then it has poured £37 mill into working capital. Simply getting to working capital neutral and selling the non-core assets could accrue about 70% to the equity, in the process paying off all the debt.
A perfect comp in Canada, Pareto (PTO CN/PTO.TO), sports negative working capital with significantly more exposure to retail clients than MEG. Not to mention PTO boasts an 11% EBITDA margin, and an 11x EBITDA multiple even while having massive customer concentration. Granted, PTO is growing 50%+ yoy, but this perhaps also bodes well for MEGs North American growth potential. I don’t suppose I have to tell anyone in the VIC crowd what kind of multiples advertising companies fetch, but for dramatics…WPP 10.5x, Omnicom 11x, Interpublic 11.5x, even with their assorted problems. Meanwhile the FTSE trades for 20x earnings, and we believe that any business capable of negative working capital is at least an average business model, thus deserving of at least a market multiple, but being stodgy value guys we won’t assume nose-bleed multiples on that order.

Valuation
When thinking about the future cash flows of this business it’s important to carve it up by segment as North America is essentially a company within itself in the early stages of its life. Note that MEG is on a February fiscal year.

Rev. ‘08E ‘07E ‘06E ‘05 ‘04
Int’l 85.4 82.0 79.0 77.4 79.0
UK 98.7 96.8 94.9 93.0 57.5
N.A. 71.2 61.9 51.6 41.3 30.1
Elim. (24) (23) (22) (22) (16)
----- ---- ---- ---- ---- ----
Total 231 218 204 190 150

OpInc ‘08E ‘07E ‘06E ‘05 ‘04
Int’l 8.1 7.4 6.7 6.3 7.2
Margin 9.5% 9% 8.5% 8.2% 9.1%
UK 5.9 5.8 5.7 6.0 4.6
Margin 6% 6% 6% 6.4% 8%
N.A. 6.4 4.0 2.3 1.3 (1)
Margin 9% 6.5% 4.5% 3.2% (3.3%)
Corp. (3.0) (2.8) (2.6) (2.4) (1)
------ ----- ----- ----- ----- -----
Total 17.4 14.4 12.1 11.2 10.1
Margin 7.5% 6.6% 5.9% 5.9% 6.7%

Debt ‘08E ‘07E ‘06E
BOP 22.5 31.2 37.0
Repmt. 10.9 8.7 5.8
EOP 11.6 22.5 31.2
Int Exp .9 1.4 1.8

‘08E ‘07E ‘06E
Net Inc(1) 10.9 8.7 7.0
Multiple 5.1x 6.4x 8x

So what’s all this worth?

Base Best Worst(2)
’08 Net Inc 10.9 11.5 5.5
Multiple 15x 16x 8x
Market Cap 164 184 44
Work. Cap. 10.0 10.0 0.0
Aquar./Zoo 7.0 7.0 0.0
Shares Out. 175 175 175
Stock Price 1.03 1.15 .25

Upside 259%
Downside 22%
Rew/Risk 12:1

(1) Using a 30% tax rate in Europe & UK, and 40% in N. America.
(2) Using 2004 numbers.

Catalyst

-Cheap today
-New mgmt
-Turn working capital around
-Sell non-core asset
-Debt paydown
-Showing progress on all this in 1H numbers due in mid-November