Dear Investor,

 DMXASF’s NAV stabilised this month, rising 0.8% (after fees and expenses) during April, though again underperforming the ASX 200 Total Return Index which rose 2.8%.

Commentary

While a fairly benign bottom-line result for the month, underlying that were some significant developments and swings in pricing. Frontier Digital completed its (small, but shotgun) cap raise which together with ongoing uncertainty around its Pakistan interest saw its shares decline 28%. The company is clearly out of favour, and is potentially now suffering as we head into tax loss harvest season. But we continue to like its diverse market-leading digital marketplace assets in rapidly developing economies, and despite having to raise capital at seemingly the worst possible time, the raise wasn’t overly dilutive and the company’s balance sheet remains debt-free and strong, with operating cashflows expected to grow considerably from here.

Kip McGrath continued its long slide, falling another 8% for no reason other than why not? Liquidity in the stock is low, with the price moving around on very light volumes. And investors are probably sceptical about its US expansion, as well as concerned about how deteriorating consumer discretionary spending may impact demand for Kip McGrath’s services. Nevertheless, at ~$25m market cap, we believe there is significant embedded value here considering the company’s rich history & strong brand in its core markets. Investors will no doubt be looking to the company’s full year result to take confidence that the US enterprise is under control, and profit growth is back on track.

On a more positive note, Shriro inched up 7% as it announced a minor distributorship win, but mainly on the back of its announced intention to pay a large special dividend later in the year. This follows the freeing up of working capital from other ceased distributorships and exited lines of business. While we would like to see reinvestment for growth, there’s clearly healthy tension within the business and board, and in the absence of clearly value-accretive investment opportunities, we’re very happy to be receiving the capital back.

The DMX Capital Partners report includes updates on each of Advanced Braking, Aeeris, AVA Group, Corum, Credit Clear, and Kinatico; each of which is also owned the DMXASF. This content is included as an Appendix to this report.

Michael Hill Acquiring Smaller Jewellery Retailer, Bevilles

With operations across New Zealand, Australia and Canada, Michael Hill is a long-established and quite profitable jewellery retailer. After a period of failed growth initiatives including the expansion into then retreat from the US, and the development and subsequent closure of its Emma & Roe brand, the company has been consolidating its efforts around its core business. This has seen dramatic improvements in efficiencies and margins, as the group has focused on moving up the value chain (toward diamonds, and increasing average transaction size). But this has been somewhat at the expense of growth, especially as Canada has reached maturity.

During the month, the company announced the acquisition of Bevilles – a mid-market jewellery retailer with 26 stores across Australia. An acquisition of this nature had been well-flagged to the market, and in terms of size, is comfortably funded utilising the company’s current cash balance. Bevilles brand positioning is important as with its lower average basket size it has a very different market, but is complementary in terms of operating leverage through being a part of the larger group.

Paying in cash and without any equity component means the purchase is expected to be immediately EPS accretive. While there will be some obvious synergies, particularly around improved vendor terms and lease negotiations, the real value-uplift will be from rolling the Bevilles store network out to a more meaningful footprint in the Australian market. From a starting position of 26 stores, the company is preparing to add 10-15 stores pa for some number of years. For Michael Hill, Bevilles provides some growth potential that has been missing over the past couple of years. Success with Bevilles, together with continued business improvement momentum within the core Michael Hill brand, could make Michael Hill look very cheap from its current ~9 times P/E base.

Smartpay to Unlock Value in NZ

Smartpay is a payments operator with an established EFTPOS terminal network in New Zealand, and a rapidly growing Australian business. In NZ, Smartpay’s business is the operation of ~30,000 terminals under a rental model with a fixed monthly charge. This business is essentially providing the hardware through which small retailers engage with customers, with payments being processed over third party networks (which Smartpay doesn’t participate in). In Australia, Smartpay predominately runs a fleet of ~16,000 terminals as an acquirer. The hardware is provided, and in addition, Smartpay processes payments in exchange for a small percentage. This charge can either be absorbed by the retailer, or passed on to the consumer at the point of sale. This acquiring business in Australia is far more lucrative than the NZ $60/month hardware rental business.

During the month, Smartpay made a small but significant announcement within its quarterly update, noting it had entered into an agreement with its Australian processing partner to unlock the strategic value of its NZ fleet. Essentially, the gameplan from here is to now convert its substantial NZ customer base onto its lucrative acquiring model.

In Australia, Smartpay has to win customers from the big banks. But in NZ, its strategy will be to simply convert existing Smartpay customers into the latest hardware technology, and simultaneously switch them over to its acquiring model. Given the sheer size of its NZ base, success in achieving this objective will likely yield a very significant profit uplift in the years ahead. Smartpay is one of the fastest growing profitable businesses on the ASX, and the evolving strategy with NZ holds the potential to super-charge that growth. Given the Australian business momentum, and NZ upside optionality, we are very comfortable holders of what has now become a core position for us at 5-6% across both our funds.

Summary

With the smaller companies sector having sold off materially over the past year, many of our companies de-rating in sympathy, but generally positive developments across many of our key holdings despite the challenging operating environment, we believe the portfolio is very well positioned for the periods ahead. The breadth and quality of the opportunity set we face and are exposed to, together with – in many cases – their heavily discounted prices, we believe, will help underwrite meaningful returns over time from here.

If you’d like to discuss the portfolio or the potential to invest or add to an existing investment, please contact Michael any time at michael.haddad@dmxam.com.au or 02 80697965.