XPP sold; PTEC bought

I have sold my holding in XP Power for a 38% profit, after director selling on Tuesday led to a sharp dip in the share price, which had already started falling. With the proceeds I have bought a new holding in Playtech.

I chose Playtech out of a few candidate shares at the top of my watchlist. The ones I didn’t go for and the reasons why:

  • Focusrite: Focusrite is a recent addition to my watchlist and probably would have been my next choice. Momentum in particular is looking very strong with a recent positive trading update and the price breaking out to new highs. However, I feel I am still getting to know this one and relative to Playtech I am less confident in the sustainability of Focusrite’s competitive advantage. I might well buy this soon though.
  • Ted Baker: I have previously unsuccessfully held Ted Baker and think it is an excellent quality business. Long term I am a big fan. However, more immediately, momentum is not great and the companies’ trading updates, while positive, refer to challenging market conditions. While the price is pretty cheap, it could get cheaper still and I think it would be less risky to wait for some more positive momentum before committing here.
  • Micro Focus: this is another recent holding and long term a favourite business of mine that I have made a lot of money on in the past. I sold recently because of a loss in momentum and am not going to buy back until this reverses.
  • Somero: similarly I am not interested in reinvesting in Somero until momentum returns.

Playtech

I bought a 3.2% position in Playtech. Playtech is a supplier of online gaming software platforms to the online and land-based gaming industry.

Quality

I believe Playtech to be a high quality and defensive business with a deep competitive moat:

  • Business economics: Playtech has consistently high operating margins varying between 25-35%. Its business model of supplying software platforms means variable costs are low and profitability is high. Cash generation is good and Playtech pays a reasonable dividend. Returns of capital are reasonable (currently 14%) though have fluctuated over the last few years, I think due to the numerous acquisitions that Playtech has undertaken. I am slightly put off by the somewhat overly acquisitive nature of Playtech, but overall think it has compelling and profitable economics.
  • Track record: the track record is generally pretty good with growth in profits and cash flow over the past few years and an appreciating share price. There have been a few bumps along the way, i.e. profits have not gone up in a straight line, suggesting some volatility in the underlying business. However, pleasingly the impact of the financial crisis on Playtech does not appear to have been very significant – this defensiveness is very attractive.
  • Competitive advantage: I believe Playtech has a very strong competitive advantage. It supplies its software through long term contracts to large customers and the costs and risks associated with customer switching either to in-house or alternative providers are likely to be very high. It appears to be the dominant supplier in this space and also has advantages from its IP and expertise over smaller potential competitors.
  • Growth prospects: despite being relatively large, Playtech appears to have decent growth prospects, both in line with the secular expansion of the online market and through further geographic expansion and acquisitions.

Pricing

Price momentum is very good with the share price steadily making new highs. Playtech’s last trading update was very positive in its outlook. Valuation also seems very reasonable given its growth prospects. I’d say it appears substantially undervalued.

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