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Bell Pottinger North - Client News
Wednesday, November 22, 2006
Leading North West companies are 'hidden gems'

Two North West-based quoted companies are significantly underrated by the UK stock market as their share price does not reflect their impressive cash flow growth, according to the annual '2006 Hidden Gems Index' (HGI) from leading firm of accountants and business advisers, RSM Robson Rhodes.

This year's index of the top 50 hidden gems highlights that Speedy Hire (25th) and Topps Tiles (47th) have a combined market capitalisation of £901 million.

The 2006 HGI, the sixth annual ranking of companies whose cash flow growth is not reflected by their share price, shows that many strong performing companies are trapped by a 'glass ceiling', unable to achieve their full stock market value because of their relative size, sector or liquidity.

The Top 50 hidden gem companies from the 2005 index have seen share prices rise by 35% since July 2005, creating £12 billion in shareholder value, compared to 19% for the FTSE All Share.

However, the research suggests this share price growth significantly understates the full potential market value of these businesses. It also explains why the private equity firms dominating M&A have been willing and able to pay high premiums in order to secure companies ignored by the stock market.

David Barnes, head of RSM Robson Rhodes Manchester office said: "Many cash-driven businesses on the stock market should command a far higher share price than they do, but they are constrained by their size or sector. Often the only time they can get the recognition they deserve is when they are bid for. It's no wonder that private equity firms have made rich pickings by snapping up these companies."

Six companies listed in last year's HGI Top 50 have since been acquired - BPB, McCarthy & Stone, Paladin Resources, Pilkington, O2 and Richmond Foods. Many more of the index have been subject to bid speculation including Woolworths, Enodis and Morgan Crucible. This trend looks to continue as this year's Top 50 includes companies such as Northgate Information Solutions, a recent recipient of 'unsolicited' offers.

'Glass ceiling'
RSM Robson Rhodes' analysis is based on an assessment of up to seven years historic and forecast performance of companies showing good cash flow growth. The rating of this growth is measured by dividing the company's share price by the average of its forecast cash flow per share for the next three years.

RSM Robson Rhodes believes that its analysis highlights a 'glass ceiling' operating within the UK equity market. Relative market capitalisation, stock liquidity and sector classification can all conspire to leave growth companies on lower ratings than they deserve. These factors are clearly at play within the HGI Top 50.

The analysis also throws up the issue of which information should be used to assess the value of a company's equity. The recent successful bid for McCarthy and Stone (14th in 2005's HGI Top 50) highlights the limits placed on value by focusing on earnings and assets rather than cash. Analysts commenting on the deal referred to high multiples of earnings and net assets but countered that the price could be justified by assessing the deal on a medium term cash basis.

In other words, bidders who are prepared to use debt to finance deals are more likely to focus on potential cash flow than earnings or the value of assets today. Despite this, the RSM Robson Rhodes analysis clearly highlights companies which are demonstrating strong cash flow growth but whose stock market 'ratings' are constrained by valuations based on other metrics.

Success stories
It is not all about bid speculation, however. The experiences of the best performing company from the 2005 Hidden Gems Index, engineering company Charter, shows what hidden gems companies can do to improve their position.

Charter moved from 1st position in the 2005 HGI to 70th in the 2006 index. Charter has shown how a turn-around situation, appropriately communicated, can result in share price performance and higher equity valuations.

New solutions needed
The last six HGI studies have highlighted a critical factor in the relationship between the corporate sector and the equity market. Companies are not simply valued on their fundamentals. Instead, issues such as the relative size of the company, the liquidity of its shares and the sector classification will all have an impact on its value.

David Barnes added: "Our research provides a wake-up call to companies whose stock market rating is at odds with their growth expectations. The key message is to take an objective look at the business from a potential acquirer's perspective and to recognise the importance of communication. It's quite clear in today's environment that the stock market takes time to reward growth but is quick to react on the merest hint of bad news."

Barnes advises companies review their approach to investors in four key areas:

1. Understand the investment community - choose investment funds whose criteria may more closely fit the future performance of the company.

2. Monitor the shareholding register regularly and keep shareholders informed of developments instead of waiting for the equity market to tell them.

3. Monitor the analysts' forecasts for the company and seek to understand the method by which the shares are valued.

4. Prepare a defence document that addresses the key fundamentals of the business and explains the reasons for continued independence.


Press contact:

Vicki Baxter (01625) 506413 vbaxter@bellpottingernorth.co.uk, Rachel Mealing (01625) 506419 rmealing@bellpottinger.co.uk or Alex Henshall (01625) 506414 ahenshall@bellpottingernorth.co.uk at Bell Pottinger North

Notes to editor:

RSM Robson Rhodes LLP
RSM Robson Rhodes LLP is a Limited Liability Partnership. The firm practices from nine offices in the UK and Ireland, offering a full range of services to the public and private sectors. As the UK member of the world's sixth largest accounting and consultancy organisation, it is able to call upon the skills and experience of more than 20,000 professionals in over 70 countries. RSM Robson Rhodes is registered to carry on audit work by the Institute of Chartered Accountants in England and Wales and is regulated and authorised by the Financial Services Authority for investment business. Visit the website at www.rsmi.co.uk

Hidden Gems Index
The Hidden Gems index is based on all of the companies listed on the FTSE All Share Index ("All Share") with the following exceptions;

1. Financial companies; as banking, insurance and related companies generate cash in a different fashion from non-financial businesses; they are excluded from our analysis.

2. Insufficient data; the research requires four years of historic cash flow per share data. Companies who have listed within this period or whose data is not available to us are excluded from the analysis.

3. Negative cash flow; Hidden Gems is specifically interested in companies which generate positive cash flow per share. Those companies with negative cash flow per share are excluded.

4. Negative cash flow growth; the formulae used to construct Hidden Gems does not allow companies with negative cash flow growth to take part.

The index is calculated by comparing the growth in cash flow over the period ('growth factor') with the price divided by average annual forecast cash flow ('rating') to derive an index relative to the company SIC sector. In effect, a company whose cash flow both grows and is expected to grow at a faster rate than the wider market but whose valuation is lower than the wider market, is defined as a 'Hidden Gem'.


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