Tern (LSE: TERN) invests in established, private software companies that operate in fast growing technology sectors and the company has become one of AIM’s hottest stocks over the past few months.
Since the beginning of June Tern’s share price has jumped by 170%, outperforming the wider FTSE AIM All-Share and AIM 100 indexes by more than 160%.
However, the company is shrouded in controversy, has a weak balance sheet and is still loss-making. What’s more, according to my figures, after the company’s recent placing Tern’s book value or shareholder equity is around £1.5m, approximately 2.8p per share. So, the company is current trading at a price to book ratio of 7.9 — a premium valuation for a loss-making company.
That being said, as an investment company, much of Tern’s value is tied up in the company’s investment portfolio.
Portfolio analysis
Tern’s most significant investment is Cryptosoft. The company owns 100% of Cryptosoft, and this one investment accounts for 95% of Tern’s potential portfolio return.
Tern’s other investments are Flexian, Push Technology and Seal Software. The company owns between 1% and 0.5% of each of these businesses.
At the end of June, Tern valued its investment portfolio at £707k and since reporting this figure, the company has gone on to raise £720k before expenses through a placing of 6m new shares at 12p each. Management has stated that the cash will be used to provide additional finance for the existing portfolio, with the development of Cryptosoft being a top priority.
And according to Tern’s press releases, Cryptosoft’s product offering is already attracting significant interest. The company claims to be the only supplier with a peer-reviewed, market-proven software security product, for Internet of Things and Machine-to-Machine applications. Moreover, Cryptosoft is in the process of discussing major contract opportunities with potential UK and US customers.
However, Tern’s management has warned that it may take several months before the first of these contracts is secured and revenues materialize.
Risky business
Even though Cryptosoft, Tern’s largest investment, claims to have a one-of-a-kind product, there’s nothing to stop competitors muscling in on the company’s target market while it tries to secure contracts. The tech sector is notoriously competitive and firms need to have deep pockets to fend off the competition.
Unfortunately, Tern is strapped for cash. While the company may have just replenished its cash reserves via a placing, £720k before expenses is unlikely to be enough to help Cryptosoft repel larger competitors. With this being the case, I wouldn’t rule out additional fundraisings and shareholder dilution in the near-future as Tern ploughs cash into its Cryptosoft subsidiary.
The bottom line
All in all, Tern should be viewed as a binary bet. If the company’s Cryptosoft subsidiary makes it to the big time, the sky is the limit for Tern’s shares. However, if Cryptosoft can’t compete with its larger peers, Tern will struggle to survive.