Tie Kinetix (Hold): Financial issue solved, normal valuation applies: Buy
The facts: We were negatively surprised by Tie Kinetix' statements about a possible repayment of EU subsidies between EUR 1.3m and EUR 2.0m relating to projects executed in the FY08-FY13 period. Because it seemed there was no recourse we assumed that immediate repayment would be required, which would have a severe negative impact on the liquidity of Tie, effectively now allowing it to operate unless the company raised cash. This explained our rating change to Reduce.
Our analysis: In the meantime, we have had discussions with the company about what could be realistic outcomes. The EUR 1.3m-2.0m repayment is Tie's assessment of what could be the final amount due for all projects executed in the period FY08-FY13 even if the EU only investigated FY08-FY11. From similar cases we have learned that in the instances where EU subsidies have not been reported incorrectly even though the executed work has been done to the satisfaction of the EU bodies reviewing the project, the EU will not demand immediate repayment but will allow the company to pay back the subsidies over a 5 year or even longer term.
We have run several scenarios with repayments varying between EUR 1.3m and EUR 2.0m, the repayment period varying between 3, 5 and 10 years, incorporating EUR 100k in legal costs, EUR 100k in restructuring costs and ignoring any possible settlement with EY, which has incorrectly audited and approved the subsidy application. In the worst case (EUR 2m to be repaid over 3 years, EUR 100k in legal fees, no settlement with EY and EUR 100k in restructuring costs for the R&D department), Tie Kinetix will have sufficient cash to fund operations in FY15-16.
But we understand that the company is not taking any chances as clients may also be more reluctant to do business with the company given its weakened financial situation. We therefore understand that Tie entered into a deal with an undisclosed party that is willing to guarantee the full claim (EUR 2m, to be issued in shares) for a commission of EUR 300.000 (also in shares). If the EU claim is less, the amount of shares to be issued will become less. This guarantee effectively works as a backstop, which should reassure investors, clients and other stakeholders.
Conclusion & Action: ? Given the back stop and our scenario analysis, we conclude that the worries over Tie's financial situation are overdone. Our Base case (including EUR 1.5m in repayments, non-recurring of EUR 200k costs plus the EUR 300k commission in shares) can be applied, resulting in a DCF based target of EUR 10. This explains our upgrade to Buy