FINOLA BURKE | from RaaS Group

In this episode we meet Finola Burke, the managing director of RaaS Group, to delve into financial modelling and price discovery of company value. Finola explains how her team searches for mispriced companies to create sound research.

Finola transitioned from finance journalism to equities analyst. She has a deep curiosity about how news impacts share prices and valuations. "I've always been very interested in business," says Burke, recalling her early days at Business Queensland.

Price discovery is about identifying the gap between a company's current share price and its true valuation, often overlooked by the market due to various reasons such as missed forecasts or lack of broker coverage.

RaaS Group specialises in providing independent equities research, particularly focusing on small and micro-cap companies. These companies often fly under the radar but can offer significant growth potential.

This rigorous selection process ensures that only companies with strong growth trajectories and competent management teams make the cut.

One standout example discussed is QuantM Intellectual Property (ASX:QIP). RaaS Group identified this company at a crucial inflection point, recognizing its cost extraction efforts and growth potential. Their research helped to identify the value lurking in Quantum IP's business model, eventually leading to a takeover offer that validated their valuation.

EPISODE TRANSCRIPT

Chloe: Shares for beginners Phil Muscatello and Fin pods are authorised reps of Money Sherpa uh, the information in this podcast is general in nature and doesn't take into account your personal situation.

Finola Burke: So essentially what we're doing is we looking at what we think the growth will be from this company. The discounted cash flow is essentially what the cash flows are, uh, derived from those estimates, and then they're discounted back to today's value. So net present value shares for beginners.

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Phil: G'Day, and welcome back to shares for beginners. I'm Phil Muscatello. How does the share market misprice companies, and where can these opportunities be found? How does financial modelling help to define investment strategies? Joining me today is Finola Burke, the managing director of research as a service. Raas. G'day, Finola.

Finola Burke: Hey Phil, good to see you.

Phil: Yeah, thanks very much for coming over. Finola is an equities market professional with a uh, proven track record in identifying companies that the market has mispriced. She's highly experienced at building financial models, forecasting and analysing companies. Raas is an independent equities research house focused on delivering price discovery for selected small and micro cap companies. So Finola, tell us about your background in the finance industry. How did you come to this point, Phil?

Finola Burke: I started out as a finance journalist for many years. For probably more than a decade I uh, was at the Fin review and the Australian covering initially food, retail, coal, oil. Then I became the media reporter and decided at the end of 2000 that I really wanted something more. I wanted to be able to sort of define what I was seeing in my stories. So I joined BNP Paribas as a media analyst and that was the beginning of my career as an equities analyst. So I spent several years with Credit Suisse with another smaller broker, Southern Cross equities, which is now the people there are now at Blue Ocean. And yes, that was sort of the beginning of my career. Set up Raas seven years ago to really find companies that we felt were mispriced. We could see that there were fewer and fewer smaller, uh, companies being covered by brokers and so we decided to target those companies.

Phil: What was a reduction in the number of brokers?

Finola Burke: I think the cost of broking. I mean, there's really no money in share trading at the small end of the market, and a lot of brokers really rely on doing capital raises and equity markets activity for those smaller companies to really justify having coverage of them. So if you're a company that doesn't need to raise capital is really just growing under your own steam, then you're probably not going to get a lot of love from brokers at the moment.

Phil: You kind of just skipped over the move from journalism into becoming an analyst because many journalists wouldn't have the mathematical skills or the knowledge or even the interest into making that leap. Was it something about looking at these companies that attracted you to the numbers and really deeply researching them?

Finola Burke: Yes, definitely. I guess I've always been very interested in business. My very first job as a journalist was at a little newspaper called Business Queensland. And we really did get to know the small businesses on the numbers front. I mean, I had to learn that on the job, really, when I became an analyst.

Phil: So you didn't have the traditional financial.

Finola Burke: Yeah, I had done the FINSIA well, what was pre FINSIA? I'd started the graduate diploma, so I had a little bit of training, but it was more that I was curious about what the impact of the news I discovered was going to have on, um, the share price and on valuation and how the market would value that company going forward. And that's what drove me into becoming a broker.

Phil: Yeah. Where did you start the journalism career? Did you go to university?

Finola Burke: I went to university, did a degree in journalism at what was became qut. Then I actually worked in, I, uh, had been working in the public services. I went through part time, joined the staff of Rob, uh, Bawbidge when he was the minister for industry development back in the late eighties, and joined Business Queensland. It was a startup in beginning of 1990 and so I took the risk of jumping into an unknown newspaper, but we helped build it and it was an exciting time to be in the space.

Phil: What is it about the small and mid cap end of the market that you really like?

Finola Burke: I love

00:05:00

Finola Burke: watching people build their businesses and I think the smaller end of the market, you generally have companies that are at the start of their journey and their life cycle. I guess I'm a bit of a junkie for startups, and although we don't cover a lot of startups these days, but I do love watching companies, you know, people grow their companies from that embryo stage to something that's quite meaningful.

Phil: Can you give listeners a quick overview of ras and what the company does?

Finola Burke: Yes, yes, definitely.

Phil: And because this research is freely available that you provide, isn't it?

Finola Burke: I'm a big believer that research should be available to everybody in the market. So it's an even mark. You know, everyone has access to information so they can be fully informed. And obviously, a lot of the companies we're working with, there is risk. Investors should be informed of the risk, and we do highlight those throughout our research. So, yes, freely available on rasgroup.com. and, sorry, with a little plug.

Phil: That's okay.

Finola Burke: No, no, quite loud. Sras group.com. so, full disclosure, we are paid by the companies that we write research on. Um, and people might say, well, you know, doesn't that make it less impactful? I don't believe so, because of the rigour that we apply. And I'm not alone. I'm very lucky to have a team of colleagues who are highly, uh, experienced. We've all come to the markets with 30 plus years experience and all been analysts for a very long time. We choose to work with the companies that we want to work with. So we're doing a lot of filtering. Some companies may not be ready for research, some companies may not need research. So we don't target, we don't bring those companies on for coverage. So the companies pay us for the research. I mean, I'd also argue that if you, any research that you see come out of a broker at the smaller end, generally the company is paid for it through their fees for capital raising. So I guess it's another way of being paid. So we try and find companies that we think, uh, look cheap. We don't have a model at that point, but we do some analysis looking at, you know, what a quick and dirty. Quick and dirty. Just to look at, you know, what their growth rate's been. Are they cash flow positive or are they close to cash flow positive? And what's the growth trajectory look like? Does their business strategy look like they're going to grow at a strong pace? What's the management team like? We really do have to like the management of any company that we work with. We also look for timing. So it might be that the strategy is in an embryonic state, we might think it's a bit too early for the company to spend money on research at that time. We don't like to waste shareholders funds because at the end of the day, shareholders are really paying for the research. So we're looking for companies that are at that particular inflection point and that we like.

Phil: Perhaps you shouldn't be so apologetic about having the research paid for because let's face it, the bigger broking houses that are providing analysis for the larger ASX, uh, 200 companies, they're a little conflicted as well, for various reasons, aren't they?

Finola Burke: Well, they are conflicted in terms of they seek to do deals with the companies. One thing that we're very strict on at RaaS is we don't seek to do deals with companies. We don't seek to raise capital. We leave that to, uh, the brokers and to corporate advisors. All we're focused on is research. So I guess that's our big point of difference with most other independent, um, houses.

Phil: And you just did the quote marks around independent just for listeners who are aware.

Finola Burke: That's right.

Phil: So you've mentioned a kind of a broad range of characteristics that you're looking for in companies. Can we just drill down, are there particular sectors that you don't look at or.

Finola Burke: Yes, so we don't tend to look at biotechs, uh, mainly because we feel that they are quite binary in their outcome. We have got people on the team that could do it, but we've chosen not to do biotechs. Apart from that, we probably would cover most other sectors. So we have expertise across resources. That's a specifically mining, exploration and energy. And then we also have very strong expertise in as well. Ah. Part of the team in industrials, tech. So we can pretty much cover most sectors.

Phil: Can you give us a specific example of a company, maybe a recent one, that you've decided to introduce for research and the reasons why?

Finola Burke: Yeah, sure, I'll give you one that sort of probably we're about to lose and because it's about to get taken over. So if it doesn't, hopefully we'll keep on with them. So quantum intellectual, um, property is a very good example of a company that we've worked with. We've been working with them for 18 months. We identified that inflection point. They had been going through a process of extracting costs out of their business. They had a full transformation plan that they had actually enunciated to the market, but the market didn't seem to believe it. So their share price was hovering around the sort of low $0.80. We initiated. They engaged us, we initiated on them. Uh, it was about eighty three cents a share. I think with successive reporting they have shown that they've actually, they are extracting costs

00:10:00

Finola Burke: out of the business. So their EBITDA margin is improving. They are getting good growth in the business. And in fact, in January, they announced to the market, we've basically provided consensus for them in the market with our earnings forecast. They announced to the market that consensus was they were trading ahead of consensus, so we had to upgrade our forecasts. That ended up taking our valuation from, I think, one dollar sixty three cents to one dollar seventy nine cents. Well, fortunately for investors, shortly thereafter, I think the Fin review broke the story that there were suitors circling. They now have an offer, uh, on the table, and I'm, um, implementing a scheme of arrangement with Adamantium Capital. For an offer at $1.81, you got the figure right. So we've delivered the valuation to the market. So we don't do price targets, but we do do valuations. We delivered valuation that we thought was reasonable based on discounted cash flow. And we also looked at peers as well. I mean, they're peers in the market. Their nearest peer, uh, which is a lot, quite a lot larger, is IPH. But there was a significant discount between Quantum IP and IPH and we felt that wasn't justified, particularly since the margin expansion was coming through and clearly coming through in quantum IPS case and iPhone, we don't cover IPH, but it wasn't showing the same sort of growth at the time. So, yeah, we feel quite justified in how we've delivered on Quantum IP, and we've had a couple of others like that as well.

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Phil: So what do quantum ip do? Presumably it's intellectual property.

Finola Burke: So they're an intellectual property patent. So they have patent attorneys. They have patent attorneys. So they actually provide the services that surround intellectual property and trademarks.

Phil: M. In that answer, you also refer to discounted cash flow. What is discounted cash flow and how important is it in terms of looking at future prospects for a company?

Finola Burke: So, discounted cash flow is part of what we do in our modelling. So when we come to model a company, I mean, a model is only as good as the inputs. We don't try to, we make mistakes.

Phil: It's still a prediction.

Finola Burke: It's a predicting a prediction. So essentially what we're doing is we are looking at what we think the growth will be from this company. The discounted cash flow is essentially what the cash flows are derived from those estimates, and then they're discounted back to today's value. So net present value of them.

Phil: How does that discount part of the formula work?

Finola Burke: So we do a discount based on the weighted average cost of capital. So across the group, we use a 6.5% equity risk premium, which is essentially the risk premium to the market. And that's across the board? Across the board, everyone on the industrials team uses an equity risk premium of 6.5%. We have. So KPMG recommends around a 5.5%, I think, last I saw a paper.

Phil: And does that represent market risk?

Finola Burke: Yeah, market risk, exactly. Right.

Phil: Because it's on the market and things, things happen.

Finola Burke: That's right.

Phil: Shit happens.

Finola Burke: Exactly, exactly. And then we also use the ten year bond rate. We've used approximately about 4% as a benchmark. As a benchmark. But we also, that goes into our, just our weighted average cost of capital, obviously that weighted average cost of capital if there's any debt in the business. But most of these smaller companies don't have a lot of debt. So generally we like to see, on the smaller end, I particularly like to see high growth, high risk. I like to see a whack of around that. Somewhere between twelve and 16% weighted average cost of capital, sorry. Of somewhere between twelve and 16%. We like to say, at the very least, it needs to be around the 10% mark. That's 10% is the proxy for the market. And particularly since we're dealing with smaller companies where, you know, often, you know, SaaS companies are subject to, they are at, uh, the mercy of large enterprises for their contracts. So there's risk, and we like to make sure that we reflect that risk in our valuation.

Phil: I like to go into these because I love hearing about the numbers and the amount of work that goes into researching a company, because so many people I talk to, they've heard about a company and they just fall in love with the story. And m the story is only a tiny part of the equation and how much valuation. And this also speaks to a slide I saw at a presentation a few weeks ago about the number of companies that actually

00:15:00

Phil: do well on the share market. They will make you money, and it's like 7% or something. It's a very tiny figure. The rest of them are either going to go bust or underperform. But yeah, I just wanted to make that point.

Finola Burke: Yeah, that's a really interesting start. I probably agree with that, particularly at the smaller end. I mean, this is why we sift. There's 1500 companies now, uh, on the ASX, which have no research coverage, so there's only 500 that have research coverage. And the ASX equity research scheme, which I'm not sure if you're aware of, but that is available to people who are on their mailing list for it. So you have to subscribe to it. But that is the ASX pays market participants, or brokers, uh, to write research on smaller, smaller companies. And that's a great thing that they do, actually, because it actually helps education on those companies.

Phil: And where can they find that?

Finola Burke: So you have to subscribe to it via the ASX website.

Phil: It's a free service.

Finola Burke: It's a free service, but the research is not available directly. It's available to subscribe to on their website.

Phil: Mhm.

Phil: So what is price discovery and how.

Phil: Is it useful for investors?

Finola Burke: Well, Phil, Price discovery, we see it as the gap between where the current share price is and where the valuation is. So we don't say price targets, but we do think, obviously we're looking for companies that do have quite a big gap in that area. So we are looking for companies that have the market has either they've either blotted their copybooks because they failed to deliver on their maybe their prospectus forecast, or they missed the consensus forecast. So they may have had broker coverage. They missed consensus. The brokers then go, oh, well, we don't, um, think we want to cover this company anymore because they've disappointed us. So those companies end up somehow getting beat, you know, their share price gets beaten down for whatever reason. We see that there's actually more value in there because they've got the earnings to deliver, that that's what's coming through in our forecasts. And so we believe that there is that gap. And so price discovery is really the process of trying to get the market to recognise that. So I guess we feel the research helps that price discovery process.

Phil: So if someone's looking at a piece of research on the Res website, mhm. Where does that price discovery appear? Well, it's really the target.

Finola Burke: We don't have a target price, but we have a valuation and we are valuation sections of where and what's the.

Phil: Difference between a valuation and a price.

Finola Burke: A price target is really pick a price that you think is going to be in the next twelve months or next three months. So there's a time value on that price target. So your valuation might be. I'll give you a good example. I used to cover ReA group many, many years ago and I had a valuation at that time of $7 a share. The stock was $1.20, mind you, not 100, whatever it is now. So it was a dollar 20. So this is some time ago, valuation was $7, but my price target was three because I thought it could get to $3 in a year. But my valuation went for ten years. So I'm doing a ten year discounted cash flow and that's what the numbers.

Phil: Came up with, correct? Yeah.

Finola Burke: And by the way, my earnings forecast for Rowery A, at least five of the ten years were absolutely spot on. And then they took off in terms of they acquired a couple of businesses, so then they outperformed my earnings forecast.

Phil: So valuation is then basically what the total value of the company is.

Finola Burke: So you can either do a discounted.

Phil: Cash flow for which is not necessarily reflected in the share price, is it?

Finola Burke: No, that's right. When we talk about price discovery, we're really talking about, well, we've got earnings estimates out there. It's a process of getting the market to understand that there's more value here to be seen and to be revealing.

Phil: The value of that's there in the company.

Finola Burke: That's right.

Phil: Uh, so here's something from the website, and I'm just going to quote it verbatim. Understanding how fund managers think and how they interpret information is an essential ingredient in obtaining an appropriate share price and appropriately, pricing capital. Is it because fund managers play such a large role in determining the value or price of a company?

Finola Burke: I think traditionally they have, particularly at the small cap end. I think there are a lot of micro cap funds and we do see that as liquidity improves in companies, and I think liquidity plays a big part in whether a fund manager will buy or sell a stock because it was.

Phil: Very hard to get in and out.

Finola Burke: Of these nodes, if they've got 40 stocks in their portfolio and they want to get set in one stock and they might need to, and their actual fund is 200 million, they're going to need to buy a lot of a company to really get set in it. But if you're a much, if you're a smaller fund or if you're running your own money, liquidity might be less of a driver. It still will be a driver though. So I mean, I guess coming from our website, I guess our quote, it's really about as equities analysts, we've broke two funds, um, for many, many years. We do know how they think. We know the pushback

00:20:00

Finola Burke: and the questions from informed investors and that really helps shape our research as well, because we know what they're looking for. And also probably, and um, to a certain extent it shapes how we look at companies. So we try to look at companies like fund managers to a certain extent, so that we can uh, really help the companies that we're working with get that price discovery process.

Phil: So just give us an example. You don't have to name any companies, but of a company that you've rejected and the reason why you've rejected, you don't have to say anything. No. Don't know many names. Yeah. Because it's always worthwhile to, I think, to think about a culling process as well as, you know, buying process.

Finola Burke: So we tend to avoid in the resources space, there are companies that I would call livestock companies where they tend to sort of run from project to project, raise capital. And the same people are obviously involved in all that process. We like to find companies that have a project. And that's not to say that those lifestyles companies don't hit upon a real project at some point.

Phil: Is it because their lifestyle is being funded by the capital that they're raising?

Finola Burke: That's where the term comes from, yeah. So we're very careful about looking for companies that we see a management team that are actually driven to create value for shareholders. Correct.

Phil: Any other horror stories? Love a horror story. Thinking hard here.

Finola Burke: I am thinking no, like we do sift a lot of companies and they might be just too early for research. We've ah, had approaches, um, from companies that, where we don't understand the technology. So there might be a tech company, we haven't understood the tech. There's been a couple of companies where we felt that they were already fully priced and so we, there was no.

Phil: Value, to be honest.

Finola Burke: We couldn't deliver more value. So we decided to pass on those. There's been a couple of projects where the analyst in question didn't had covered other companies with that management team and they wouldn't touch that management team. So we are very strong on, um, management and the companies that we work with currently. We really admire and respect all the management teams in those companies. So we do have to give the management team a tick before we take them on.

Phil: Another guest that I had on mentioned that if you want to get a broad exposure to the market, you know, ETF's are fine and, you know, for.

Phil: The bigger end than the 200, the.

Phil: 300, or whatever, but that if you want exposure to small caps that it's smaller fund managers are good to go with and it has to be active. There's not really an index, is that the case?

Finola Burke: The small odds is probably the closest index, but that's not really reflective of micro caps or nanocaps. So the small lords, you're really looking at companies that have sort of two to three 4500 million market cap versus or billion market cap, whereas a lot of the companies we're working with are in that, you know, between ten and 100 million market cap. So we do work with large companies as well. We've got a growing number, um, of companies in that 150 to 200 million market cap. But it is, yes, definitely there's no real index for those companies. The tech index doesn't reflect the smaller end of the tech market. And there's some great technology companies out there with very good growth prospects, who are profitable, who have cash in the bank. We're working with a number of those companies.

Phil: So let's hear about a couple of examples.

Finola Burke: Okay, Kinetico is a really good example. They have close to 10 million in the bank. I think it's about 9 million in the bank at the moment.

Phil: And of course, this is no recommendation to buy. Do your own research.

Finola Burke: That's right. Or have a look at AYP. If anyone can download our research or view our interviews with the, uh, management team, we see very good growth. What they're doing in the business is they are essentially taking what was somewhat of a legacy business. They were originally called cv check. So they used to do police checks for companies, but they're really transforming that into a business now that provides an ongoing service to corporates, large corporates in particular, in government, where, uh, for example, you might have a number of contractors coming in, they need to have certifications on a regular basis, like every 90 days. And so Kinetico has a platform that puts those reminders into the contractor, into the business itself. So it provides that compliance that's needed for a smooth operation of a larger enterprise. And so essentially, they have about, they started off a couple of years ago, they had very little, that's what we call the SaaS part of the business. They have very little of that software as a service. Subscription revenue, they now have, I think it's 36% of revenues are now coming from SaaS revenues. And, um, we anticipate that it'll get to 80%. It may get higher than that. The reason why we like that is that SaaS revenues, it's recurring revenue. It's also higher margin. So SaaS revenue traditionally gets 70% gross profit margin, whereas your one time transactional revenue might be more like 30%. So you can see

00:25:00

Finola Burke: they're actually going to become a much more profitable business over time.

Phil: And of course, one of the S's in SaaS is subscription, which is the important part of the equation.

Finola Burke: That's right, yeah. That's right, yeah.

Phil: Software as a service, isn't it? Sorry?

Finola Burke: It's not subscription service or subscription service, or software as a service. Yes, it's definitely, uh, there's a subscription element there. So that recurring revenue is highly desirable.

Phil: I can see why you like this end of the market, because you hear about these stories about these companies, and you don't even know that there's a problem that there's a solution for.

Finola Burke: That's right, that's right.

Phil: Any other stories?

Finola Burke: Just trying to think of many other stories, because we've got the same thing going on with rent.com. dot au smaller company, their core portal, which is essentially a service to people who rent, that they've developed a platform for people to basically pay their rent, also get deals from energy companies, perhaps go move to mortgages. So they're actually moving to more of a financial transactional platform. And that's much, much higher margin, more recurring revenue. And so that's another one that over time, it's still embryonic with the rent pay platform, but over time we see that becoming quite a meaningful business.

Phil: And so the business model for this one is the renter doesn't, they're not, uh, clipping the ticket of the rental, but they're using it as an advertising platform.

Finola Burke: They have an advertising platform that's the core business. So they have the advertising platform. They also provide products for renters to utilise. So they provide smoothing, like they provide a rental bond product, and they do get a little small fee for providing that to a company. So it's a two way to an individual. So, for example, a rental will come along and they're still waiting for their bond to come back from the last rental. Rent.com dot au provide that service abridging rental bond. So that's part of their core business. But then they've developed this platform called Rent Pay, which essentially has both the agents and the renters utilising it. It allows renters to smooth out. So you get paid on a, you might get paid fortnightly, but your rent's monthly. It allows them to put aside that rent so it's not spent and it goes into a trust fund which then gets released on when it's required to the agent. And rent pay gets a small fee from them for that.

Phil: So, yeah, and you don't want to just generate ideas yourself. You want to hear what ideas other people have for, uh, companies that may be worthy of research. Tell us about that.

Finola Burke: Absolutely, Phil. I mean, I guess many eyes on the market is an important thing. So we like to get feedback from people. We like to hear about ideas for companies that they might want to see covered. And so always welcome to contact me directly.

Phil: Oh, that's great. I know where to send them now because I get so many people contacting me and say, what about this company? What about that company? You know?

Finola Burke: That's right. And we're always happy to answer questions as well where we can. Yeah.

Phil: Uh, fantastic.

Finola Burke: Yeah.

Phil: So, Fanola, tell people about RAS Research Group and how they can find out more and where to find you in this research as well, which is free. Absolutely.

Finola Burke: So your listeners can find us at our website, which is www.razgroup.com. if they're on LinkedIn, we are razgroup. Uh, and this is Ra, sorry, r aas, sorry, Srais Group on, uh, LinkedIn, but the easiest way is all our research is available on it and including interviews are available on our website. So, and if they'd like to subscribe, there is a registration button there. Registration is free. You just go on our mailing list so that you get an alert when we're actually putting out a new report.

Phil: Fantastic. We'll put all those links in the web, in the blog post and the episode notes so people can just click.

Phil: Rather than try and write all this down.

Phil: Yes, Finola, it's been great to finally get you here. I think we met over a year ago and finally got together for this interview.

Finola Burke: Well, thanks, Phil. Really delighted to be here and happy to come back again.

Chloe: Thanks for listening to shares for beginners. You can find more at sharesforbeginners.com. if you enjoy listening, please take a moment to rate or review in your podcast player, or tell a friend who might want to learn more about investing for their future.

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