RJH writes...

Codascisys (CSY) demerges at the end of the month. Looking over the financials, sector and management commentary one wonders why.

Demergers in the UK were rare before the 1980s at which point they were encouraged via tax incentives in order to break up inefficient (allegedly) conglomerates.

Market capped at £128m CSY is hardly worth the bother on that rationale although management claim Coda and Scisys are very different animals. The broader argument they offer is that value gains will come through better organisational and incentivisation focus. And of course two boards eliminates difficult discussion over which business is more deserving of funds.

Still, this looks fairly thin logic for a business selling at 20 times earnings. Science Systems removed Coda from the-road-to-nowhere when they bought them from Baan 6 years ago. Growth since has been steady; financially, the company has net cash [for those who still look at balance sheets, the £19m long-term liability is deferred income]; and key ratios have moved up over the last 3 years from an already decent base in 2003. Together things have not been too bad and, despite management claims that operating costs will remain as is, it is hard to believe there won't be increased margin pressure from the split.

On the other hand, the demerger looks likely to increase the odds of a re-merger or bid with/from third parties. A Scisys potentially market capped at circa £35m looks especially vulnerable: in 2003 Vega plc sought to buy them but decided not after completing due diligence. They may regret that seeing Scisys turnaround since.

If so, this scribe advises them to consider early action. Academic research* reveals that the smaller bits of small company demergers outperform the broader market by 27% over the following 780 trading days (the other bit outperforms by 9% but after a very poor first year).

Which, assuming the end-September interims are sound, points investors towards accumulating Scisys equity post-demerger.

*Thomas Kirchmaier, The Performance Effects of European Demergers, May 2003 (Centre for Economic Performance, London School of Economics and Political Science)

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