Tern (LSE: TERN)invests in established, private software companies that operate in fast growing technology sectors and the company has become one of AIMs hottest stocks over the past few months.
Since the beginning of June Terns 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. Whats more, according to my figures, after the companysrecent placingTerns book valueor shareholderequity is around 1.5m, approximately2.8p per share. So, the company is current trading at aprice to book ratio of 7.9 a premium valuation for a loss-making company.
That being said, as an investment company, much of Terns value is tied up in the companys investment portfolio.
Portfolio analysis
Terns most significant investment isCryptosoft. The company owns 100% of Cryptosoft, and this one investment accounts for 95% of Terns potential portfolio return.
Terns other investments areFlexian,Push Technology andSeal 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 720kbefore expensesthrough a placing of 6m new shares at 12p each. Management has stated that the cash will be used toprovide additional finance for the existing portfolio, with thedevelopment of Cryptosoft being a toppriority.
And according to Terns press releases,Cryptosoftsproduct offering is already attractingsignificant interest. The company claims to bethe 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 ofdiscussing major contract opportunities withpotential UKand US customers.
However, Terns 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, Terns largest investment, claims to have a one-of-a-kind product, theres nothing to stop competitors muscling in on the companys target market while it tries to secure contracts. The tech sector is notoriously competitive and firmsneed 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 helpCryptosoft repel larger competitors. With this being the case, I wouldnt rule out additional fundraisings and shareholder dilution in the near-future as Tern ploughs cash into itsCryptosoft subsidiary.
The bottom line
All in all, Tern should be viewed as a binary bet. If the companysCryptosoft subsidiary makes it to the big time, the sky is the limit for Terns shares. However, ifCryptosoft cant compete with its larger peers, Tern will struggle to survive.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.