Should I Buy Shares in Tesla, and ShareSoc Seminar Report

Should I buy shares in Tesla, or perhaps short the stock?  This thought was prompted by the recent large jump in the share price which has made the company worth more than Ford, General Motors and BMW put together. But there is still a considerable short interest in the company based on the fact that the financial ratios look far fetched and are discounting a lot of future growth. Plus of course the doubters worry about the leadership of Elon Musk.

The technology in Tesla cars is brilliant (I have had a test drive of a Model S) and is claimed to be way ahead of competitors. But other auto makers are fast catching up. Announcements by the UK Government that no diesel, petrol or hybrid vehicles can be sold after 2035, or even 2032 as the UK seems to be making decisions on the hoof on this matter, and by EU directives that promote the sale of zero emission vehicles has meant that everyone has realised the future is electric. That’s even if there are doubts about the grid capacity and how people will recharge them. As a result there are plenty of new electric vehicles from major car manufacturers being announced.

But I have decided not to purchase or short Tesla shares. There is one simple reason why. It’s basically a bet as to which car manufacturer will end up the most successful and make real money as a result. It’s not even a “binary bet” as there are many horses in the race. I simply have no clue as to which will be the winners or losers. So it’s not the kind of investment I like. It’s for speculators not investors.

There was a very relevant quotation repeated by Kate Burgess in the FT yesterday on this subject. Apparently Warren Buffett said “The wise bet in the early days of cars was to short pony traps rather than try to pick the winners”. So sell Shell and BP perhaps, although that might be a simplistic analysis as they are involved in gas and plastics production also. But you should disregard BP’s claim to be zero carbon by 2050 – it’s only window-dressing. Instead buy software companies and battery manufacturers or those helping to develop automated vehicles such as AB Dynamics (ABDP).

For more analysis of Tesla you could also read the latest edition of Shares magazine who have an article headlined “Why Tesla shares can’t continue to motor”. It covers the arguments for and against the company in some depth.

A second reason for not investing in the company is that this is clearly a stock that is very heavily researched by institutional investors, even if they have ended up with contrary opinions. How could I as a private investor without a big team of researchers behind me hope to come to better conclusions? I may find it better to simply rely on funds/trusts who are holding the company (Scottish Mortgage has a big stake in Tesla for example). They can also follow the company closely when I cannot.

I find it easier to make money as a direct investor in companies in smaller or mid-cap stocks. I often get wrong-footed by the changing views of big company analysts.

Which brings me onto the subject of the ShareSoc seminar I attended on Wednesday (12/2/2020). These events focus on smaller companies so they tend to be a very mixed bag. I will give some impressions of the companies presenting this week:

DX Group (DX.): This is a parcels and document delivery service. In 2015 it hit difficulties after a failed strategy and the next two years saw big losses. It’s been in turnaround mode since and is at least making profits now on an EBITDA basis. But bottom-line profits and positive cash flows are still in the future. They seem to be investing a lot in improving IT support and in other areas to improve quality of service which seems to be the only thing that might differentiate them from competitors.

My conclusion: insufficient differentiation from competitors and still weak financial fundamentals (e.g. low current ratio even excluding subscription liabilities) so the future may be bright but is it really “well-placed…..” as a FinnCap note on the company says. Document delivery is a declining market and I doubt they can fix that, and the freight market is fragmented with lots of competitors. The management who presented made a good pitch and they have experience of turning around a similar business so there are some positives while parcels will always need physically delivering but there are too many negatives at present I suggest. But some investors like recovery stories.

Diaceutics (DXRX): This company is a data analytics and implementation services company which services the global pharmaceutical industry. It provides diagnostic services which are very important for developing and applying personalised treatments, or “precision medicines” as they are sometimes called. It is primarily service based, with projects being sold to pharma companies but is it also now developing a “platform” which will contain patient data. This is effectively a “big data” model which is one of the hot buzzwords of late.

The presentation was short on financial information – like a lot of those from pharma companies the approach was to sell you on what they can do to cure the millions of cancer patients by developing better treatments. It’s the “gold at the end of the rainbow” syndrome. Looking at the financial profile they are making profits but the prospective p/e is sky high. Clearly punters (or should I say investors) in the shares think they will be a winner.

But I can’t say I was convinced by the presentation. There are also other companies that seem to be developing platforms to hold/analyse patient and drug data such as Open Orphan and Renalytix AI plus no doubt some US organisations. I would need to get a much better understanding of what they were developing and how it was differentiated from competitors, before investing in the company as it was certainly not clear from the presentation. There was also no indication of how they would make money from the new “platform” while I don’t generally like project based businesses.

SDI Group (SDI). Formerly called Scientific Digital Imaging, this is a company I hold but had not seen them present before. The company is a conglomerate of small technology businesses which it has acquired in the last 5 years (11 in all). All the acquired companies are profitable. Mike Creedy, the CEO, was the lead speaker and he is clearly an energetic person. He spoke rapidly.

The business model is similar to Judges Scientific – buying small companies in niche sectors cheaply and then letting them run independently with the management retained. Only treasury functions are centralised.

They like to buy businesses on 4 to 6 times EBIT and have done placings to finance the deals. Private shareholders can be left out as they don’t have time to do open offers although they have used Primary Bid to raise money in the placings.

They don’t do significant business in China where they operate through distributors which is a common question of late. The company has no significant patents or other IP.

The company has been widely promoted to private investors and hence has become highly rated. Only recently has the share price fallen back slightly, but it still reflects a lot of growth expectations. Perhaps the key question that comes to mind is “how many small companies can be acquired before the whole company becomes unmanageable”? There does not seem to be much synergy between the acquired businesses so the company is really a financial construct that needs to keep acquiring to grow profits. Using highly rated equity to buy more lowly rated companies is a good way to grow profits. But other than that I did not identify any concerns.

NVM (Northern VCTs). Charles Winward then spoke about the Northern VCTs who are currently raising more equity. The Northern VCTs are managed by NVM who were recently acquired by Mercia. I hold shares in the Northern VCTs and have written about their past performance previously.

Mr Winward covered his background in early stage development capital which is now important with the changed rules for VCT investment. He was also a director of Tracsis for a number of years which has been a very successful small cap technology company which I hold. Apparently it was not always a smooth ride there, which is news to me, but which reflects the typical problems of early stage businesses.

He suggested that the returns on development capital were improving – it is no longer an area in which to lose money. Comment: this probably simply reflects the valuations being put on early stage companies when they are still loss-making rather than some great improvement in profitability. Hope is being valued highly of late.

The valuations of Tesla (who have just raised another $2 billion via an equity placing) and Diaceutics are a reflection of the current market view of the future prospects of technology companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Coronavirus Impact on Supply Chains

There was an interesting review by Paul Scott in his Stockopedia Small Cap Report of the impact of the Coronavirus on Chinese supply chains yesterday. As readers are probably aware, many companies have shifted the production of electrical and mechanical products to the Far East in the last 30 years. Paul covered announcements from three companies who may be affected by problems of production or transport in China – namely Up Global Sourcing Holdings (UPGS), Tandem (TND) and Volex (VLX). All three companies made announcements yesterday that gave some coverage of the issue.

Up Global, producer of branded household products. said that the majority of its manufacturing was in China. The extension of the Chinese New Year holiday is expected to cause production delays but it gave positive noises about having experience of similar disruptions in the past.

Tandem, a distributor of leisure and mobility equipment (e.g. cycles), said the virus outbreak was restricting the movement of raw materials and labour throughout China and had been delaying orders. They said they had no ability to forecast how big or how long the problem will last.

Tandem was already on a lowly valuation before this and had even been tipped by some investors as due for a re-rating, but has now slipped back to a historic p/e of about 6. Amusingly the departing Chairman who is leaving after ten years at the helm had some negative things to say about internet posters and suggested that the change in the share price during his tenure from 110p to 205p should not be disparaged. But is that good enough? It actually equates to a growth in the share price of about 5% per annum which is not what I like to see in any small cap company with growth ambitions. Sure investors have also received generous dividends but the share price went nowhere for a long time in that period.

Volex said it had four manufacturing plants in China and although they are not in Wuhan only one of the four sites has resumed operations at a reduced capacity. The Volex share price has also been on a roll of late after the company was rerated by analysts and tipped by various sources, but has now fallen back recently. As with the other companies, details provided are sparse, but that may simply be because the companies do not know the impact in detail or have any good view of the future. But Paul Scott criticised all of them for just providing “bare, disjointed facts, with zero interpretation”. It certainly makes it difficult for investors to decide whether to hold on or bale out.

It definitely appears that the vigorous steps taken by Chinese authorities to halt the spread of the disease is disrupting supply chains and my guess is that they are likely to do so for some time. Investors in companies that rely on such supply chains from China, particularly of the “just-in-time” variety need to consider what the impact might be. But it also seems likely to me that the virus will spread outside China and have some impact worldwide. But the actual impact on commercial operations might be small. The likely deaths might be tragic but it seems no worse than any other flu epidemic and we might simply learn to live with it. The best hope is probably the development of a vaccine before the disease becomes very widespread.

In the meantime, I won’t be buying shares in the aforementioned companies until the picture is clearer (and I don’t hold them already).

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Rio Tinto Requisitioned Resolutions – Paranoia Exemplified

Yesterday (7/2/2020), Rio Tinto (RIO) issued an announcement which said that resolutions had been requisitioned by shareholders for the Annual General Meeting in May of Rio Tinto Ltd. Note that Rio Tinto has a rather peculiar corporate structure.  Rio Tinto plc and Rio Tinto Limited established a dual listed companies (DLC) structure in 1995. As a result, the two companies are managed as a single economic unit, even though both companies continue to be separate legal entities with separate share listings and share registers. We may see similar resolutions for the UK Plc company in due course as the resolutions might require a “Joint Decision”.

The first resolution is a Special one that seeks to amend the Constitution to give shareholders the right to pass ordinary resolutions that give the directors an opinion on how they should exercise their powers. But it is only an “advisory” resolution and appears to be more aimed at supporting or enabling the second resolution.

The second resolution is an Ordinary one and is worded as follows: “Shareholders request that the company, in subsequent annual reporting, disclose short, medium and long-term targets for its scope 3 greenhouse gas emissions (Targets) and performance against the Targets, consistent with the guidance of the Task Force on Climate-related Financial Disclosures. Targets should reflect decarbonisation pathways for the company’s products in line with the climate goals of the Paris Agreement”.

Readers might not know what Scope 3 emissions are, but as this issue recently came up at a local council meeting which I attended, I do know something about them. Scope 3 emissions are all indirect emissions that occur in the value chain of the reporting company, including both upstream and downstream. That’s as opposed to Scope 1 emissions which are direct emissions from owned or controlled sources and Scope 2 emissions which are indirect emissions from the generation of purchased energy.

Reporting of Scope 3 emissions would require a company to identify all the emissions made by suppliers and customers and even include such emissions as from staff travel to work. A company will in practice have no control over most of those emissions and obtaining the required information might be very difficult.

It’s basically a pointless and expensive exercise to impose such an obligation on any organisation whether it’s a major international company such as Rio Tinto or my local council, but there are many people who would like it done.

This is surely a demonstration of the extreme paranoia that is gripping the world at present over CO2 emissions with the concern that such emissions are contributing to global warming. Even it that is the case, and that argument is far from proven beyond doubt as there are other credible explanations, there is no financial justification for imposing such reporting obligations on companies. It will simply have no impact on CO2 emissions. It’s bad enough that companies such as Rio now have to report Scope 1 and 2 emissions, which incidentally are falling but not very rapidly. Note: please don’t start an argument with this writer about the reality of global warming and its threat to destroy the world. I do not have the time to explain the science of the matter to you. There are plenty of good internet resources on the subject.

As a shareholder in Rio I advise other shareholders to vote against these proposed resolutions at the company.

It seems likely though that the coronavirus outbreak in China might have a significant impact on CO2 emissions. Businesses are shutting down there and imports of oil/gas and other commodities are falling. China consumes half the world’s metals and prices have been falling as a result. It’s hardly surprising that the share price of Rio has been falling of late also.

The coronavirus threat and other similar plagues are probably more a threat to humanity on a global scale than any slight rise in the temperature.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Micro Focus – A Real Mess and “Systems Not Fit For Purpose”

Yesterday Micro Focus (MCRO) announced its Annual Results and it makes for sad reading. The company specialises in selling legacy software products, which as an old IT hand I should understand. But I have not held the stock lately, even though it had a good run up in share price until the end of 2017 under Executive Chairman Kevin Loosemore. The company managed to pay high dividends from strong cash flow but revenue growth other than from acquisitions was generally negative. There is potential value in selling and supporting old software but the acquisition of HPE in 2017 including the Autonomy software appears to have been a major mistake – simply too big to digest it seems.

I quote from some of the announcement:

“The revenue performance in the period was impacted by a combination of volatile macro-economic conditions and changing buying behaviour leading to the delay of customer investment decisions, and inconsistent execution, which was further impacted by the greater than expected complexities arising from the integration of the Hewlett Packard Enterprise (HPE) Software business acquisition”; and:

“The HPE Software business acquisition presented the typical challenges associated with making a large and complex acquisition and significant additional complexities relating specifically to this being a “carve-out” of a division from a much larger parent.

To enable this “carve out “, HPE designed and initiated the build of new IT systems, new business processes and identified the key functions and people required to support a standalone organisation. The adoption of these purpose-built systems and business processes across the enlarged Group was one of the key benefits expected from the acquisition.

In reality, the systems were proven to be not fit for purpose, the business processes were overly complex, and the organisational design was highly fragmented.  This has continued to have a material impact to core business operations, execution levels and overall productivity”; and:

“Through multiple acquisitions, the business has inherited a mix of regional and product orientated Go-to-Market models. These differences have led to inconsistent approaches to customer engagement and the associated deployment of resources and when combined with the systems issues outlined above impacted overall levels of execution and predictability of performance. This led to reduced productivity and elevated levels of staff attrition”.

It rather emphasizes the importance of robust, reliable and high-quality IT systems in companies and one would have thought that a software company would not manage to make such a hash of things. Morale in the company must be quite low now.

However they have a new non-executive Chairman in Greg Lock who is an old IBM hand. His name seemed familiar and he was Chairman in a company called Surfcontrol when I held shares in it. I do not recall he made any mistakes while there and he has considerable experience of other directorships since.

He says in the announcement that “I am pleased to join Micro Focus as non-executive Chairman, well aware of the previous successes and the present challenges.  I am looking forward to rolling my sleeves up to help management execute the plan”. It sounds like he is going to take a “hands-on approach” to resolve some of the problems.

Existing investors in the company may wish to hold on to see how events pan out, but it looks a risky punt for any new investors. Existing investors will appreciate an increased dividend and the yield is now over 10%, but a Daily Telegraph writer suggested they should press the Delete button. The share price fell 22% yesterday.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Bernard Baruch – Speculating in the Twentieth Century

Someone on Twitter recently mentioned Barnard Baruch as a legendary investor. I have just read his autobiography which is entitled “Baruch – My Own Story” and it is indeed interesting for several reasons.

Firstly he had a long life and the book covers the period from the American civil war until the 1960s. So it covers more than one period of financial crisis such as the 1929 Wall Street crash and two World Wars. Baruch’s father was a doctor and surgeon in the Confederate Army. For those interested in American history, as I am, it’s a revealing account of why the USA became so dominant in the world financial scene.

Baruch became a stock market speculator and a millionaire by his thirties when a million dollars was worth a great deal. He later became an advisor to Presidents and was involved in US responses to both major wars. But he also was almost wiped out at times in his early career. One thing he learned to do was to always reflect on and try to learn from his mistakes so as not to repeat them – sound advice for all investors.

He is scathing about share tips. So he says about his losses in American Spirits that “Nothing but my own bad judgement was responsible. My course violated every rule of speculation. I acted on unverified information after superficial investigation and, like thousands of other before and since, got just what my conduct deserved”.

It covers an age before the second world war when stock market manipulation was very common and there is an interesting mention of “bucket shops” and how they operated to wipe out their patrons (I mentioned the resurgence of bucket shops in a previous blog post).

Baruch is particularly good on the manias that sweep stock markets. He was adept it seems at knowing when the market was too high and when it was time to get out. He has a chapter on his investment philosophy that includes this advice:

  1. Don’t speculate unless you can make it a full-time job.
  2. Beware of barbers, beauticians, waiters – or anyone – bringing gifts of “inside information” or “tips”.
  3. Before buying a security, find out everything you can about the company, its management and competitors, its earnings and possibilities for growth.
  4. Don’t try to buy at the bottom and sell at the top. This can’t be done – except by liars.
  5. Learn how to take your losses quickly and cleanly. Don’t expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible.
  6. Don’t buy too many different securities. Better only a few investments which can be watched.
  7. Make a periodic reappraisal of all your investments to see whether changing developments have altered their prospects…
  8. Study your tax position to know when you can sell to greatest advantage.
  9. Always keep a good part of your capital in a cash reserve. Never invest all your funds.
  10. Don’t try to be a jack of all investments. Stick to the field you know best.

These are all wise words indeed.

In summary, the book is an interesting read as Baruch is a good communicator as well as it being a slice of America’s financial history when it was dominated by J.P. Morgan, the Rockefellers and other giants of the age.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit – Over and Out – and Why Shareholder Votes Matter

Last night Brexit got done. We exited the EU after 47 years. Our last words to the EU bureaucrats were surely “over and out”. But we will need to resume the conversation to secure a trade deal. That still leaves room for many more arguments within the UK and with the EU.

Some people seem to think that there is a hope we might rejoin the EU some time in the future. But while the EU is dominated by bureaucrats and real democracy is so lacking in the EU institutions that seems exceedingly unlikely to me. Hope of any reform to the EU is surely forlorn.

It might be preferable to have some alignment on product and financial regulations but in the latter area the EU either follows well behind the UK anyway, or creates regulations like MIFID II that are over complex or simply incomprehensible.

One area that the EU could have been a leader in was to improve financial regulation such as on shareholder rights. They have produced a Shareholder Rights Directive but it is so badly written that it can and is being effectively ignored in the UK. Just take the area of shareholder voting and the problem of nominee accounts.

The Investors Chronicle (IC) have published an article by Mary McDougall this week entitled “Why Shareholder Votes Matter”. It shows how the nominee account system has disenfranchised most individual shareholders as they either cannot vote their shares, or it is made so difficult to do that they don’t bother.

I contributed to the IC article because I have a lot of knowledge of this area having pioneered the ShareSoc campaign on the issue and having experience of using multiple platforms over many years (see https://www.sharesoc.org/campaigns/shareholder-rights-campaign/ ).

The article mentions Sirius Minerals (SXX) which is currently subject to a takeover bid via a scheme of arrangement. A very large proportion of the shares are held by individual investors in nominee accounts but because of the voting rules on Court hearings all of them will only get one vote by the nominee operator who might not even vote at all. That’s because nominee accounts are generally “pooled” with only one name on the share register as a “Member” of the company – and that name is that of the nominee operator (i.e. the platform).

Another example that shows where votes are important is that of the forthcoming AGM scheduled for the 12th February at RWS Holdings (RWS), an AIM company. You might think that this will be a routine matter with just the standard resolutions. But not so. There is actually a resolution to waive the need for a Concert Party that might acquire more than 30% of the shares to make an offer for the company under the City Takeover Code. The Concert Party comprises Chairman Andrew Brode, Diane Brode and a Trust they control. They already hold 32.8% of the shares but as there is also a share buyback resolution that might increase their holdings, and hence trigger the need for an offer, a waiver is required. I voted against both resolutions – I always vote against share buy-backs unless there are very good reasons, and I don’t like public companies to have shareholders with more than 30%.

You can see that just a few private shareholders in nominee accounts might affect the outcome as the Concert Party cannot vote on the waiver. But will they?

Regardless I encourage shareholders in RWS to vote their shares – if you hold shares in an ISA your platform operator has a legal obligation to cast your votes.

The IC article mentions that the Law Commission is currently looking at the problems and legal uncertainties created by nominee accounts, but it also discloses that they only expect a “scoping study” on intermediated securities to be published in Autumn 2020. No great urgency there then!

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Miton UK Smaller Companies Fund In Decline

There was an interesting article published a couple of days ago by Citywire on the problems at the LF Miton UK Smaller Companies Fund. The fund is managed by well known investor Gervais Williams and Martin Turner and focuses mainly on AIM listed companies. Performance in 2019 was dire with the fund losing 14% when the sector was up 25%. Over the last 18 months this open-ended fund has shrunk by 75% as investors bailed out.

In the Citywire article Gervais is quoted as giving some positive comments including “The stocks in the fund are particularly undervalued on a relative and absolute basis, with an overall price-to-book ratio of 1.1 times, for example, versus 2.2 times for the FTSE AIM All-Share index”. A quick look at the portfolio gives me some doubts though.

The top holdings are Aquis Exchange, Kape Technologies, CentralNic Group, Totally, Corero Network Security, Kromek Group, Amino Technologies, Frontier IP, Hydrogen Group and Reabold Resources. I have held CentralNic and Corero in the past but not currently. Corero who operate in the digital security (DDOS) sector has been a consistent disappointment over many years with repeated placings required. Perhaps some of these business are undervalued and may turn into winners in due course, but the problem with holding small caps in an open-ended fund is that a hiccup in the overall fund performance causes investors to sell the fund and that means the fund manager has to sell some of the relatively illiquid shares to meet redemptions. That drives the share prices down.

This is similar to the problem Woodford had but in a slightly different form. The Miton holdings are at least listed but probably quite illiquid, i.e. low normal share volume and selling the size of holding that Miton might have would be difficult. But it’s similar in that the managers seem to have lost their touch at share picking.

The situation works in reverse of course if the fund grows in size after a positive period. Folks pile in and the share prices of the shares the fund invests in are driven up.

One has to question whether this kind of fund should be an open-ended fund rather than an investment trust. The bigger the fund grows (it’s now still £57 million in size), the more dangerous the situation becomes.

But for private investors, one way to avoid this “herding” problem is to invest directly in small cap shares rather than in a fund. Any individual investor may have such a small holding that one can move in and out of the shares without moving the share price too much. Or if you still wish to invest in small cap open-ended funds, make sure you jump on the bandwagon when it’s going up and bail out as soon as there are any performance hiccups.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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