Avoiding Another NMC Debacle

Yesterday the shares in NMC Health (NMC) were suspended and a formal investigation by the FCA was announced. The suspension announcement said that the company has requested the suspension of its shares and that the company is focused on providing additional clarity to the market as to its financial position.

The events at NMC are hardly the kind of thing one expects from a FTSE-100 company with reported revenue of $2.5 billion and profits of $320 million. The company operates hospitals and other healthcare facilities in the Middle East – hardly a sector that should be particularly volatile. The company has of course been the subject of an attack by Muddy Waters and the share price was already down by 80% from their peak in 2018, before they were suspended.

There now seems to be considerable doubts about the accounts (the finance director is on long-term sick leave which is never a good sign), there are doubts about who holds the shares, and questions about related party transactions and debt. The founder and CEO have departed from the board leaving the COO as interim CEO.

I recall NMC being tipped in numerous publications before all this bad news came out and it certainly looked a good proposition at a glance. Both revenue and profits were rising at 30% per year driven by rising wealth in the Arab states. So why did I avoid it?

The key point I would make is that “financial numbers are not important when picking shares” which is the subtitle of my book “Business Perspective Investing”. The numbers alone cannot be trusted even if they have been audited by a big firm such as Ernst & Young.

The company is registered in London and listed in the UK but the company had a peculiar governance structure with two joint Chairman and an Executive Vice-Chairman. They had a large number of directors otherwise and at the last AGM actually approved a resolution to increase the maximum number to 14. That is way too large for any company and results in board meetings being dysfunctional. The Muddy Waters financial analysis clearly raised some concerns and it is well worth reading. It also raised issues about the level of remuneration of the board and share sales. These might be considered warning signs and there is the key issue that it might be very difficult for UK based investors to monitor the operations of the company.

These are the kind of issues that I suggested investors need to look at in my book.

What do investors do if they find they have been suckered into a company with dubious accounts and when other negative facts have come to light? The simple answer is to study the evidence carefully and if in doubt sell the shares. It is never too late to sell is phrase to remember. You only have to look at the share price graph of NMC to see that investors with a trailing stop-loss of 20% would have exited long ago and hence avoided the worse outcome.

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

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Venture Capital Trusts, the Baronsmead VCT AGM and Political Turmoil

Yesterday (26/2/2020) I attended the Annual General Meeting of the Baronsmead Venture Trust (BVT) held at Saddlers Hall in the City of London. It was reasonably well attended. I will just report on the major issues:

The Net Asset Value Total Return for last year I calculate to be -2.7% which is certainly disappointing. Note that it is annoying that they do not provide this figure in the Annual Report which is a key measure of the performance of any VCT and which I track for all my VCT holdings. I tried to get in a question on this issue but the Chairman (Peter Lawrence) only allowed 15 minutes for questions which is totally inadequate so I will be writing to him on that subject.

The company does give a chart on page 3 of the Annual Report showing the NAV Total Return for the last ten years. There was also a fall in 2018 according to that chart although I am not sure it is correct as my records show a 6.9% Total Return. I will query that as well.

The main reason for the decline in the return was a disappointing result from the listed company holdings – mainly AIM shares. However it was noted that there was an upturn after the year end and it is now up 17.2%. Major AIM company losses last year were in Crawshaw and Paragon Entertainment – both written off completely now – and a bigger loss in Staffline which was one of their major holdings. However they did realise some profits on Ideagen and Bioventix which were still their largest AIM holdings even so at the year end.

There was criticism from two shareholders about the collapse in Staffline with one asking why they did not exit from Staffline and Netcall (another loser) instead of following them down, i.e. they should have invoked a “stop-loss”. The answer from Ken Wotton who manages the listed portfolio was that there were prospects of recovery and they had sold some Staffline in the past so were still making 4 times the original cost. Comment: Losing money on an AIM portfolio in 2019 is not a great result – certainly my similar portfolio was considerably up last year. They seem to be selling the winners while holding onto the losers – not a sound approach. However it would certainly have been difficult to sell their large holding in Staffline after the company reported accounting/legal problems. Selling such a stake in an AIM company when there are no buyers due to uncertainty about the financial impact is simply impossible at any reasonable price.

One shareholder did question the poor returns from AIM companies when they might have made more from private equity deals. The certainly seem to have ended up with a rag-bag of AIM holdings which could do with rationalising in my opinion. The fact that the new VCT rules will impose more investment in early stage companies may affect the portfolio balance over time anyway.

Robin Goodfellow, who is a director of another VCT, asked why they are holding 20% in cash, and paying a management fee on it. Effectively asking why shareholders should be paying a fee on cash when the manager is paid to invest the cash in businesses. The Chairman’s response was basically to say that this is the deal and he did not provide a reasoned response. This is a typical approach of the Chairman to awkward questions at this company and I voted against his reappointment for that and other reasons. The Chairman is adept at providing casual put-downs to serious questions from shareholders as I have seen often in the past.

Another reason to vote against him was the fact that he has been a director of this company and its predecessor before the merger since 1999 (i.e. twenty-one years). Other directors are also very long serving with no obvious move to replace them. This is contrary to the UK Corporate Governance Code unless explained and likewise for the AIC Corporate Governance Code which says “Where a director has served for more than nine years, the board should state its reasons for believing that the individual remains independent in the annual report”. There is no proper justification given in the Baronsmead Annual Report for this arrangement.

I have complained to the Chairman in the past about them ignoring the UK Corporate Governance Code in this regard so that’s another item to put in a letter to him.

All resolutions were passed on a show of hands.

ShareSoc VCT Meeting

In the afternoon I attended a meeting organised by ShareSoc for VCT investors – they have a special interest group on the subject. VCTs have generally provided attractive and reasonably stable returns (after tax) since they were introduced over twenty years ago and I hold a number of them. In the early days there were a number of very poorly performing and mismanaged funds and I was involved in several shareholder actions to reform them by changes of directors and/or changes of fund managers. Since them the situation has generally improved as the management companies became more experienced but there are still a few “dogs” that need action.

Current campaigns promoted by ShareSoc on the Ventus and Edge VCTs were covered with some success, although they are still “works in progress” to some extent. But they did obtain a change to a proposed performance fee at the Albion VCT.

However there are still too many VCTs where the directors are long serving and seem to have a close relationship with the manager. Baronsmead is one example. It is often questionable whether the directors are acting in the interests of shareholders or themselves. There are also problems with having fund managers on the boards of directors, with unwise performance incentive fees and several other issues. I suggested that ShareSoc should develop some guidelines on these matters and others and there are many other minor issues that crop up with VCTs.

There also needs to be an active group of people pursuing the improvements to VCTs. Cliff Weight of ShareSoc is looking for assistance on this matter and would welcome volunteers – see https://www.sharesoc.org/campaigns/vct-investors-group/ for more information on the ShareSoc VCT group.

Political Turmoil Ongoing

Apart from the disruption to markets caused by the Covid-19 virus which is clearly now having a significant impact on supply chains and consumption of alcohol as reported by Diageo, another issue that might create economic chaos is the decision by Prime Minister Boris Johnson to ditch the political declaration which the Government previously agreed as part of the EU Withdrawal Agreement, i.e. that part which was not legally binding.

The Government has today published a 36 page document that outlines its approach to negotiations on a future trade deal and its ongoing relationship with the EU – see https://tinyurl.com/tlhr3pk . It’s worth a read but there are clearly going to be major conflicts with the EU position on many issues and not just over fish! Needless to say perhaps, but the Brexit Party leaders are happy.

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

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Warren Buffett’s Shareholder Letter and Market Comments

Warren Buffett has issued his annual letter to shareholders in Berkshire Hathaway. It is usually worth reading for his market insights.  Last year was not a great one performance wise – annual percentage change in per share market value up only 11%. If you look back over the last 50 years of the company, and he publishes the whole track record, it is obvious that he has not been achieving the large outperformance against the market in recent years as he was up until the year 2000. That’s probably simply a reflection of the size of the company now and his inability to acquire controlling interests in good companies of late with the stock market being so buoyant.

The letter covers how the company uses insurance company floats to finance the business and the future as both Buffett and his partner Charlie Munger are now both very old.

Buffett has some interesting comments about how boards of directors have changed over the years. But he says: “The bedrock challenge for directors, nevertheless, remains constant: Find and retain a talented CEO – possessing integrity, for sure – who will be devoted to the company for his/her business lifetime. Often, that task is hard. When directors get it right, though, they need to do little else. But when they mess it up,……”

He also says this about remuneration committees: “Compensation committees now rely much more heavily on consultants than they used to. Consequently, compensation arrangements have become more complicated – what committee member wants to explain paying large fees year after year for a simple plan? – and the reading of proxy material has become a mind-numbing experience”.

Obviously he is referring to US companies primarily but the same applies to UK companies. He also has some negative comments about boardroom pay (which is even more gross in the USA than UK) and how the independence of non-executive directors is undermined by their pay, while he was happy to accept $100 per year for one directorship in the early 1960s. How times have changed!

You can read the full shareholder letter here: https://www.berkshirehathaway.com/letters/2019ltr.pdf

As I write this the markets are still falling sharply for the second day. Having been through several market downturns, I am not too fazed by the biggest ever one-day drop in my portfolio value. There will probably be some momentum in the downward trajectory as recent stock market investors will realise it’s not a one-way bet investing in shares. Shares likely to be affected by a worldwide pandemic are also particularly sharply down while there is general feeling that the long-running bull market must come to an end sometime.

But I am a dedicated follower of fashion as nobody knows how long the impact of negative news will last, what steps Governments might take to keep the economy afloat and stock markets bouyant, or what will be the emotional reaction of investors. So in general I will be selling shares as the market declines until the outlook appears more positive and when the bargains appear.

Having loads of cash is always a good thing to have so as to take advantage of opportunities as they arise.

Needless to say, this is not investment advice. You may choose to take a different path and you need to make up your own mind based on your investment strategy, long term objectives, what proportion of your holdings are in ISA or SIPPs and your tax position.

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

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Moneysupermarket News and Market Exuberance

Moneysupermarket.com (MONY) issued their preliminary results this morning. It was headlined “Return to profit growth and good progress on reinvent”. The results were much as forecast so far as I could see, although the outlook suggests some second half weighting for the current year. But the share price has jumped 18% today to 365p which is where I started buying some last June. But I got somewhat nervous when the share price subsequently consistently fell after an initial spurt upwards despite forecasts being positive.

The other significant news was that CEO Mark Lewis indicated he wished to step down yesterday “and pursue his career in a new direction” so the board has started a search for a replacement. This is rather surprising as he has not been there very long. More explanation as to why he is departing would have been helpful.

Price comparison businesses like Moneysupermarket still seem to be growing but clearly they are maturing somewhat. However on a prospective p/e of 17 (before today’s jump) and a dividend yield of 4.6% according to Stockopedia they surely looked good value.

The company does generate considerable cash with a good return on capital but most of the profits are paid out in dividends rather than used to generate growth or acquire complementary businesses. Is that the strategic issue that caused the CEO to depart I wonder? We may no doubt learn more in due course.

Otherwise the stock market seems to be ignoring the global trade threats such as the coronavirus outbreak in China and the US/China trade war, plus the possible risk of a failure of UK free trade talks with the EU. It’s one of those markets where almost everything is rising and investor are just buying everything that looks reasonable. I may have to go on a share buying strike until the market calms down as it seems somewhat irrational at present. Too much investor exuberance in summary.

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

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Competition in the Audit Market

I attended a “roundtable” event at the Financial Reporting Council (FRC) on Monday. It was primarily a discussion of audit market competition and how to improve it, with private investors attending. But as I said at the meeting the key issues in the audit market are the quality of audits and the accountability of auditors. Too many blatant frauds go undetected by auditors, and they avoid any responsibility for their errors. Being able to avoid accountability for their failings has resulted in declining audit standards over the last few decades. The Caparo legal judgement is one big reason as it prevents shareholders suing auditors for their failings. It needs overturning.

These thoughts were echoed by other speakers at the meeting although the FRC made clear that their focus is on quality.

The Kingman review of the FRC was critical of the audit sector and its regulation by the FRC while the Competition and Markets Authority (CMA) is undertaking a review of the market for audit services which is dominated by the big four audit firms.

Would improved competition for audit services improve the quality of auditing is one key question? Or simply lead to a race to the bottom as price competition was increased? Alternatively could quality be improved by improving the work of audit committees and how they select auditors? All of these questions were discussed but no specific conclusions reached.

One proposal to improve competition is to enforce “joint” or “shared” audits where all audits of larger companies would require the involvement of more than one audit firm. This might enable smaller audit firms to become more experienced and more credible to take on larger audits it is argued. But as I said in my response to the CMA consultation: “ So far as investors are concerned, joint and several liability would be a positive advantage to ensure audit quality in theory. But in practice as auditors avoid liability for most failings, it might not matter a great deal”.

I do not see how joint or shared auditing will improve the quality of audits or necessarily improve competition either. An alternative suggestion that there should simply be a cap on the market share of any one audit firm seems a better and simpler solution to the competition issue.

Apparently according to a report in the FT, audit firms have been lobbying hard to retain the status quo. The FT reported the comments of Will Hayter, a director of the CMA that those in the industry should not doubt the CMA’s resolve to go “from four to more” [audit firms].

Improving competition is undoubtedly of benefit even if it just avoids the risk of one of the big four collapsing (as happened with major audit firm Andersen a few years ago after reputational damage and criminal charges over the Enron fraud). But shareholders major concern is improving the quality of audits so that fraud is detected and dubious financial reports are not published; in other words to ensure that published accounts do indeed contain a “true and fair” view of the financial position of a company.

One example of where they might not be was mentioned in the meeting which is the accounts of Burford Capital (BUR) which I have also commented on myself negatively recently, much to the displeasure of Burford holders. All Burford shareholders should read the article by John Dizard published in the FT on the 17th February and entitled “Burford faces long wait over $1bn Argentina claim”. It questioned the valuation of the Petersen legal claim. See https://www.ft.com/content/6debcc05-e368-44b2-bb99-618b7bc0a618 . The key issue is reliance on the management to value the legal claims where any cash arising from the claimed profits based on the valuation of on-going claims may be a long time in coming, if at all.

In summary we need to improve the accounting and auditing standards if investors are to rely on the published accounts of companies. In the meantime investors will need to take a more sceptical view of the accounts of companies and not take them at face value.

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

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Share Centre Takeover and Holding Unlisted Shares

This morning it was announced that the Share Centre (Share Plc: SHRE) were recommending a takeover bid from Antler Holdco, the holding company of Interactive Investor and the ii Group. This has two very negative consequences for private investors:

  1. The Share Centre is one of the favourite platforms for many private investors with an efficient and low-cost trading service and also a simple system to enable one to vote the shares you hold in their nominee accounts. There may well be some rationalistion of systems so the downside is that Share Centre clients may have to learn a new software platform.
  1. The other negative is for holders of Share Plc shares, which many clients of the Share Centre probably are because there is a discount on trading costs if you held shares. The share price has risen this morning, perhaps on the hope of a counter-bid, but the terms of the offer appear very unattractive. The offer is for 4.1 pence in cash, but the equivalent of 90% of the offer value is in shares in ii (that’s assuming you accept their valuation). The ii business is an unlisted company incorporated in Guernsey and is majority owned by J.C.Flowers IV L.P.
  1. The new ii shares to be issued as part of the offer will be definitely unlisted and hence holders of Share Plc shares will have no idea of when or how they will be able to sell them and they will lack almost all protection from being minority shareholders. Any investor who understands the legal position of holding unlisted securities with no shareholder agreement in place will realise this is a very invidious position to be in and I suggest shareholders will need to seriously consider whether they should sell the Share Plc shares in the market while they can. If in doubt take legal or other professional advice on the matter!
  1. Could the takeover bid be defeated? That seems very unlikely as they already have 70% of acceptances via irrevocable undertakings, including the holdings of Gavin Oldham and his family who was the founder. Winning a required 75% vote of shareholders (by number of shareholders) to defeat it at the Court Meeting (this is a Scheme of Arrangement proposal) would be very tricky as with many shareholders in nominee accounts they might only be counted as holding the “one share” held by the nominee operator as a pooled account. And that share would be in the power of the Share Centre and its management. Many people hate takeover bids via schemes of arrangement as they undermine the normal democratic process that applies to more normal takeovers.

Just to give readers some understanding of the problem of holding unlisted shares, I received some bad news this morning. I have been holding some shares in an unlisted company for 20 years. I was one of the founder investors as part of an EIS scheme and although I have sold some of the shares to other investors over the years I hoped to finally get out as it has been somewhat of a rocky road. That looked like it might happen after the business received an offer a couple of months ago but the bad news today is that the deal of off.

I’ll have to live in hope a bit longer it seems.

P.S. The offer document actually says that the Share Centre clients will be migrated to the Interactive Investor Services platform. Let us hope it goes smoothly.

Note that some investors might have held Share Plc shares as clients of the company so that they could easily monitor the financial position of their broker. That is somewhat critical because of the danger of holding shares in any broker that gets into financial difficulties where your shares are held in nominee accounts. That will no longer be easily possible after this takeover.

Note also that  I am advised that at the court meeting for a Scheme of Arrangement 75% of SHARES need to be voted in favour for the scheme for it to pass AND a simple majority of SHAREHOLDERS.

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

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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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