Acquittals Over Tesco Fraud

Yesterday (6/12/2018) was another sad day for those who would like to stop false accounts being published by public companies. Two former executives of Tesco who had been charged with their involvement in the inflating of Tesco’s profits by including supplier credits were discharged by the court on the basis that they had no case to answer. The judge, Sir John Royce, said the case was so weak that it should not be put to a jury.

It appears that the problem was proving that the defendants, John Scouler and Christopher Bush, knew about the false accounting or were the cause of it. This is despite the fact that Tesco, the company, entered into a Deferred Prosecution Agreement (DPA) with the SFO over the case, and the company agreed with the FCA to compensate affected shareholders who relied on the false accounts.

A DPA does not include any admission of guilt, so it seems we now have the situation where nobody is to be held personally liable for these events.

Was this a trivial technical offence committed by a low-level employee? Not exactly. Tesco plc made an exceptional charge of £235m in respect of the DPA of £129m, the expected costs of an FCA compensation scheme of £85m, and related costs.  The profit figure of Tesco was reduced by £250 million in one quarter alone.

Auditors PwC also escaped any censure over their audits of the accounts of Tesco after an investigation by the Financial Report Council (FRC).

In summary we now have the situation where a major fraud on investors took place by the publication of false accounts but nobody is held accountable. Not until UK law is tightened considerably will such events no longer happen. Directors should be held strictly liable for the publication of false accounts on their watch, and auditors likewise. It is simply not good enough when everyone can evade responsibility by saying “nobody told me”.

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

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KIDs and New Bank Claim Platform

The rules for the production of KIDs (Key Information Documents) laid down by the EU have been severely criticised because they may give investors very misleading views on likely future returns from funds. This is because their estimate of future returns are based on short-term historic data. This has caused many fund managers of investment trusts to suggest that they should be ignored and investors look at the other data that the companies publish to get a better view of likely future returns. This writer certainly ignores the KIDs for the investment trusts I hold.

One anomaly is that KIDs are now only required for investment trusts not open-ended funds such as OEICs. Implementation for the latter was delayed and a decision has been made to delay them again. This is what the Association of Investment Companies (AIC) just said about this: “The expected delay to KIDs for UCITS funds is welcome but leaves investors in non-UCITS funds out in the cold.  Recent EU proposals to reform KIDs do not address their fundamental failings and will either do no good or make matters worse.  Investors now face being misled by KIDs for years to come. As the EU appears unwilling or unable to protect non-UCITS investors, the FCA should take the lead and warn investors not to rely on these documents.  It should ensure that the misleading information in KIDs does not pollute other areas of the market, for example by prohibiting it from being used in financial promotions and in search filters on websites.”

It’s worth pointing out that investment trusts are a peculiarly British approach to providing funds to retail investors. In effect the EU has adopted rules that prejudice investment trusts and if our future financial rules are aligned with the EU that prejudice will continue after March 2019.

Incidentally I was somewhat baffled by the furore in Parliament over disclosure of the legal advice on Brexit. The previous legal advice on Brexit was 43 pages long. The new “full” legal advice is 6 pages and does not appear to contain more information. It’s just an executive summary which highlights a few issues. So many MPs and the media are just stirring and creating dissension in my view for no good reason. Perhaps they simply have not read both documents like me.

Neil Mitchell, who has been fighting the Royal Bank of Scotland (RBS) over their actions over the pre-pack administration of Torex Retail for years, has launched a judicial review against the Financial Conduct Authority (FCA) over their failure to disqualify certain executives of RBS involved in the activities of the Global Restructuring (GRG) at RBS. This is the group that is alleged to have connived in destroying good small companies for the benefit of RBS. It looks a difficult judicial review to get even past the first hearing by a judge to me for more than one reason from my knowledge of such cases, but I am no lawyer.

He has also launched a new Claims Management company to pursue legal claims against RBS and other banks on behalf of those aggrieved by what happened in the bank financial crisis and the activities of banks in general. The new platform has a web site here: www.banksclaimsgroup.com . Anyone who thinks they have such a claim needs to look very carefully about how this new group is to be run and financed. There are lots of lawyers keen to earn fees from pursuing such claims but whether they have a realistic prospect of success is often ignored. Also just because folks feel they have a grievance does not mean they have a winnable legal case. And as we have seen from the RBOS Shareholders Action Group, often any awards when won are can be largely diverted to litigation funders and others.

But Neil Mitchell certainly has much knowledge and experience that might be of assistance to others.

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

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Bellway AGM for Early Risers Only

Should Annual General Meetings of companies be held at reasonably convenient locations and on convenient dates and times so that as many shareholders as possible can attend? Most private shareholders certainly think so. But Bellway (BWY) seem to be taking the opposite approach.

Their 2016 AGM was at the very sensible and easily achievable time of 2pm in the afternoon so all shareholders hoping to attend could actually meet the directors and ask questions. They could travel from all over the country and even have time for lunch!

But this year’s AGM kicks off at 8.30 am on Wednesday 12 December 2018 at Jesmond Dene House Hotel, Jesmond Dene, Newcastle upon Tyne NE2 2EY.

So what changed….Do directors at Bellway not want shareholders any more….maybe the huge remuneration at housebuilders and recent furore at Persimmon has made directors devise cunning plans to avoid awkward questions and attention from the media.

This anti-shareholder mindset seemed to set in last year with an early morning start at 9.30 am in Newcastle but still six shareholders made it through the doors. That must have been too many for the directors because this year they have moved it even earlier. They have moved it closer to breakfast for those who like to vote whilst eating their cornflakes.

Here’s hoping that the 2019 AGM is not held at 7.30am and that at least one shareholder will make it through the early morning fog on the Tyne !!

But it is simply not acceptable for boards to take this approach. There are too few shareholders attend AGMs already without deliberately making it difficult for them. I suggest that perhaps the UK Corporate Governance Code should be modified to include coverage of when and where AGMs should be held and other aspects of how they are run (such as the answering of questions which I covered in a previous article).

Thanks to David Stredder for notes on the above events.

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

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Autonomy, FRC Meeting, Retailers and Brexit Legal Advice

The big news last Friday (30/11/2018) was that former CEO Mike Lynch has been charged with fraud in the USA over the accounts of Autonomy. That company was purchased by Hewlett Packard who promptly proceeded to write off most of the cost – see this blog post for more information: https://roliscon.blog/2018/06/02/belated-action-by-frc-re-autonomy/. As this was a UK company, are we anywhere nearer a hearing in the UK over the alleged “creative accounting” that took place at the company and the failure of the auditors to identify anything amiss? That’s after 8 years since the events.

As I was attending a meeting held by the Financial Reporting Council (FRC) for ShareSoc and UKSA members yesterday, I thought to review the past actions by the FRC on this matter. In February 2013 they announced an investigation but it took until May 2018 to formally announce a complaint against auditors Deloitte and the former CFO of Autonomy Sushovan Hussain who has already been convicted of fraud in the USA. On the 27th November, the action against Hussain was suspended pending his appeal against that conviction, but other complaints were not. But why the delay on pursuing the auditors?

The FRC event was useful in many ways in that it gave a good overview of the role of the FRC – what they cover and what they do not cover which is not easy for the layman to understand. They also covered the progress on past and current enforcement actions which do seem to have been improving after previous complaints of ineffectiveness and excessive delays. For example PWC/BHS was resolved in two years and fines imposed are rising rapidly. But they still only have 10 case officers so are hoping the Kingman review of the FRC will argue for more resources.

It was clear though that audit quality is still a major problem with only 73% of FTSE-350 companies being rated as 1 or 2A in the annual reviews when the target is 90%. The FRC agreed they “might be falling short” on pursuing enforcement over poor quality audits. So at least they recognise the problems.

One useful titbit of information after the usual complaints about the problems of nominee accounts and shareholder rights were made (not really an FRC responsibility) was that a white paper on the “plumbing” of share ownership and transactions will be published on the 30th January.

There were lots of interesting stories on retailing companies yesterday. McColl’s Retail Group (MCLS) published a very negative trading update which caused the shares to fall 30% on the day. Supply chain issues after the collapse of Palmer & Harvey are the cause. Ted Baker (TED) fell 15% after a complaint of excessive hugging of staff by CEO Ray Kelvin. This may not have a sexual connotation as it seems he treats male and female staff similarly. Just one of the odd personal habits one sees in some CEOs it seems. Retail tycoon Mike Ashley appeared before a Commons Select Committee and said the High Street would be dead in a few years unless internet retailers were taxed more fairly. He alleged the internet was killing the High Street. But there was one bright spark among retailers in that Dunelm (DNLM) rose 14% after a Peel Hunt upgraded the company to a “buy” and suggested that they might be able to pay a special dividend next year. There was also some director buying of their shares.

Before the FRC meeting yesterday I dropped in on the demonstrations outside Parliament on College Green. It seemed to consist of three fairly equally balanced groups of “Leave Means Leave” campaigners, supporters of Brexit and those wishing to stay in the EU – that probably reflects the composition of the Members in the House across the road. You can guess which group I supported but I did not stay long as it was absolutely pelting down with rain. There is a limit to the sacrifices one can make for one’s country.

But in the evening I did read the legal advice given to Parliament by the attorney-general (see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/761153/EU_Exit_-_Legal_position_on_the_Withdrawal_Agreement.pdf

Everyone is looking very carefully at the terms of the Withdrawal Agreement that cover the Northern Ireland backstop arrangements. The attorney-general makes it clear that the deal does bind the UK to the risk of those arrangements continuing, although there is a clear commitment to them only lasting 2 years when they should be replaced by others. There is also an arbitration process if there is no agreement on what happens subsequently. However, he also makes it clear that the Withdrawal Agreement is a “treaty” between two sovereign powers – the UK and the EU.

Treaties between nations only stick so long as both parties are happy to abide by them, just like agreements between companies. But they often renege on them. For example, the German-Soviet non-aggression pact in 1939 was a notorious example – Hitler ignored it 2 years later and invaded Russia. Donald Trump has reneged on treaties, for example the intermediate nuclear weapons treaty last month. Similarly nations and companies can ignore arbitration decisions if they choose to do so.

What happens after 2 years if no agreement is reached and the UK insists on new proposals re Northern Ireland? Is the EU going to declare war on the UK? We have an army but they do not yet have one. Are they going to impose sanctions, close their borders or refuse a trade deal? I suspect they would not for sound commercial reasons.

Therefore my conclusion is that the deal that Theresa May has negotiated is not as bad as many make out. Yes it could be improved in some regards so as to ensure an amicable future agreement but I am warming to it just like the Editor of the Financial Times recently. He did publish a couple of letters criticising his volte-face when previously he has clearly opposed Brexit altogether, but changing one’s mind when one learns more is just being sensible.

Note: I have held or do hold some of the companies mentioned above, but never Autonomy. Never did like the look of their accounts.

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

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EMIS Investor Event

On Thursday (29/11/2018) I attended the EMIS Group (EMIS) Capital Markets Day at the London Stock Exchange. Having held shares in the company since 2011, this was a great opportunity to get an update on the situation of the company and its future plans.

First some background. EMIS is best known as the provider of software that general practitioners use – EMIS Web (primary care). That has more than 50% of the UK GP market. But the company also has many other solutions for other healthcare sectors such as secondary and acute care, pharmacy services and diabetic eye screening. Many of these services are sold to the NHS but there is also private income. The company has also been investing in development of a Patient app and web site for providing information and services directly to the general public (https://patient.info/ ).

It goes without saying that the healthcare sector is growing as the population increases and the age profile rises – particularly now the baby boomers are entering retirement. The population seems to be becoming generally less healthy and one example of this is the growth in diabetes sufferers.

EMIS has certainly managed to grow revenue both as a result of increasing demand for medical services but also because of the provision of new services and minor acquisitions over the years. Revenue has almost doubled in the last 5 years £160 million, but profits have not shown the same growth. Reported profits fell in 2017 to £8.8 million mainly due to £5.8m of reorganisation charges, £11.2m of “Service Level” charge provisions (see below) and high amortisation charges of £15.2m mainly relating to past software development costs. Perhaps that is why this event barely covered the financials of the business, either historic or future projections, but concentrated on software and business developments. That was somewhat surprising considering the audience must have been mainly investment professionals.

The share price has been trending down since January 2016 and is now on a prospective p/e of 20.3 for the current year ending in December according to Stockopedia (analyst consensus forecasts are actually given on the company’s web site).

What was the exceptional Service Level provision of £11.2 million for? That arose because the company discovered that it had not been meeting the service level agreement terms for EMIS Web with the NHS. They expect to conclude a settlement soon within the terms of the provision. I asked the CFO about this matter because my own GP was certainly not aware of any failings in support of EMIS Web. His answer was that certain reports of minor bugs had simply been lost rather than been progressed. This all seems rather odd to me that this had ever happened yet alone required financial compensation when the client was not apparently aware of it.

There were a number of demonstrations of the software and solutions on display for attendees both before and after the presentation. The latter was very slick and well-rehearsed with two very professional videos on trends in healthcare (ppt slides available from the company’s web site). It covered:

  • Financial progress of the business since IPO which of course looks a lot better than over the last 5 years.
  • Improved relationship with NHS Digital which is good to hear as future renewal of the EMIS Web contract is very important.
  • Current leadership team including relatively new CEO Andy Thorburn appointed in May 2017. Also clear they have added substantially to the team lately.
  • Intention is to build sales momentum including rapid growth of private sector business to 50% of group and margin improvement.
  • Acceleration of technology roadmap which is to be “self-funded” (by customers and “operational leverage”).

Comment it is clear that the company has committed to very substantial development in software and technology with staff numbers growing as a result (will be up by 150 this year). The focus is to transition from just being number 1 or 2 in lots of individual healthcare sectors to providing an integrated platform where applications can communicate with each other – including partner or even competitor solutions. So for example, EMIS Web is to become EMIS-X and enable an integrated view of multiple practices so you could book appointments with other GPs in your local area. In addition the Patient App will provide access to GP appointments and other services such as repeat prescriptions (it was noted that 45% of the UK population have such prescriptions which helps to explain why the NHS is so costly to run).

The objective is to make EMIS the centre of healthcare. They also see opportunities to grow by entering new markets. They expect their addressable market to double by 2022. The plans are aligned with NHS initiatives and the provision of more “joined-up” healthcare which everyone is demanding – there is still too much paper in the NHS and lots of independent systems and medical practitioners who cannot easily communicate, e.g. hospital systems with GPs and social care providers.

EMIS-X will be an “open” platform and enable the sharing of information between “tenants” (i.e. authorised users) and will help to reduce development costs and be a scalable solution. Technically it will be a cloud-based service using Amazon Web Services (AWS). This raised one question concerning security concerns which might be a roadblock to wide adoption. Certainly there are concerns about this in the healthcare professionals I know and by some patients.

As regards the Patient App, it was noted that we have been “patient” with the Patient App but “next year will be the year”. Personal note: I had an old copy of the Patient App on my i-Phone which I could not update for unknown reasons. Had to delete and download a new version which I did after the event – but was unable to do so without entering credit card info so gave up. Don’t see why that should be required until needed.

Included in the presentations was one on the management of medicines where there is an opportunity. Some 23,000 deaths per annum are from prescribing errors which cost £1.6 billion, but only one third of patients adhere to taking their prescriptions after a few weeks.

Another question raised was how are they going to compete with Babylon which I covered in a previous blog post: https://roliscon.blog/2018/11/13/should-you-give-up-fags-and-booze-plus-coverage-of-babcock-and-babylon/ . Babylon is providing a GP service and triage capability. They have been receiving a large amount of venture capital funding. The answer was that EMIS does not need external funding because they already have the customers so don’t need to spend on customer acquisition and on people. They claim to have more App users also. EMIS is not going to provide GP services themselves, but solutions to support GPs. An interesting comment from CEO Andy Thorburn at this point was that the EMIS model will be similar to BTs (where he used to work) where they will have both wholesale and retail customers where wholesale provides the infrastructure which other suppliers might use. The focus will be on development of a “partner ecosystem”.

It was disappointing that insufficient time for Q&A was given.

Demonstrations included the new video GP appointment service which will be available very soon in some GP practices, and booking appointments using AI capabilities in EMIS-X. Another one was talking to a smartwatch to access GP services via the Patient App.

In conclusion, the event provided good coverage of the technology direction that EMIS is pursuing. It was unclear though how that would be turned into revenue and profits. It was more of a technology presentation than a business presentation with little mention of target markets and segmentation.

However, the company already has a dominant and key position in the NHS and in medical services in the UK in general. Their future plans should enhance that position and be in alignment with NHS priorities. Profits are forecast to grow but the rate of growth is not great (revenues are expected to provide “mid-to-high single-digit annual growth” according to one presentation slide which seems to be relatively unambitious to me and analysts forecast is for only 5.9% this year).

Bearing in mind the cost pressures in the NHS and the reliance by the company on that one customer to such a large degree, you can see why the company is keen to develop its private sector business and why the shares are not currently more highly rated.

But for heavy personal users of medical services like myself, it gave a useful overview of what we soon might be seeing in the real world. Not having to repeat one’s past medical history to numerous medical professionals could save the NHS an enormous amount of money alone, and improve safety in many areas. The key for EMIS is how to turn that and other opportunities into profits.

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

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AJ Bell and FinnCap IPOs

Here are some comments on the IPOs of AJ Bell and FinnCap which are open to private investors  ̶  the former to any of their clients who wish to put in £1,000 or more. The latter can be purchased from the PrimaryBid platform.

Bearing in mind that I have previously said that you should never invest in IPOs (see my comment on Aston Martin which was certainly right as the shares are now down over 20% since IPO here: https://roliscon.blog/2018/09/09/the-market-dunedin-and-standard-life-smaller-companies-merger-and-aston-martin-ipo/ ), these comments will be reserved in nature. Even the very successful launch of Smithson Investment Trust which went to an initial premium seems to have retraced its steps. But there are exceptions.

One reason why you might wish to buy AJ Bell shares, or at the very least read their prospectus, is if you are a client who uses their Youinvest platform. As we saw with past debacles in stockbrokers, such as the recent events at Beaufort, because investors on such platforms are in nominee accounts it’s definitely worth keeping an eye on their accounts. Being a shareholder means you can go along to their AGMs and ask questions. Investors will be pleased to hear that AJ Bell claim to have a “strong regulatory capital position which is supported by a high Pillar I coverage in excess of approximately 440%”.

The company has 95,000 retail investor customers and 89,000 customers via advisors. All are execution-only clients, i.e. AJ Bell provides no advice. Their average customer account value is higher than most of their big competitors and this is probably because of their historic concentration on SIPP accounts which represent 63% by asset value of their accounts.

Founder Andy Bell is still with the company as CEO after 23 years and will remain. No very specific reasons are given for the IPO – it’s just referred to as a “natural next step”. No new capital is being raised and Andy Bell is selling 10% of his shares in the IPO, which will cut his holding to 25%, but together with related parties (a “Concert Party”) he will still control more than 30% after the IPO. Major shareholder Invesco is also selling a major proportion of their shareholding. No new money is being raised for the company.

The financials look very good in comparison with many platform operators, other than possibly Hargreaves Lansdown who are the gorilla in this market, but the shares are likely to be cheaper than theirs. Share price range will be between £1.54 and £1.66 giving a market cap of over £626 million.

Is it a good time to invest in platform operators whose profits can depend on the volume of share trading and assets under management? Certainly recent volatility might have helped but it is difficult to judge the longer-term trend. But as stockbrokers are highly regulated businesses it’s worth reading the “Risk Factors” and associated warnings in the prospectus. Market trends of an ageing population who may be tending to move their pension funds into SIPPs or have saved in ISAs has no doubt helped AJ Bell in recent years and is likely to continue to do so. This has generated compound growth in numbers of customers at AJ Bell of 24% in the last 7 years.

It’s particularly interesting to read the “asset transfer momentum” table on page 45 of the prospectus. That shows AJ Bell among the top few for transfers in, while Alliance Trust Savings is at the bottom – perhaps Alliance Trust were wise to dispose of it.

I have never heard complaints about the AJ Bell IT platform (they have a proprietary client front-end with “outsourced” software being used for the back-office work), so that bodes well for the future. Although it would be good if they made it easier for investors to vote their shares on their nominee platform which I think was promised but has not arrived.

I think this will be a popular IPO and although the market has been depressed by Brexit worries it might therefore get away easily. But you’ll have to make your own mind up whether it is good or bad value. I repeat my warning about buying IPOs in general – the sellers know more about the business and market trends than you do.

Details of the IPO can be found here: https://www.youinvest.co.uk/markets/ipo/ajbell

As regards FinnCap, they spell it as “finnCap” which rather shows their ignorance of English grammar. The business is a small company corporate broker and AIM Nomad. I hold a number of AIM companies who they act as broker for and they seem to do a competent job on the whole – at least no worse than any other AIM Nomad who operate in a market full of companies with optimistic future growth projections but frequently unrealistic ambitions and unproven management. This is no doubt a business with substantial regulatory risk.

FinnCap are merging with Cavendish Corporate Finance before the IPO. As a very people-dependent business, operating in a cyclical market sector, I am not sure these kinds of companies are ideal to be public companies. Therefore I won’t even attempt to comment on the valuation.

I repeat my warning about investing in IPOs – see above.

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

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British Smaller Companies VCT Offer

It’s that time of year when share subscription offers for Venture Capital Trusts (VCTs) tend to be launched. One of the first is that for the British Smaller Companies VCT (BSV). This one that has shown a relatively good performance for a generalist VCT – share price total return of 225 over ten years according to the AIC compared with a sector performance of 136. It also has a high dividend yield and a narrow discount to NAV. However I have never liked their manager’s performance incentive fee arrangement and consistently vote against the Chairman, Helen Sinclair, who introduced it. But they are proposing to change it.

Currently the incentive fee is based simply on dividends paid – at the rate of 20% of those paid – so long as a dividend hurdle is met. There is also a hurdle for Net Asset Value (NAV) which has to be met, which presumably was intended to ensure that the NAV did not fall to too low a level. However, very high dividends can be paid by the company even though the company has lost money on many of its investments. In effect, dividends can be paid out and incentive fee based on them paid to the manager even though the company’s earnings do not cover the dividends. Incentive fees based on dividends paid out in VCTs are simply wrong.

What can happen is that dividends are paid out based on realisations, while ignoring the unrealised losses in the portfolio. This arrangement resulted in a very large incentive fee being paid to the manager in 2017 – dividends of 22.0p paid out when reported earnings were only 4.6p. The result was total management fees of £5.5 million paid when assets at the start of the year were only £96 million.

What is the new management fee arrangement? In essence it will remain dividend based with the same 20% figure. The only change is to introduce a Total Return hurdle to replace the Net Asset hurdle. There are other changes and complications to the incentive agreement which are very difficult to understand, including an overall cap, for which you need a spreadsheet to understand the effect. But the company says “Note that the historic incentive payments would have been significantly lower if the proposed incentive arrangements had been in place since 2009 due to this cap”. I’ll take their word on it, but it’s still a bad arrangement and should be simplified.

There is also going to be a reduction in the fixed “investment advisor fee” of 2% of assets so that only 1% is paid on cash balances held.

Shareholders may wish to vote for these changes as they may be better than the past arrangements but I suggest shareholders write to the Chairman as I shall be doing and complain that the board needs to try harder. This looks like an agreement that has been written by the fund manager. Incentive schemes for fund managers should be simple to understand by shareholders and the board, and not based on dividends paid out but on total return.

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

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