Steps Down With Immediate Effect – Diploma and IDOX

The phrase “stepped down with immediate effect” is used by companies to announce the instant departure of a director. It usually simply means they have been fired. It is of course frequently bad news as it often follows past uninspiring events and it means that the company has to scratch around for a replacement or ask another director to step into the breach.

This week I saw such announcements on a couple of my holdings. The first was Diploma Plc (DPLM) where the CEO Richard Ingram was the victim. The announcement also said “the Board believes that a change in the CEO is in the best interests of the Company and its shareholders”. The surprising aspect here was the Mr Ingram had only joined the company a few months ago and the trading announcement issued on the same day was positive. Mr Ingram had been recruited to replace long-serving CEO Bruce Thompson who retires at the end of September. Clearly the recruitment process seems to have failed but there is always a high chance of failure when recruiting a senior position from outside. John Nicholas, the Chairman, is taking over on an interim basis rather than Mr Thompson. Better to admit a mistake sooner rather than later.

The share price initially dipped on the morning of the announcement, but then rose as much as 4% during the day. Clearly some investors saw it as good news.

This morning there was a similar announcement this morning from IDOX (IDOX). Long-serving CFO Jane Mackie has resigned and leaves the board with immediate effect. That’s perhaps not greatly surprising as she was the CFO in the period when IDOX had to back-track on some rather aggressive revenue recognition practices. A new CEO has recently been appointed so a change in CFO was not surprising. However Ms Mackie is not actually leaving the company until February 2019 which certainly gives the company plenty of time to find a replacement.

The share price of IDOX has fallen by 1.8% today at the time of writing, but I rather judge this as positive news so it might recover I suspect in due course unless there is other news announced. The departure of a finance director sometimes means they have just given some unexpected bad news to the board. I do recall in my early career to suddenly finding my finance director boss was departing for that very reason after a stormy board meeting. He was rather easy going so it was great to be junior to him, but that character defect did not impress the board.

Let us hope that is not the situation at IDOX.

It is unfortunate for investors that such announcements tend to be somewhat cryptic in nature. Often a “settlement agreement” with the departing individual has yet to be proposed or agreed so they don’t want to prejudice the legal negotiations by saying more. But of course they might well inform their major investors while private investors are left guessing.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Whitewash at Gordon Dadds AGM, and Insolvency Warnings

I attended the Annual General Meeting of law firm Gordon Dadds Group (GOR) this morning. The company was tipped as a buy in Investors Chronicle on the 3rd August so I bought a few shares. It’s always good to go to the AGMs of new investments to get an impression of the management and ask a few questions. This is one of only three listed legal firms (the others being Gateley and Keystone which I do not hold).

This AGM was very unusual in that both on the “show of hands” vote and the proxy vote counts, there were no votes against at all, i.e. exactly zero on all resolutions. That is exceedingly unusual for a public company. As I said to the Chairman, he managed to achieve that by not having a share buy-back resolution on the agenda as I normally vote against such resolutions. Likewise no resolution to change to 14 days notice of general meetings. I congratulated him on that and a well run AGM where questions were taken first before the formal business.

There were about a dozen shareholders present, some of whom might have been staff. I questioned the increase in overheads in the last year – they are working to bring that down but it was increased as they “set up to expand” – and the high debtors. Although they bill work in progress monthly, it seems their corporate clients are slow payers. Another shareholder asked how work in progress was valued, and it’s at cost apparently. Otherwise I did not pick up any concerns although the legal market does seem fragmented and it is not clear to me how they are differentiated from others although they do have some specialisations. One might see it as a market ripe for consolidation with too many small firms and Gordon Dadds seem to have acquisition ambitions.

The company only listed on AIM a year ago so it’s early days as yet.

Interesting that the national media failed to pick up on the changes to the insolvency regime announced by the Government last Sunday. Perhaps not surprising on a Bank Holiday weekend although I covered it here: https://roliscon.blog/2018/08/26/insolvency-regime-changes-a-step-forward/

Perhaps private investors were not concerned because they think they can bail-out before such events unlike institutional shareholders who frequently have such large holdings that they can’t place them on the market at any price. But you cannot always do so. I have been caught twice in over twenty years of investing by unexpected administrations of retailing companies who often appear to have lots of revenues and positive cash flows. But a retail market turn-down can catch them unawares when they have high fixed costs (staff and property rentals). The result is often a cash flow problem when quarterly rent payments are due, or an unexpected tax bill appears, or suppliers’ insurers simply get nervous and withdraw cover.

A simple ratio to look at to pick up businesses at risk of insolvency is the Current Ratio which I like to see above 1.4. Remember business only go bust when they run out of cash. However, retailers often pay their suppliers after they have sold the goods to their customers so the Current Ratio is not a reliable measure for retailers. Likewise it tends to be unreliable when looking at software companies where they might have deferred support revenue in their current liabilities which should really be ignored as it will never be paid.

The Current Ratio is easy to calculate (it’s Current Assets divided by Current Liabilities). A better measure but a more complex one is the Altman Z-Score. This was very well covered in this week’s Investors Chronicle where it was argued that it was also a good measure of the overall performance of companies. It’s not foolproof in terms of predicting insolvency but it’s certainly a good warning indicator – the big problem is that accounting figures on which it is calculated are often out of date.

The Z-Score can be obtained from a number of sources as it’s a bit tedious to calculate it yourself – for example Stockopedia display it on their company reports.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Productivity, Sage, Sophos and Investment Trust Discounts

There was an interesting article last week in Investors Chronicle where Bearbull attempted to analyse the variations between company productivity. Productivity, or the lack of it in the UK, is one of the big issues weighing on the minds of politicians of late. Is the productivity of UK companies getting better or worse was one of the questions he attempted to answer.

For investors, productivity is surely one thing we should look at when deciding in which companies to invest. Those businesses that get the most out of the capital they employ (measured by Return on Capital, or ROCE), and also get the most out of their employees, are surely the ones most likely to be successful and generate the profits and dividends we like as investors.

But one needs to combine the two because obviously employees can be traded off against capital. By investing in more automation, employees can be reduced. But there is also the problem that businesses vary in nature. So natural resource companies such as oil producers can have large revenues and profits generated by relatively few staff, while retailers generate equivalent profits from much larger staff numbers.

Bearbull had a stab at producing a combined productivity index for a range of large cap companies, but as the results were still very wide ranging ended up focusing on whether their productivity was increasing or decreasing. Results were still varied.

There is a way to make use of such figures and that is to compare companies in the same business sector. For example software companies employ a lot of staff, but generally little capital apart from their past investment in developed software or in acquisitions. One way I used to look at companies in the software industry when I worked in it was to look at the revenue and profits per employee and I still find those useful measures. They can tell you a lot about the nature of the business.

It’s informative for example to compare two of the larger UK software businesses – Sage (SGE) and Sophos (SOPH). Sage has recently been the subject of a downgrade by analysts at Deutsche Bank and the shares have been heading south for some time as competition from new entrants into the accounting software space seems to be increasing. But at least they are making profits. Sophos is in the hot IT security sector but is still reporting operating losses.

But it’s interesting to look at their sales per employee – that was £124,320 in the case of Sage (13,795 employees) and £116,975 in the case of Sophos (3,187 employees) from the latest Annual Reports that are available. In other words, very similar. Operating profits per employee were £25,154 at Sage while Sophos reported a loss of £8,000 per employee.

The big difference was in average employee costs which were £57,194 at Sage and £95,387 at Sophos. The latter is a very high figure which helps to explain why they are losing money.

Sophos looks to be an example of where the directors and employees are taking most of the profits leaving very little for shareholders – indeed a negative return to them.

Investment Trust Discounts

I mentioned in a previous article the high share price discount to Net Asset

Value at RIT Capital Partners which encouraged me to sell the shares. The discount was actually a premium of 6.8% which I reported although I am advised it had actually been even higher in the recent past.

It is common knowledge with anyone who invests in investment trusts that discounts have narrowed in the last year with popular trusts now often on premiums. The dangers of buying trusts that trade at a high premium was recently evidenced by the fall in the share price of the Independent Investment Trust (IIT). As reported by Citywire recently, the share price unwound by 10.9% in one week after the premium shrank from a peak of 20% in June. It’s now only 6.2% but that’s still too high in my view.

The company performed exceptionally well in 2017 (NAV up 53%) but even so this is surely a case of investors expecting “past performance to be indicative of future performance” when every health warning on stock market investments tells you the contrary. The long-term performance record is good but there is a limit to the price one should pay for anything.

You can track the company’s performance, and the discount it trades at on the Association of Investment Companies (AICs) web site. There are many other relatively high performing investment trusts that still trade at a discount.

Why should investment trusts trade at a discount? Because just looking at the income they produce, if the management and administration charges reduce their income by 1%, when their yield was otherwise 5%, then the share price should be at a discount of 20% because otherwise people can buy the individual holdings of the company directly and increase their income in that proportion. That ignores the relative proportion of dividends paid out of income versus capital growth. Of late we have had lots of capital growth but that is not always the case. If the market starts to go down then share price premiums on investment trusts could well collapse.

A particular problem with investment trusts, and the reason why discounts, or premiums, can sometimes become extreme, is the relatively low volume of share trading even in large trusts, i.e. there is low liquidity. Buyers are often long-term holders with few active traders speculating in the shares. This problem tends to worsen in the summer months when many investors are on holiday so one needs to be wary of trading such shares in that period.

I hold none of the companies mentioned above, for the avoidance of doubt.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Mulberry Profit Warning – Better Late Than Never

On Saturday (18/8/2018) I wrote about the damage to suppliers from the pre-pack administration at House of Fraser. One of the companies mentioned was Mulberry Group Plc (MUL) and I queried why they had not issued an RNS announcement indicating the likely impact on their profits. I suggested it could be £2.4 million.

This morning Mulberry issued a profit warning that spelled out the likely figure. There will be a provision of £3 million of “exceptional costs” related to the 21 “concessions” that they operated in House of Fraser stores. That arises from “a review of debtor balances, fixed assets and potential costs that may result from restructuring”.

For the avoidance of doubt, I have never owned the shares, nor bought their products. They do sell some nice handbags at £1,000 plus though. Both the products and the share price are too rich for me. At a prospective p/e of over 50 even before this morning’s profit warning, they must have some loyal followers.

The share price has fallen by 17% this morning at the time of writing. I hope shareholders in Mulberry will complain to the Insolvency Service (part of the BEIS Department – the responsible Minister is Kelly Tolhurst M.P.). The insolvency regime needs major reform.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

House of Fraser – The Real Damage from the Pre-Pack and to Mulberry

I have covered the abuse of pre-pack administrations and the case of House of Fraser in two previous blog articles. But now that the initial administrators report has been published the real damage is very clear.

House of Fraser had total debts of £884 million of which trade suppliers were owed £484 million. The latter means goods supplied to the company, and sitting in the stores being sold to customers which will not be paid for by either the administrator or the new owners. The suppliers included big names such as Mulberry, Giorgio Armani, Gucci and Prada plus no doubt a large number of smaller suppliers as is common in the “rag trade”. Some of the latter might well go bust as a result.

Let’s look at luxury products supplier Mulberry which is a UK listed company (TIDM MUL). They are owed £2.4 million when last year their net profits were £6.2 million so the potential hit to their profits is very substantial as the administrator is very unlikely to pay them. What might offset those losses?

They might have “reserved title” on the goods supplied if they wrote their contracts correctly although such claims are typically resisted by administrators. They might also have insured the risk of not being paid by their customers in which case the cost will fall on the insurers. They may also do some kind of compromise deal with new owner Mike Ashley whereby he pays a figure to ensure continuity of supply. But Mulberry have made no public announcement of the likely impact on profits which is surely required sooner or later from a public company. Perhaps they are still trying to figure out the impact or are simply “in denial” about the cost.

Retail concession operators within the House of Fraser stores are also in a difficult position. Stock in the stores is theirs and has been removed in some cases. But past sales will have been put through the House of Fraser till system. The cash may be in a trust account, or it may not.

Retail customers of House of Fraser have also been affected, particularly those who ordered products from the company’s web site. These should have been delivered from warehouse operator XPO Logistics who are owed £30 million and stopped processing orders soon after the administration. Whether the customers will get refunds or will have to claim against their credit card suppliers is not currently clear.

The House of Fraser web site is currently unusable so they will be missing a lot of potential orders. The site simply says “We’re currently working hard to make some improvements to the website” which is a misleading euphemism for “systems needing to be totally rebuilt with a new supply chain”.

You can see from the above that although a pre-pack administration appears a simple way for a business to continue while jobs are protected, in reality it is far from simple and enormously damaging to a wide range of people and companies. The bankers and lenders to the company are first in line for any payout as “secured” creditors but typically all other creditors get nothing in such cases. It seems unlikely that it will be any different here.

In conclusion, you can see from the above, and the impact on the pension fund of the company covered in a previous article, that pre-pack administrations are only simple solutions for insolvency practitioners and bankers. For everyone else they are a nightmare. The disruption they cause creates much wider impacts and justifies looking for a better solution to the problems of companies that are losing money and running out of cash.

THE INSOLVENCY REGIME NEEDS REFORM. THERE ARE BETTER SOLUTIONS TO THE HANDLING OF INSOLVENT BUSINESSES.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

RIT Capital Partners, Foresight 4 VCT and Sepsis

RIT Capital Partners (RCP) is an investment trust that recently issued its interim report. As one of my longer standing holdings, first purchased in 2003 although I have reduced my holding of late, I read the report with interest. RCP has been a long-standing favourite of private investors having traditionally taken a somewhat defensive investment approach. But the portfolio is now most peculiar. It contains 8.8% of “quoted equities” but many of them are held as “swaps”, 27.7% in “long-only funds”, 19.7% in hedge funds and 0.6% in derivatives. There is 9.1% in direct private investments, 13.2% in private investment funds, 23.1% in “absolute return and credit funds”, 3.0% in “real assets” (which includes gold, silver, corn and soyabean futures) and 2.0% in Government bonds (with more swaps in there also). This is certainly an unusual portfolio to say the least.

Personally when I invest in a fund or an investment trust, I prefer them to invest directly – not pass the buck to some other fund manager. This trust has effectively become a “fund of funds” of late with a large proportion of its investments placed into other funds. Otherwise it appears to be hedging against armageddon.

The Chairman of the company is long-standing Lord Rothschild who is aged 82. When I have attended the AGM of this company I have never been very impressed by the way he handled the meeting or the responses to questions.

The total return net asset value performance in the half year was 3.2%, but 6.2% on share price. The current share price discount to NAV is actually at a premium of 6.8% according to the AIC and the dividend yield is 1.6%. Over ten years the total return (NAV) has been 103% when sector performance was 135%. So it’s not exactly been a great performer. I sold the remainder of my holding after reading the interim report.

Foresight 4 VCT

Another investment trust but of a very different nature is Foresight 4 VCT (FTF) which is of course a venture capital trust. It recently issued its Annual Report for the AGM due on the 11th October. I may attend it although my holding is very small.

The Annual Report does make interesting reading although it fails to mention a past complaint by some shareholders about the over-statement of reserves in the years 2013-2015 which resulted in an illegal dividend allegedly being paid. The auditor, KPMG, who still audits this company make no comment on this and neither do the directors in the Annual Report. But the Audit Committee report does mention that the company has received a letter from the FRC questioning the accounting policy for performance related incentive fees. The company has responded. Both issues are likely to be the subject of questions at the AGM no doubt.

This company has two very large holdings in its portfolio – Datapath and Ixaris. I have been very dubious about the valuations put on the latter company by this and other VCTs as I know quite a lot about the business. I used to be a director and still have a direct holding. This is particularly so after the disclosure by the Ixaris Chairman of the latest business challenges at the recent Oxford Technology VCT meeting.

I will be voting against the reappointment of KPMG as auditors at this company, against the sole director who is standing for re-election (is it not recommended that all directors of fully listed companies stand for re-election?), and against approval of the Report & Accounts.

But FTF did raise some more money this year and is investing in what appear to be interesting companies. One of their new investments has been in Mologic which is a medical diagnostic company. What sparked by particular interest was their product for rapid diagnosis of sepsis which I only narrowly survived a few years ago. Up to 50% of people who develop sepsis die from multiple organ failure, even though it can be treated with antibiotics. It is often misdiagnosed or treatment commenced too late, so a rapid diagnostic tool will be of great use.

Dr Hadiza Bawa-Garba was convicted of gross negligence manslaughter over the death of six-year-old Jack Adcock from sepsis but subsequently challenged being struck of the medical register. She won the latter legal case this week after a big campaign by doctors and a major crowdfunding exercise. Bearing in mind the other contributory factors, and the difficulty in spotting sepsis I consider the original conviction a gross miscarriage of justice. You can feel just slightly under the weather and next minute you are unconscious and in the intensive care unit as I know very well. Jack Adcock had other medical conditions that will not have helped.

There are 44,000 deaths from sepsis every year in the UK, and children are particularly at risk. It appears that cases of sepsis are rapidly rising although that might be due to better diagnosis. Even surviving it can mean life changing injuries. See https://sepsistrust.org/ for more information or if you wish to support a charity that is raising awareness of this deadly disease.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

RedstoneConnect (Smartspace Software) AGM and Branding

Today (30/7/2018) I attended the Annual General Meeting of RedstoneConnect Plc (REDS) which was promptly renamed Smartspace Software Plc at the meeting.

Although there were only a few ordinary shareholders present, this proved to be an informative meeting. It was chaired by new Chairman Guy van Zwanenberg. With former CEO Mark Braund having departed recently after major disposals leaving the company to focus on the remaining software business, the new CEO is Frank Beechinor who was the former Chairman. Frank is also Chairman of DotDigital which I also own shares in (a lot more than in RedstoneConnect which has had a mixed history – the focus on software alone makes it more attractive to me and I fully supported the disposals).

I asked whether Frank’s appointment was a permanent one. The answer was effectively “yes” as he is committed to it for 2 or 3 years. This is despite the fact that he promised his wife that he would not take another full-time job back in 2011 (he is only aged 54 according to Companies House though). He is apparently involved with 5 businesses and is stepping back from 3 of them, but remaining Chairman of DotDigital. He hopes to develop the company into a business with a market cap of £300 to £400 million in a few years.

The disposals meant the company now has substantial cash after paying off some debt but they are clearly not going to use it on share buy-backs in the short term. They are looking for acquisitions and would only return cash to shareholders if they don’t use it within the next couple of years. Acquisition will be focused on three areas: 1) Complementary to existing activities where they may pay 1 to 1.5 times revenue; 2) Analytics and 3) Visitor management solutions where their existing offering is quite weak. At present they have too large a focus on big deals (which can be lumpy) and are keen to move into the low-end, entry-level where sales can be automated web-based ones.

They have reduced staff down from 360 to 67 and now only have three buildings – in Luton, Mildenhall and Bristol with no “head office”. There are no overseas offices and they are likely to use partners to expand there.

It’s difficult to determine likely financial forecasts (Cantor have recently issued a positive note on them) – it rather depends on the success of any acquisitions, how much they pay for them, and controlling the overheads. But there are apparently no tax issues from the disposals.

The New Name

I spoke to Frank Beechinor before the AGM and advised him that I thought the new name was a bad choice. This is because I did a search of the UK/Euro trade mark register and found over 500 possible conflicting registrations – although some may be in different “classes” of goods and can be ignored. If you also use Google to search the internet for “smartspace” there are lots of matches. There is even a company listed at Companies House named “Smartspace Software Ltd”. So I think it is very likely they will get a lawyer’s letter sooner or later asking them to desist from trade mark infringement and even registering the change of name at Companies House might be difficult. Here’s a quick lesson in branding and trade mark law taken from my book “Beware the Zombies” (currently under revision):

Brand names for products or companies should be unique What are the key things to remember when inventing a new name? These are:

  1. It should be memorable.
  2. It should have the right, positive connotations with the product/service.
  3. It should be legally capable of being protected by appropriate trademark registrations.
  4. It should be usable as an Internet domain name in the chosen form(s).
  5. It should be unique, original, and not confusing with any existing trademark or brand name, and particularly not with competing or potentially competitive products.

A product or company name that cannot be registered as a trademark should never be considered. Registration of trademarks is relatively low cost and gives you much stronger legal protection (and easier enforcement of your legal rights) than an unregistered mark. Even more to the point, if you infringe someone else’s mark they can pursue a very simple and low cost legal action to force you to stop using the name – the result being that all your web site, sales literature, etc, will need revising and reissuing.

You should apply to register trademarks in all the main legal jurisdictions in which you are likely to trade. There are some differences between the different jurisdictions as to what is legally possible to register, and also as to what would be seen as a conflict with existing registrations, but the following is a good starting point:

  1. Do not use a purely descriptive or superlative mark.
  2. Make sure it is unique, distinctive and is not similar, even phonetically, with existing registered marks. You can search the main trademark registers on-line to do some basic checking.
  3. Try to think up something new and original, which is more difficult than you may imagine. Anyone new to the game of brand name creation tends to come up with the same old names that have already been thought of and previously used. Like “Smartspace”!
  4. Note that you can sometimes take a name that is already in use on other types of goods (trademark registers are based around “classes” of goods). But you need to take care with names that are in widespread use on more than one type of product.
  5. Do not fall in love with your chosen name before you have had it thoroughly researched by a trademark lawyer.

So often I have seen start-up ventures select a name which they think is original—but often it is some half-remembered echo of an existing product name or has been used before because it is so obviously appropriate. They name the business after it, start using it in sales literature and with prospective customers, and yet it turns out to be legally very questionable. You need to come up with several possible names before you go through the full legal search and registration procedure.

You probably also need to check that the chosen name is not already in use as an unregistered trademark (searching the internet can help here) and is not already in use as a corporate name (you can search company name registers also).

One of the big issues is that you will also want to protect the product name as a domain name on the internet, under the “.com” suffix, under any of the common national suffixes such as “.co.uk”, and also possibly with other newer suffixes as “.biz”. Finding a name that is free in all those domains and the relevant trademark registers and is not already in use as an unregistered trademark or corporate name is exceedingly difficult! Note that www.smart-space.com is already in use by another business so endless confusion will undoubtedly result.

Finally don’t start using a new trademark until you are sure it can be registered and is protectable. Having to change the name after a few months of usage will destroy your investment in marketing, product literature, web site design and other activities.

The resolution to change the name of RedstoneConnect to Smartspace Software was of course voted through. The directors said they had committed to change the name and had consulted legal advisors on it and might consider changing it again if necessary. I had offered some advice on the subject from my past experience in this field of inventing and registering marks but it was too late to reconsider in essence.

When I look at investing in small listed or unlisted companies, this is one area I look at because it tells you whether they have got the basics right. Hence my comments on “GB Group” naming in a previous post, and my dislike of “Tungsten” for the name of another AIM company. Unmemorable and unprotectable in both cases.

Registered trade marks are low cost and important to ensure brand recognition and legal protection but few people realize how important they are. The importance of branding is another very key area on which many books have been written but technology companies are often inept in this area.

So I just hope the directors of Smartspace Software have not fallen in love with the new name, or if they do choose to change it again that they do it properly next time.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.