LoopUp Profit Warning and Brexit Party Policy

Conference calling AIM company LoopUp (LOOP) issued a trading statement this morning which contained a profit warning. At the time of writing the share price is down 47% on the day but it has been falling sharply in recent days which suggests the bad news had already leaked out.

This is an example of what happens when lofty growth expectations are revised downwards. Revenue is now expected to be down 7% on the previous market consensus and EBITDA down 20%. The company blames the shortfall on “subdued revenue across its long-term customer base” driven by macro-economic factors and diversion of sales staff into training new ones.

LoopUp is presenting at the ShareSoc seminar event on the 10th July so it will be interesting to hear what they have to say about this – see https://www.sharesoc.org/events/sharesoc-growth-company-seminar-in-london-10-july-2019/ . This news comes only a month after LoopUp held a Capital Markets Day when there was no hint of these problems. I did a report on that here: https://roliscon.blog/2019/06/07/broker-charges-proven-vct-performance-fee-and-loopup-seminar/

I do hold a few shares in LoopUp but thankfully not many.

Brexit Party Policy

I mentioned in a recent blog post that the Brexit Party is looking for policy suggestions to enable them to develop a platform for any prospective General Election. Here’s what I sent them with respect to financial matters:

  1. The personal taxation system is way too complicated and needs drastically simplifying. At the lower end the tax credit system is wide open to fraud while those on low incomes are taxed when they should not be. The personal tax allowance, both the basic rates, and higher rates, need to be raised to take more people out of tax altogether.
  2. The taxation of capital gains is also now too complicated, while tax is paid on capital gains that simply arise from inflation, which are not real gains at all. They should revert to being indexed as they were some years ago. For almost anyone, calculating your own tax that is payable is now way too difficult and hence requiring the paid services of accountants using specialist software.
  3. Inheritance tax is another over-complex system that wealthy people avoid by taking expert advice while the middle class end up paying it. It certainly needs grossly simplifying, or scrapping altogether as a relatively small amount of tax is actually collected from it.
  4. The taxation of businesses is inequitable with the growth of the internet. Small businesses, particularly retailers, pay a disproportionate level of tax in business rates while their internet competitors often avoid VAT via imports. VAT is now wide open to fraud and other types of abuse such as under-declarations, partly because of the EU VAT arrangements. VAT is in principle a simple tax and the alternative of a sales tax would create anomalies but VAT does need to be reformed and simplified.
  5. All the above tax simplifications would enable HMRC to be reduced in size and the time wasted in form filling by individuals and businesses reduced. Everyone would be a winner, and wasted resources and expenditure reduced.
  6. The taxation of company dividends on shares is now an example of the same profits being taxed twice – once in Corporation Tax on the company, and then again when those profits are distributed to shareholders. This has been enormously damaging to those who receive dividends and the lack of tax credits has also undermined defined benefit pension funds. The taxation of dividends should revert to how it once was.
  7. The regulation of companies and financial institutions needs very substantial reform with much tougher laws against fraud on investors. Not only are the current laws weak but the enforcement of them by the FCA/FRC is too slow and ineffective. Although some reforms have recently been proposed, they do not go far enough. Individual directors and senior managers in companies are not held to account for gross errors or downright fraud, or when they are, they get off too lightly. We need a much more effective system like they have in the USA, and better laws.
  8. Shareholder rights as regards voting and the receipt of information have been undermined by the use of nominee accounts. This has made it difficult for individual shareholders to vote and that is one reason why investors have not been able to control the excesses in director pay recently. The system of shareholding and voting needs reform, with changes to the Companies Act to bring it into the modern electronic world.
  9. The pay of directors and senior managers in companies and other organisations has got wildly out of hand in recent years, thus generating a lot of criticism by the lower paid. This has created social divisions and led partly to the rise of extreme left socialist tendencies. This problem needs tackling.
  10. Governance of companies needs to be reformed to ensure that directors do not set their own pay, as happens at present, but that shareholders and other stakeholders do so. Likewise shareholders and other stakeholders should appoint the directors.
  11. Insolvency law needs reform to outlaw “pre-pack” administrations which have been very damaging to many small businesses. They are an abuse of insolvency law.
  12. All the EU Directives on financial regulation should be scrapped (i.e. there should be no “harmonization” with EU regulations after Brexit). The MIFID regulations have added enormous costs to financial institutions, which have passed on their costs to their customers, with no very obvious benefit to anyone. Likewise the Shareholder Rights Directive might have had good objectives but the implementation has been poor because of the lack of knowledge on how financial markets operate in the UK. Other examples are the UCITS regulations which have not stopped Neil Woodford from effectively bypassing them, or the PRIIPS regulations which have resulted in misleading information being provided to investors.

Let me know if you have other suggestions, and of course the above policies might be good for adoption by other political parties in addition.

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

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Redcentric – Devasting Report on Audit Quality

I have commented on the accounting problems at Redcentric (RCN) before – see https://roliscon.blog/2019/06/13/pwc-fined-over-audit-at-redcentric/ . Mark Bentley of Sharesoc has written a good article on the audit issues at this company on their blog here: https://www.sharesoc.org/blog/regulations-and-law/redcentric-rcn-campaign-important-developments/

He covers the report from the Financial Reporting Council (FRC) on the audit which has only taken them two years to produce – that’s fast for the FRC. But if you read the report you will see that it is a devastating critique of the quality and professionalism of the audit by PwC.

An investigation by the Financial Conduct Authority (FCA) is still on-going apparently and ShareSoc is talking to lawyers about possibly legal action to recover losses suffered by investors from reliance on clearly inaccurate accounts.

But there are simply too many such cases and shutting the stable door several years after the horse has bolted is not good enough. The Government needs to look at how to prevent such problems by improving the standards of accounts, and improving the auditing of them. Some reforms have already been proposed in that regard but whether they will have an impact on the activities of smaller AIM companies, where a lot of the problems occur, has yet to be seen.

At the core of the problem is the failure to make the individuals (i.e. the directors and senior management) in such companies personally responsible. Pursuing the companies or their auditors is only a limited solution and shareholders often bear the costs when the individuals concerned need to be deterred by prison sentences I suggest. But that means changes to the law to make it easier to prosecute such cases.

And the FCA needs much more resources to enable them to pursue such cases quickly and forcefully. There is so much fraud taking place in the financial world that most goes undetected, unrecognised and unprosecuted.

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

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Slack IPO, Web Privacy and Sell on Monday

The IPO of Slack in the USA has received a lot of media coverage. This is one of those technology stocks that is on what at first glance is a sky-high valuation. Slack provides workplace collaboration software and last year had revenues of $400 million, and lost $140 million. The market cap is now around $20 billion which means it is valued at about 50 times revenue. Those are the negative numbers. The positive aspect is that it roughly doubled revenue in each of the last two years. With such growth are profits or losses important? But it’s surely a case of investors piling into a hot story, i.e. following the herd.

There’s an interesting article by Megan Boxall in this week’s Investor’s Chronicle comparing the current mania for technology stocks with the dot.com bubble of the 1990s. She reports that 2018 saw the highest proportion of loss-making company IPOs since 2000 and the market is awash with private equity money being ploughed into early stage loss-making companies.

Well I lived through the dot.com era and managed to sell a software business and retire before the boom became a bust. The current mania for technology stocks certainly reminds me of that era. Growth certainly adds to value, but growth in profits not revenue is what matters. Many early stage companies can grow revenue given enough investment but often they never make a profit. And when the realisation comes, investors drop the company like a hot potato. The key question is to look at when a company will stop consuming cash and at least look like it will breakeven. Before that point, it’s simply a speculation. Investors in the dot.com boom realised later on that they were going to lose money on most of their punts and the whole sector became untouchable for some years.

The other question to ask about Slack is whether it has some unique technology that cannot be easily copied. I am not sure it does on a quick review.

ICO and Adtech

I mentioned in a blog post om April 10th my concerns about privacy after I was bombarded with advertising for SuperxxDry products after mentioning the company in my blog. The Information Commissioner’s Office (ICO) has now published a report which says the Adtech industry must mend its ways. Basically personal data is being shared without the users’ consent, possibly to hundreds of advertising firms.

The ICO has effectively warned the industry that they must reform themselves as the use of personal data has been unlawful. See https://tinyurl.com/yxk7d494 for more information and to read their report. This will clearly affect any company operating in this sector including such giants as Google. But it is surely a move that is to be welcomed by anyone concerned about privacy and those not wanting to be bombarded by irrelevant advertising.

Buy on Friday, Sell on Monday

I have noticed over the last few months that my portfolio tends to rise on Mondays and fall on Fridays. It certainly did this week again. It appears that investors pile in to small cap stocks and investment trusts on Monday morning, but lassitude sets in on Fridays.

Researching the internet seems to suggest that this is a known pattern. So clearly it is best to be contrarian and buy when prices are temporarily down on Friday and avoid buying on Monday. So that’s my tip for today.

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

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FairFX AGM Report, Woodford Fund Issues and Zero Carbon

Firstly a brief report on the Annual General Meeting of FairFX (FFX) which I attended today in the City. Only I and one other shareholder asked any questions, and there may not have been many others there.

This is a payments company which had an initial focus on the provision of foreign exchange but they now do a lot more. They are planning to change the name in the near future and there was a resolution tabled to change the articles to enable them to do this without reverting to shareholders. I abstained on that because I prefer companies to put a change of name to investors. But talking to one of the directors after the meeting it sounds like they are taking a professional approach to the name change.

Revenue of the company was up 69% last year to £26 million with profits of £2.6 million. Adjusted EBITDA was up 687% if you wish to look on the bright side. There was a positive AGM announcement with phrases such as “a strong year to date” both in revenue and margins. Full year trading should be in line with market expectations.

The accounts of payment/credit card companies can be complex as I know from being a director of one of them in the past. So I asked a few questions on that area.

FairFX now exclude customer deposits from their accounts which is a definite improvement. But it does capitalise a lot of software development – £4.7 million last year, which I have no concerns about so long as it is in accordance with accounting standards. In response to a question I was told this level of expenditure might be a bit more in the current year. They are building a new unified front end on their 3 applications (platforms) – some of which were acquired.

I queried the collateral requirements of financial institutions they deal with (see page 6 of the Annual Report) and was told this is taken out of the cash figure on the balance sheet and is now in “Other receivables” – hence the large increase in that figure plus the impact of acquisitions on it and general increase in turnover.

Wirecard was mentioned during these questions. Apparently FairFX has historically used them as a “Card Issuer” but they now have the capability to issue cards themselves which will improve margins – customers will be migrated over. That’s reassuring because Wirecard has been getting some very negative publicity in the FT lately.

The other shareholder attending asked about the economic trends and their impact. Corporates are apparently sitting on their hands re FX and clearly Brexit risk might be impacting the demand for personal FX credit cards as holidays in Europe might be impacted by the uncertainty. However the CEO seemed confident about the future.

I might sign up for one of their “Everywhere” Pre-paid Credit Cards which looks cheaper than the company I am using at present.

This is one of those companies that has stopped issuing paper proxy forms – promoted by their Registrar Link Asset Services. I complained about that. I was also not happy that the resolutions were taken on a poll rather than a show of hands. But I understand the proxy counts were all higher than 99% so that was an academic issue.

Link acting as ACD for Woodford Funds

Link, in the guise of “Link Fund Solutions”, also got their name in the FT today over their activities as the Authorised Corporate Director (ACD) of the Woodford Equity Income Fund. An ACD is supposed to ensure that a fund sticks to the rules. They would have been involved in the decision to close the fund to redemptions.

It also seems very odd to me that they approved the listing of some fund holdings in Guernsey to get around the limitations of unlisted holdings. That was clearly an abuse as the reality was that these were not listing that provided any significant liquidity, with minimal dealing taking place. It’s the substance that counts, not how it might simply appear to meet the technical rules.

This looks to be yet another case of those who are supposed to be keeping financial operators in line not doing their job properly. But ask who is paying them.

FT article on Net Zero Emissions

I commented previously on Mrs May’s commitment to go for net zero carbon emissions by 2050. I called it suicidal.

There is a very good article on this topic in the FT today by Jonathan Ford (entitled “Net Zero Emissions Require a Wartime Level of Mobilisation”). The article explains how easy it is to get to the £1 Trillion cost mentioned by the Chancellor on required housing changes alone to remove all fossil fuel consumption. There may be some payback from the investment required but the payback period might be 37 years!

The whole energy system will need to be rebuilt and some of the required technologies (e.g. carbon capture) do not yet exist on a commercial basis. For more details go to the web site of the Committee on Climate Change and particularly the Technical Report present here: https://www.theccc.org.uk/publication/net-zero-technical-report/

If this plan is proceeded with there are enormous costs and enormous risks involved. But it will certainly have a major impact on not just our way of lives but on many UK companies many of which consume large amounts of power. That is definitely something investors must keep an eye on. Companies like FairFX may be one of the few that are not affected in a big way as they only manufacture electronic transactions. That’s assuming the rest of the economy and consumers are not too badly depressed by the changes as a result of course.

Nobel prize winning economist William Nordhaus has shown how a zero-carbon target is unwise. See this note for more information: https://www.econlib.org/library/Columns/y2018/MurphyNordhaus.html

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

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Worldwide Healthcare Trust and Investor Voting

I recently received the Annual Report of Worldwide Healthcare Trust (WWH). This is one of those companies that has stopped sending out proxy voting forms for their AGM. The Registrar is Link Asset Services who seem to be making it as difficult as possible for shareholders on the register to vote. You either have to contact them to request a proxy voting form, or register for their on-line portal. I don’t want to register (and the last time I tried it was not easy), I just want to vote!

But as I have mentioned before, I have provided a form that anyone can use to submit as a proxy instruction – see here: https://www.roliscon.com/proxy-voting.html. There is an option you can use if you are not on the share register but in a nominee account.

As regards WWH, performance last year was OK with net asset value total return up 13.7% although that’s less than their benchmark which managed 21.1%. Relative underperformance was mainly attributed to being underweight in the global pharmaceutical sector. The fund manager (OrbiMed Capital) believes there are better opportunities elsewhere such as in emerging markets and biotechnology. We will no doubt see in due course whether those bets are right.

But I do have some concerns about corporate governance at this trust. Not only are the directors highly paid, but two of them have been on the board for over 9 years, including the Chairman Sir Martin Smith. He also has a “number of other directorships and business interests” without them being spelled out. The UK Corporate Governance Code spells out quite rightly that directors who have served on the board for more than 9 years cannot be considered “independent”.

In addition Director Sven Borho is a Managing Partner of OrbiMed so he is clearly not independent either. So 3 of the 6 directors cannot be considered independent. I therefore give you my personal recommendations for how to vote on the resolutions at the AGM (or by proxy of course) of the following:

Vote AGAINST resolutions 2, 3, 7, 9, 14 and 15. Vote FOR all the others.

This is not “box ticking”, it’s about ensuring directors of trust companies do not become stale, not too sympathetic to the fund managers and not too geriatric. The excuses given for the directors I am voting against to remain do not hold water.

Nominee Accounts and Voting

As regards the difficulty of voting if you hold your shares in a nominee account (as most do now for ISAs etc), ShareSoc has some positive news after years of campaigning on this issue (including a lot of personal effort from me).

The Government BEIS Department have commissioned a review of “intermediated securities” by the Law Commission. See this ShareSoc blog post for more information: https://tinyurl.com/y4wk4edz . Please do support the ShareSoc campaign on this issue.

It is important that all shareholders can vote, whether you are in a nominee account or on the register, and you need to be able to vote easily. Bearing in mind the furore over the proposed requirement for voters in general elections to at least show some id before voting, which has been criticised, wrongly in my view, for possibly deterring voting, it is odd that this issue of disenfranchising shareholders has not been tackled sooner.

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

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Paying Illegal Dividends, Burford Capital, Woodford Patient Capital Trust and Zero Carbon Objective

A group of investors including Sarasin, Legal & General, Hermes and the UK Shareholders Association (UKSA) has written to Sir Donald Brydon who is undertaking a review of the audit market. They have yet again raised the question of whether the International Financial Accounting Standards (IFRS) are consistent with UK company law. In particular they question whether profits are sometimes being recognised, thus allowing the payment of illegal dividends. The particular issue is whether profits can arise on certain transactions under IFRS from transactions between parent and subsidiary companies or by the use of “mark to market” accounting. The problem is “unrealised profits” that might turn into cash in the future, but may not.

This may appear a somewhat technical question, but it can in practice lead to over-optimistic reporting of profits, leading to excessive bonus payments to managers, and the general misleading of investors. Actually calculating when a dividend can be paid as dividends are not supposed to be paid out of capital is not easy and is not self-evident to investors. The published accounts do not make it obvious. Regular mistakes are made by companies requiring later “whitewash” resolutions to be passed by shareholders. The ICAEW has previously rejected complaints on this issue but it is surely an area that requires more examination.

Incidentally I was reading a book yesterday entitled “White Collar Crime in Modern England” (from 1845-1929) which is most enlightening on common frauds that arose when limited companies became popular – many of the frauds still persist. In the “railway mania” of the 1840s it was common to set up companies and raise the capital to build a railway when the chance of it operating profitably was low. To keep the share price high, and the directors in jobs, dividends were paid out of capital. To quote from the book: “unscrupulous directors could easily pay dividends out of capital undetected – projecting a false image of profitability and enticing further investment in their lines”. That was an era when auditors did not have to be accountants and were often simply the directors’ cronies. Standards and regulations have improved since then, but there are still problems in this area that need solving.

There was an interesting discussion on Twitter recently on Burford Capital (BUR) with regard to their accounting methods. Not that I am an expert on the company as I do not hold shares in it, it but as I understand it they recognise the likely future settlements from the litigation funding cases they take on. In other words, they estimate future cash flows based on projections of likely winning the case and the possible settlements. As I said on Twitter, lawyers will often tell you a case is winnable but they will also tell you the outcome of any legal case is uncertain.

It’s interesting to read what Burford say in their Annual Report under accounting policies where it spells it out: “Owing to the illiquid nature of these investments, the assessment of fair valuation is highly subjective and requires a number of significant and complex judgements to be made by management. The exit value will be determined for each investment by the contractual entitlement, the underlying risk profile of the litigation, a trial or an appellate outcome or other case events, any other agreements in respect of settlement discussions or negotiations as well as the credit risk associated with the investment value and any relevant secondary market activity”.

The auditors no doubt scrutinise the reasonableness of the estimates but any outside investor in the shares of the company will have great difficulty in doing so.

Neil Woodford’s Equity Income Fund has a big holding in Burford Capital. I commented on the Woodford Patient Capital Trust yesterday here: https://roliscon.blog/2019/06/11/woodford-patient-capital-trust-is-it-an-opportunity/ and suggested the Trust made a mistake in naming the Trust after him. It makes it more difficult to fire the manager for example. But the FT reported this morning that the Trust has indeed had conversations about doing just that. Woodford’s firm has a contract that only requires 3 months’ notice which is a good thing. At least they can keep the “Patient Capital” moniker because investors in this trust have already had to wait a long time for much return and it could take even longer to improve its performance under a new manager. But as Lex in the FT said, “patience is now in short supply” so far as investors are concerned.

Another major item of news yesterday was soon to be ex-Prime Minister May’s commitment to enshrine in law a target for net zero carbon emissions in the UK by 2050. This is surely a quite suicidal path for the UK to follow when most other major countries, including all the big polluters, will be very unlikely to follow suit. Even Chancellor Philip Hammond has said it will cost about £1 trillion. It will effectively make the UK completely uncompetitive in many products with production and jobs shifting to other countries. We might become the first really “de-industrialised” country which is not a lead that many will follow, and it will actually be practically very difficult to achieve if you bother to study what is required to achieve zero emissions. It will completely change the way we live with the transport network being a particular problem (trains, planes and road vehicles).

As I have said before, if we really want to cut air pollution and CO2 emissions, then we need to reduce the population as well as rely on such wheezes as electrification of the transport and energy systems. Mrs May’s last act as Prime Minister might be to commit the UK to economic suicide. It might not be a good time to invest in UK manufacturing companies.

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

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Good News – Autonomy CFO Jailed

Good news – former CFO of public company jailed for fiddling the accounts. Oh to see that happen more often so as to deter manipulation of accounts that is so prevalent and so damaging to investors.

Sushovan Hussain, the former CFO of software company Autonomy, was sentenced to 5 years imprisonment by a US Court yesterday plus he was fined $4 million and ordered to forfeit $6.1 million he made from the sale of the company to Hewlett-Packard. He won’t even be spending time in a cushy minimum-security prison as he is a foreign national. He was found guilty some months ago on 16 counts of security fraud and other counts. In essence the allegation was that sales were inflated in the accounts and the result was that when HP bought the company, they had to write off much of the $11 billion they paid for it.

Although Autonomy was a UK public company, and the Serious Fraud Office did look at the case they decided to do nothing. However a civil action against Mr Hussain and the former Autonomy CEO, Mike Lynch is still being pursued in the English courts, and the latter also faces criminal charges in the USA.

Mr Hussain is planning to appeal the verdict. Let us hope he does not succeed because such cases provide a good deterrent to future malefactors.

These were some of the allegations against Autonomy:

  • Booking transactions to resellers as revenue when there was no end-user license (i.e. “channel stuffing” as it is sometimes called).
  • Engaging in “round-trip” transactions where purchases were invented so it could pay money to companies which then returned it to Autonomy to cover fictitious sales.
  • Backdating sales transactions so they fell into a previous accounting period.

There was also a claim that bundles of hardware/software sales were treated as solely software in the accounts. Why does this matter? Because software sales are valued in company valuations much more highly than hardware sales.

The above are some of the things that investors in IT companies need to look at although abuse can be difficult to spot in the published accounts of a public company. High accounts receivable and apparent lengthy payment delays can be clues. There were some questions raised about Autonomy’s accounts even before the takeover.

Hussain and Lynch have claimed that some of the disputed differences were simply down to different accounting standards (US GAAP versus IFRS) and I said when originally commenting on the case that I was unsure that this stood up to scrutiny. The US Court judge clearly rejected that argument.

But the sad thing is of course that we rarely see such cases pursued to criminal convictions in the UK, whether they are large or small companies.

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

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