Category: Laws & Regulations

Tesla, Unilever, EasyJet IT Write-Offs and Cash Holdings

The big news today is that the US Securities and Exchange Commission (SEC) have charged Tesla CEO Elon Musk with securities fraud. This charge relates to his comments on Twitter that he would likely be taking Tesla private. To quote from the SEC complaint: “Musk’s statements, disseminated via Twitter, falsely indicated that, should he so choose, it was virtually certain that he could take Tesla private at a purchase price that reflected a substantial premium over Tesla stock’s then current share price, that funding for this multi-billion dollar transaction had been secured, and that the only contingency was a shareholder vote. In truth and in fact, Musk had not even discussed, much less confirmed, key deal terms, including price, with any potential funding source”. Mr Musk vigorously rejected the charges, as did the company.

The full SEC complaint is here: https://www.sec.gov/litigation/complaints/2018/comp-pr2018-219.pdf

Comment: it is of course the oldest trick in the book if you are unhappy with the share price of your company to announce a potential bid from yourself or a third party. Making such an announcement via Twitter, if that was the motivation which has yet to be proven, would certainly be something new though. Making any announcements via Twitter is exceedingly risky and Tesla’s advisors must be tearing their hair out over this sequence of events. Who else if anyone reviewed the tweets before they were sent? Probably nobody I suspect. And anyone who uses Twitter will know it’s very easy to let typos, grammar errors and Spoonerisms creep in. Such important announcements should only be issued by the proper regulatory news channels. Elon Musk should have known better.

But if Elon Musk was forced to step down from Tesla, which might be the outcome, would it matter? I suspect not. The merit of Tesla as a company is in the technology in the cars which is still ahead of most potential electric car competitors. I have driven a Tesla Model S and it is a very good car indeed. But unfortunately my wife thinks I don’t need to buy expensive, flash cars to impress people any more so I’ll have to wait for the cheaper Model 3 to become available in the UK.

Unilever and Shareholder Voting

Unilever is planning to consolidate the two arms of the business in Holland, and drop the dual listing. UK shareholders would end up holding shares listed only in Holland, and as a result the dividends would be subject to Dutch withholding tax which is currently at the rate of 15%. Such taxes always cause problems although sometimes they can be refunded by submitting claims to do so. There is also the possibility that the withholding tax will be dropped. Another difficulty is that as Unilever is in the FTSE100, any funds running a FTSE-100 tracker would have to sell the shares. The Investors Chronicle ran a longish article on this subject and suggested it was a “no-brainer” for UK shareholders to vote against it.

But it seems that might be easier said than done. According to a report on Citywire, any shareholders in nominee accounts (i.e. in ISAs, SIPPs or other broker accounts – which means most UK shareholders now) will have to “rematerialize” their shares if they want to vote them, i.e. convert them to a paper share certificate. The company is not accepting votes submitted by nominee operators. Dematerialising shares is typically a costly and time-consuming process and is actually impossible to do if the shares are in an ISA or SIPP which have to be held in nominee form. This is truly outrageous news and any shareholders holding Unilever shares who wishes to oppose the move by the company should complain to the FCA, your Member of Parliament, the Company Chairman Marijn Dekkers, and anyone else you can think of.

[Postscript: the issue here seems to be the votes for the Court Hearing where the number of individual voters is taken into account. But for the shares held by a nominee operator, which may represent many thousands of underlying beneficial owners, only one vote would be counted even if it was submitted as there is only one holding on the register. ]

It has been reported that a number of institutions might oppose the unification of the company but it would certainly help to get retail shareholders voting.

Incidentally I attended a meeting today with Link Asset Services (one of the largest registrars) where the problem of retail shareholders not voting was discussed. I’ll write a separate blog post on that later.

EasyJet

If you recall, I mentioned previously the large expenditure on a “big-bang” IT project at Abcam which is clearly over-budget and over-time. That might have contributed to the 35% share price drop immediately after their recent preliminary results announcement. Now EasyJet have made a similar announcement today in their trading update. To quote: “…easyJet has now made the decision to change its approach to technology development through better utilisation and development of existing systems on a modular basis, rather than working towards a full replacement of our core commercial platform.  As a result of this change in approach, we are recognising a non-headline charge of around £65 million relating to IT investments and associated commitments we will no longer require. EasyJet will continue to invest in its digital and eCommerce layers that will enable it to continue to offer a leading innovative, revenue enhancing and customer friendly platform.”

That £65 million is no small sum and just shows you how IT is so critical to how businesses are managed in the modern world. Similar problems arose at TSB where they attempted to replace their old Lloyds systems with completely new software which was allegedly not adequately tested. But any IT professional will tell you that you cannot test and anticipate all the problems in a diverse customer environment ahead of going live with new technology. The NHS was another prime example of a “big-bang” approach to IT system development that ended up costing the Government, and us as taxpayers, at least £10 billion (that’s not a typo – it was ten billion and more). Evolution rather than revolution is the way to develop IT systems as EasyJet and Abcam seem to be learning, the hard way.

Cash Holdings

I suggested in a previous blog post that a newly available easy-access deposit account might be a suitable place to move cash from your stockbroking account to get a decent rate of interest rather than none. The problem of course is that most retail investors have most of their money in ISAs and SIPPs and taking cash out is problematic.

For ISAs, you may not realise that you can actually take cash out of a “flexible” ISA (which most ISAs are such as Stock & Share ISAs or Cash ISAs) and put it back in later. This was a recent change to the ISA regulations. However you can only do that within the same tax year without affecting your ISA allowance.

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

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The Impact on Investors of the Labour Party’s Plans

I commented briefly yesterday on the plans by John McDonnell of the Labour Party to give employees shares and possible future nationalisations – see: https://roliscon.blog/2018/09/24/labours-plans-for-confiscation-of-shares-and-rail-system-renationalisation/

More information is now available on the share scheme and the more one studies it the more one realises that whoever devised it does not understand much about business and the stock market. In other words they were typical politicians with no experience of the real world I would guess.

The scheme would apparently operate by companies with more than 250 employees being forced to hand over 10% of the shares in a company to an employee trust fund. That would be over a period of time – possibly ten years – and presumably that would be by the issuance of new shares rather than confiscating existing shares, but it still means 10% dilution for investors.

Shareholders normally get a vote on the issuance of new shares but presumably that could be legally subverted. Otherwise the scheme would cover about 11 million employees. However, foreign owned companies would not be covered so that excludes perhaps a third of the employees (the Labour Party apparently admits they would not be and it is difficult to see how legally any such law could be enforced on them).

One simple way for companies to avoid the scheme would be to move their country of registration elsewhere – no need to change where their shares are listed, just move domicile. We could see a host of companies re-registering in such places as Panama! An unintended consequence that I am sure the Labour Party would not like.

The shares accumulated in the trust fund would pay dividends to the individual shareholders out of the dividends paid to the fund by the company. But there would be a cap of £500 per employee. Any amount payable above that cap would revert to the Government. It is estimated this might generate £2 billion a year to the Government after 5 years – another large tax hike in addition to proposed increases in Corporation Tax the Shadow Chancellor is promising.

Employees could not buy or sell the shares held on their behalf, so presumably could not take them away when they leave or retire. So in practice those companies with high staff turnover would see the dividends accumulating for the benefit of the Government, particularly if the £500 cap remain fixed, i.e. unindexed.

But the company could avoid paying out this windfall to the Government simply by not paying dividends. Many companies don’t pay dividends anyway. Alternatively they could pay a dividend in shares (a “scrip” dividend), or offer to buy back shares occasionally via a tender offer or market share buy-backs– these would not be dividends and hence would be excluded.

Another problem with the scheme is that companies who had a few less than 250 employees could decide not to expand and hence become subject to this scheme, i.e. this would discourage companies from growing which is not what the Government wants. Alternatively they could create new separate companies owned by the same shareholders to expand their business and avoid it that way.

Apart from the 10% dilution that will hit not just direct investors but those investing via pension schemes, you can see that this scheme is not just daft because of its unintended consequences and likely avoidance, it’s an insidious way to raise taxes on companies and investors very substantially.

The only good aspect of the scheme is that it would help to give employees a stake (albeit indirect) and hence interest in the company they work for. It might also ensure some representation of their interests because the trust fund would be controlled by employees and could vote the shares. But there are much better ways to provide both those benefits.

In conclusion, the idea of an employee trust fund sounds attractive at first glance but it has not been properly thought through. A lot more consideration needs to be given to come up with a workable scheme that does not prejudice companies and their investors. Any foreign investor who saw such a scheme being imposed on his UK investment holdings would promptly run a mile – and don’t forget that most of the UK stock market is now owned by foreign investors. The impact on the Uk stock market, and the economic consequences of investors taking their businesses and investment money elsewhere beggars belief.

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

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Labour’s Plans For Confiscation of Shares and Rail System Renationalisation

Jeremy Corbyn made it clear in a speech last night that the rich will be under attack if Labour gets into power. John McDonnell, Shadow Chancellor, will present his plans today to give 10% of shares in all larger companies to employees over a period of years. The Daily Telegraph described it as a Marxist plot to control businesses while Carolyn Fairburn of the CBI attacked it as a “new tax that adds to the impression that Labour sees business as a bottomless pit of funding”. The proposal seems to be based on setting up a trust for employees into which the shares would be deposited and from where dividends would be paid to employees.

Comment: It will certainly dilute existing shareholders so readers of this blog might find they and the pension funds that invest in shares are proportionally poorer. Although it sets a bad principle, if the numbers being proposed are enacted it might not have a major impact on companies or investors. Enabling employees to have a financial interest in the profits of a company is quite a sensible idea in many ways. But it might simply encourage companies to take their business elsewhere. If they are registered in another country, how will the UK Government enforce such legislation?

Last week Chris Grayling, Transport Secretary, announced a review of the privatised rail system. That follows the recent problems with new timetables where the regulator concluded that “nobody took charge”. John McDonnell said that he could renationalise the railways within five years if Labour wins the next election – it’s already a manifesto commitment. Perhaps he thinks he can solve the railway’s problems by doing so but this writer suggests the problem is technology rather than management, although cost also comes into the equation.

The basic problem is that the railways are built on inflexible and expensive old technology. There has never been a “timetable” problem on the roads because there are no fixed timetables – folks just do their own thing and travel when they want to do so.

Consider the rail signalling system – an enormously expensive infrastructure to ensure trains don’t run into each other and to give signals to train drivers. We do of course have a similar system at junctions on roads – they are called traffic lights. But they operate automatically and are relatively cheap. Most are not even linked in a network as train signals are required to be.

Trains run on tracks so they are extremely vulnerable to breakdowns of trains and damage to tracks – even snow, ice or leaves on the line cause disruption – who ever heard of road vehicles being delayed by leaves? A minor problem on a train track, often to signals, can quickly cause the whole line or network to come to a halt. Failing traffic signals on roads typically cause only slight delays and vehicles can drive around any broken-down cars or lorries.

The cost of changes to a rail line are simply enormous, and the cost of building them also. For example, the latest estimate for HS2 – the line from London to Birmingham is more than £80 billion. The original M1 was completed in 1999 at a cost of £26 million. Even allowing for inflation, and some widening and upgrading since then the total cost is probably less than £1 billion.

Changes to railway lines can be enormously expensive. For example, the cost of rebuilding London Bridge station to accommodate more trains was about £1 billion. These astronomic figures simply do not arise when motorways are revised or new service stations constructed.

Why invest more in a railway network when roads are cheaper to build and maintain, and a lot more flexible in use? At present the railways have to be massively subsidised by the Government out of taxation – about £4 billion per annum according to Wikipedia, or about 7.5p per mile of every train journey you take according to the BBC. Meanwhile road transport more than pays for itself and contributes billions to general taxation in addition from taxes on vehicle users.

So here’s a suggestion: scrap using this old technology for transport and invest more in roads. Let the railways shrink in size to where they are justifiable, or let them disappear as trams did for similar reasons – inflexible and expensive in comparison with buses.

No need to renationalise them at great expense. Spend the money instead on building a decent road network which is certainly not what we have at present.

Do you think that railways are more environmentally friendly? Electric trains may be but with electric road vehicles now becoming commonplace, that justification will no longer apply in a few years’ time, if not already.

Just like some people love old transport modes – just think canals and steam trains – the attachment to old technology in transport is simply irrational as well as being very expensive. Road vehicles take you from door-to-door at lower cost, with no “changing trains” or waiting for the next one to arrive. No disruption caused by striking guards or drivers as London commuters have seen so frequently.

In summary building and managing a road network is cheaper and simpler. It just needs a change of mindset to see the advantages of road over rail. But John McDonnell wants to take us back to 1948 when the railways were last nationalised. Better to invest in the roads than the railways.

It has been suggested that John McDonnell is a Marxist but at times he has denied it. Those not aware of the impact of Marxism on political thought would do well to read a book I recently perused which covered the impact of the Bolsheviks in post-revolutionary Russia circa 1919. In Tashkent they nationalised all pianos as owning a piano was considered “bourgeois”. They were confiscated and given to schools. One man who had his piano nationalised lost his temper and broke up the piano with an axe. He was taken to goal and then shot (from the book Mission to Tashkent by Col. F.M. Bailey).

Sometimes history can be very revealing. The same mentality that wishes to spend money on public transport such as railways as opposed to private transport systems, or renationalising the utility companies such as National Grid which is also on the agenda, shows the same defects.

The above might be controversial, but I have not even mentioned Brexit yet. Will the Labour Party support another referendum as some hope and Corbyn is still hedging his bets over? I hope not because I think the electorate is mightily fed up with the subject. In politics, as in business, you should take decisions and then move on. Going back and refighting old battles is not the way to succeed. All we should be debating is the form of Britain’s relationship with the EU after Brexit.

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

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Worldwide Healthcare Trust AGM – But No Proxy Voting Form

Today I attended the Annual General Meeting of Worldwide Healthcare Trust (WWH) in London. This is an investment trust focused on a portfolio of worldwide pharmaceutical and biotechnology companies. It has a very good long-term track record, consistently beating its benchmark and is the top performer of all UK investment trusts measured since formation.

The fund manager is OrbiMed where Sam Isalay was the managing partner until recently when he departed under a cloud of sexual harassment claims. He also resigned from the board of the Trust at the same time and was replaced by Sven Borho who did the manager’s presentation this year. Sam Isalay was present at the meeting and asked a question. He also got a vote of thanks for his past work, prompted by the Chairman.

There were about 100 shareholders present including quite a number of institutional investors apparently by the cut of their suits and age, which is unusual.

I will summarise Sven’s talk in brief although it was particularly interesting. He said the recipe for success was still very much in place. The team is still in place even after the change of leadership. The trust was up 2.8% last year against a benchmark decline of 2.5%. The share price discount narrowed and it is now trading at a premium (now 0.8% according to the AIC).

Year to date (since March year end) the NAV is up 15.8%. The consistent out-performance seems to be down to stock-picking with a focus on small/mid cap companies.

Sven also said that it was strong year of scientific progress and mentioned in particular gene therapy, gene silencing and CAR-T work. He also discussed the progress on a cure for alzheimer’s disease at some length where real progress is being made. There have been many past failures in cures for that disease with billions of dollars being spent but there are 5.7 million patients needing treatment in the USA which is more than all cancer patients combined. There are several companies in clinical trials with phase 3 results due by 2020.

I might need a cure because this morning I had a “senior moment” and shut the garage door while my wife was backing her car out. Fortunately no damage done or I would not have heard the last of it.

Apparently the drug approval rate has increased substantially due to a change in management at the FDA who has changed the regulations to make it easier and cheaper to get approval for new drugs.

After about an hour of Sven’s presentation, which was rather long, we moved onto the formal business of the meeting.

One shareholder asked how much had the company borrowed? He also said he asked the same question last year and was still waiting for an answer. The simple answer he got was they are 117% invested, but as they use derivatives the full answer was more complex and I did not understand what was said – there is more clarity in the Annual Report. The shareholder was clearly not satisfied because he voted against the Chairman when it came to the vote.

I questioned what the impact would be of the announcement in the Annual Report that they would no longer be issuing proxy voting forms with their invites to the AGM. The Chairman referred me to the Company Secretary who could not give an answer. So I made it clear I objected to this change as it would be likely to discourage voting. As I said, I had already raised this issue with their Registrar’s Link Asset Services in an exchange of correspondence (see my previous blog post on this topic here: https://roliscon.blog/2018/07/23/voting-at-general-meetings-link-asset-services-and-centralnic/ ). Why did the Chairman not ask the audience at this meeting what they preferred? He declined to do so.

He also suggested there was not time to spend on this issue at which point I said he would have plenty of time if he had not set the start time of the AGM at 12.00 noon. This is a practice I have seen at other trust AGMs where after presentations there is little time left for questions before lunch is served. I think this is very bad practice.

Note if you don’t receive a paper proxy voting form in future, go here for one you can use at any General Meeting: https://www.roliscon.com/proxy-voting.html . If you think this is a retrograde step which will reduce voting by private shareholders from the already low level, please do complain about it to the Chairmen of companies and to Link Asset Services.

I did not have time to raise the issue of the Chairman having served on the board since 2007. This is contrary to the UK Corporate Governance Code, so that’s another reason why I will be voting against him next year. He got 6.6% against him on the proxy vote counts at this meeting.

Other than the issues mentioned above, this was a very informative meeting and well worth attending. As readers may be aware, I have suddenly taken an interest in the gene therapy area and this trust is one way into it. The manager, OrbiMed, also manage the Biotech Growth Trust which is more focused and somewhat smaller. It also trades at a significant discount at present but has underperformed its benchmark of late.

Postscript: there is an interesting article on the departure of Sam Isalay here on Citywire: http://citywire.co.uk/investment-trust-insider/news/fund-manager-accused-of-harassment-hits-out-over-exit/a1157479?

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

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Damning Treasury Report on Crypto-Assets

Thinking of investing in some Bitcoins or other Crypto-Currencies? Or perhaps I should have said thinking of speculating in them. Best first read the report published today by Parliament’s Treasury Committee. It’s a damning attack on the “wild-west” of this new market and calls for it to be regulated by the FCA as soon as possible.

Their report suggests that most crypto-currencies has used mainly for speculation and they say there is minimal consumer protection.

The report also puts a damper on the alleged wonders of blockchain technology with the Bank of England arguing to the Committee that it does not function well as a means of payment because it cannot handle the payment volumes required, plus it’s too slow and too expensive to meet even current UK payment transaction volumes. It also consumes large amounts of power.

They examine the price volatility of crypto-currencies and the problems associated with them – namely the vulnerability of the exchanges and client holdings to hacking, the potential for market manipulation and the use of crypto-currencies for money laundering and other criminal activities. Crypto-asset markets fall outside the market abuse rules so anything goes in essence, and Initial coin offerings (ICOs) are in a regulatory loophole so are open to abuse.

A bitcoin was worth $20 in January 2013, and reached $19,206 in December 2017 but is now back down to below $7,000. Extreme volatility and even illiquidity seem to be features of crypto-currency markets even in the more widely used ones.

Comment: It is very clear that crypto-currencies and ICOs are promoted as “get rich quick” products mainly to part fools from their money – in other words it’s the same old story of financial innovation being exploited to seduce suckers. There may be some merit in establishing a digital currency that is independent of banks and that cannot be corrupted by Government. But the lack of regulation leaves it wide open to abuse and use for criminal activities. Regulation needs to be introduced as soon as possible to introduce proper controls on those operating exchanges or performing ICOs and there obviously need to be better audit trails and anti-money laundering controls to remove the criminal elements.

The FCA may have been reluctant to take on responsibility for this new area as they barely have the resources to do their job properly at present. But if the resources cannot be made available, or are unjustifiable, then the UK Government should consider banning crypto-currency trading, exchanges and initial coin offerings as in China. If it can’t be regulated it should be banned.

As regards blockchain technology, it might have an advantageous use in some applications but it hardly looks likely to be the wonder drug for electronic accounting as some seem to believe. Too much hype and not enough evidence of real applications where it provides cost benefits as yet.

The Treasury Committee Report is available from here: https://www.parliament.uk/business/committees/committees-a-z/commons-select/treasury-committee/news-parliament-2017/digital-currencies-report-pubished-17-19/

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

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Lehman Collapse, Labour’s Employment Plans, Audit Reform Ideas and Oxford Biomedica

There was a highly amusing article in today’s FT by their journalist John Gapper explaining how he caused the financial crisis in 2008 by encouraging Hank Paulson, US Treasury Secretary, to resist the temptation to rescue Lehman Brothers. So now we know the culprit. Even more amusing was the report on the previous day that the administrators (PWC) of the UK subsidiary of Lehman expect to be left with a surplus of £5 billion. All the creditors are being paid in full.

Why did Lehman UK go bust then? They simply ran out of cash, i.e. they were cash flow insolvent at the time and could not settle payments of £3bn due on the day after their US parent collapsed. Just like Northern Rock where the assets were always more than the liabilities as also has been subsequently proven to be the case.

Perhaps it’s less amusing to some of the creditors of Lehman UK because many sold their claims at very large discounts to third parties rather than wait. Those that held on have been paid not just their debts but interest as well. So the moral is “don’t panic”.

Lehman’s administration is in some ways similar to the recent Beaufort case. Both done under special administration rules and requiring court hearings to sort out the mess. PWC were administrators for both and for Lehman’s are likely to collect fees of £1billion while employing 500 staff on the project. It may yet take another 10 ten years to finally wind up. Extraordinary events and extraordinary sums of money involved.

An editorial in the FT today supported reform of employment legislation as advocated by Labour’s John McDonnell recently. He proposed tackling the insecurity of the gig economy by giving normal employment rights to workers. I must say I agree with the FT editor and Mr McDonnell in that I consider that workers do have some rights that should be protected and the pendulum has swung too far towards a laissez-faire environment. This plays into the hands of socialists and those who wish to cause social unrest. Even the Archbishop of Canterbury suggested the gig economy was a “reincarnation of an ancient evil” and that it meant many companies don’t pay a living wage so employees rely on state welfare payments. A flexible workforce may give the country and some companies a competitive advantage but it takes away the security and dignity of employment if taken to extremes. The Conservative Government needs to tackle this problem if they wish to be certain of getting re-elected. If you have views on this debate, please add your comments to this blog.

Mr McDonnell also promoted the idea of paying a proportion of a company’s profits to employees – effectively giving them a share in the dividends paid out. That may be more controversial, particularly among shareholders. But I do not see that is daft either so long as it is not taken to extremes. After all some companies have done that already. For example I believe Boots the Chemists paid staff a bonus out of profits even when a public company.

Another revolutionary idea came from audit firm Grant Thornton. They suggest audit contracts should be awarded by a public body rather than by companies. This they propose would improve audit standards and potentially break the hold of the big four audit firms. I can see a few practical problems with this. What happens if companies don’t judge the quality of the work adequate. Could they veto reappointment for next year? Will companies be happy to pay the fees when they have no control over them. I don’t think nationalisation of the audit profession is a good idea in essence and there are better solutions to the recent audit problems that we have seen. But one Grant Thornton suggestion is worth taking up – namely that auditors should not be able to bid for advisory or consultancy work at the same company to which they provide audit services.

Oxford Biomedica (OXB) issued their interim results this morning (I hold the stock). They made a profit of £11.9 million on an EBITDA basis. OXB are in the gene/cell therapy market. What interests me is that there are some companies in that market, at the real cutting edge of biotechnology with revolutionary treatments for many diseases, that are suddenly making money or are about to do so. That’s often after years of losses. Horizon Discovery (HZD) which I also hold is another example. Investors Chronicle recently did a survey of similar such companies if you wish to research these businesses. It is clear that the long-hailed potential of cell and gene therapy is finally coming to fruition. I look forward with anticipation to having all my defective genes fixed but I suspect there will be other priorities in the short term particularly as the treatments can be enormously expensive at present.

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

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AIC Calls for KIDs to be Suspended

The Association of Investment Companies (AIC) have called for KIDs to be suspended. KIDs are those documents devised by the EU that were aimed at giving basic information on investment funds – and that includes investment trusts which the AIC represents.

It was a typical piece of badly implemented EU regulation even if the motive was worthy. But KIDs give a very misleading view of likely returns from investment funds. Whoever designed the performance rating system clearly had little experience of financial markets, and neither did they try it out to see what the results would be in practice. Similarly, if they had bothered to consult the AIC or other bodies representing collective funds, or experienced investors as represented by ShareSoc, they would have realised how misleading the results might be.

It also imposes costs on investment managers and on brokers who have to ensure their clients have read the KID before investing – even if they are already holding the fund/shares or have invested in it previously. This means for on-line brokers we now get a tick box that we have to click on which is simply tedious. I just click on them automatically because if I intend to buy an investment trust there is a great deal of information available elsewhere in the UK and the KID does not add anything of use in my opinion.

I think KIDs should be scrapped rather than just suspended. They serve little useful purpose and just add a costly bureaucratic overhead. This is the kind of nonsense that Brexit supporters are keen to get rid off when we do finally get out of the EU monster. But will we if Mrs May gets her way?

The AIC press release is here if you want more information: https://www.theaic.co.uk/aic/news/press-releases/aic-calls-for-kids-to-be-suspended

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

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Brexit, Abcam, Victoria and the Beaufort Case

Another bad day for my portfolio yesterday after a week of bad days last week when I was on holiday. Some of the problems relate to the rise in the pound based on suggestions by Michel Barnier that there might actually be a settlement of Brexit along the lines proposed by Theresa May. This has hit all the companies with lots of exports and investment trusts with big holdings in dollar investments that comprise much of my portfolio. But a really big hit yesterday was Abcam (ABC).

Abcam issued their preliminary results yesterday morning. When I first read it, it seemed to be much as expected. Adjusted earnings per share up 27.1%, dividend up 17.1% and broker forecasts generally met. The share price promptly headed downhill and dropped as much as 32%, which is the kind of drop you see on a major profit warning, before recovering to a drop of 15.2% at the end of the day.

I re-read the announcement more than once without being able to identify any major issues or hidden messages that could explain this drop. The announcement did mention more investment in the Oracle ERP system, in a new office and other costs but those projects were already known about. Indeed I covered them in the last blog post I wrote about the previous Abcam AGM where I was somewhat critical of the rising costs (see https://roliscon.blog/2017/11/15/abcam-agm-cambridge-cognition-ultra-electronics-wey-education-and-idox/ ). The Oracle project is clearly over-budget and running behind schedule. A lot of these costs are being capitalised so they disappear from the “adjusted” figures.

The killer to the share price appears to have been comments from Peel Hunt that the extra costs will reduce adjusted earnings by 9% based on reduced margins. The preliminary results announcement did suggest that the adjusted EBITDA margin would likely be 36% as against the 37.8% that was actually reported for last year. Revenue growth of 11% is expected for the current year so even at the reduced margin that still means profits will grow by about 5%. That implies only a slight reduction in adjusted e.p.s. on my calculations which implies a prospective p/e of about 34. That may be acceptable for such a high-quality company with an enviable track record (which is why it is one of my larger holdings) but perhaps investors suddenly realised that the previous rating was too high and vulnerable to a change of sentiment. That realisation seems to be affecting many highly rated go-go growth stocks at present.

The excessive IT project costs are of concern but if the management considered that such investment (£33 million to date) was necessary I think I’ll take their word on it for the present. At least the implementation of the remaining modules is being done on a phased approach which suggests some consideration has been given to controlling the costs in the short term.

I attended the AGM of another of my holdings yesterday – Victoria (VCP). They manufacture flooring products such as carpets, tiles, underlay and also distribute synthetic flooring products (I think that means laminates etc). There was a big bust-up at this company back in 2012 in which I was involved. The company was loss making at the time but some major shareholders decided they wanted a change or management and lined up Geoff Wilding who is now Executive Chairman. After an argument over his generous remuneration scheme and several general meetings, it was finally settled. After meeting Geoff I decided he knew more about the carpet business and what was wrong with the company than the previous management and therefore backed him – a wise decision as it turned out. Since then, with aggressive use of debt, he has done a great job of expanding the business by acquisition and this has driven the share price up from 25p to 760p. Needless to say shareholders are happy, but there were only about half a dozen at the AGM in London.

I’ll cover some of the key questions raised, and the answers, in brief. I asked about the rise in administration costs. This arises from the acquisitions and investment in the management team apparently. I also questioned the high amortisation of acquisition intangibles which apparently relates to customer relationships capitalised but was assured this was not abnormal. This is one of those companies, a bit like Abcam, where the “adjusted” or “underlying” figures differ greatly to the “reported” numbers so one has to spend a lot of time trying to figure out what is happening. It can be easier to just look at the cash flow.

Incidentally the company still has a large amount of debt because that has been raised to finance acquisitions in addition to the use of equity placings. In response to another question it was stated that the policy is to maintain net debt to EBITDA at a ratio of no more than 2.5 to 3 times. But earnings accretion is an important factor.

Geoff spent a few minutes outlining his approach to acquisitions and their integration which was most revealing. He talked a lot of sense. He will never ever buy a failing company. He wants to buy good companies with enthusiastic management. Thereafter he acts as a coach and wants to avoid disrupting the culture. He said a lot of acquisitions fail as people try to change everything wholesale. One shareholder suggestion this was leading to a “rambling empire” but the CEO advised otherwise.

The impact of Brexit was raised, particularly as there is nothing in the Annual Report on the subject. Were there any contingency plans? Geoff replied that if it is messy it will help Victoria as a lot of carpet is made on the continent and a fall in sterling will also help. He suggested they have lower operational gearing than many people think but obviously they might be affected by changing customer confidence. The CEO said that Brexit is on his “opportunity list”, not his “problem list”.

A question arose about the level of short selling in the stock which seems to have driven down the share price of late. Geoff suggested this was a concerted effort by certain hedge funds but he was confident the share price will recover.

Clearly Geoff Wilding is a key person in this company so the question arose about his future ambitions. He expects to do 2, 3 or 4 acquisitions per year and life would be simpler if he didn’t do so many. He tends to live out of a suitcase at present. But he still hopes to be leading the company in 5 year’s time.

In summary this was a useful meeting and I wish I had purchased more shares years ago but was somewhat put off by the debt levels.

Lastly, there was a very interesting article by Mark Bentley on the Beaufort case in the latest ShareSoc newsletter (if you are not a member already, please join as it covers many important topics for private investors). It seems that the possible “shortfall” in assets was only 0.1% of the claimed assets with only three client accounts unreconciled. But administrators PWC and lawyers Linklaters are racking up millions of pounds in fees when the client assets could have been transferred to other brokers in no time at all and at minimal cost. An absolute disgrace in essence. Be sure you encourage the Government, via your M.P., to reform the relevant legislation to stop this kind of gravy train in future.

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

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House of Fraser Pre-Pack – Is It Such a Great Deal?

The acquisition of House of Fraser by Sports Direct is a typical “pre-pack” administration. In administration one minute, sold the next. The national media promptly welcomed it as the rescue of everyone’s favourite department store, the protection of 17,000 jobs and just what is needed to help save Britain’s High Streets.

Mike Ashley of Sports Direct trumpeted this as a great deal. All the stores and stock were purchased for £90 million when gross assets were £946 million and the company made a profit last year of £14.7 million – more on the financial numbers below. He plans to turn House of Fraser into the “Harrods of the High Street”.

But is it such a great deal? I have written many times in the past about the iniquities of pre-pack administrations. How creditors and shareholders are dumped, and pension schemes likewise. The administrators save themselves the hassle of winding up the business or looking for a buyer of the business as a “going concern” while collecting large fees for little work. I think the insolvency regime should be reformed.

The figure of £946 million of gross assets given by Sports Direct is from the last published accounts of the parent company House of Fraser (UK & Ireland) Ltd for the year ending January 2017, which is the last set of accounts filed at Companies House. The truth is that the company had net assets of £111 million with trade creditors of £365 million and long-term borrowings of £284 million. Debts including short terms borrowings probably grew substantially since then. Although Mr Ashley is paying the administrators £90 million for the assets, it would appear that both the trade creditors and the lenders will be very substantially out of pocket.

That’s not to mention the property companies who are the store landlords who face a default on their leases. Mr Ashley is unlikely to want to keep half the stores, so many of the jobs will be lost and he will no doubt want to renegotiate the leases on other stores downwards. So any property companies you may have invested may be damaged.

The company will have got shot of its defined pension schemes (approximately 10,000 members) which will be taken on by the Pension Protection Fund. That’s a public body that is funded by a levy on all pension schemes, so basically someone else will be paying if there is any shortfall. Although the pension scheme may be in surplus at this time, in such circumstances pensioners usually face a substantial cut in their future income as there will be no more contributions from the company.

Now House of Fraser might have been a retailing basket case with excessive debt, but surely a more equitable solution was possible? Indeed the Mail on Sunday today called it a “Fix” because there was an alternative offer on the table from retail billionaire Philip Day who allegedly offered £100 million for the company including taking on the pension obligations. The Mail suggested that the bankers and bondholders forced acceptance of the Ashley proposal in their interests. This is not unusual in pre-packs.

Sir Vince Cable suggested an investigation by the BEIS Department is required followed by reform of the pre-pack system. I agree with him. There are better solutions to how to deal with companies that run out of cash or become insolvent due to excessive debt which could protect the interests of trade creditors, employees and pensioners.

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

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Lax Regulation (Globo, GRG) and Japanese Trust AGM

Globo was one of those AIM companies that turned out to be a complete fraud. Back in December 2015 the Financial Reporting Council (FRC) announced an investigation into the audits of the company by Grant Thornton (GT). Even the cash reported on the balance sheet in the consolidated accounts of the parent company proved to be non-existent (or had been stolen perhaps). I have previously complained about the slow progress and the lack of any information on this investigation.

But former shareholders need no longer hold their breath – the FRC have announced that they have dropped the investigation on the basis that there is no realistic prospect of a finding of “misconduct” by Grant Thornton UK. It would seem that GT relied on the audits of the subsidiary companies in Greece and elsewhere over which the UK authorities have no jurisdiction.

There may be on-going investigations by other bodies including a review of the activities of GT in Greece but this makes it appear that the chance of action is fading away. Not that shareholders were ever likely to recover their losses. It is disappointing that the FRC have not taken a tougher line on this matter as questions about the accounts of Globo were publicly raised a long time before it went bust, and I even spoke to some staff of Grant Thornton UK at a Globo meeting telling them they needed to examine their accounts carefully. One would have thought that they would have done a very thorough examination of the subsidiary audits, but it seems not so.

I was about to submit my comments on the Kingman “Review of the Financial Reporting Council” – all ten pages of it – but will now have to amend it to include more criticism. I’ll publish it on the Roliscon web site a.s.a.p.

Another example of regulatory inaction is the announcement that the Financial Conduct Authority (FCA) will not be doing anything about the past activities of the Global Restructuring Group (GRG) at the Royal Bank of Scotland (RBS). After a review they found no evidence that RBS artificially distressed firms for their benefit (that’s not what the complainants say) although they did find inappropriate treatment of customers. But the FCA decided they could do nothing because some parts of the activities of GRG were unregulated and action against the senior management had little hope of success. So the perpetrators are off the hook.

I received an interesting newsletter from White & Case, one of the leading commercial law firms, which summarized the latest report from the FCA on their enforcement activities. It was headlined “FCA Enforcement – More cases, increased costs, fewer fines” which put the report in context. The number of “open cases” has doubled in two years while the number of staff has remained the same, i.e. more work but no more resources. Enforcement action has slowed down, probably for that reason, and fines have also dropped. Only 16 fines were imposed in the last year.

JPMorgan Japan Smaller Companies Trust

Yesterday I attended the AGM of JPMorgan Japan Smaller Companies Trust (JPS) which turned out to be a more interesting meeting than I anticipated. This is one of my Brexit hedges – pound falling means any overseas investment is likely to be a good one, and I always like small cap funds.

This trust has a good track record – NAV up 27.8%, 20.8% and 12.2% in the last three years so it is well ahead of its benchmark. Not knowing much about the Japanese market the presentation from the fund managers (via video from Japan) was particularly interesting. Equity markets in Japan have been buoyed by QE activities from the Bank of Japan – apparently they have not just been buying bonds but also equities in the stock market! But the economy is facing major structural challenges from an ageing and declining population. This was one slide they presented:

Japan's Structural Challenge

However, the managers are not too concerned because they ignore “macro” trends when investing anyway. They clearly think they can still achieve good results because of a focus on specific areas of the market, e.g. healthcare, employee benefits (staff are being paid more as they become in short supply), robot appliances, etc. Also corporate governance is improving, albeit slowly, which is of benefit to minority shareholders.

The other interesting issue that arose at this AGM was the proposed new dividend policy. They changed the Articles at the meeting to allow the company to pay dividends out of capital and also proposed a resolution to adopt a new dividend policy of 1% of assets per quarter, i.e. 4% dividend yield per annum when it was nil last year. This prompted a vigorous debate among shareholder attendees with complaints about it meaning shareholders will be paying more tax, often on unwanted dividends. The retiring Chairman, Alan Clifton, said the board had proposed this because they were advised that this would help to make the company’s shares more attractive to investors. The shares are currently on a persistent wide discount of about 11% and it was hoped this would close the discount. Also as most private shareholders now hold their shares in ISAs and SIPPs, there would be no tax impact on them. I pointed out direct shareholders could always sell a few shares if they wished to receive an “income” but there are obviously many small shareholders who do not understand this point or prefer to see a regular dividend payment. At least the above summarized the key points in the debate.

When it came to the show of hands vote on the resolution, it looked to me as though there were more votes AGAINST than FOR. The Chairman seemed to acknowledge this (I did not catch his exact words), but said that the proxy votes were overwhelmingly in favour. He then moved on to the other resolutions. I suggested he needed to call a poll, which of course nobody fancied because of the time required even though it would be legally the correct thing to do. So instead it was suggested that perhaps the count of hands was wrong so that vote was taken again – and narrowly passed this time. My rating as a trouble maker has no doubt risen further.

Anyway, I actually abstained on the vote on that resolution because I am in two minds on the benefit. As Alan Clifton pointed out, the impact of a similar change at International Biotechnology Trust (IBT) where he was also Chairman was very positive. My only comment to him was I thought 4% was a bit high. The board will no doubt review the impact in due course, but it seems likely that it will have a positive impact on the discount as the shares will immediately look more attractive to private investors.

In conclusion, what I expected to be a somewhat boring event turned out to be quite interesting. That is true of many AGMs. Japan might have more difficult “structural” challenges even than the UK, with or without Brexit. As regards the regulatory environment covered in the first part of this article I suggest the laws and regulations are too lax with too many loopholes. I think they need rewriting to be more focused on the customers or investors interests.

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

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