ULS Technology, Keystone Law and Collusion on IPO Pricing

Yesterday I attended an interim results presentation by ULS Technology (ULS). They have been listed on AIM for a couple of years and have grown both from organic increases in revenue and from acquisitions which is often a good formula. They operate in the legal conveyancing and estate agency market where volumes have not been great of late – it seems house prices have made it difficult for folks to move plus changes to stamp duty and buy-to-let taxes have deterred transactions. But they seem to be prospering regardless.

I first became interested in this company, and acquired some shares, when I noticed that Geoff Wicks have become a director. He has also just been made Chairman. Geoff used to be CEO of Group NBT which was one of my most successful technology investments and he did a great job of sorting out and then growing a failing dotcom business.

I did perhaps amuse the CEO of ULS, Ben Thompson, by noting that I don’t really like companies with unmemorable three letter acronym names (ULS, NBT for example). Investors can never recall what they do. ULS used to be called United Legal Services but needed a new “umbrella” name so came up quickly with ULS. Should have used a branding consultancy I suggest. Unless you are a really big company, like IBM or BAE, establishing name recognition for such “brands” is hard work.

So ULS it is for the present, but understanding what they do and how they make money is not necessarily easy. Attending the seminar helped with understanding that. In summary, ULS aim to make house moving easier by making conveyancing easier, quicker and lower costs. They use web technology to support that. So if you are looking for a conveyancing solicitor they can help, and they have partnerships with other businesses in the house buying space such as mortgage brokers/lenders so that their service is offered when required. For example, Lloyds Bank is one of their largest partners. In addition they have a specialist comparison web site for when you are looking for an estate agent (includes price and performance comparisons).

For the conveyancing service they get paid by solicitors to which customers are referred, who pay 5 days after the legal completion with a fixed fee (does not vary with house price cost). The customer saves on paperwork such as filling out multiple forms. The customer introducers are many small mortgage brokers, large financial networks and others such as Moneysupermarket.com and Home Owners Alliance. They do seem to have some competitors but these are generally smaller in size and have nowhere near the same size of “panel” containing solicitors to which referrals are sent. The market generally for conveyancing services is still very old fashioned and dominated by “cottage industry” firms. ULS have only 2.6% of the conveyancing market but have a desire to become much larger. It certainly seems a market that is ripe for technical disruption.

Estateagent4me.com is their estate agency comparison site where you can search for agents and select on the basis of: the Fees they will charge; Average time to sell a property like yours; How close they might get to achieving an asking price; and How successful they are at selling similar homes. I asked whether they had received any legal threats from Purplebricks who apparently were not happy at all about some reviews that were published on their service, but it seems they have not.

The company expects to grow by: 1) Organic growth; 2) M&A (already done some of those); 3) Future new product development. They are not rushing to move outside the UK although there might be opportunities there. In essence they seem to be aiming for a conservative, profitable growth strategy which is often the kind of company I like, rather than betting the farm on a very rapid expansion as per Purplebricks. Return on capital is what matters, not empire building at huge cost.

There were a number of good questions from the audience of private investors (organised by Walbrook) but I’ll only cover one that arose. The accounts show a very low “current ratio” because the current liabilities, particularly the “Trade and other payables” figure is high at £7.8 million. This does include two earn-out payments due from past acquisitions of £5.2 million and taking those out makes the ratio look more reasonable. It would seem they do have a credit facility lined up to cover those payments, but this will add to the gearing of the company of course, at least temporarily even if operating cash flow is positive as it appears to be. They may wish to raise more equity also I suspect, particularly if other acquisitions are contemplated.

Also yesterday a legal firm named Keystone Law Group Plc listed on AIM. I think this is only the second of two commercial legal firms to list (Gateley Holdings, GTLY, was the first). Keystone promptly went to a premium over the listing price. I’ll have to read the IPO Prospectus which is available on the company’s web site under AIM Rule 26. Keystone are different to many law firms in that most of their solicitors are effectively freelances and they only get paid when the client pays (yes they are part of the new “gig” economy). The prospectus should make interesting reading as I have been a client of theirs in a libel action I have been pursuing of late which you should hear more about very soon. But buying shares in new IPOs is generally something to avoid.

Meanwhile the Financial Conduct Authority (FCA) FCA has accused fund managements of colluding on IPOs. The regulator alleges Artemis, Newton, River and Mercantile and Hargreave Hale shared the prices they were willing to pay for shares. This story should run and run as it attacks the informal nature of conversations in the City of London about deals under consideration. But colluding on pricing is a breach of competition law as anyone in business should surely know.

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

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Budget Feedback, the Patient Capital Review and Productivity

My last post was on the Chancellors Budget which was written quickly but seems to have covered most of the important points. Perhaps one significant item missed was the additional liability of foreign investors for capital gains tax on property sales, although institutional investors may be exempt. This might have some impact but as the details are not yet clear, it remains to be seen what.

Otherwise the media feedback on the budget was generally positive although there was a big emphasis on the poor economic forecast for growth that the Chancellor announced. The OBR has substantially reduced growth forecasts which is one reason why debt will not be falling as quickly as previously indicated and future tax revenues will likewise be lower. Part of the problem is a failure to improve productivity. This also means that average wages in real terms may not grow as expected.

Why did I not comment on this? Because firstly economic forecasts (the OBR or anyone else’s) are notoriously unreliable, and secondly it makes little difference to most UK investors. It might suggest it would be wiser to invest more in overseas companies than UK ones, but in reality many UK companies have major revenues and profits from abroad. In any case, a lot of investors have already hedged their portfolios against the possible damage of a “hard Brexit” by adjusting their portfolios somewhat.

My experience is that investing based on country economic forecasts is very questionable. Good companies do well irrespective of the state of the general economy.

Patient Capital Review

On Budget day the Government (HM Treasury) also published their consultation response to the “Patient Capital Review” – or “Financing Growth in Innovative Firms” as it is officially called. You can find it on the internet. This review was aimed to review incentives to invest in early stage companies with a view to promoting more investment in such companies as part of the attempt to improve productivity in the UK economy. It potentially had significant impacts for investors – for example on the EIS and VCT tax reliefs. What follows is an attempt to bring out the key points:

The review considered not just the tax incentives, and whether they were effective, but whether more direct investment (supported directly or indirectly by the Government) should be undertaken. They got more than 200 written responses to the original consultation on this subject (see mine here: http://www.roliscon.com/Roliscon-Response-to-Financing-Growth-in-Innovative-Firms.pdf ), plus some on-line responses and they also used a panel of industry experts.

Although they have not published all the responses or broken them down in detail, one gets the impression that most respondents considered that the VCT/EIS regime was generally effective in stimulating investment in early stage companies and that there were few abuses. But the Treasury had expressed concern about some of the investments made in EIS/VCT companies which were often focussed more on “asset preservation” than in funding new growing businesses. So the rules are being tightened in that regard – see below.

A personal note: having invested in two EIS schemes that promoted country pubs the asset preservation capability might have made for a good sales pitch by the promoters but they subsequently turned out to be very poor investments even after the generous EIS tax reliefs. One is being wound up with the assets being sold for much less than purchased while the other one only made any money after it turned into a bailiff business subsequent to a shareholder revolt. The Government’s policy of ensuring a focus on “riskier” investments might actually be good for the investors as well as the economy! It will avoid inexperienced investors getting sucked into dubious investments by sharp promoters who can make even lemons sound attractive because of the generous tax reliefs.

On the support for new investment front, the Government is taking these steps:

  • Establishing a new £2.5 billion Investment Fund incubated in the British Business Bank with the intention to float or sell once it has established a sufficient track record. By co-investing with the private sector, a total of £7.5 billion of investment will be supported.
  • Significantly expanding the support that innovative knowledge-intensive companies can receive through the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) while introducing a test to reduce the scope for and redirect low-risk investment, together unlocking over £7 billion of new investment in high-growth firms through EIS and VCTs.
  • Investing in a series of private sector fund of funds of scale. The British Business Bank will seed the first wave of investment with up to £500m, unlocking double its investment in private capital. Up to three waves will be launched, attracting a total of up to a total of £4 billion of investment.
  • Backing first-time and emerging fund managers through the British Business Bank’s established Enterprise Capital Fund programme, supporting at least £1.5 billion of new investment.
  • Backing overseas investment in UK venture capital through the Department for International Trade, expected to drive £1 billion of investment.
  • Launching a National Security Strategic Investment Fund of up to £85m to invest in advanced technologies that contribute to our national security mission.

In addition the Pensions Regulator will clarify guidance on inclusion of venture capital, infrastructure and other illiquid assets in portfolios and HM Treasury will encourage defined contribution pension savers to invest in such assets.

Entrepreneur’s Relief rules will be changed to reduce the disincentive to accept more outside investment, and the Government will also look at a guarantee programme modelled on the US “Small Business Investment Company”.

They will also work with the Intellectual Property Office on overcoming the barriers to high growth in the creative and digital sector. What this implies is not clear. Does that mean they are suggesting introducing software patents perhaps?

Several gaps in the investment market for early stage or follow-on funding were identified but one telling comment from the expert panel was this: “…the UK venture capital market has historically delivered poor returns; this results in less capital being attracted to the asset class, which in turn results in less talent being attracted to the patient capital sector; this then depresses returns, completing the circle”. But they did suggest this could be fixed.

There apparently were many comments on the importance of the EIS/SEIS schemes for funding innovative businesses – for example: “EIS and SEIS incentives have been particularly effective at stimulating investment and are extremely valuable to bioscience investors”. But I suspect that has been of more benefit to companies raising capital than it has been in terms of achieving long-term positive returns for investors. It is a pity not more evidence was provided on that.

The Treasury response is to double the annual investment limit to £2 million for EIS investors, so long as any amount over £1 million is invested in knowledge-intensive companies. Also the annual investment limit for knowledge-intensive firms will be doubled from £5 million to £10 million for EIS and VCT companies, and a new fund structure for such firms will be consulted upon. There will also be more flexibility on how the “age limit” is applied for companies applying. Question: what is a knowledge-intensive company? The answer is not given in the Treasury’s response.

A “principles-based” test will be introduced for all tax-advantaged venture capital schemes. This will ensure that the schemes are focussed “towards investment in companies seeking investment for long-term growth and development”. Tax motivated investments where the tax relief provides most of the returns to investors will be ruled out in future. There must be “a risk to capital” for firms to qualify. Detailed guidance will be published on this and there are some examples given in the response document, although it is far from clear from those what the rules might be. Comment: as this is going to be “principle-based” rather than based on specific rules it looks like a case of the Treasury saying “we can’t say what is objectionable now but we will know when we see it”. This might create a lot of uncertainty among VCT and EIS fund managers and company advisors.

The rules for VCT investments will also be tightened up with the following changes:

  • from 6 April 2018 certain historic rules that provide more favourable conditions for some VCTs (“grandfathered” provisions) will be removed
  • from 6 April 2018, VCTs will be required to invest at least 30% of funds raised in qualifying holdings within 12 months after the end of the accounting period
  • from Royal Assent of the Finance Bill, a new-anti abuse rule will be introduced to prevent loans being used to preserve and return equity capital to investors. Loans will be have to be unsecured and will be assessed on a principled basis. Safe harbour rules will provide certainty to VCTs using debt investments that return no more than 10% on average over a five year period
  • with effect on or after 6 April 2019 the percentage of funds VCTs must hold in qualifying holdings will increase to 80% from 70%
  • with effect on or after 6 April 2019 the period VCTs have to reinvest gains will be doubled from 6 months to 12 months

Comment: these changes would not seem to cause great difficulties for VCT managers and should not affect the returns to investors. Some of the changes might be helpful. The feedback from VCT managers is awaited.

But the income and capital gains tax reliefs for investors are basically unchanged, as is Business Property Relief on “unlisted” companies such as AIM stocks which were both mooted as being under consideration. As I wrote in my previous blog post on the budget, at least the Chancellor and the Treasury seem to have minimised the changes which is always helpful for investors. Being unable to plan many years ahead because of taxation rules and levels continually changing has been a major problem for investors. So on that score alone, the budget is to be welcomed.

As regards Entrepreneurs’ Relief, the government is concerned that the qualifying rules of Entrepreneurs’ Relief should encourage long-term business growth. The rules will therefore be changed to ensure that entrepreneurs are not discouraged from seeking external investment through the dilution of their shareholding. This will take the form of allowing individuals to elect to be treated as disposing of and reacquiring their shares at the then market-value. The government will consult on the technical detail. Comment: this seems to be yet another complication to taxation rules which is unfortunate.

Productivity

These changes to the tax incentivised schemes, and the Government investment in funds, may assist to improve the productivity of the UK population by focussing on high growth technology businesses. One cannot improve productivity by employing more coffee bar baristas, and such jobs are always likely to remain low paid. The budget change to increase the National Living Wage (the Minimum Wage) from next April will also promote improvement in productivity as it will make employers consider investment in automation rather than simply employing more staff.

There is also investment in infrastructure committed to in the budget, which might assist. Is it not the case that productivity is reduced because of the distances and time wasted in commuting in the South-East of England? The transport network (road or rail) is truly abysmal in the UK and has been getting worse. This means that folks are tired before they even get into work. The encouragement of commuting by cycle also surely results in tired and unproductive staff. It might be fashionable, and good for their health in the long term, but is it good for the economy? Unfortunately the housing market has been made more inflexible in recent years in some respects so people cannot move nearer to their workplace. Stamp duty increases have deterred moving to reduce travel costs, and higher house prices in some areas have not helped. For example, this writer recently met someone who lives in Southampton when his employer was based in Oxford – he could not afford to move. The reduction in stamp duty for first-time buyers in the Budget is not going to make a big difference to these problems.

So overall the Budget changes are more “nudges” in the right direction to improve the economy, while not being revolutionary. The Government’s tax base is not undermined and investors tax planning not significantly affected, so Philip Hammond may find he is in the job longer than expected after all.

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

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Chancellor’s Budget and How It Affects You

What follows is a summary of Chancellor Philip Hammond’s Budget speech today, and the impact of the tax changes. Private investors were particularly concerned about the impact of tax reliefs in the VCT/EIS schemes following the Patient Capital Review but these are in fact relatively minor (see end of document).

This is a summary of the key points he announced:

  • The Chancellor said we are on the brink of a technological revolution, we must embrace it. Britain is at the forefront, but we must invest to secure it.
  • Regrettably our productivity performance remains disappointing.
  • Our debt interest is too high. OBR expects debt to peak this year and fall thereafter.
  • He maintained his commitment to fiscal responsibility but will use the headroom to prepare Britain for the future.
  • The strategy is to raise productivity and employment in all sectors of the economy. A white paper will be issued on this within a few days.
  • Following the Patient Capital Review an action plan will be published which commits to more funding of the British Business Bank, including £2.5 billion of Government seed funding (to co-invest with private firms). But there will be some restrictions on EIS tax relief (see later).
  • First year VED on cars that do not meet the latest emission standards will be increased. However there will be no “benefit in kind” from the provision of free electric charging of vehicles at work.
  • There will be more support for maths teaching including specialist schools. More maths for everyone! And there will be a tripling in the number of computing teachers. There will also be more “distance learning” support.
  • Universal credits will be paid more quickly and there will be easier access to advances to overcome complaints in this area.
  • The National Living Wage will rise by 4.4% from April (Comment: this will obviously impact employers of large numbers of low paid staff such as retailers and hospitality firms).
  • The Personal Tax Allowance will rise to £11,850 from April and the Higher Rate Threshold will also increase to £46,300, in line with inflation.
  • Taxes on beer, wine and spirits will be frozen (apart from cheap cider). A Merry Christmas to all. Fuel duty will also be frozen.
  • An additional £10 billion of capital investment will go into NHS frontline services. That includes £7.5 billion this year and next, plus there will be a review of staff pay.
  • There will be more attacks on tax evasion. In addition, the anomaly of the indexation of capital gains for companies (but not individuals) will be removed.
  • The VAT registration threshold will be reviewed but it is not intended to amend it from the current £85,000 level for at least two years.
  • There will be amendments to business rates to help smaller businesses.
  • There will be a review of international taxation arrangements. Royalties paid to low tax countries will be taxed and on-line marketplaces will be jointly liable for the sellers VAT.
  • Councils will have powers to tax empty properties, plus the Government will look at barriers to long tenancy agreements.
  • The Chancellor said house prices are getting out of reach. Successive Governments over decades have failed to meet the demand for housing (comment: surely nobody can dispute that). He committed £45 billion in capital and loans to boost the supply of skills, resources and building land. Plus there will be reforms of the planning process/laws. There will also be an inquiry into why plots with planning approval are not built.
  • Seven new town developments are planned with 1 million new homes in the Cambridge, Milton Keynes, Oxford corridor. The plan is to build 300,000 new homes per year.
  • Stamp duty will be abolished on the homes up to £300,000 in price for first time buyers and the same allowance available for homes up to £500,000 in price.

More details on taxation changes.

Changes additional to those mentioned above include:

  • The IR35 rules allowing contractors to avoid being taxed as employees may be tightened further (to follow through changes in the public sector to the private sector).
  • There will be a consultation on reform of the taxation of trusts to make them simpler, fairer and more transparent (Comment: surely a positive move).
  • Individuals operating property businesses will have the option of using mileage rates to simplify their tax affairs.
  • ISA subscription rates will remain unchanged (£20,000 for 2018-2019).
  • Lifetime allowance for pensions will be increased by inflation to £1,030,000.
  • Carried interest transitional arrangements will be removed with immediate effect (so pity those asset managers who will now pay full capital gains tax rates).
  • The restriction of relief on VCT investments sold within six months where VCTs merge will no longer apply to mergers more than two years after the subscription or where they do so only for commercial reasons. This will avoid a trap that investors can accidentally fall into.
  • VCT and EIS schemes tax relief will need to ensure they are investing in assets subject to “real risk” rather than those simply aiming for “capital preservation”. Certain “grandfathering” provisions that enable VCTs to invest funds under older rules will be removed from April 2018.
  • VCTs will need to invest 30% of new funds raised to be invested within 12 months.
  • VCTs will need to have 80% of their funds as “qualifying” investments (currently 70%) from April 2019, but they will have 12 months to reinvest the proceeds of disposals (currently 6 months). This presumably might enable them to smooth dividend payments somewhat when currently they often have to pay out the result of realisations rapidly.
  • EIS rules will double the limit on the amount an individual can subscribe in a year to £2 million, but any amount over £1 million must go into “knowledge intensive” companies. Comment: I await some simple definition of what they might be. Such companies will also have the limit on annual EIS and VCT investments raised to £10 million

I have only included what seem to be the most significant changes in the above. In general there seems to be a policy to avoid rapid and abrupt changes to taxation (which thwart people from planning their tax affairs) which is to be welcomed.

Whether the VCT and EIS tax changes will have significant impact on those vehicles remains to be seen although some of the changes had already been indicated and threats of major changes that had been rumoured seem to have been avoided. This writer expects that the managers of those funds will adapt as they have already been doing. Encouraging investment in riskier assets may increase the risk profile of those companies but might also increase the returns and a large size and diverse portfolio will provide a hedge against the risks.

The full report on the Patient Capital Review consultation has also been published and is available here: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/661398/Patient_Capital_Review_Consultation_response_web.pdf

I may provide further comments on that after reading.

In summary I view this budget positively with no unexpected surprises or likely perverse outcomes from unintended consequences we have seen from the surprises announced by previous Chancellors. But it would be interesting to get readers comments – please add.

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

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Standard Life UK Smaller Companies and FRC Meetings

Yesterday I attended two meetings in the City of London. Here are brief reports on each.

Standard Life UK Smaller Companies Trust Plc (SLS) held a meeting for investors to “meet the manager” in London as their AGM was in Edinburgh this year – only about 10 people attended the latter so there were more in London. I have held this trust for some years and the manager, Harry Nimmo, who has been with the company for 33 years has been a consistently good performer. The management company has recently merged with Aberdeen and is now called Aberdeen Standard Investments but apparently there have been no significant changes internally as yet. Mr Nimmo’s comments are summarised below.

He said they have a discount control policy which is unique to UK smaller companies trusts. They buy back shares if the discount gets about 8%. The investment policy is unchanged and they are not keen on blue-sky or concept stocks. AIM is now a better place than 5 years ago as it is now more broadly based and no longer dominated by mining stocks and blue sky tech stocks.

They have put a new debt facility in place which will ultimately replace their CULS (Convertible Unsecured Loan Stock). The final date for conversion is coming up and investors need to pay attention to that as they are “well in the money”.

The trust shows a ten year CAGR dividend growth of 23.7% and the capital return since 2003 is 851% (plus dividends of course). But there have been some bear markets during his management which one needs to allow for as investors. However, if you had sold the trust after the Brexit vote you would have made a terrible mistake – the company is up 54% since June 2016.

The trust looks for companies that can grow irrespective of the economic cycle, and those with good cash flow and strong balance sheets. Mr Nimmo covered their investment process which is somewhat formulaic using a screening process (I have covered it in past articles) but they do meet investee companies twice a year. They have about 50 holdings in the fund which is a “bottom-up” stock selection actively managed fund.

He mentioned they have 10% in animal care and still hold NMC although as it is now a FTSE-100 stock they have been selling out. They still have a large holding in Abcam and have bought RWS recently. Their second largest holding is First Derivatives where most profits come from outside the UK. They generally do not hold oil/gas/mining stocks and are very light on real-estate [note: I agree with the former and many of my individual holdings overlap with the trusts but I do hold some real estate companies]. An exception though is Workspace who recently produced an excellent set of results with a rapid growth in dividends.

They have also been selling Fevertree as it exceeded 5% of their portfolio value.

I did not manage to stay until the Q&A session as I had to go to a meeting organised jointly by ShareSoc and UKSA with the Financial Reporting Council (FRC). This was a long meeting and I hope one or other organisations will produce a lengthier report on it because it was an exceedingly useful meeting. I will simply highlight a few points of particular interest.

FRC Meeting

The FRC is responsible for audit policy, standard setting and audit quality including investigation and enforcement of past transgressions. So it is a rather important body for those private investors who have come unstuck on an investment because the accounts of the company turned out to be misleading – for example the recent debacle at Carillion was mentioned by one attendee, but I can think of numerous other examples.

The speakers covered the role of audits, both currently and how they might develop in the future (partly as a result of technology changes such as the use of data analytics). After Brexit it is likely there will be a broadly equivalent regime as investors are opposed to “unpicking”.

The FRC reviews about 150 audits every year and grades them into four categories (the reviews are listed on the FRC web site). By 2019 they want 90% to be in the top two ratings which they are not at present. It was noted that KPMG come out worse of the big audit firms. A common reason for audits falling short are lack of professional scepticism.

The FRC also undertakes thematic reviews of particular issues. I raised the issue of the lack of common standards for “adjusted” data commonly reported by companies (such as earnings, or return on capital that I mentioned in previous recent blog posts). The response was it was mandated to explain the definitions of such adjustments but I pointed out this did not help with comparability (e.g. of broker forecasts). The FRC said they will be consulting on this issue shortly, which is good news.

The role of the FRC in “enforcement” was covered. They stressed that their remit does not cover crime, they merely regulate accountants and actuaries although it is of course true that the failure of auditors to identify false accounts is one area they often investigate. It was mentioned that the size of the team on this had grown from 11 people in 2013 to 30 now and they are still looking for more bodies. This really just shows how under-resourced the FRC has been in the past. A total budget of £15m per year was mentioned. Comment: this seems hopelessly inadequate to me bearing in mind the number of public companies (and other organisations) and the number of auditors they have to monitor. It explains partly why complaints to the FRC often seem to disappear into a black hole, or why investigations often take so long as to be pointless. A list of cases under formal investigation is on the FRC web site (See here for that and two linked pages for the full list: https://www.frc.org.uk/auditors/enforcement-division/current-cases-accountancy-scheme which of course will tell you that Globo was commenced in December 2015 and Quindell in August 2015 and have yet to report).

I did suggest to the speaker that the FRC should be a party to the Code of Practice for Victims of Crime (as some audit failures involve the crime of fraud) as the Police, the SFO and FCA are, and which has improved their disclosure culture. This might assist those who report failings to get some feedback on the progress of a case. But the FRC argue that their role is not to investigate crime as such and they are inhibited by legislation/regulation on what they can disclose. However it is very clear to me that too often complaints get made to the FRC, but the complainants are not advised of progress and often have no idea on the outcome. This is an issue they will be looking at.

They hope the extra staffing will speed up investigations. The investigation process was discussed, but for example, Carillion had not even been placed under formal investigation as yet. It was suggested by audience members that the FRC was quite ineffective but recent cases such as AssetCo and Healthcare Locums were mentioned as demonstrating strong action and they have issued fines of £12 million in the last year which is the biggest ever. It was mentioned that fines go to the Treasury which is not ideal.

Confusion between the different regulatory bodies (e.g. the FRC, FCA, SFO, etc) was mentioned by attendees and the speakers, not helped by similar three letter acronyms. One attendee suggested that a unified regulatory body would help (such as the SEC in the USA). Comment: I agree at present it is unclear except to experts on who is responsible for what and the accountability of these bodies to the Government or to any democratic body of investors.

The FRC also has an interest in the UK Corporate Governance Code and the Stewardship Code. A consultation on a new Corporate Governance Code is imminent. There was also a session on the role of the Financial Reporting Lab where both ShareSoc and UKSA members have been involved in the past.

I’ll have to stop here because the budget speech by the Chancellor will commence soon and I wish to listen to it as there may be some major changes on investment tax reliefs. I’ll do another blog post later on it.

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

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Halma and Return on Capital

Yesterday I talked about Diploma (DPLM) and their calculation of adjusted return on capital. This morning Halma (HLMA) published their half year results and they also have a strong emphasis on return on capital, but in this case they call it “ROTIC” (Return On Total Invested Capital). This was down slightly at 13.4% and they define it as Adjusted Profit After Tax divided by Total Invested Capital. The latter is shareholders funds, plus retirement benefit obligations, less deferred tax assets, plus cumulative amortisation of acquired intangible assets plus historic adjustments to goodwill. This similar to the Diploma definition but it is not clear whether it is exactly the same and they call it something different.

As almost every company now reports “adjusted” figures of one kind or another, and analyst forecasts of earning are also usually based on adjusted profits, would it not make sense to have some standard for such data? That’s in addition to the current “statutory” figures which are mandated by the Financial Reporting Council (FRC).

Some of these adjustments, like the ones above in the case of Halma to calculate return on capital make a lot of sense if you wish to obtain a somewhat different view of a company’s performance. But some do not – for example I commented negatively only recently on the figures reported by National Grid.

The FRC would be the best body to set such standards, although they appear to have avoided doing so in the past. Now it just so happens I am attending a meeting with the FRC organised by ShareSoc/UKSA later today and if I get the opportunity I will raise this issue. It would certainly help investors if companies, financial analysts and information web sites reported such adjusted data in a consistent manner, would it not?

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

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On-Line AGMs and City of London IT

I mentioned in a previous article the growing concerns about the use of “virtual” Annual General Meetings (AGMs) in the USA. There are not many on-line AGMs yet in the UK but yesterday there was a good example at the City of London Investment Trust (CTY). I actually had to complain to the company last year about the defects when I attempted to attend it on-line rather than in person – it did not work on the day, plus a later recording that was available had all the Q&A part cut out.

This year it was better, but a long way from perfect. Parts of fund manager Job Curtis’s presentation could not be heard. But at least it gave shareholders the opportunity to attend in person, or attend on-line. Questions could be submitted on-line.

Here’s a brief report on the company and the AGM:

The City of London IT is probably the most boring holding in my portfolio. It invests mainly in large cap UK listed companies. Top ten holdings are British American Tobacco, Royal Dutch Shell, HSBC, Diageo, Unilever, Vodafone, Prudential, GlaxoSmithKline, Lloyds Banking Group and BP, totalling 32% of the portfolio. It’s in the “UK Equity Income” sector for trusts. So you can see it’s not going to be any racehorse as these are quite defensive stocks. However the performance over many years has been good and it tends to outperform its benchmark. Not last year though where it underperformed the benchmark but still managed to achieve a total return of 14.5% (All-Share was up 18.1% for example with growth and smaller cap stocks more in fashion in a buoyant market). The current yield is 3.9%.

Here’s a few comments from fund manager Job Curtis from his presentation who has been with the fund management company (Henderson) for 26 years. He mentioned the fact that dividends have grown every year for more than 50 years. They manage this by keeping some cash back in revenue reserves in good years, which are then used to pay dividends in the bad years.

They use gearing and last year moved up the gearing to 7% by taking advantage of the very low interest rates – they are now borrowing at 2.4% over 32 years. (Note: have mentioned before how astonishing it is that such trusts can borrow at rates lower than inflation and for long periods).

Job Curtis said their on-going charge figure was now 0.42% which is the lowest in the equity income sector.

Positive contributors to performance last year were housebuilders (they hold three – Persimmon, Taylor Wimpey and Berkeley) and pharmaceuticals (Glaxo and AstraZeneca, but they also hold Merck, Johnson & Johnson and Novartis). They also benefited from a below average exposure to oil and gas producers. Detractors from performance were banks, mining companies and a holding in Provident Financial which they have now sold.

There were few questions in the Q&A session (a good indication that shareholders are happy), and you can hear those and the rest of the event by going to this web site: www.janushenderson.com/trustslive .

Certainly this format provides a good approach for those investors who cannot easily get to AGMs, while not prejudicing those who wish to attend in person and chat to the directors. They do need to iron out the technical glitches though.

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

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Lloyds Case Impressions, Ideagen AGM and Return on Capital

Yesterday I attended the Annual General Meeting of Ideagen (IDEA) at 12.00 noon in the City of London – see below – and afterwards spent an hour in the High Court listening to one of the witnesses being cross-examined in the Lloyds Banking Group case. What follows is just an impression of the scene because the whole case is running for months so in no way can this be considered a comprehensive report. I have covered some more details of the case in previous articles, but to remind you the litigants are suing Lloyds and the former directors of the company over the takeover of HBOS which they declare was contrary to their interests as shareholders in Lloyds TSB. Lloyds deny liability.

The case is being heard in the Rolls Building in New Fetter Lane – a modern building very different to the ultra Victorian main Courts of Justice building in the Strand. See this link for a video tour of the building: https://www.judiciary.gov.uk/you-and-the-judiciary/going-to-court/high-court/the-rolls-building/virtual-tour/

The witness being cross-examined on the day was Tim Tookey, the former Finance Director of Lloyds TSB. Richard Hill QC was undertaking the task for the litigants under the eyes of a single judge, Mr Justice Norris (sans wig). It was a pretty impressive scene with at least 6 barristers in wigs and gowns plus about another 10 supporting legal staff. Why do barristers still wear wigs? To quote from the web: “The courts didn’t officially add wigs to the legal dress code until the 18th century when they became culturally chic. … They continue to wear them because nobody has ever told them to stop”.

It was a pretty impressive scene, somewhat lost on the few members of the public present – half a dozen litigants and members of the press. But the court was digitally up to date with every desk holding a screen on which the written evidence was displayed as it was invoked. However the witness being cross examined still referred to a paper copy, extracted from 150 large A4 binders stored in shelves on the left hand side of the court – filling almost the whole wall.

Mr Tookey gave his responses to questions firmly and without emotion. A confident witness giving clear answers. He was questioned about the events leading up to the announcement of the acquisition of HBOS and over how much capital Lloyds anticipated would be required to ensure the deal was “bullet-proof” (i.e. not creating unacceptable risks if the economic circumstances worsened). He was questioned about the extent the risks had been considered and whether enough due diligence on HBOS had been done before the decision was taken to proceed. Apparently it came down to a decision at 4.00 am on a Monday morning to proceed. They we being forced to decide to proceed or not by the Government before the markets opened on Monday. But he said that he thought all the risks had been considered and the board was supportive of the deal because of the strategic advantages of the HBOS takeover in the longer term. Recapitalisation involving the Government was necessary because there was no way it was possible to raise even £3 billion (underwritten) by the Monday, which was the minimum requirement. Government involvement “de-risked” the deal. The case continues….. for another dozen weeks.

One can see from the above exactly why the costs of such cases are so enormous.

Ideagen AGM

Ideagen (IDEA) is a software company in the Governance, Risk and Compliance sector. I have held the shares for some years when it has grown revenue and profits considerably, both from acquisitions and organic growth. They have a strong emphasis on the importance of recurring revenue. They are presenting at the ShareSoc Seminar on the 8th November, although that event is fully booked I understand.

There were fewer sharesholders at the Ideagen AGM than members of the public at the Lloyds hearing, but that’s not exceptional for small companies. But it was still a useful event – a brief report follows.

One question I raised was about return on capital. Now you might think this was prompted by an interesting article on that subject by Leon Boros in the latest ShareSoc Newsletter, but I did not get around to reading that until later in the day so it’s somewhat of a coincidence. Leon compared the return on capital at Bioventix (one of his favourite stocks which he likes to talk about regularly), and YouGov. He pointed out that not only are measures such as Return on Equity (ROE), Return on Capital Employed (ROCE) and Return on Assets (ROA) better at Bioventix calculated on the headline numbers, but that those for YouGov are somewhat doubtful because they capitalise and amortise the cost of recruitment of their survey panels. Plus they capitalise and amortise software development costs. But they then produce adjusted earnings figures that excluded the amortisation of both those costs, effectively pretending they are not real costs. He has a point.

Now I always look at returns on capital when I am investing in new companies because I consider it one of the most important measures of a company’s performance – as I told the directors of Ideagen. Hence at the Ideagen AGM I asked a question on that subject. On page 18 of their Annual Report they give the “Key Performance Indicators”, 9 of them, that the directors use to monitor the performance of the company. They all look good, but none of them measure return on capital. Should they not include a return on capital measure?

In reality the headline figures for ROE, ROCE and ROA reported by Stockopedia for Ideagen are all less than 2%, and that ignores even the large number of shares under option that the company has that would dilute the earnings. The reason for this is partly the fact that the profit measures used are “unadjusted” and as the company has very substantial amortisation of goodwill from past acquisations, and £1.2 million of share-based payment charges, these distort the numbers. The CEO David Hornsby, responded with “what measure would I like to use?” to which I responded that I did not mind so long as it was consistent from year-to-year. Companies often publish such figures, which are frequently based on “adjusted” profits. I also suggested cash return on assets might be a good measure, something I also look at.

The company actually generated Net Cash From Operating Activities of £8.3m last year which on Net Assets of £30m at the start of the year is very respectable, although technically one should probably write back the cost of past acquisitions that have been written off. In addition some of the cash generated was spent on contingent consideration on past acquistions and on “development costs” which they class as “investing activities”. This demonstrates that for some businesses, looking at headline return on capital figures or those reported by financial web sites can be misleading. One needs to look at the detail to get a real understanding on what is going on in such a business.

A short debate on the issue followed. Otherwise after a couple of other questions, the CEO mentioned the half year for the company ends today, and shareholders should be very pleased with the results.

In summary, a short AGM meeting, but a useful one. And the ShareSoc newsletter is well worth reading – it even includes some articles from me.

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

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