Metro Bank, Improving Accounts, Patisserie, Telford Homes and GoCompare

The latest example of a public company publishing misleading accounts is Metro Bank (MTRO). Both the FCA and PRA (the bank regulator) are looking into the “misclassification” of some loans which resulted in the bank overstating its regulatory capital. The result was that it has had to do an equity share issuance to bolster its capital.

There was a very good letter to the FT today on the subject of improving accounting and audits from Tim Sutton. He suggested the US Sarbanes-Oxley Act had improved the standards in the USA enormously so that revision of financial statements has been declining. To quote: “Section 404 requires management to assess and report annually on the effectiveness of the company’s internal control structure and procedures. In addition, the company’s external auditors must attest to the effectiveness of those controls”. As he points out that might have prevented the fraud at Patisserie (CAKE), and no doubt avoided the issues at Metro and other companies. It sounds an eminently good idea. I realise Sarbanes-Oxley did receive some criticism in the USA after it was first introduced due to the extra costs it imposed, but if that is the only way to ensure reliable accounts, I suggest it is worth paying. It was perhaps over-complicated in implementation in the USA but some of the key features are worth copying.

This morning Telford Homes (TEF) published a trading statement which was mostly bad news and the shares fell over 15%. This is a London focused housing developer which I used to hold but I got nervous some months ago about the housing market in the capital. You can read my acerbic comments made in last October here: https://roliscon.blog/2018/10/10/black-hole-in-patisserie-holdings-audit-review-telford-homes-and-brexit/

The latest announcement says that “the London sales market remains subdued”. Sales are being achieved but at a slower rate and margins are under pressure due to increased incentives and discounts. So they are putting an increased focus on “build-to-rent”. Other bad news is that contracts are being delayed on larger projects, partly due to planning delays. The result will be profit before tax for FY2020 will be significantly below FY2019.

Another announcement this morning was the preliminary results from GoCompare (GOCO). This is a price comparison web service, particularly focused on car insurance, but also covering utilities and other products. It is of course fronted by Italian opera singer Gio Compario in TV advertisements which I certainly prefer to the Moneysupermarket ones.

It was particularly interesting watching the results presentation – probably available as a recording on their web site. Results were much as forecast, with only a slight increase in revenue but a 20% increase in adjusted earnings. This is due to optimisation of marketing. You can see that these kinds of companies have to spend an enormous amount on marketing to catch customers when they are thinking of switching suppliers. GOCO spent £80 million on marketing last year, down from £89 million) to achieve revenue of £152 million.

They have made acquisitions to diversify revenue and this has led to an increase in debt, but the interesting news was about a new subscription service called WEFLIP. This automatically switches your energy supplier, among a panel of agreed suppliers, if you can potentially save £50. This will enable them to retain customers, with the suppliers paying the subscription fee. They plan to spend £10 million on marketing this in the coming year and have already done a “soft” launch to ensure the product and market are OK. Clearly though, this might be perceived as a bit of a gamble.

The market was unimpressed and the shares have fallen by another 5% today after a long decline in recent months. It’s now on a prospective p/e of less than 9 and yield of about 3%. I remain a holder at those levels.

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

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Luxembourg Regulators Inept?

There were a couple of interesting articles on Luxembourg financial regulation in Mondays FTfm publication. The first was on the allegation by victims of the Madoff fraud that the regulator was “inept” because UBS were not being forced to compensate investors in the $1.4 billion Luxalpha fund that fed money to Madoff. UBS were the funds investment manager and custodian and should therefore have paid compensation under the regulator’s rules. But they are declining to enforce their own rules it is claimed. There also seem to be difficulties in investors pursuing legal claims in Luxembourg over this “due to bureaucratic hurdles”.

I have past experience of dealing with the Luxembourg regulator (the CSSF) over the actions of Paypal some years back. Paypal in Europe (and the UK) was and still is regulated by the CSSF. They proved to be totally useless in dealing with my complaint. I came to the conclusion that Paypal chose that regulatory venue for good reason.

I would be very wary of investing in any business that was registered or regulated in Luxembourg. The UK regulator might be quite inept at times, but at least they try to some extent to deal with complaints. The Luxembourg regulator seems to be asleep at the wheel or to simply not have the resources to provide the required service.

Surprisingly the second article in FTfm was how funds are moving to Luxembourg and Ireland spurred by Brexit so as to give them access to EU markets. This is being done by the use of “supermancos” (super management companies) that provide administration services for multiple fund providers and effectively it seems act as a “front” with the appropriate regulatory licences. The EU has laid down some rules that require them to have some “substance” but all that means apparently is that they need to have up to seven staff rather than just one or two. Does that inspire confidence? Not in me.

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

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Quindell (Watchstone), SFO inaction and Tungsten Corporation

The Daily Telegraph this morning (25/2/2019) disclosed that law firm Harcus Sinclair is preparing a legal case for investors who lost money in Quindell (now renamed Watchstone). Quindell was once the largest AIM company – valued at £2.6 billion. But its accounts were extremely dubious and many investors think they were downright fraudulent. The company is still being investigated by the Serious Fraud Office (SFO) but only two days ago it was announced that the SFO was dropping investigations into Rolls-Royce and GlaxoSmithKline. The SFO said there was “either insufficient evidence” or it was “not in the public interest” to continue. That’s despite the fact that Rolls-Royce paid nearly £500 million under a Deferred Prosecution Agreement over the allegations of bribery and corruption. Will the Quindell case be dropped also one wonders?

Watchstone (WTG), now worth £44 million, is also the subject of a law suit by Australian firm Slater & Gordon over the acquisition of businesses from the company in 2015. They claim breaches of the warranties and deceit but Watchstone denies they have a valid claim.

Why is it so difficult to pursue directors and other senior executives over false accounts? Tesco was a similar situation where the company conceded wrongdoing and paid a fine but the prosecutions of individuals collapsed. It seems clear that the whole legal framework for fraud under which the SFO operates needs reviewing and changing to make such cases easier to prosecute. Either that or companies should not be conceding wrongdoing and paying fines (a charge on shareholders effectively) when it cannot apparently be proven. It’s the individuals who need convicting, not the company, if future frauds are to be deterred.

Also this morning Tungsten (TUNG), another AIM company and in which I have a miniscule holding, issued a trading update. This is a company that has been consistently loss making, and it was always doubtful whether it had a viable business model in the new sector of electronic invoicing and supply chain enablement.

CEO Richard Hurwitz, who was appointed to the board in 2015, after a revolution, left “with immediate effect” on the 14th February. He did seem to have made changes in the last three years that gave some hope that the company was not going to continue to be a bottomless cash pit. But losses persisted. However, this mornings announcement was somewhat more positive in that it mentioned “significant reductions in the cost base over the past three years” and there are other changes afoot including a review of the Group’s “remuneration structures”. That includes a reduction in cash bonuses in favour of shares and introduction of “clearly defined performance conditions”. Perhaps that prompted the CEO to quit (he got paid £1.3 million last year despite the company still losing money).

Other good news was that net cash inflow of £0.5 million in the quarter represented the first ever positive cash flow from operations! But the underlying EBITDA of £0.4 million includes a “seasonal working capital” inflow of £1 million so the “normalised” cash outflow was still £0.5 million. Does that make sense or is this fanciful presentation?

The share price only perked up slightly this morning on this announcement which probably reflects continuing concerns about when it will actually show some profits and (and I am not just talking about EBITDA), and the added uncertainty of a new CEO but it seems good candidates have already been lined up.

Still a “wait and see” situation so far as I am concerned.

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

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Plus500 Share Price Dive and Betting Against Your Customers

My last blog post mentioned my brief holding in Petrofac. Another company I held briefly was Plus500 (PLUS). Yesterday its share price dropped over 30% following a profit warning in a preliminary results announcement. The cause is simply that tightening regulations are impacting revenue.

Plus500 is big CFD provider. That fact that most “investors” in CFDs lose money is widely acknowledged and the Financial Conduct Authority (FCA) and EU regulators have been tightening up on the rules that apply to Contracts for Difference. The reality is that most such “investors” are ill-informed speculators.

The FT said today that the announcement was most revealing as it showed “for the first time how much its earnings relied on betting against its customers”. Columnist Lex also described it as a “risky business” and that is one reason I sold the shares and have not considered reinvesting since. There are some companies that are simply too dubious to hold – rather like Petrofac, particularly if you also have ethical qualms about how they operate.

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

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Tesco and Barclays Legal Cases; Rent Controls and Telford Homes

A few events transpired last week which I missed commenting on due to spending some days in bed with a high temperature. Here’s a catch-up.

The remaining prosecutions of former Tesco (TSCO) executives for the accounting scandal in 2014 that cost the company £320 million and resulted in the company signing a Deferred Prosecution Agreement (DPA) and paying a big fine has concluded. The defendants were found not guilty. The prosecutions of other executives were previously halted by the judge on the grounds that they had no case to answer. Under the DPA, Tesco were also forced to compensate affected shareholders.

Everyone is asking why Tesco agreed to the DPA, at a cost of £130 million, when it would seem they had a credible defense as no wrongdoing by individuals has been confirmed. The defendants were also highly critical of the prosecution on flimsy evidence that destroyed their health and careers. This looks like another example of how the UK regulatory system is ineffective and too complicated. The only winners seem to be lawyers.

Another case that only got into court last week was against former Barclays (BARC) CEO John Varley and 3 colleagues. This relates to the fund raising by the company back in 2008 – another example of how slow these legal cases progress in the UK. This case is not about illegal financial assistance given to Qatari investors as one might expect, those charges were dropped, but about the failure to disclose commissions paid to those investors as part of the deal and not publicly disclosed. The defendants deny the charges.

Comment: this long-running saga seems to stem from the Government’s annoyance over Barclays avoidance of participation in the refinancing of banks at the time. Lloyds and RBS ended up part-owned by the Government, much to the disadvantage of their shareholders. Barclays shareholders (I was one at the time) were very pleased they managed to avoid the Government interference, precipitated by the Government actually changing the capital ratios required of banks. Barclays were desperate for the Qatari funds of at least one £ billion with one Barclays manager saying “They’ve got us by the balls….”.

Will this case conclude with a conviction, after a few millions of pounds spent on lawyers’ fees? I rather doubt it. And even if a guilty verdict is reached, how severe will be the likely penalty? Bearing in mind that the damage suffered by investors as a result seems minimal, i.e. it’s purely a technical breach of the regulations, it seems both pointless and excessive to pursue it after ten years have elapsed. Again the only winners seem to be lawyers.

One amusing aspect of this case was the grim “mug-shots” of 3 of the defendants attending court that appeared in the Financial Times. It was clearly a cold day and one of them was wearing a beanie hat. Is this the new sartorial style for professional gentlemen? Perhaps so as my doctor turned up wearing one to attend my sick-bed. Clearly I may need to revise by views on what hats to wear and when.

One has to ask: Are the cases of Tesco and Barclays good examples of English justice? Prosecutions after many years since the events took place while the people prosecuted have their lives put on hold, their health damaged and with potentially crippling legal costs. This is surely not the best way of achieving justice for investors. Justice needs to be swift if it is to be an effective deterrent and should enable people to move on with their lives. Complexity of the financial regulations makes high quality justice difficult to achieve. Reform is required to make them simpler, and investigations need to be completed more quickly.

Investors might not have noticed that London Mayor Sadiq Khan is going to include a policy of introducing rent controls in his 2020 election manifesto. Rent controls have never worked to control rents and in the 1950s resulted in “Rackmanism” where tenants were bullied out of controlled properties. It also led to a major decline in private rented housing as landlords’ profits disappeared so they withdrew from the market. That made the housing shortages in the 1960s and 70s much worse. The current housing shortage in London would likely be exacerbated if Sadiq Khan has his way as private landlords would withdraw from the market, leaving tenants still unable to buy although it might depress house prices somewhat.

But the real damage would be on the construction of new “buy-to-let” properties which would fall away. Institutions have been moving into this market in London and construction companies such as Telford Homes (TEF) have been growing their “build-to-rent” business in London.

Sadiq Khan is proposing a policy that he would require Government legislation to implement, which with the current Government he would not get. No doubt he is hoping for a change in that regard. Or is it simply his latest political gambit to get re-elected? In the last election he promised to freeze public transport fares as a vote winner, so he clearly has learnt from that experience. But he’s probably already damaging the private rented sector.

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

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RBS Share Buy-Back

The Royal Bank of Scotland (RBS) is proposing to buy-back up to 4.99% of its shares from the stake held by the Government (by UKFI on its behalf). At present the Government holds 62% of the company stemming from the bailout in the banking crisis ten years ago. They have been trying to get shot of it ever since as no Tory government thinks it should be investing in banks. This latest proposal makes it clear that UKFI cannot easily sell the shares in the market, nor place them with institutions, perhaps because there are still outstanding lawsuits faced by the company.

Should shareholders support this proposal? I don’t think so, and I will be voting against it with the few shares I hold which were acquired to support the ShareSoc campaign for the appointment of a Shareholder Committee. Incidentally this proposal rather suggests that it is now even more important to have such a Committee because this proposal may be of advantage to the Government but it is not at all clear whether it is of benefit to shareholders as a whole.

Fortunately UKFI won’t be able to vote their shares at the EGM to approve the proposed buy-back so other shareholders will decide the issue.

Other shareholders might wish to ask themselves, why should shares only be bought back from UKFI and not all shareholders, e.g. via a tender offer. Another negative is that this share buy-back is effectively a reduction in capital when banks like RBS still have a relatively thin equity capital base. In any case, I generally vote against buy-backs other than in investment trusts. They are usually misconceived. The Government commissioned research into share buy-backs a year ago on the grounds that they may be being used to inflate executive pay (reducing the number of shares in issue increases earnings per share which is a common element in executive pay bonus and LTIP schemes). The research has yet to produce a report.

Personally I would like to see share buy-backs made illegal except in very limited circumstances, as they used to be. They are rarely of benefit to other shareholders and can be used by foolish management to try to manage the share price.

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

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FCA Views of the Financial Landscape

The Financial Conduct Authority (FCA) have published a document entitled “Sector Views” giving their annual analysis of the UK financial landscape and how the financial system is working – see https://tinyurl.com/yc492lkt . For retail investors there is a chapter on “Retail Investments” which is particularly worth reading.

But we also learn that the “FCA continues to plan for a range of scenarios regarding Brexit” which is good to hear. I somehow doubt it will be settled tomorrow in Parliament – I continue to forecast March 28th. We otherwise learn that cash is still king as a payment method with 40% of payment transactions, albeit falling; that 44% of consumers say nothing would encourage them to share their financial data (that has been encouraged by recent regulatory changes); that car insurance premiums are rising even though mine just fell which very much surprised me; that the ageing population presents a considerable challenge for pension savings and that mortgage borrowers are getting older (39% will have mortgages maturing when they are older than 65).

Cash ISA subscriptions continue to exceed Stock/Share ISAs by a wide margin, although the number of new cash ISA subscriptions fell last year. But only one third of the UK population hold any form of investment product. It looks like the rest are replying on pensions, state support or housing wealth to keep them in retirement.

They claim the investment platforms market is working well “in many respects” despite the fact that their use of nominee accounts for investors has disenfranchised retail investors. You can send them some comments on that via an email to sectorviews@fca.org.uk . But they do at least highlight the difficulty of switching platforms and they note that comparing pricing is also difficult.

Assets under management by the investment management sector grew to £9.1 trillion in 2017 with 20% managed for retail investors. The proportion of passively managed assets rose to 25% which continues the past trend.

Overall this review shows the size and complexity of the UK financial sector. At 36% of European Assets Under Management, it is much larger than any other European country. The next largest is France at 18% and Germany is only 9%. Let us hope it stays that way after Brexit.

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

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