FairFX AGM Report, Woodford Fund Issues and Zero Carbon

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

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

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

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

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

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

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

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

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

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

Link acting as ACD for Woodford Funds

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

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

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

FT article on Net Zero Emissions

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

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

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

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

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

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

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Worldwide Healthcare Trust and Investor Voting

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

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

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

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

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

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

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

Nominee Accounts and Voting

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Good News – Autonomy CFO Jailed

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

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

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

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

These were some of the allegations against Autonomy:

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

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

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

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

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

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

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Changes Proposed at Companies House

The Government BEIS Department have recently proposed a number of important changes to the way Companies House operates in a public consultation entitled “Corporate Transparency and Register Reform” (see https://tinyurl.com/yysf9gdn ). Here’s a brief summary of the main points:

This consultation will be of interest to anyone who is a director of a private or a public company, or a major shareholder in such a company (i.e. those People with Significant Control). Even directors of the smallest companies could be affected.

A major proposal is to verify the identity of directors and to collect more information on them (although not their email address apparently, which I have suggested be added). This can now be done very quickly and at minimal cost electronically using various verification services (e.g. listed GB Group in which I hold shares). This will help to prevent fraud and they even hope to be able to link all directorships in various companies together. For example, this might make it easier to track the past activities and record of directors which even in small listed companies can be very informative as to their competence and reliability.

They propose to continue to retain the records of dissolved companies for 20 years which many investors consider important and is useful for investigators of all kinds.

They also plan some changes to improve the protection of personal information held at Companies House. Bearing in mind that there are well over 6 million records of directorships, with significant personal information, this is clearly important.

For public company investors there are two significant proposals:

1 – Improved digital tagging standards for accounts, which might make it simply to provide information services based on them.

2 – A possible cap on the number of directorships any one person can hold. There are common complaints about “overboarding” where directors take on too many roles. I have suggested a maximum of 5 in public companies, with some possible exemptions, should be imposed.

In general the proposals seem eminently sensible and I suggest they be supported on the whole. You can see my detailed comments in a response submitted to the consultation here: https://tinyurl.com/y6j9u4do 

But you should of course submit your own comments on those points of interest to you.

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

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Warren Buffett and FCA Review of RDR & FAMR

 

There was an interesting article on the career of Warren Buffett in the last FT Weekend magazine. It was a wide-ranging interview with the renowned investor who became one of the richest persons in the world by making investments which consistently outperformed the markets over the last 50 years. At aged 88 he still claims to be having fun by working at investment.

But in the last ten years he has fallen behind the S&P index. The reason is primarily because he has to look now for enormous deals to soak up the $112 billion in cash the Berkshire Hathaway fund holds and there are not many such opportunities now available. In addition he has to compete with leveraged private equity funds who currently have access to very low cost money and who are willing to pay high prices for good assets.

The last paragraph of the article contains the usual pithy and wise quote from Buffett as to why investors enjoy the game: “If you played golf and you hit a hole in one on every hole, nobody would play golf, it’s no fun. You’ve got to hit a few in the rough and then get out of the rough….That makes it interesting”.

The Financial Conduct Authority (FCA) yesterday published a call for comments on the Retail Distribution Review (RDR) and the Financial Advice Market Review (FAMR) – see: https://www.fca.org.uk/publication/call-for-input/call-for-input-evaluation-rdr-famr.pdf .

They would like some input from consumers on how the past changes to regulations on advice to consumers and how advisors are remunerated have worked out. Do you consider financial advice is accessible and affordable? If you have views on this subject, please let the FCA have them.

Other news from the FCA is that “dawn raids” as part of investigations is at a ten year high at 25 last year. It also has more investigations open at the end of the year, at 504 which is a 20% increase on the prior year. This suggests that enforcement action is increasing which is surely what is required. There are way too many financial frauds and abuses in the modern world.

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

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Debenhams PrePack, Dunelm Trading, ASOS and Privacy

Department store operator Debenhams (DEB) has been put through a pre-pack administration. It’s been bought by a new company formed by its secured lenders. Mike Ashley of Sports Direct is furious. His company invested £150 million in the shares of the company in the hope of taking it over, which will now be worthless. He had some choice words to say on the subject which included that it was an “underhand plan to steal from shareholders”, “as normal politicians and regulators fiddled while Rome burnt”, and that they “have proven to be as effective as a chocolate teapot”. I have much sympathy with Mike Ashley and the other shareholders as I have consistently criticised the use of pre-pack administrations in the past. It is an abuse of legal process. Why could it not have been put through an ordinary administration as the company appears to be a going concern, albeit with excessive debt, or Ashley’s offers considered?

Mike Ashley had previously made various offers to refinance the business including a pledge to underwrite a rights issue, but to no avail. It is not clear why his proposals were rejected, but as usual with pre-packs it is probably just a case of the lenders seeing the opportunity to make more money from a pre-pack. Ashley suggests he might try to challenge the pre-pack although that will be difficult now the deal is done.

What went wrong at Debenhams? Basically an old-fashioned retail format where sales were relatively stafic compounded by very high and onerous property leases and massive debt.

Contrast that with the trading statement from Dunelm (DNLM) this morning. This company sells home furnishings from out of town warehouse sites (not on the High Street like Debenhams) and have moved successfully into “multi-channel” operations with a growing on-line sales proportion. Overall like-for-like revenue in the third quarter is up by 9.8% with on-line sales up 32.1%.

Retailer ASOS (ASC) also announced their interim results this morning. Sales were up 14% but profits collapsed with margins declining and costs increasing while they invested heavily in technology and infrastructure. Competition in on-line fashion is increasing but you can see that such companies are taking a lot of business from High Street retailers, particularly in the younger customer age segment. The world has been changing and Debenhams has been an ex-growth business for many years. I do most of my clothes shopping, but not all, on the internet which shows even oldies are changing their shopping habits. I have never held Debenham shares although I do hold some Dunelm and have held ASOS in the past. But declining businesses with high debt are always ones to avoid however cheap the shares may appear.

Readers of my blog should be aware that after many years and growing amounts of spam I am changing all my email addresses. You can either contact me in future via the Contact page of my web site (see https://www.roliscon.com/contact.html ) or via the Contact tab on this blog.

It’s taking me some time to notify all the hundreds of organisations I am signed up with of my new email address. But that was almost frustrated when one of them sent out an email to all their clients using cc. rather than bcc. They have reported themselves to the Information Commissioner! But will they take any action? I doubt it. Thankfully the company in question used one of my older addresses which will soon be deleted. Such idiocy is not acceptable.

Another problem I am having of late is that if I mention a company or look at its web site, I then subsequently get bombarded with web advertising. So I am now seeing repeated advertisements for SuperDry products when I have absolutely no interest in such products. Despite removing cookies they still appeared. This is the kind of problem that is annoying people about the lack of privacy in the modern world and which needs tackling.

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

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