Jack Welch Obituary and Coronavirus Impact

Jack Welch, the former CEO of General Electric (GE) has died at the age of 84. He turned the company around from a slumbering US corporate giant into a much more profitable business that awarded shareholders handsomely. His management style was of the “slash and burn” variety with jobs being reduced and anyone rated as underperforming being fired. This was similar to the management style of Fred Goodwin at Royal Bank of Scotland and with what they might consider tough but required decisions being made. In both cases their legacies proved to be toxic with successors facing difficulties.

Both had a large media presence and big egos. But is that what you want in a CEO? And do the ends always justify the means? Certainly Jack Welch showed that the ability of management is probably the key factor in the success of a business but the cult of personality that surrounds such leaders and the decisions they make often makes for difficulties in management succession. For investors, such managers tend to make good short-term returns but you need to know when to bail out while humble and more sensitive managers can be better long-term bets.

As I write this stock markets are zooming up after large falls in the last week. Your portfolio is probably down substantially like mine, but is this recovery a “dead cat bounce” or a realisation that the Covid-19 virus impact might be lower than anticipated?  I have no more great wisdom to impart than others on the future impact nationally or worldwide but it does seem to me that we might well see a major pandemic. Some industries such as travel and entertainment venues might see much reduced revenue for a short period of time and supply chains will be disrupted in many markets. I don’t think it will really hit home in the UK as it has done in China until people you know start dying. The fact that it may be mostly fatal to the elderly or those with poor immune systems (like me incidentally) may be little comfort. As with the 1918 flu pandemic, the long-term economic impact may be small but there may be short term disruption.

It was interesting reading the announcement this morning from 4Imprint (FOUR) whose shares I hold. Their final results were very good and the share price is up 20% at the time of writing. But this is a company that sells promotional products and most of the manufacturing takes place in China. This is what the company had to say: “Impact on the business has so far been minimal, reflecting the timing of the inventory cycle of our domestic suppliers. However, the situation is very fluid and if production restrictions in China persist, the potential for disruption of our supply chain increases”. They go into a lot more detail in their operational review which is quite helpful. But they have not estimated the possible impact on reduce sales volumes if there is a general impact on the economy of the USA which is their major sales market.

In essence I think it is way too soon to judge the likely impact so having sold some shares (not those of 4Imprint though) in the face of the declining markets I don’t plan to rush back into the markets in a big way and particularly I will be avoiding shares that may be vulnerable. Companies with longer term or recurring revenues are a better bet as usual because they should be able to survive short-term economic disruption. Property companies may be a good bet as they mostly have long-term leases spanning multiple years when the virus impact may only last a few months before everyone has survived it or died even if there is a global pandemic.

On that positive note, I think it’s best to close before I get seduced into giving share tips.

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

You can “follow” this blog by clicking on the bottom right in most browsers or by using the Contact page to send us a message requesting. You will then receive an email alerting you to new posts as they are added.

 

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

De La Rue, Excessive Debt, Victoria and Link’s Debt Monitor

Link Asset Services have issued a note pointing out that De La Rue (DLAR) has net debt that now exceeds its market cap. The high debt in the company and recent falling revenue no doubt accounts for much of the recent fall in the share price, although the report of an investigation by the Serious Fraud Office (SFO) cannot have helped. But if you read the last interim report which was issued a couple of days ago, there are lots of other points that might put you off investing in the company. For example, it declares the business is in “turnaround” mode so restructuring is being accelerated, and that all of the Chairman, CEO, senior independent director and most of the executive team have left or resigned in the period.

How do you judge whether a company has excessive debt? There are two simple ratios which I look at for companies. The Current Ratio (current assets divided by current liabilities) and the interest cover (operating profits divided by net interest paid). For operating businesses I prefer to see a current ratio higher than 1.4 and interest cover of several times.

Why because companies go bust, or have to come to some accommodation with their bankers or raise urgent equity finance – all of which can be very damaging for equity shareholders, when they run out of cash. A low current ratio or low interest cover means that any sudden or unexpected decline in revenue and profitability can mean they get into financial difficulties. They simply have no buffer against unexpected adversity.

De La Rue’s Current Ratio is only 0.63 according to Stockopedia and as there were negative profits (i.e. losses) in the half year the Interest Cover is zero.

There are some exceptions to the Current Ratio rule so sometimes it is necessary to look more closely at the reasons for a low figure, but De La Rue just looks like a business in some difficulty.

Link Asset Services’ note also points readers to their Debt Monitor (see https://www.linkassetservices.com/our-thinking/uk-plc-debt-monitor ) which gives a comprehensive overview of the indebtedness of UK listed companies. They point out that it has risen by 5.8% to a new record of £433 billion. For comparison that’s only just higher than the Labour Party proposes to borrow for its “Infrastructure Fund”! But it’s worth pointing out that the FTSE is dominated by relatively few very large and traditional companies. They have probably been using financial engineering to enable them to maintain dividends and the result is higher debts. Or they are dedicated to the mantra of having an “efficient” balance sheet where there is significant debt so as to maximise shareholder returns, and have been buying back shares using debt.

Debt has become easier to obtain after the financial crisis of 2008/09 when banks were reluctant to lend at all. Interest rates have also come down making debt very cheap for those with good credit ratings and good security. It’s worth reading the Link Asset report to see which major companies and sectors have the most debt.

In smaller companies, particularly technology companies, there tends to be much less debt partly because they have few fixed assets against which to secure cheap debt. So they find equity less costly and more readily available. Or perhaps they just have more sense in realising that business is essentially uncertain so equity is preferable to debt.

There is relatively little debt in the companies in which I am invested (De La Rue is definitely not one of them) with one exception which is Victoria (VCP). If you wish to be convinced of the wonders of debt financing read the comments of Victoria’s CEO Geoff Wilding in their last Annual Report. In such companies one has to have faith in the management that they can control the risks that come with high debt levels. But most investors get very nervous in such circumstances which is probably why it’s only on a p/e of 10 (and my personal holding is relatively small). That’s so even though it has a Current Ratio of 1.8 and Interest Cover of 1.2 – the latter is too low for comfort in my view.

Of course it depends whether this is a temporary position (say after an acquisition) and how soon the debt is likely to be repaid. So you need to look at the cash flows. In the case of De La Rue it was minus £42 million in the half-year before investing/financing activities which is yet another negative sign, but it was a positive £38 million at Victoria in their half-year results announced on the same day. Clearly two very different businesses!

Note that there are some other financial ratios that you can look at to see the risk profile of a company but as always, a few simple things that you actually pay attention to plus getting an understanding of the business trends are to my mind more important.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

Speedy Hire Presentation, Burford Analysis and Treatt Trading Statement

On Tuesday the 1st October I attended a company seminar organised by ShareSoc in Birmingham, mainly to present my new book. But there was an interesting presentation given there by Speedy Hire (SDY). This is not a company I have looked at before because it seemed to be in a sector driven by construction activity which tends to be cyclical and in a fragmented market with few barriers to entry. This is probably why other listed companies in the sector such as HSS and VP are on low valuations (typically P/Es of less than 10). Speedy Hire is on a prospective P/E of 9.5 and a dividend yield of 4.2% according to Stockopedia.

So why was the company interesting? Firstly Speedy Hire seems to be somewhat of a turnaround situation from dire 2016 results. The presenter, Chris Morgan, explained how the company has a new focus on improving the proportion of services in the revenue mix which have better margins and there is a new focus on SME customers which they consider a significant opportunity. They are also undertaking a “digital transformation” to reduce costs and improve service. That includes a new “app” that enables customers to order items whereas most orders are taken over the phone at present. This is currently in essence a very labour intensive business – for example they have over 50 people on credit control alone.

There are clearly opportunities to improve efficiencies in the business by investing in technology which small local hire companies would be unable to match. There is also a focus on improving the return on capital employed (ROCE) which I always like to see – it’s now about 12.8% excluding the recent Lifterz acquisition so is moving in the right direction. On the 3rd October the company issued a positive trading statement with revenue up 6% and higher growth in the sectors focused upon mentioned above.

In summary a company that may be worth a closer look as management seem to be improving the business substantially.

After the Speedy Hire presentation I covered my book “Business Perspective Investing” (see https://www.roliscon.com/business-perspective-investing.html ) which explains the important things that you should look at when choosing companies in which to invest. It suggests ignoring the typical approach of looking for “cheap” shares based on low P/Es and high dividend yields but focusing on the business model and other attributes.

As Burford Capital (BUR) is a company in the news after the shorting attack by Muddy Waters, I chose to run through why I would never have invested in the company based on the check lists given in the book. In essence it fails too many of them, no doubt to the consternation of some in the audience who held the stock. Here are just some of the problems:

  1. High barriers to entry? None I am aware of – I suspect anyone could set up a litigation funding company given enough capital.
  2. Economies of scale? I doubt there are any as legal claims are labour intensive.
  3. Differentiated product/service? I am not clear that they differ much from other litigation funding businesses.
  4. Low capital required? Absolutely the contrary as they have to fund legal cases for years at enormous cost before they get any payback.
  5. Proprietary technology or IP? There is none.
  6. Smaller transactions? The opposite. Burford’s profits depend on a few large legal cases.
  7. Repeat business? I question whether there is any. Legal cases tend to be one-offs.
  8. Short term contracts? The opposite. The cases they take on can run for years.
  9. No major business risks obvious? Significant risks of losing major cases.
  10. Low debt? The contrary as they use debt to finance their legal cases.
  11. Appropriate corporate structure? Odd to say the least until recently with the CFO being the wife of the CEO and no executive directors on the board.
  12. UK or US domicile? No they are registered in Guernsey.
  13. Adhere to UK Corporate Governance Code? No.
  14. AGMs at convenient time and place? No, they are in Guernsey.
  15. No big legal disputes? Apart from participating in the legal actions they fund, they also have received a claim from their founder and former Chairman recently.
  16. Accounts prudent and consistent? Is recognition of the value of current legal claims prudent (upon which the reported profits rely) and the accounts conservative? It’s very difficult to determine from the published information but I have serious doubts about them.
  17. Do profits turn into cash? Not in the short term. They are effectively recognising what they consider to be the likely chance of success in current profits. But winning legal claims is always in essence uncertain. I have been involved in several big cases and your lawyer always tells you that you have a very good chance of winning as they wish to collect their fees, but even if you win collecting any award can be uncertain.

I could go on further but the above negatives are sufficient to rule it out as a “high quality” business so far as I am concerned. That’s ignoring the allegations of Muddy Waters and the counter allegations by Burford of share price manipulation (i.e. market abuse).

Treatt (TET) issued a trading statement today (4th October). This is a company that specialises in natural ingredients for the flavour and fragrance markets, particularly in the beverage sector. I hold a few shares in it.

The statement says that there has been “a significant fall in certain key citrus raw material prices…..”. This is impacting revenue growth although they have been diversifying into other product areas. Profit before tax and exceptional items is still expected to be in line with expectations – which was for a fall in EPS for 2019 based on consensus broker forecasts.

Now when a company says its input prices are coming down by more than 50% as in this case, you would expect the company to be making bumper profits as a result. But clearly this is not so. It would seem that their customers expect to pay less which suggests this is a “commodity price” driven business where competitors track the prices of the raw material downwards.

This might be a well-managed business in a growth sector for natural ingredients but there may well be low barriers to entry and an undifferentiated product in essence. So it may well fail the checklists in my book.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Intercede AGM and Tech Stock Valuations

Yesterday I attended the Annual General Meeting of Intercede Group Plc (IGP) at their offices in Lutterworth. I have held a very few shares in this company since 2010 in the hope that it would be able to turn its identity software solution into a profitable and growing business. Although they have some great major account customers, revenue has been static at around £10 million for the last 5 years and in 2017/18 they reported substantial losses. It always looked to me a typical example of a common failure in technology driven companies – great technology but inability to sell it. There was a revolution in the management in 2018 though with founder Richard Parris who was Executive Chairman departing in March 2018. Last year (year end March 2019), revenue was £10.1 million, a slight increase, and a small profit was reported after substantial reductions in costs.

New Chairman Chuck Pol introduced the board including the new CEO Klaas van der Leest and they have also appointed a new non-executive director, Rob Chandok. The other two non-executive directors have been there since 2002 and 2006 which is too long but they were not up for re-election.

There was no trading statement or other announcement on the day, so we went straight into questions. I asked about the “distractions” referred to on page 9 of the Annual Report and Klaas covered the management changes. It seems quite a number of staff left and new hires were made including sales staff, pre-sales and new developers, but the situation was now stable.

I asked about the status on development of channel partnerships which is what they are now clearly focusing on rather than direct sales. In response it was stated that 2 new channel managers had been appointed – one for the USA and one for the rest of the world. But it takes time to develop channel sales. The previous 4 offices have been cut to 2 in Lutterworth. Is it difficult to recruit staff bearing in mind the Lutterworth location? Not an issue it seems as remote working is now practical – Klaas lives in Surrey for example and visits the office a few days per week.

I also asked about the comment about development of a more standard variant of MyID (see page 6 of the Annual Report). Klaas said when he arrived the product had not been standardised – they were more selling a toolkit with “lots of arms and legs” so significant implementation expertise and effort was required. Comment: this explains why sales were not easy in the past because from my experience in the software industry this adds to costs substantially and slows sales.

I later asked whether the development effort put into before the management changes were made was of any use, but it seems that has been “mothballed” and they are concentrating on sales of MyID.

Another shareholder asked about the £1.45 million of receivables that are “past due” (see page 40) – have they been received? The answer from the CFO was in the main yes. The reason for the long payment times were because they are involved in large projects, often acting as sub-contractor. But he was somewhat evasive about whether they were now all collected and refused to disclose the current outstanding position. But he did say that with the type of clients they have, collection is not usually a problem.

I asked about the convertible loan note they have which is quite expensive – £4.7 million outstanding at 8% p.a. interest and repayable by December 2021. Could they be redeemed early? Answer was no but the board is considering that issue. As one shareholder commented, all they need to do is get the share price above the conversion price to remove the problem, although there would be some dilution as a result of course.

I chatted to Klaas after the formal meeting closed, and it’s good to have the company led by an experienced sales person. The changes he has been making look altogether positive but it seems to be taking some time to produce better results – but that might simply be the long lead times on major account sales and the time it takes to develop the partnerships. But it would have been preferable to have a trading statement of some kind at this meeting. I think we will have to wait and see on this company.

Technology Stock Valuations – Bango and Boku

Intercede is an example of a company which has minimal profits at present so valuing it is not easy. Based on broker’s forecasts of some increase in revenue this year it’s valued by the market at 1.4 times revenue approximately. That simply reflects the slow growth and the convertible debt issue. The large number of shares still held by Richard Parris may not help either. If the sales and profits can be ramped up, that may appear cheap in due course.

It’s interesting to compare this company with other technology stocks which have announced figures recently, which I also hold (none in a big way as they are all somewhat immature businesses to my mind with no proven profit or positive cash flow record).

Bango (BGO) issued interim results on the 17th September. It operates in the mobile phone payment and identity verification markets. It has forecast revenue for this year about the same as Intercede’s at £12 million and may break even after substantial historic losses. Its valuation is over £100 million, i.e. about 10 times revenue. The big difference from Intercede is that it is seen as a high growth business in terms of revenue! Another similar business is Boku (BOKU) which is also rapidly growing but historically loss making. They issued an interim statement on the 10th September. Revenue was up 39% and they appear to be on target to meet full year forecasts of revenue of $52 million. Their market cap valuation is £280 million at about 7 times revenue. Both companies have volatile share prices and tend to talk about EDITDA as profits are ephemeral.

You can see how important revenue growth is to technology stocks and why Intercede’s valuation is so low at present. If growth disappears as it did at Intercede then valuations quickly fall. You can see why it is necessary to look at the business dynamics, the management and the future prospects for the company to be able to understand the valuations.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Standard Life UK Smaller Companies Trust, The Merchants Trust and Management Longevity

Today I received the Annual Report of Standard Life UK Smaller Companies Trust (SLS) which I have held for many years. Performance last year was disappointing – NAV total return of -1.1% but that was considerably better than their index benchmark.

I attended a presentation by The Merchants Trust (MRCH) at the ShareSoc seminar in Manchester. Merchants have a very different market focus which is on UK large cap companies predominantly. They offer a dividend yield of 5.7% which is of course much higher than SLS and higher than most other similar trusts. It’s interesting to compare their performance to SLS using AIC figures. Merchants produced a share price total return of 144.9% over ten years, while SLS produced a comparable return of 417.8% over the same period.

I know which trust I would prefer to invest in. I suspect Merchants’ problem is basically trying to buy cheap stocks on high dividend yields which I do not think is a sound investment strategy longer term even if some investors like the high dividend they can generate as a result. But what really matters is total return. Merchants probably appeals to a different type of investor than me though as it may be less volatile than a smaller companies trust.

One interesting comment in the SLS Annual Report is under a page entitled “Investment Process”. Under “qualitative factors” is says “Founders retaining positions of authority within the companies after flotation, along with longevity of tenure for CEOs are a positive signal. Four of the top ten holdings in the portfolio are still run by the company’s founder”.

That actually conflicts with what I said in my recent book “Business Perspective Investing” where I said: “Founders can remain at the helm of companies long after they should have given way to others. This is even so in public companies even if the board or shareholders have in theory the power to remove them – the fact that they still often own a large proportion of the shares and have often appointed “yes men (or women)” to the board who are unlikely to challenge them thwarts any change. One question to ask for investors is: Is a founder still in charge and does that create a risk?”. I also reported academic research that suggests that founder CEOs are the worst type.

This issue is clearly more complex than my comments have suggested and I may need to revise those in a future edition. There are examples of very successful founders but other ones of failures. Perhaps smaller companies are helped by longevity in CEOs whereas larger companies are not. I would welcome readers’ views on this subject.

But SLS clearly believes in the principle of longevity as Harry Nimmo has been the lead fund manager of the trust since 2003.

They also say “valuation is secondary” which is very much the theme of my book.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

Burford Capital, Goals Soccer Centres, Carillion, and Why Numbers Are Not Important

To follow on from my previous comments this morning on Burford Capital (BUR), this is a typical “shorting” attack where the shorter (Muddy Waters) and their supporters make a lot of allegations which investors are unable to verify in any useful time frame. I certainly questioned the accounting approach used by Burford and other litigation finance firms as I commented on it back in June, but disentangling the factual accusations in the Muddy Waters dossier from innuendo and comment is not easy.

It is surely wrong for anyone to make such allegations and publicize them with the objective of making money from shorting the stock without first asking the company concerned to verify that what they are alleging is true – at least as far as the facts they report are concerned rather than just their opinions.

The company may threaten legal action for libel where misleading or inaccurate information is published but in practice such law suits take so long to conclude, with major practical problems of pursuing those who are resident overseas while actually worsening the reputational damage rather than improve it that few companies take that route.

This is an area of financial regulation that does need reform. In the meantime the damage to Burford is probably likely to persist for many months if it ever recovers.

What is the real moral of this story so far as investors are concerned? Simply that trusting the financial accounts of companies when picking investments is a very poor approach. This was reinforced by more news about the accounting problems at Goals Soccer Centres (GOAL) which I also commented on previously. Apparently a report to the board by forensic accountants suggests that the former CEO corroborated with the former CFO to create fictitious documents including invoices (see FT report on 3/8/2019). Clearly the audits over some years failed to pick up the problems. In addition it looks like the demise of Carillion is going to be the subject of a legal action against their former auditors (KPMG) by the official receivers. Financial accounts, even of large companies such as Carillion, simply cannot be trusted it seems.

This is not just about poor audits though. The flexibility in IFRS as regards recognition of future revenues is one of the major issues that is the cause of concerns about the accounts of Burford, as it was with Quindell – another case where some investors lost a lot of money because they believed the profit statements.

This seems an opportune moment to mention a new book which is in the process of being published. It’s called “Business Perspective Investing” with a subtitle of “Why Financial Numbers Are Not Important When Picking Shares”. It’s written by me and it argues that financial ratios are not the most important aspects to look at when selecting shares for investment. Heresy you may say, but I hope to convince you otherwise. More information on the book is available here: https://www.roliscon.com/business-perspective-investing.html

There are some principles explained in that book that helped me to avoid investing in Burford, in Quindell, in Carillion, in Silverdell and many of the other businesses with dubious accounts or ones that were simple frauds. These are often companies that appear to be very profitable and hence generate high investor enthusiasm among the inexperienced or gullible. It may not be a totally foolproof system but it does mean you can avoid most of the dogs.

With so many public companies available for investment why take risks where the accounts may be suspect or the management untrustworthy? One criticism of Neil Woodford is that his second biggest investment in his Equity Income Fund was in Burford. If you look at his other investments in that and his Patient Capital Trust fund they look to be big bets on risky propositions. He might argue that investment returns are gained by taking on risk which is the conventional mantra of investment professionals. But that is way too simplistic. Risks of some kinds such as dubious accounts are to be avoided. It’s the management of risk that is important and size positioning. The news on Burford is going to make it very difficult for Woodford’s reputation as a fund manager to survive this latest news.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

All Change at Superdry and Intercede – Perhaps

Readers are probably aware that founder Julian Dunkerton managed to win the votes yesterday at the EGM that he requisitioned at Superdry (SDRY). The votes to appoint him and Peter Williams were won by the narrowest of margins despite proxy advisors such as ISS recommending opposition. My previous comments on events at Superdry are here: https://roliscon.blog/2019/03/12/superdry-does-it-need-a-revolution/ . It did not seem clear cut to me how shareholders should vote, but I did suggest there was a need for change.

There will certainly be that because the incumbent directors (including the CEO and CFO although that does not necessarily mean they have quit their executive positions) have all resigned from the board although some of the non-executive directors are serving out their notice. Dunkerton has been appointed interim CEO.

Perhaps the most apposite comment on the outcome was by Paul Scott in his Stockopedia blog. He said “To my mind, the suits have made a mess of running this company, so bringing back the founder seems eminently sensible to me”. However, I suggest there is still some uncertainty as to whether the Superdry fashion brand can be revived – perhaps the world has moved on and it has gone out of fashion. But Dunkerton should be able to fix some of the operational problems at least. Retailing is still a difficult sector at present so I won’t personally be rushing in to buy the stock.

Another momentous change took place at Intercede (IGP) yesterday. This company provides secure digital identities and has some very interesting technology. But for many years it has failed to turn that into profits and revenue has been also remained flat. But yesterday the company announced a large US Government order and hence they expect a “return to profitability”. This certainly surprised the market as another loss was forecast. The share price jumped 60% yesterday after it had been in long decline for several years.

I have held a small holding in the stock since 2010 (very small prior to yesterday) but I was never convinced that the company knew how to sell its technology – a common failing in UK IT companies. The former CEO and founder Richard Parris who was there for 26 years was surely part of the problem but he departed in 2018. Has the company actually learned how to make money under the new management? Perhaps, but one deal does not totally convince. One swallow does not make a spring as the old saying goes.

Even after the jump yesterday, the market cap is still not much more than one times revenue which is a lowly valuation for such a company. But investors need to be aware that the company has £4.6 million of convertible loan notes which would substantially dilute shareholders if they were converted. A company to keep an eye on I suggest, to see if it has really changed its spots.

Another surprising change yesterday was the abrupt departure of Richard Kellett-Clarke from the boards of both DotDigital (DOTD) and IDOX (IDOX) “due to private matters in his other directorships” according to the announcement from DOTD. DOTD is looking for a new Chairman. I wonder what that is about? We may find out in due course.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

CEO Quits, Should I Sell Tracsis?

It is always disturbing when the CEO of a successful investment quits out of the blue. That’s what has happened at Tracsis (TRCS) today. John McArthur is departing in the “first half of 2019 to focus on family and other non-business matters outside the Group”. That’s after 14 years of growing the company. I have held the shares since January 2013 with a compound total return of 21.8% per annum. Thanks John.

A replacement CEO has already been lined up in Christopher Barnes, previously with Ricardo. The Tracsis share price is down slightly today, at the time of writing.

In such circumstances I tend to wait and see if there is any impact. Good companies can survive a change of management and 14 years is a long time for anyone to stick in the same job. Boredom and desire to do something else are the symptoms and as companies grow the bureaucracy becomes more onerous.

A change of CEO can actually be a positive move if well executed as it helps to bring new experience and ideas into a company. Will just have to keep our fingers crossed on this one.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

The Signs Were There – Corporate Disasters and How to Avoid Them

This is a review of the recently published book entitled “The Signs Were There” by Tim Steer. It’s worth reading by any investor who invests directly in stock market shares, but particularly by those new to the game. Experienced investors will know about many of the causes of companies collapsing, and how accounts can deceive, from their own past experiences. But it’s best to learn what to look for in other ways.

The book covers many UK examples of corporate disasters – not all of them went bust but many did. It profiles Connaught, NCC Group, Sports Direct, Hewlett-Packard/Autonomy, Cedar Group, iSoft, Utilitywise, Slater & Gordon/Quindell, Mitie, Guardian IT, Tribal Group, Conviviality, Amey, Capita, Carillion, Northern Rock, Cattles, Healthcare Locums, Erinaceous, Findel, AO World and Toshiba; and explains why investors were fooled. I have been involved in a few of those as an investor or trying to help those who were caught out, and have written about some of them in the past to try and educate investors on how to spot the dogs.

The author shows how many of the problems in these companies could have been identified in advance by reading the Annual Reports, or looking at some financial ratios. One comment I saw on the book was that few investors have the time to read Annual Reports – if they don’t they should not be investing in my view. Perhaps one criticism is that the author is an accountant and hence is more used to reading the accounts of companies than the average investor. But that is surely a capability that all investors should acquire. The fact that so many of the above companies had professional fund managers as investors in them, or were acquired by supposedly experienced managers (e.g. Hewlett-Packard/Autonomy) tells you that there is a lack of education on such matters.

Reasons given for disappearing profits are frequently revenue recognition problems, accruals misstated, assets wrongly valued, goodwill unreasonably inflated or not written down, capitalisation of operating costs and unexplainable related party transactions. The author also warns about companies that grow via acquisitions when the acquisitions do not help but enable “exceptional” costs to be buried.

You won’t pick up all the future corporate black holes after reading this book. For example, anyone can be fooled by false accounts where even the cash on the balance sheet simply is not there (e.g. at Globo and Patisserie). Simple frauds can conceal many ills, but most of the examples covered in the book were more down to management incompetence and a desire to present profits rather than losses. As is pointed out, accounting rules permit a lot of interpretation and flexibility which is why published accounts cannot always be relied upon. The book will help you avoid a lot of those errors.

The last chapter covers more general issues about why the “System isn’t working”, i.e. the failings of auditors to identify such problems and what to do about it. The author’s comments on the FRC are similar to those in the recent Kingman review. To quote: “The trouble with the FRC is that, rather like the Keystone Cops, who always arrived late to the scene of a crime, their important investigations often commence some time after the damage has been done”.

One suggestion made is that the FRC could take a proactive role in identifying companies that were at risk. Either by reviewing those shares that were being shorted, or a “specially tailored financial screening tool”. The latter might identify those companies where there was a widening gap between reported profits and cash flows, or other declining financial ratios. That seems an eminently sound idea that should be pursued. A public report of such ratios would be an even better idea.

As the author points out, the amount and quality of published research on companies is declining because of the impact of MIFID rules and market dynamics. So investors need to do more of their own research. This book tells you some of the things to look out for.

I have suggested to ShareSoc that they put this book on their “Recommended Reading List”. Let us hope that it does not get lost like the innumerable cookery books that all cooks who pretend to aspire to be good cooks keep in their libraries but never use. Investors have the same tendency to read numerous books on how to pick stocks but then either forget what they have read or get confused by too many answers. They buy more such books while looking for the one simple answer to their quest for the holy grail of a finding a share on which they can make a fortune. There is of course no one simple answer which is why stock market investment is still an art rather than a science. It is just as important to avoid the real dogs in addition to picking winners if your overall portfolio performance is to be better than average. The book “The Signs Were There” is certainly a book that can contribute to your knowledge of how to avoid the worst investments.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Bad Blood and a Hymn for Christmas

One of my books for Christmas reading is “Bad Blood” by John Carreyrou. This is the story of Theranos who developed a novel way of testing blood samples. It has won the FT Business Book of the Year award, perhaps because it was written by a Wall Street Journal reporter and is a good example of investigative financial reporting.

Theranos was set up by the very young and physically attractive Elizabeth Holmes who apparently proceeded to attract many elderly males to her cause. She even had Henry Kissinger and George Shultz (former US Secretary of State) on her board. Her pitch to investors was that she had developed a blood testing method that would remove the need for drawing blood from a vein via a trained phlebotomist. Just a pin-prick on a finger would suffice and anyone could do it so home testing by patients could be done – exceedingly useful for those with on-going medical conditions. It could also avoid the “needle-phobia” that some people suffer from – I know at least one person who would regularly faint when a needle was presented.

There are about 300 million blood tests taken each year in the UK now at very significant cost to the NHS as they cost several pounds each. So you can see how attractive a business would be that could reduce the cost of blood tests worldwide.

Elizabeth Holmes was also a very good sales person in promoting the gospel of reducing and simplifying the process of blood testing. She raised many millions of dollars from investors such as Larry Ellison, Rupert Murdoch and west coast venture capital firms. Later rounds valued the company at $9 billion!

But the only problem was that the product produced unreliable results, i.e. the reports produced were not accurate. This could be potentially life threatening as patients could think they were perfectly healthy when they were not or patients could be referred for emergency investigations when they were perfectly normal. Not only that but the company was faking some demonstrations of the product and actually using a full-size blood-testing machine from Siemens to produce results from such small blood samples by simply diluting the samples to increase the volume – not a sound practice.

Business wise, the book is an interesting insight into the milieu of the venture capital world in the USA and how investigative reporting can get around problems of what was a very secretive company where all employees signed confidentiality agreements. But it is also an example of how vibrant is the US venture capital world when hundreds of millions of dollars can be sunk into a business with a great concept but ultimately unproven product.

In summary, the book is an amusing read in parts about the gullibility of investors and the peculiarities of doing business on the west coast of the USA, but I would not rate it as one of my favourite business books. That’s probably because I prefer happy endings. Elizabeth Holmes was charged with criminal fraud in 2018.

A Hymn for Christmas 2018 (after Christina Rossetti)

In the bleak midwinter, frosty wind made moan,

but earth stood soft and wet due to global warming,

markets had fallen, down and down,

in the bleak midwinter, only yesterday.

Our god mammon cannot hold, nor Governments sustain,

stock prices will flee away despite his reign,

in the bleak midwinter no stable place can be found

when market confidence freezes.

 

What can I give, poor as I am?

if I were a shepherd, I would bring a lamb;

if I were a wise man, I would do better;

yet what can I give, but my hopes for a better year.

 

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.