Woodford Changes, FT Political Comment, and Digital Services Tax

Apparently Neil Woodford is losing some of his senior staff. Perhaps he needs to cut costs as the funds being managed by his firm have shrunk as investors have walked and holdings in the funds have shrunk in value. But the Equity Income Fund is still closed to redemptions with no certain date when it will reopen, and there is no sign of the vigorous action I suggested. I put forward these alternatives on June 5th, but Neil Woodford is clearly not rushing into action:

1) That Neil Woodford appoint someone else to manage the fund – either an external fund management firm or a new fund management team and leader. Neil Woodford needs to withdraw from acting as fund manager and preferably remove his name from the fund; 2) Alternatively that a fund wind-up is announced in a planned manner; 3) Or a takeover/merger with another fund be organised – but that would not be easy as the current portfolio is not one that anyone else would want.

Once a reputation is lost, resignations should follow, with new leadership put in place. Which brings me onto the subject of the comments in the Financial Times over the last two days over the position of our ambassador to the USA and Brexit.

Yesterday I sent these comments to the FT’s political editor about his views on the position of Sir Kim Darroch which were headlined “Darroch pays price for would-be PM’s craven and shameful conduct”:

“Dear Mr Shrimsley,

I found your article in today’s FT on the US Ambassador and Boris Johnson most objectionable. Mr Johnson’s comments on Sir Kim Darroch’s position were restrained and not unreasonable. President Trump has indicated he will not work with our ambassador which surely makes his position untenable. There is no point in the UK defending or retaining him in post. He has subsequently resigned – and quite rightly.

Sir Kim clearly made some injudicious comments which unfortunately have leaked out even though foreign embassies have very secure communications facilities. Was this in a private communication by him? If so it was unwise in the extreme. But if there is to be any witch hunt it should be focussed on that issue alone.

This has nothing to do with Brexit and it should have nothing to do with your newspaper’s dislike of Trump or support for Brexit. So I suggest your article was misconceived as was the accompanying FT article printed on the same page about the relationship between the Civil Service and Government Ministers. The fact that Boris Johnson failed to defend or back Darroch while Jeremy Hunt rushed injudiciously to do so surely shows which politician is wiser.”

Today we have another article in the FT so extreme as to be comic by Martin Wolf which is headlined “Brexit means goodbye to Britain as we know it”. It suggests the UK will lose its reputation for being stable, pragmatic and respected. It describes Boris Johnson as a serial fantasist and concludes that the UK is no longer a “serious country”.

But the FT did cover well the publication of draft legislation on a new Digital Services Tax – see https://www.gov.uk/government/publications/introduction-of-the-new-digital-services-tax . This will impose a tax on companies that operate social media platforms, search engines or online marketplaces to UK users. This is aimed to collect tax on revenues in such companies that are currently avoided by the fact they frequently operate from low tax jurisdictions. The focus is clearly on companies such as Alphabet (Google) and Facebook who generate large revenues from the UK but pay relatively little tax.

However there are some UK companies that are potentially liable such as Rightmove or Just Eat but they are likely not to have to pay because a group’s worldwide revenues from these digital activities needs to be more than £500m with more than £25m of these revenues derived from UK users.

The USA is crying foul over a similar French tax and surely quite rightly. The size exclusion means only the big US firms are going to be liable, and there is the issue of double taxation – they will be taxed on both revenue in the UK and potentially profits also. I suggest the USA has a justifiable complaint. It should surely be a tax on all such companies other than very small ones, with a deduction from Corporation Tax allowed to offset the double taxation issue.

There is one thing for certain. Such measures from the UK and France may threaten retaliation by the USA and might certainly jeopardize any new trade agreement between the UK and USA post-Brexit.

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.

LoopUp Profit Warning and Brexit Party Policy

Conference calling AIM company LoopUp (LOOP) issued a trading statement this morning which contained a profit warning. At the time of writing the share price is down 47% on the day but it has been falling sharply in recent days which suggests the bad news had already leaked out.

This is an example of what happens when lofty growth expectations are revised downwards. Revenue is now expected to be down 7% on the previous market consensus and EBITDA down 20%. The company blames the shortfall on “subdued revenue across its long-term customer base” driven by macro-economic factors and diversion of sales staff into training new ones.

LoopUp is presenting at the ShareSoc seminar event on the 10th July so it will be interesting to hear what they have to say about this – see https://www.sharesoc.org/events/sharesoc-growth-company-seminar-in-london-10-july-2019/ . This news comes only a month after LoopUp held a Capital Markets Day when there was no hint of these problems. I did a report on that here: https://roliscon.blog/2019/06/07/broker-charges-proven-vct-performance-fee-and-loopup-seminar/

I do hold a few shares in LoopUp but thankfully not many.

Brexit Party Policy

I mentioned in a recent blog post that the Brexit Party is looking for policy suggestions to enable them to develop a platform for any prospective General Election. Here’s what I sent them with respect to financial matters:

  1. The personal taxation system is way too complicated and needs drastically simplifying. At the lower end the tax credit system is wide open to fraud while those on low incomes are taxed when they should not be. The personal tax allowance, both the basic rates, and higher rates, need to be raised to take more people out of tax altogether.
  2. The taxation of capital gains is also now too complicated, while tax is paid on capital gains that simply arise from inflation, which are not real gains at all. They should revert to being indexed as they were some years ago. For almost anyone, calculating your own tax that is payable is now way too difficult and hence requiring the paid services of accountants using specialist software.
  3. Inheritance tax is another over-complex system that wealthy people avoid by taking expert advice while the middle class end up paying it. It certainly needs grossly simplifying, or scrapping altogether as a relatively small amount of tax is actually collected from it.
  4. The taxation of businesses is inequitable with the growth of the internet. Small businesses, particularly retailers, pay a disproportionate level of tax in business rates while their internet competitors often avoid VAT via imports. VAT is now wide open to fraud and other types of abuse such as under-declarations, partly because of the EU VAT arrangements. VAT is in principle a simple tax and the alternative of a sales tax would create anomalies but VAT does need to be reformed and simplified.
  5. All the above tax simplifications would enable HMRC to be reduced in size and the time wasted in form filling by individuals and businesses reduced. Everyone would be a winner, and wasted resources and expenditure reduced.
  6. The taxation of company dividends on shares is now an example of the same profits being taxed twice – once in Corporation Tax on the company, and then again when those profits are distributed to shareholders. This has been enormously damaging to those who receive dividends and the lack of tax credits has also undermined defined benefit pension funds. The taxation of dividends should revert to how it once was.
  7. The regulation of companies and financial institutions needs very substantial reform with much tougher laws against fraud on investors. Not only are the current laws weak but the enforcement of them by the FCA/FRC is too slow and ineffective. Although some reforms have recently been proposed, they do not go far enough. Individual directors and senior managers in companies are not held to account for gross errors or downright fraud, or when they are, they get off too lightly. We need a much more effective system like they have in the USA, and better laws.
  8. Shareholder rights as regards voting and the receipt of information have been undermined by the use of nominee accounts. This has made it difficult for individual shareholders to vote and that is one reason why investors have not been able to control the excesses in director pay recently. The system of shareholding and voting needs reform, with changes to the Companies Act to bring it into the modern electronic world.
  9. The pay of directors and senior managers in companies and other organisations has got wildly out of hand in recent years, thus generating a lot of criticism by the lower paid. This has created social divisions and led partly to the rise of extreme left socialist tendencies. This problem needs tackling.
  10. Governance of companies needs to be reformed to ensure that directors do not set their own pay, as happens at present, but that shareholders and other stakeholders do so. Likewise shareholders and other stakeholders should appoint the directors.
  11. Insolvency law needs reform to outlaw “pre-pack” administrations which have been very damaging to many small businesses. They are an abuse of insolvency law.
  12. All the EU Directives on financial regulation should be scrapped (i.e. there should be no “harmonization” with EU regulations after Brexit). The MIFID regulations have added enormous costs to financial institutions, which have passed on their costs to their customers, with no very obvious benefit to anyone. Likewise the Shareholder Rights Directive might have had good objectives but the implementation has been poor because of the lack of knowledge on how financial markets operate in the UK. Other examples are the UCITS regulations which have not stopped Neil Woodford from effectively bypassing them, or the PRIIPS regulations which have resulted in misleading information being provided to investors.

Let me know if you have other suggestions, and of course the above policies might be good for adoption by other political parties in addition.

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.

Impressions from the Brexit Party Rally

Brexit rallyAs I received an invite to the Brexit Party Rally at the NEC in Birmingham, I went along yesterday to see what I could learn about their policies – apart from wanting Brexit of course. Not that there was a great deal to learn as clearly policies for a prospective general election are still being developed, but there were a few hints. However they do plan to have 600 candidates ready to fight such an election by the Autumn and 100 of them can be seen in the photo left of the event.

It was a lively meeting, and clearly professionally organised. With the party only being in existence for 49 days, it is surprising how much they have achieved already. They are clearly going to be a force to be reckoned with in UK politics whatever happens on Brexit.

The main speakers were Annunziata Rees-Mogg, Richard Tice, Tim Martin and Nigel Farage. Richard Tice is the party Chairman and spoke particularly well. He runs a property firm and was formerly CEO of CLS Holdings – a listed property company. He made it clear that the Brexit party has an “anti-London” focus where they think too much money is spent and have already committed to scrapping HS2. Another big commitment was to scrap interest on student loans and cancel all historic interest.

Tim Martin runs the Wetherspoon pubs and suggested that on a hard Brexit happening we will not need to drink French wine or German/Dutch beer. We can produce it ourselves or import from Australia. But his main focus was on the lack of democracy in the EU. He just wants to leave on WTO terms, i.e. without a deal.

Other speakers argued that the electoral system needs reform with some type of proportional representation introduced, and the House of Lords reformed or scrapped altogether (cheers for that from the audience). The events in the Peterborough by-election where the party failed to win the seat were explained as an abuse of the postal voting system (see below). Reform was also planned for the Civil Service – exactly why or how was not made clear, and the party wants to scrap the BBC License Fee but not scrap the BBC.

Unlike Boris Johnson and Jeremy Hunt, there was no great commitment for tax hand-outs to bribe the electorate – maybe they will come later. But cancelling HS2, not paying the Brexit bill as proposed in the Withdrawal Agreement and halving the foreign aid budget will create many billions of pounds to spend on the regions outside London.

The Brexit Party is clearly a party of protest – members don’t like the EU, don’t like Westminster politicians, don’t like the BBC who collected boos from the audience, don’t like the London elite and the Civil Service, and more…. At a general election they might simply split off a lot of Conservative voters enabling the Labour Party to take power. That is an issue they have yet to tackle.

But that’s about all I learned about their policies which are clearly still under development. You can submit your own suggestions for what they should be by sending an email to policy@thebrexitparty.org .

You can see a video of the event and Nigel Farage’s speech on YouTube here: https://www.youtube.com/watch?v=eXk0tChqOUk

Voting Reform

The alleged abuse of the postal voting system by the Labour Party in Peterborough is the subject of a legal challenge by the Brexit Party, who only lost by 683 votes. They are lodging a petition under the Representation of the People Act and several allegations of voter fraud are being investigated by the police.

Now I do personally have some experience of how the Labour party operates with postal votes. A few years ago we happened to visit my late mother-in-law when the Labour candidate was visiting to collect her vote. It was clear they had organised a postal vote for her, and had come to ensure she ticked the right box and they then promised to post her vote for her.

She might have been on their list of traditional Labour voters but given her age at the time she was hardly acting independently or with due consideration of the candidate and his policies. In other words, the Labour Party was leading the prospective voters by the nose with a well organised machine to collect votes from those who only had a vague commitment to the candidate and the policies they were supporting.

The Brexit Party certainly have a case to argue for reform in this area.

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.

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 )

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.

 

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 )

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.

Tory Leadership Contest and Brexit

It’s Sunday morning and time to talk politics, which I have not done for some time. A satisfactory resolution of Brexit is of some relevance to the performance of many UK companies which is a key focus of my readers.

How did we get into the current mess? Weak leadership and a lack of consensus both among Government ministers and in Parliament. Our negotiating position with the EU was confusing with changes of policy and people leading the team changing whereas the EU Commission decided what they wanted and stuck to it. The EU insisted early on that any post exit trade relationship would not be part of the withdrawal negotiations which the UK meekly conceded. The Withdrawal Agreement looks like it was drafted by the EU as a result.

It was very interesting watching the Storyville TV documentary that followed Guy Verhofstadt, MEP and leader of the EU Parliament team during the Brexit negotiations. Consistently it seemed that Britain did not know what they wanted. It was also clear of course that in the EU elected Parliament members (MEPs) have little influence and the Commission and the Council dictate policy – a good example of how undemocratic an institution it is.

Where to from here? Firstly the Conservative party need to elect a new leader who will be appointed as Prime Minister. The bookies seem to be tipping Boris Johnson who is popular among Tory party members. He also managed to get elected twice as Mayor of London despite London being generally very left wing in outlook due to the number of immigrants now living there. For those readers who do not live in London, here’s a brief summary of his record there. He removed the Western extension of the Congestion Charge, a popular move, but retained it otherwise and proposed a ULEZ scheme for the central zone. On the Environment his steps were reasonable but he fell in love with cycling and cycle superhighways which has made traffic congestion much worse. His support for the Garden Bridge was a mistake but he otherwise did keep the TfL budget in some kind of order, unlike his successor, and public transport was improved. He did not make unwise promises to the electorate to ensure his election. His record on crime and policing was OK, and better than his successor, but housing in London remained a major issue mainly because of the policies of his predecessor (and since followed by his successor), to encourage immigration and more business development when the needed infrastructure and housing lagged behind.

As Foreign Minister Boris was prone to gaffs and he is certainly not appreciated by some. My wife’s latest comment on him was: “he just needs to grow up”. His chances of unifying the Tory party behind him seem low.

Another leading contender is Dominic Raab, but like all the others, he lacks a lot of public recognition. But he did give a very polished performance on the Andrew Marr show this morning. He was very definite about wanting Brexit to happen on the 29th October with no further delays, and would accept a “No Deal” Brexit if it is impossible to change the Withdrawal Agreement before then. That to my mind is the right approach to take and I do not see a No Deal Brexit as a disaster like some. The economy would soon recover from any temporary disruption and the money saved from our EU contributions would help a great deal.

Some are tipping Michael Gove but I just do not see him as a personality that could win a general election for the Tories. Sajid Javid might be a better bet, but none of the other declared runners looks a winner to me.

The ability to win a general election, and face down Nigel Farage and his Brexit Party, is quite essential because Jeremy Corbyn is still fence sitting in the hope of forcing a General Election. He is 70 today so must realise that his chance of winning power may be slipping away.

Any new prime minister needs to tackle the issue of the Irish border and the “backstop” in the withdrawal agreement. He needs to appoint a cabinet that will back his chosen approach and either conclude that with the DUP or call a general election. That needs to be done quickly if it is to take place before October 29th when we exit the EU unless something else is put into law.

Apart from the Irish backstop proposal in the Withdrawal Agreement, which tied the UK into a Customs Union potentially for ever, there were other aspects of it which were not favourable. If the EU sits on its hands and refuses to renegotiate it a No Deal exit might be best so we can go back to square one and settle on a new trading relationship with them.

Economically the EU needs a good trading deal with the UK just as much as the UK needs one with the EU, if not more so taking into account the balance of trade. But if you have weak, inconsistent or muddled leadership then the chance of the UK getting what it wants is low. To my mind, Dominic Raab might be a better bet to achieve that than Boris Johnson.

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.

How Damaging Would a Labour Government be to Water Companies?

The Labour Party has long argued that some utility companies should be renationalised and a prime target would be water companies if they got into power. If they were nationalised would current shareholders expect to get compensation and if so at what level? An article in the Financial Times over the weekend covered this issue and anyone holding the shares in water companies should be aware of the implications.

Shadow Chancellor John McDonnell said recently that he expected a compensation bill of only £14.8 billion based on paying the “book value” of the companies. That’s on the basis that shareholders should not be compensated for future profits, only what they have put into the business historically.

The two largest listed water companies are United Utilities (UU.) and Severn Trent (SVT). The comparison of the current market capitalisation of those companies with the book value (i.e. shareholders equity) shown on the last Annual Report Balance Sheet shows the following:

United Utilities: Book value: £2.95 billion, Market Cap: £5.56 billion.

Severn Trent: Book value: £0.99 billion, Market Cap: £4.76 billion.

In other words, shareholders might expect to receive only 21% of the current market share price in the case of Severn Trent and 53% in the case of United Utilities. The book value is not a basis for the valuation of companies because shareholders value companies on the basis of future profits, cash flows and dividends. The book value is, for most companies, of more interest to accountants than investors.

It would appear that the Labour Party would ignore the normal principles of independent valuation of companies and rig the valuation process to obtain the lowest possible figure. Is this legal one might ask or could it be challenged in law?

It’s worth pointing out that this is exactly what happened the last time the Labour Party was in power when Northern Rock and Bradford & Bingley were nationalised. In those cases shareholders received nothing because the valuation was based on artificial terms of reference. The valuer was forced to assume that they were worthless based on the companies having received financial support from the Government.

A fair valuation of any company is what a willing buyer is willing to pay a willing seller. In the case of listed companies, that is clearly what the market price of the shares is based upon. The shareholders in Northern Rock challenged the artificial assumption in the UK courts but lost in the Supreme Court based on the presumption that Parliament had the right to set the valuation assumptions. The European Court of Human Rights (ECHR) refused to hear the case.

So shareholders in the UK listed water companies need to consider these facts very carefully. The risk of future water company nationalisation seems not to have been reflected in the share prices of water companies even though Mrs May’s leadership of the Conservatives has improved the electoral chances of the Labour Party while Corbyn compounds the difficulties of the former by frustrating a decision on the Brexit Withdrawal Agreement with the apparent objective of prompting a General Election. How the politics will work out is anybody’s guess but those investors who have purchased shares in these companies because of their high dividend yields should surely not ignore the capital risk.

Institutional investors are some of those most exposed because you only have to look at the portfolios of high-income funds to see they are stacked up with the shares of such companies. Pension funds held by millions of people would be some of those most affected.

Let us hope that this threat never comes to pass.

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.