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 )

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Market Crashes and Burford Capital

Investors might have been panicked by the recent market falls driven by the US/China trade wars, Brexit and gloomy economic forecasts. As usual, the UK market is led by the US markets. The S&P 500 is down 5% since the 26th July even though there was a slight bounce upwards yesterday. There can be few readers portfolios which have not suffered some impact because there were few stocks that did not fall.

Now I am an inveterate trend follower so how did I react to the falls? I did nothing because a few days is too short a period to determine whether it is a short-term panic or a real change in the trend. I am not convinced that we have moved from optimism about shares, to a real bear market. I’ll wait and see whether a trend develops because responding to short term share price fluctuations can be an expensive mistake.

One big faller this morning was Burford Capital (BUR) – down 60% at the time of writing. This is a litigation funding business that has come under attack for alleged dubious accounting by Muddy Waters in a report published this morning. I do not hold the stock and made some somewhat negative comments on their revenue recognition on June 12th – see https://tinyurl.com/y3ljqqvr . You can see Carson Block of Muddy Waters describing some of the issues in a video here: https://tinyurl.com/yxcq24ol or you can read the full report here: https://tinyurl.com/y6arozr9 .

I have read the report and I think it makes some valid points. The company issued a statement this morning calling it a “shorting attack” which it undoubtedly is, i.e. Muddy Waters have taken a position that might motivate them to exaggerate as shorters invariably do. For example they say Burford is a fund that “invests in an illiquid and esoteric asset class” and suggests they are using a “mark to market” accounting model of “Enron fame”. But they highlight the fact that the CFO is the wife of the founder/CEO which I find somewhat surprising, and the long service of all the directors which is not good corporate governance.

I remain skeptical of the accounting treatment of litigation funding by this company and others. Burford is of course one of the big investments made by Neil Woodford which will not enhance his reputation for prudence.

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

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Goals Soccer Centres, Renishaw, Economic Forecasts, Politics and Portfolio Transfers

It’s Friday in August, the markets and the pound are falling, the Conservative Party have lost a bye-election meaning their majority in Parliament is vanishing, and the Governor of the Bank of England has forecast a shrinking economy as a result of Brexit. It’s gloom all around which explains the falling UK stock market today. But Mark Carney is only forecasting a 33% chance of a contraction in the UK economy in the first quarter of 2020, which means that there is a 67% chance it won’t and even then for only a short period of time. That’s assuming you have any confidence in Bank of England forecasts which are notoriously unreliable. The media are not exactly reporting matters in an unbiased way. Those who support Brexit are unlikely to be worried by such forecasts and they would probably accept a temporary disruption to the economy. Remaining or leaving the EU was never a primarily economic decision so far as Brexiteers were concerned – it’s about democracy and who makes our laws.

But there is certainly bad news for investors in Goals Soccer Centres (GOAL) who have reported that the defects in their accounting go back to at least 2010. The 2018 audit has had to be suspended, there is no time frame for producing the accounts and therefore the company is going to be delisted from AIM. This looks to be another example of defective audits – the past auditors were KPMG and BDO.

I have complained about the length of time it takes to switch portfolios between investment platforms in the past. The good news today is that I finally completed one. This latest one I have done has taken from the 23rd May to the 31st July, i.e. 70 days. And that’s one where it was a transfer of holdings in a personal crest account with Charles Stanley, after they raised their charges on such accounts, to another personal crest account with another provider which was already in existance. That should have been very simple as there were no fund holdings in the account – just all direct holdings on the register.

It is really quite unreasonable that account transfers should take so long and require so much effort, including numerous emails and letters to get it completed. It’s anti-competitive to allow such delays to continue.

Well at least that’s one simplification of my portfolios. I also sold out from Renishaw (RSW) yesterday after disappointing final results – revenue down 7% and below forecasts mainly as a result of alleged economic conditions in the Asia Pacific region. The share price is down another 5% this morning at the time of writing. This may be a fundamentally sound business with good products in essence but clearly investors like me are losing confidence that the company can justify its high p/e rating when growth is going into reverse.

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

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Slack IPO, Web Privacy and Sell on Monday

The IPO of Slack in the USA has received a lot of media coverage. This is one of those technology stocks that is on what at first glance is a sky-high valuation. Slack provides workplace collaboration software and last year had revenues of $400 million, and lost $140 million. The market cap is now around $20 billion which means it is valued at about 50 times revenue. Those are the negative numbers. The positive aspect is that it roughly doubled revenue in each of the last two years. With such growth are profits or losses important? But it’s surely a case of investors piling into a hot story, i.e. following the herd.

There’s an interesting article by Megan Boxall in this week’s Investor’s Chronicle comparing the current mania for technology stocks with the dot.com bubble of the 1990s. She reports that 2018 saw the highest proportion of loss-making company IPOs since 2000 and the market is awash with private equity money being ploughed into early stage loss-making companies.

Well I lived through the dot.com era and managed to sell a software business and retire before the boom became a bust. The current mania for technology stocks certainly reminds me of that era. Growth certainly adds to value, but growth in profits not revenue is what matters. Many early stage companies can grow revenue given enough investment but often they never make a profit. And when the realisation comes, investors drop the company like a hot potato. The key question is to look at when a company will stop consuming cash and at least look like it will breakeven. Before that point, it’s simply a speculation. Investors in the dot.com boom realised later on that they were going to lose money on most of their punts and the whole sector became untouchable for some years.

The other question to ask about Slack is whether it has some unique technology that cannot be easily copied. I am not sure it does on a quick review.

ICO and Adtech

I mentioned in a blog post om April 10th my concerns about privacy after I was bombarded with advertising for SuperxxDry products after mentioning the company in my blog. The Information Commissioner’s Office (ICO) has now published a report which says the Adtech industry must mend its ways. Basically personal data is being shared without the users’ consent, possibly to hundreds of advertising firms.

The ICO has effectively warned the industry that they must reform themselves as the use of personal data has been unlawful. See https://tinyurl.com/yxk7d494 for more information and to read their report. This will clearly affect any company operating in this sector including such giants as Google. But it is surely a move that is to be welcomed by anyone concerned about privacy and those not wanting to be bombarded by irrelevant advertising.

Buy on Friday, Sell on Monday

I have noticed over the last few months that my portfolio tends to rise on Mondays and fall on Fridays. It certainly did this week again. It appears that investors pile in to small cap stocks and investment trusts on Monday morning, but lassitude sets in on Fridays.

Researching the internet seems to suggest that this is a known pattern. So clearly it is best to be contrarian and buy when prices are temporarily down on Friday and avoid buying on Monday. So that’s my tip for today.

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

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Abcam Interims, Brexit Amusement and Superdry

Abcam (ABC) published their Interim Results this morning (4/3/2019). The share price promptly dropped 20% although it has recovered half of that at the time of writing. What was the reason for the price drop? A major profit warning, totally unexpected results or other issues? None that I could see. Before giving you my analysis, you may care to read what I said about the company after attending their last AGM – see https://roliscon.blog/2018/11/07/persimmon-departure-abcam-agm-and-over-boarding/ .

I expressed concerns about the cost and delays to the major Oracle ERP system which they are building to replace legacy systems. Clearly over budget and running late. I was also not impressed by the failure to answer questions by the Chairman.

The latest results did not seem exceptional to me – the IT project is still bogged down it seems with financial and procurement modules only “on-track for implementation in Summer 2019” but that’s hardly surprising. There is one more major module to do after that. Revenue growth was 10.8% which is better than they achieved for the whole of last year but slightly less than forecast for the full year.

Perhaps the major concern for investors was the decline in net margins although gross margins were up. Clearly administrative expenses are up, partly as the result of a move of their headquarters to a new site in Cambridge and product development costs have apparently increased.

One amusement was that it was mentioned that they are opening a new distribution facility in Holland to avoid any disruption post Brexit. This generated a question in the on-line analyst presentation (which you can see a recording of on their web site) on the cost, and the answer mentioned the new “HQ”. That was rapidly corrected to “Logistics Centre”, but the costs were not indicated as being of significance.

Another negative was the mention of a new banking facility of £200 million when they don’t seem to be particularly short of cash. This might be used for “future corporate transactions” and it was made clear they are looking for acquisitions.

A further issue is no doubt the typical bad habit of referring to “adjusted figures”. What does that mean? Here is what it says: “Adjusted figures exclude systems and process improvement costs, costs associated with the new Group headquarters, amortisation of acquired intangibles, the tax effect of adjusting items, and in respect of the six months ended 31 December 2017, one-off tax arising from new US tax legislation”. It sounds like there is a lot thrown in there that might be dubious.

One only has to look at the cash flow figures to see what is happening. Overall cash decreased by £7.8 million after £11.9 million spent on acquisitions. Purchases of “property, plant & equipment” and “intangible assets” almost doubled. Clearly costs have been ramped up as part of the aggressive growth strategy pursued by CEO Alan Hirzel since he joined. That required a major rebuild of internal systems and facilities which is proving costly.

The shares are still highly rated after this hiccup which looked somewhat of an over-reaction to me, but we seem to be in one of those markets where the share prices of companies can collapse on the hint of possible problems even though overall market trends are up. Investors are nervous.

Another company that has suffered sharp share price declines in recent weeks has been Superdry (SDRY), a retailing and brand company. Last Friday the company announced the requisition of a General Meeting to appoint two new directors, including founder Julian Dunkerton who left the board last year. He and another founder, James Holder, are clearly unhappy with recent events which includes more than one profit warning and a 65% drop in the share price. Between them the founders hold almost 30% of the shares and it looks like this is shaping up for a big proxy battle. The company has rebuffed any return of Mr Dunkerton or the appointment of an experienced independent non-executive director suggested by the founders.

Such a prompt rebuff with the likely costs that will be involved in a proxy battle as a result never seems a good idea to me. It tends to destroy any chance of an amicable resolution.

I may write more on this situation after obtaining more information on the key issues which seem to be other than the difficulties faced lately by many clothing retailers.

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

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Cloudcall Placing, Patisserie News, Brexit and Momentum Investing

I reported a week ago on a “Capital Markets Day” at Cloudcall (CALL) – see https://roliscon.blog/2019/01/18/cloudcall-investor-meeting-sophos-rpi-and-brexit/ . There was much discussion on whether the company should raise more finance, via debt or equity. I suggested they needed more equity. This morning they announced a placing of 2.4 million shares at 100p to raise (the share price last night was 109p. It represents about 10% dilution for other shareholders. The placing was completed in minutes so they had clearly lined up existing investors in advance. The cash will be invested (i.e. spent) on sales and marketing.

But they are also refinancing and extending their debt facility. Let us hope they don’t have to use it.

More bad news from Patisserie (CAKE). A report in the Guardian, based on sight of the information sent to bidders by the administrator, suggests that the accounts were false as far back as 2014. That’s when the IPO on AIM took place. In addition, sales in established stores had fallen by 4% in the last two years and the remaining 122 stores were on course to make a £2 million loss in the year to September 2019.

The Guardian report mentioned a number of possible bidders for some of the outlets, but generally few of them. So the chance of a major realisation for the benefit of creditors in such a “fire sale” process seems unlikely.

Brexit. After last night’s votes in the Commons, the battle lines between Theresa May and the EU look to be drawn up. She is getting near a clear mandate from Parliament which will help in the battle with EU bureaucrats and politicians who are adamant they won’t renegotiate the Withdrawal Agreement. But they will have to if they don’t want the UK to exit without one, which would threaten a lot of EU country exports. Come March 28th, it will be time for a face-saving compromise – no change to the Withdrawal Agreement – just the addition of a codicil providing alternatives to the Backstop.

Momentum Investing. Are investors falling out of love with Momentum Investing? Momentum investing has been one of the most attractive investing strategies in the last few years. If a share price was going up, you just bought more, regardless of fundamentals. There were many academic studies showing that it was a very effective strategy. In ten years of rising shares prices, it was relatively foolproof. But when share prices are going down, as in the last part of 2018, it does of course work in reverse. You have to sell shares as the prices drop.

Just reviewing a few model portfolios run by investment magazines and on-line portals suggests to me that momentum investing is no longer working as the 5 year and longer returns generated are worse than the market as a whole. The moral is that there are no simple solutions to achieving superior investment returns. Once everyone is aware of a successful strategy, its benefits disappear as they are traded away.

It looks like we will have to revert to the hard work of doing financial and business analysis of companies rather than simply following shooting stars.

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

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FCA Views of the Financial Landscape

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

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

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

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

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

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

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

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