Book Review: Debtonator by Andrew McNally

Now here’s a book well worth reading on your summer holidays. It’s called Debtonator by Andrew McNally. Indeed if you are taking a long-haul flight to your holiday destination, you might be able to read it in one sitting. Like all good books it is short at only 98 pages excluding notes and index, and the format is small as well. But there is an enormous amount of information embodied in there.

It covers the problems caused by excessive debt in the modern world. The author explains how the balance of company finance has moved from equity to debt which has had many negative effects. He links the rise in income inequality, a major social concern in leading economies, to the excessive use of debt and the discouragement of investment in equities by Governments and pension regulators. The housing market is another example of the distortion created by too much debt at very low cost, engineered by Government and central banks.

The author suggests we need to move to an equity financed, rather than a debt financed economy and proposes how that could be achieved. Reform of the tax system is one aspect of achieving that.

He is also scathing about the current costs of equity investment for retail investors due to high “intermediation” with too many people taking a cut of the real investment returns before they arrive in the hands of the beneficial owners. That’s despite his apparent long career in the investment industry.

The book is a very good summary of what is wrong with the modern financial system. But it also gives the reader some tips on how to become one of the wealthy few rather than the impecunious many. You need to take a direct stake in the real economy where companies are generating real returns, and minimize the costs imposed by advisors, brokers, platform operators and all the other gougers who erode the returns.

In summary one of the best books I have read lately on the defects in the modern financial world. A little gem of erudite analysis.

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

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Just Eat – Capital Markets Day

I recall other ShareSoc Members complaining about how some companies publicly announce “Capital Market Day” events on the morning that the event takes place. This ensures that private investors are excluded as only institutional investors are given advance notice. A very good example was that for Just Eat (JE.) yesterday. Given in an RNS at 7.00 am in the morning, with the event commencing at 9.00 am.

Usually such announcements say something like “no new information will be provided”, or in this case it said “no update on trading will be provided”. But in fact there was obviously very significant new information provided because the share price fell 7.1% on the day, mainly in the afternoon.

There was a webcast provided and I tried to listen to a recording of it in the evening but it kept breaking up so I did not hear anything of interest. The Financial Times reported this morning that “management comments about costs and profitability jolted investors”, and that “investment levels in the coming years would remain elevated and margins were likely to flatline at its marketplace business”. Consensus forecasts were likely to fall it suggested. There was no announcement this morning from the company clarifying what was said or why the share price fell.

This debacle follows a similar sharp fall in the share price following an unexpected statutory loss due to exceptional write-offs in the annual results in March. It is also clear the market for food delivery is changing rapidly with new entrants in addition, meaning the sector is getting more competitive and more investment seems to be required.

I did previously hold a significant number of shares in the company but sold the remainder today. Just too many unexpected events at this company. I hate unpredictable companies and lack of clarity in management statements (or no statements). When confidence in a company and its management evaporates, it’s always time to sell in my view.

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

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Scottish Mortgage Investor Meeting

Yesterday I went to the meeting for investors held by Scottish Mortgage Investment Trust (SMT) in London. This was a useful event as they normally hold their AGMs in Scotland. Needless to say this company’s name is now grossly misleading as it does not invest in mortgages nor in Scotland but is a “global” investment trust. It has a great track record in the last few years and has a focus on growth companies. Their top 10 investments are Amazon, Alibaba, Illumina, Tencent, Tesla, Baidu, Kering, Inditex, Netflix and Ferrari which gives you a good idea of their focus. Here are some of the words of wisdom from manager James Anderson:

He finds the stock market ever more puzzling. Investors think daily headlines help you to invest but there is no correlation. Comment: I think he is saying ignore the political gyrations and such matters as Brexit. He suggested that people way cleverer than us get the world wrong and referred to the work of Hans Rosling and that of Hendrik Bessembinder who reported that 0.4% of all US stocks created half the wealth. Comment: Anderson implied that the key was to pick a few of those really successful growth companies because they will have the biggest impact on overall returns.

SMT therefore tries to identify businesses that are focused on growth markets with great potential – at least 40% per annum. Typically they are also run on a completely pragmatic basis.

Anderson thinks that deflation is highly likely in the next few years as companies they are investing in are reinventing the world. For example healthcare may become a lot cheaper as diagnostics improves and reduces the burden of expensive late stage interventions in cancer and heart disease.

Catherine Flood talked about the companies they are invested in and about the biotechnology sector where genome mapping is creating major opportunities. They have a rising number of private companies in their portfolio.

In response to questions, Anderson said they sold Apple two years ago because growth prospects seemed limited and had reduced their holding in Facebook for other reasons. He also questioned whether the kind of investment strategy following by Warren Buffett will continue to work in future as markets get disrupted by new companies using innovative technology. We may be facing a different world in future where “value” is less important.

As regards their large number of holdings in Chinese companies, Anderson was not worried about the political risks in China and expected China to become the dominant world economy in the near future. They are leading in technology in some areas (e.g. NIO in electric cars).

Overall this was an educational presentation as we got some understanding of the investment strategy of the company which clearly has worked well when economies have been buoyant and markets have been heading consistently upwards. The share price is at a premium to assets of 3.6% at present so might be vulnerable to a correction if there is any hiccup in the global economy. There was no mention of cash flows, return on capital or other “fundamental” measures of value in companies which tells you something does it not. But if you wish to invest in global growth companies, this is certainly one investment trust to consider.

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

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Tungsten, RedstoneConnect, Proactis, LoopUp, Mello and productivity

ITesterday there was an announcement by Tungsten Corporation (TUNG) that there was press speculation about a possible requisition of a general meeting to remove some of the directors, including the Chairman and CEO, and appoint others. This is likely to come from Odey Asset Management supported by other large investors the company understands. Their combined holdings could give them a good chance of winning any vote, or at least it would be a hard-fought proxy battle.

It would seem that the former CEO Edi Truell is involved in this initiative. It would be most unfortunate in my view if he returns to this business (and I did purchase a very few shares in the company after he departed which I still hold). Richard Hurwitz has done a good job in my view of turning this company from a financial basket case with very substantial annual losses into a sounder one. Revenue has been rising and costs have been cut although profits have been longer to appear than hoped. However the company does report that EBITDA was at breakeven for the first four months of the calendar year. It’s at least heading in the right direction now so I am unlikely to be voting for any such requisition.

I attended the Mello event at Hever yesterday and was hoping to get an update from Mark Braund on RedstoneConnect (REDS) where he was due to present. But his presentation was cancelled. Now we know why because an announcement this morning from the company said he was leaving. Perhaps he wants a new challenge. This was another basket case of a company where Mark turned it around in the two years he has been there. So some investors may not be pleased with his departure and the share price predictably dropped on the news. The new CEO will be Frank Beechinor who is currently the Chairman. He is also Chairman of DotDigital and clearly has experience of running IT companies so it’s probably a good choice. A new non-executive Chairman has been appointed (Guy van Zwanenberg).

The Mello event, organised by David Stredder of course, was held near Hever Castle in deepest Kent. I know some of the roads in the area as I live nearby but even so managed to get lost. Not the ideal location. But it was a useful event otherwise. I did an interview for Peter of Conkers Corner and sat on the panel covering the Beaufort case. Videos of both are likely to be available soon, and I will tweet links to them when they appear.

A company that did present at Mello was Proactis (PHD) with CEO Hamp Wall doing the talking. I was unsure of the potential future growth for the company as I thought the market for procurement software might be quite mature (i.e. most likely users had such a product/service). But not so it seems, particularly in the USA and their target vertical segments. Hamp spoke clearly and answered questions well. He is clearly an experienced IT sales/marketing manager. He said he was surprised though that the share price fell over 40% recently when they announced the loss of two of their largest customers. He thought it might fall 15%. I agreed with him that it seemed excessive. But the market does not like surprises.

Today I attended the AGM of LoopUp Group (LOOP) who sell conferencing software. They recently merged with a competitor named MeetingZone and it looks likely to double revenue and more than double profits if things go according to plan. The joint CEOs made positive noises about progress. The company is chaired by heavyweight Chairperson Lady Barbara Judge CBE which is somewhat unusual for this kind of company – at least heavyweight in terms of past appointments if not lightweight in person.

Tim Grattan was the only other ordinary shareholder present and may do a fuller report for ShareSoc. A disappointing turnout for a very informative meeting as both I and Tim asked lots of questions.

Tim advised me after I mentioned the Foresight 4 VCT fund raising that it was odd that no mention was made in the prospectus of the alleged illegal payment of a dividend. Is this not a “risk factor” that should have been declared he asked? That company and its manager seem to be turning a blind eye to that problem.

There was an interesting letter from Peter Ferguson in the Financial Times today. It covered the issue of a declining productivity growth in the UK and other countries aired in a previous article by Martin Wolf. This is certainly of concern to the Government and should be to all investors because only by increasing productivity can we get richer. Mr Ferguson suggested one cause was the negative impact of increasing regulation. He suggested it has three impacts: 1) more unproductive people appointed to monitor and enforce the regulations, 2) more compliance officers, and 3) less productivity as a result in companies due to sub-optimal practices. Perhaps fortuitously I am invested in a company that sells risk and compliance solutions. It’s certainly a growth area and there may be some truth in this argument. Has MIFID II reduced productivity in the financial sector with few benefits to show for it? I think it has.

But Rolls-Royce are going to improve the productivity in their business at a stroke. They just announced they are going to fire 4,600 staff. But are any of them risk and compliance staff?

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

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RBS Sale and Blackrock Smaller Companies AGM

The Government is selling off another tranche of its holding in the Royal Bank of Scotland (RBS). By selling another 8% it will reduce its holding to 62% of the company. The Government (or “taxpayers” as some described them) will face a loss of about £2 billion on what it originally paid for the shares. There were howls of protest from some politicians. John McDonnell, shadow chancellor, said “There is no economic justification for this sell-off of RBS shares. There should be no sale of RBS shares full-stop. But particularly with such a large loss to the taxpayers who bailed out the bank”.

I think he is suffering from the problem of “loss aversion”, i.e. a reluctance to sell a losing investment rather than looking at the current value of the bank and its prospects. The market price is surely the best indicator of the value of the company – it’s what willing buyers will pay, and what sellers consider a fair price. One aspect to consider is that the value of the business may be depressed because nobody likes to buy shares in companies where there is one dominant controlling shareholder and particularly so if that shareholder is a government. The only way the UK Government can solve that problem is to reduce its holding in stages, as they are doing. Forget the prospective loss on the share sale. Better to accept the price offered and reinvest the proceeds in something else. The Government has lots of things where it needs more cash – the NHS, Education, Defence, Brexit plans, you name it.

Mr McDonnell may be particularly unhappy as he hopes to take power at the next General Election and RBS is one of the few remnants of the past Labour government’s major stakes in UK banks. After Gordon Brown nationalised Northern Rock and Bradford & Bingley, they took effective control of RBS, and to a large extent Lloyds. Only Barclays managed to escape by doing a quick deal with middle-east investors which has been the subject of legal action, only recently thrown out by the courts. For any socialist, particularly of the extreme left like Mr McDonnell, the ability to tell banks what to do is an undoubted objective. Banks tend to reduce lending when the economy worsens and their clients start to have difficulties but the claim is often that such reduction in lending compounds the economic woes.

Yesterday I attend the Annual General Meeting of Blackrock Smaller Companies Trust Plc (BRSC). What follows are some brief highlights. This company has a good track record – some 15 consecutive years of outperforming its benchmark by active management. So much for passive index investing. It has been managed by Mike Prentis for many years assisted by Roland Arnold more recently. The share price rose by 25% last year but the discount to NAV has narrowed recently to about 6% so some might say it is no longer a great bargain. The company does not have a fixed discount control mechanism and has traded at much higher discounts in the past.

It’s a stock-pickers portfolio of UK smaller companies, including 43% of AIM companies and 143 holdings in total. Many of the holdings are the same companies I have invested in directly, e.g. GB Group who issued their annual results on the same day with another great set of figures.

Mike Prentis gave his key points for investing in a company as: strong management, a unique business with strong pricing power, profitable track record, throwing off cash, profits convert into cash and a strong balance sheet. They generally go for small holdings initially, even when they invest in IPOs, i.e. they are cautious investors.

When it came to questions, one shareholder questioned the allocation of management fees as against income or capital (25% to 75% in this company). He suggested this was reducing the amount available for reinvestment. But he was advised otherwise. Such allocation is now merely an accounting convention, particularly as dividends can now be paid out of capital. But he could not be convinced otherwise.

Another investor congratulated the board on removing the performance fee. Shareholders were clearly happy, and nobody commented on the fact that the Chairman, Nicholas Fry had been on the board since 2005 and the SID, Robert Robertson, had also been there more than 9 years – both contrary to the UK Corporate Governance Code. The latter did collect 5% of votes against his re-election, but all resolutions were passed on a show of hands.

I was positively impressed on the whole.

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

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Belated Action by FRC Re Autonomy

I commented previously on the conviction of former Autonomy CFO Sushovan Hussain for fraud in relation to the accounts of Autonomy Plc (see https://roliscon.blog/2018/05/02/they-do-things-differently-in-the-usa/ ). Just to show that this was not solely a case prompted by Hewlett Packard over their disastrous acquisition of the company and supported by a partisan California court as some have alleged, the Financial Reporting Council (FRC) have now announced formal complaints over the conduct of auditors Deloittes and senior finance staff of Autonomy – including Mr Hussain.

Allegations include: failings by the auditors to adequately challenge Autonomy’s accounting and disclosure of its purchases and sales of computer hardware; adequately to challenge Autonomy’s accounting for transactions with value added resellers (“VARs”) and to correct false or misleading communications made by Autonomy to the Financial Reporting Review Panel (“FRRP”) of the FRC.  Sushovan Hussain and Stephen Chamberlain are alleged to have breached the fundamental principle of integrity by acting dishonestly and/or recklessly when preparing and approving Autonomy’s Annual Report and Accounts for the years ended 31 December 2009 and 31 December 2010 and related charges.

There will be tribunal hearing to hear these complaints for which a date has not yet been set. It seems likely that the claims will be defended.

So 8 years later we have a non-criminal action by the regulatory authorities in the UK over accounting and audit failures while the US prosecuted for fraud. Surely this is not good enough if the allegations are true? Plus it’s been too long before action has been taken. If the claims are upheld then the accounts were wrong and sufficiently wrong not just to mislead the investors in Autonomy but to prompt Hewlett Packard to purchase the company at a grossly inflated price – that is their claim which is the subject of an on-going civil action. But it could also be seen as a fraud on stock market investors which is a criminal offence in the USA but not the UK. That is what needs changing.

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

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The Departure of Sir Martin Sorrell

At last the highest paid and longest serving FTSE-100 CEO has departed from WPP after 33 years. His total pay last year was £48 million, down from the previous year’s “single figure” of £70 million. Sir Martin was certainly perceived to be a “star” businessman, and the financial performance of WPP pleased shareholders for many years. Despite recent problems the Annual Report of the company claims a Total Shareholder Return of 1,006% over the last twenty years as against a measly 241% for the FTSE-100.

Will the company find a suitable replacement manager who can continue to grow the business? Will the company survive in its current form or be broken up? Those are the questions all the media are pontificating upon.

My thoughts on this subject were crystalized by reading the business management classic “Good to Great” on a recent holiday break. First published in 2001, the author Jim Collins reported on research he had undertaken to determine what separated out simply “good” companies from the “great” ones, i.e. those that really offered investors superior returns rather than average ones. He also looked at what turned good companies into great ones, i.e. the crystalizing factors or turning points. It’s well worth reading by investors for that reason alone, even if some of the companies reported on as “great” have subsequently gone bust (e.g. Circuit City), and amusingly Berkshire Hathaway was only rated as “good” at the time so was not included in the analysis.

Management and the quality of the leadership was one of the key factors identified. It seemed that humble, self-effacing leaders were best. They often attributed the company’s success to luck or the other senior management team members. Star managers with high profiles such as Jack Welch at GEC or Lee Iacocca at Chrysler frequently proved to be shooting stars whose achievements rapidly disappeared after they left. In other words, they did not build great companies where their legacy lived on after their departure.

This is one very applicable quote from the book when you are considering director pay in companies: “We found no systematic pattern linking executive compensation to the process of going from good to great. The evidence simply does not support the idea that the specific structure of executive compensation acts as the key lever in taking a company from good to great”. In other words, high pay does not generate exceptional performance in managers, and schemes such as LTIPs which allegedly align managers’ interests with shareholders do not help either.

It’s a book well worth reading for tips on how to identify the companies and their CEOs that are likely to generate great returns for investors.

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

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