Another Accounting Scandal – Goals Soccer Centres

Yet another problem in accounting has been revealed at Goals Soccer Centres (GOAL). This morning they disclosed in a trading update the discovery of “certain accounting errors” and are reviewing their accounting practices. As a result, the board now expects full year results to be below expectations and publication of the 2018 results has been delayed.

The even worse news is that they have breached their banking covenants so are having to have one of those difficult conversations with their bankers. The share price has fallen 30% this morning (at the time of writing).

Goals is an operator of soccer pitches which listed on AIM as long ago as 2004. Revenue has been flat for the last few years and profits variable. Net debt approximates to revenue which is never a good sign. The company changed auditors from KPMG to BDO in June 2018 and in July 2018 the CFO resigned from the board “with immediate effect” to join his family business but continued in his role as CFO. A new “interim” CFO was not appointed until the 15th January 2019.

After this “own goal”, the company suggests it “will take a more prudent approach” in future. But it reinforces the need to reform the accounting and auditing professions because we are very likely to be told that this issue extends back for more than one year.

Note: I have never held shares in this company despite the fact there was some enthusiasm for it among investors at one time. The share price peaked at 425p in late 2007 but it’s been steadily downhill since. It’s now 38p. I was always doubtful whether there was any real money to be made enabling amateurs to play soccer.

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

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Alliance Trust Results and Directors’ Pay Cuts

Very long-established investment trust Alliance Trust (ATST) issued its annual results for 2018 on the 1st of March. Total return for the year was minus 5.4% with its equity portfolio slightly behind its benchmark index. It put this down to not holding a “narrow group of very large companies”. That performance is similar to my own personal investment portfolio and better than a number of active managers so I hope investors will be satisfied with it after the past revolution at the company.

It is of course disposing of Alliance Trust Savings which finally managed to show an operating profit after many years of losses, and it is also getting shot of some private equity investments and mineral rights in North America. It’s basically returning to its roots as a simple global investment trust which will please many investors.

Citywire have highlighted that many of the directors are taking a pay cut, with Chairman Lord Smith seeing his annual pay reduced from £120,000 to £80,000, Deputy Chairman Gregor Stewart losing £55,000 as he will no longer be a paid director of Alliance Trust Savings. Other directors’ fees are also reduced. Do not be too concerned about Lord Smith’s descent into poverty though – he still has a couple of other well paid jobs.

The pay changes are a rational move because although it was necessary to pay highly to new directors for the effort required to sort out the mess that was the company before Elliott launched their bid for changes, and for the reputational risk if they failed, it is hopefully now more stable and more similar to other investment trusts who do not pay enormous amounts to their non-executive directors. The pay changes will undoubtedly please the many Scottish holders of shares in the trust.

I do hold a few shares in Alliance Trust. I consider it can now be one of those core holdings that any investor who does not wish to track every gyration of the market can hold.

The current share price discount to NAV is 4.4% which is acceptable but the company says it is considering how they can stimulate additional demand for the shares. Investment trusts often have the problem of spending very little on marketing which can be a shame when they provide a low cost route for stock market exposure by investors and have a number of advantages over open-ended funds and ETFs.

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

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Inconvenient AGM at Phoenix, Changes to “Going Concern” and GoCompare

I have been advised that life insurance and pension consolidator Phoenix Group (PHNX), a FTSE 250 company, is holding this year’s AGM in Edinburgh at 9.00 am. That’s a damn inconvenient time and location for most investors. Previous general meetings have been held in London where their registered office is located, although I am told that only one director and no shareholders turned up for the 2018 AGM.

This is the explanation given by the company for the latest venue in the Annual Report: “Our three general meetings in 2018 were held in London. Following the acquisition of Standard Life Assurance, our 2019 Annual General Meeting will be held on 2 May 2019 in Edinburgh, which is now our largest operational centre”. But it’s surely where investors are located rather than operations that matter.

It is undoubtedly time for some standards to be imposed on the timing and location of AGMs because setting a time of 9.00 am suggests they wish to deter shareholders from attending. Why not 2.00 pm which at least would give any shareholder in the UK some chance of getting there without an overnight stay?

There also needs to be more encouragement to attend by the promise of a presentation on the affairs of the company and the attendance of all directors so that questions can be fully answered. Institutional investors should also have an obligation to attend. This practice of trying to turn AGMs into meaningless events needs to be stopped in the interests of improved shareholder engagement.

Going Concern

Auditors have to confirm in their audit reports published in companies Annual Reports that the business is a “going concern”, i.e. will be able to continue trading for the foreseeable future. Any uncertainty in that regard has to be disclosed. But that did not prevent the unexpected collapse of companies such as HBOS, BHS and Carillion. Such events can be very damaging to both investors and suppliers.

The Financial Reporting Council (FRC) is proposing to tighten up the ISA 570 standard used in the UK that defines a going concern. A public consultation on it is present here: https://www.frc.org.uk/consultation-list/2019/exposure-draft-proposed-isa-(uk)-570-(revised)

Comment: The proposed changes to the standard may improve matters but company management will be absolutely horrified with any suggestion they are not a going concern. For a bank it might produce a “run” on the bank and a serious downgrade of its credit rating. For a trading company it would mean suppliers might refuse to trade with it. As a result the management will take enormous effort to convince the auditors they are a going concern, and auditors will be under severe pressure to agree. Such pressure, when companies hire and pay the auditors at present might be irresistible.

There is also the problem that auditors can have built a relationship with the appointing company and its management over several years. They may not be of a nature, or have the inclination, to challenge management. Unless tougher sanctions are imposed on auditors who are too easy going, when collapses take place soon after a clean audit report, I doubt much will change.

GoCompare

I covered the preliminary results of GoCompare (GOCO) on the 28th February. Subsequently there was some director share buying and this morning it was announced that Chairman Sir Peter Wood had bought shares. In fact he purchased 17.8 million shares – about 4% of the company thereby raising his stake to 29.9% (i.e. the limit before he is obliged to make an offer for the company). The announcement quotes Sir Peter: “My share purchase underlines my view, which is shared by my fellow Board members, that the current Gocompare share price does not fully reflect the operational and strategic momentum in the business. I’m particularly excited about our weflip brand and the potential opportunities it offers.  If we deliver on our wider Savings as a Service strategy it will be brilliant for savers everywhere, reinforcing my decision to increase my holding to 29.9%.”

The share price jumped 7% this morning, but if there is a big buyer then there is also a big seller of course. However, insiders might have a better view of the future prospects for the business.

Note: I do hold GoCompare. I do not hold Phoenix.

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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Metro Bank, Improving Accounts, Patisserie, Telford Homes and GoCompare

The latest example of a public company publishing misleading accounts is Metro Bank (MTRO). Both the FCA and PRA (the bank regulator) are looking into the “misclassification” of some loans which resulted in the bank overstating its regulatory capital. The result was that it has had to do an equity share issuance to bolster its capital.

There was a very good letter to the FT today on the subject of improving accounting and audits from Tim Sutton. He suggested the US Sarbanes-Oxley Act had improved the standards in the USA enormously so that revision of financial statements has been declining. To quote: “Section 404 requires management to assess and report annually on the effectiveness of the company’s internal control structure and procedures. In addition, the company’s external auditors must attest to the effectiveness of those controls”. As he points out that might have prevented the fraud at Patisserie (CAKE), and no doubt avoided the issues at Metro and other companies. It sounds an eminently good idea. I realise Sarbanes-Oxley did receive some criticism in the USA after it was first introduced due to the extra costs it imposed, but if that is the only way to ensure reliable accounts, I suggest it is worth paying. It was perhaps over-complicated in implementation in the USA but some of the key features are worth copying.

This morning Telford Homes (TEF) published a trading statement which was mostly bad news and the shares fell over 15%. This is a London focused housing developer which I used to hold but I got nervous some months ago about the housing market in the capital. You can read my acerbic comments made in last October here: https://roliscon.blog/2018/10/10/black-hole-in-patisserie-holdings-audit-review-telford-homes-and-brexit/

The latest announcement says that “the London sales market remains subdued”. Sales are being achieved but at a slower rate and margins are under pressure due to increased incentives and discounts. So they are putting an increased focus on “build-to-rent”. Other bad news is that contracts are being delayed on larger projects, partly due to planning delays. The result will be profit before tax for FY2020 will be significantly below FY2019.

Another announcement this morning was the preliminary results from GoCompare (GOCO). This is a price comparison web service, particularly focused on car insurance, but also covering utilities and other products. It is of course fronted by Italian opera singer Gio Compario in TV advertisements which I certainly prefer to the Moneysupermarket ones.

It was particularly interesting watching the results presentation – probably available as a recording on their web site. Results were much as forecast, with only a slight increase in revenue but a 20% increase in adjusted earnings. This is due to optimisation of marketing. You can see that these kinds of companies have to spend an enormous amount on marketing to catch customers when they are thinking of switching suppliers. GOCO spent £80 million on marketing last year, down from £89 million) to achieve revenue of £152 million.

They have made acquisitions to diversify revenue and this has led to an increase in debt, but the interesting news was about a new subscription service called WEFLIP. This automatically switches your energy supplier, among a panel of agreed suppliers, if you can potentially save £50. This will enable them to retain customers, with the suppliers paying the subscription fee. They plan to spend £10 million on marketing this in the coming year and have already done a “soft” launch to ensure the product and market are OK. Clearly though, this might be perceived as a bit of a gamble.

The market was unimpressed and the shares have fallen by another 5% today after a long decline in recent months. It’s now on a prospective p/e of less than 9 and yield of about 3%. I remain a holder at those levels.

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

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Luxembourg Regulators Inept?

There were a couple of interesting articles on Luxembourg financial regulation in Mondays FTfm publication. The first was on the allegation by victims of the Madoff fraud that the regulator was “inept” because UBS were not being forced to compensate investors in the $1.4 billion Luxalpha fund that fed money to Madoff. UBS were the funds investment manager and custodian and should therefore have paid compensation under the regulator’s rules. But they are declining to enforce their own rules it is claimed. There also seem to be difficulties in investors pursuing legal claims in Luxembourg over this “due to bureaucratic hurdles”.

I have past experience of dealing with the Luxembourg regulator (the CSSF) over the actions of Paypal some years back. Paypal in Europe (and the UK) was and still is regulated by the CSSF. They proved to be totally useless in dealing with my complaint. I came to the conclusion that Paypal chose that regulatory venue for good reason.

I would be very wary of investing in any business that was registered or regulated in Luxembourg. The UK regulator might be quite inept at times, but at least they try to some extent to deal with complaints. The Luxembourg regulator seems to be asleep at the wheel or to simply not have the resources to provide the required service.

Surprisingly the second article in FTfm was how funds are moving to Luxembourg and Ireland spurred by Brexit so as to give them access to EU markets. This is being done by the use of “supermancos” (super management companies) that provide administration services for multiple fund providers and effectively it seems act as a “front” with the appropriate regulatory licences. The EU has laid down some rules that require them to have some “substance” but all that means apparently is that they need to have up to seven staff rather than just one or two. Does that inspire confidence? Not in me.

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

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Words of Wisdom from Warren Buffett

Warren Buffett has published his latest annual letter for investors in Berkshire Hathaway (see http://berkshirehathaway.com/letters/2018ltr.pdf). These letters are always worth reading for their insight into how a successful stock market investor thinks. I’ll pick out a few highlights:

Berkshire’s per share book value only rose by 0.4% in 2018 but he assigns that to the need to write down $20.6 billion on his investment holdings in unlisted companies due to new GAAP accounting rules using “mark-to-market” principles. He is not happy about that change.

He expects to make more purchases of listed securities as there are few prospects for mega-sized acquisitions. But that is not a market bet. He says “Charlie [Munger] and I have no idea as to how stocks will behave next week or next year”. He just buys shares in attractive businesses when their value is more than the market price.

At the ages of 88 and 95 for Warren and Charlie, they are not considering downsizing and becoming net consumers as opposed to capital builders. He quips “perhaps we will become big spenders in our old age”.

He comments on “bad corporate behaviour” induced by the desire of management to meet Wall Street expectations. What starts as an innocent “fudge” can become the first step in a full-fledged fraud. If bosses cheat in this way, subordinates will do so likewise.

He criticises the use of debt which he uses only sparingly. He says “at rare and unpredictable intervals, credit vanishes and debt becomes financially fatal”. It’s a Russian roulette situation in essence.

He’s still betting on the commercial vibrancy of the USA to produce investment returns in the future similar to the past. He calls the nations achievement since 1942, when he first invested, to be “breathtaking”. An S&P index fund would have turned his $114.75 into $606,811. But if it was a tax-free fund it would have grown to $5.3 billion. He also points out that if 1% of those assets had been paid to various “helpers” (he means intermediaries), then the return would have been only half that at $2.65 billion. He is emphasising the importance of avoiding tax if possible, and minimising what you are paying in charges.

But if you panicked at the rising debts in this world and invested in gold instead the $114.75 would only be worth $4,200. Clearly Warren believes in investing in companies and their shares as not just a protection against inflation but as the better investment than “safe” assets. He suggests the USA has been so successful economically because the nation reinvested its savings, or retained earnings, in their businesses.

The moral for private investors is no doubt that you should not spend all your dividends but at least reinvest some of them, or encourage companies to reinvest their earnings rather than pay them out as dividends. But you do need to invest in companies that reinvest their earnings to obtain a good return.

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

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