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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Quindell (Watchstone), SFO inaction and Tungsten Corporation

The Daily Telegraph this morning (25/2/2019) disclosed that law firm Harcus Sinclair is preparing a legal case for investors who lost money in Quindell (now renamed Watchstone). Quindell was once the largest AIM company – valued at £2.6 billion. But its accounts were extremely dubious and many investors think they were downright fraudulent. The company is still being investigated by the Serious Fraud Office (SFO) but only two days ago it was announced that the SFO was dropping investigations into Rolls-Royce and GlaxoSmithKline. The SFO said there was “either insufficient evidence” or it was “not in the public interest” to continue. That’s despite the fact that Rolls-Royce paid nearly £500 million under a Deferred Prosecution Agreement over the allegations of bribery and corruption. Will the Quindell case be dropped also one wonders?

Watchstone (WTG), now worth £44 million, is also the subject of a law suit by Australian firm Slater & Gordon over the acquisition of businesses from the company in 2015. They claim breaches of the warranties and deceit but Watchstone denies they have a valid claim.

Why is it so difficult to pursue directors and other senior executives over false accounts? Tesco was a similar situation where the company conceded wrongdoing and paid a fine but the prosecutions of individuals collapsed. It seems clear that the whole legal framework for fraud under which the SFO operates needs reviewing and changing to make such cases easier to prosecute. Either that or companies should not be conceding wrongdoing and paying fines (a charge on shareholders effectively) when it cannot apparently be proven. It’s the individuals who need convicting, not the company, if future frauds are to be deterred.

Also this morning Tungsten (TUNG), another AIM company and in which I have a miniscule holding, issued a trading update. This is a company that has been consistently loss making, and it was always doubtful whether it had a viable business model in the new sector of electronic invoicing and supply chain enablement.

CEO Richard Hurwitz, who was appointed to the board in 2015, after a revolution, left “with immediate effect” on the 14th February. He did seem to have made changes in the last three years that gave some hope that the company was not going to continue to be a bottomless cash pit. But losses persisted. However, this mornings announcement was somewhat more positive in that it mentioned “significant reductions in the cost base over the past three years” and there are other changes afoot including a review of the Group’s “remuneration structures”. That includes a reduction in cash bonuses in favour of shares and introduction of “clearly defined performance conditions”. Perhaps that prompted the CEO to quit (he got paid £1.3 million last year despite the company still losing money).

Other good news was that net cash inflow of £0.5 million in the quarter represented the first ever positive cash flow from operations! But the underlying EBITDA of £0.4 million includes a “seasonal working capital” inflow of £1 million so the “normalised” cash outflow was still £0.5 million. Does that make sense or is this fanciful presentation?

The share price only perked up slightly this morning on this announcement which probably reflects continuing concerns about when it will actually show some profits and (and I am not just talking about EBITDA), and the added uncertainty of a new CEO but it seems good candidates have already been lined up.

Still a “wait and see” situation so far as I am concerned.

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

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John Murphy, Branding, Fevertree, Downsizing, McCarthy & Stone & the Motor Industry

In yesterday’s Financial Times there was an article on John Murphy, my ex-brother-in-law. It covers his “downsizing” which in his case means moving from three houses (Tuscany, Suffolk and Islington) to one in London. Although I rarely meet him nowadays as he divorced my sister many years ago, he has an interesting history. He developed the first large branding and trade mark consultancy (Interbrand) and I worked with him briefly in it. He taught me the importance of strong branding and protectable trade marks. He subsequently was involved in the re-establishment of Plymouth Gin and claims to have started the whole fashion for gin which was otherwise a declining market at the time. Charles Rolls, one of the founders of Fevertree (FEVR), worked with John at Plymouth and that company is another good example of how important strong branding is in consumer products. The FT article is here: https://www.ft.com/content/c48fcdec-3071-11e9-8744-e7016697f225

On the subject of downsizing, I visited the latest McCarthy & Stone (MCS) “retirement living” development in Chislehurst recently – Shepheards House. It’s recently been completed and is not far from where I and my wife currently live. And very nice it is too. A 2-bedroom apartment costs £552,000 but the big problem would be downsizing to fit all our offices (3 including two “work rooms” for my wife), books and art into the one apartment. They have limited storage space in them. My wife suggests we would need two of them. Don’t think we are yet old enough to justify doing this and the economics of two of them don’t work.

Just reviewing the latest share price of McCarthy & Stone, which I held briefly, it’s still only about half the price at which it did an IPO in 2016. With the housing market in London and the South-East declining that is not going to make life easier for the company, although they seem to have sold the apartments in Shepheards House very rapidly. Profits were down last year and build costs are increasing which combined means the shares are looking relatively cheap now. It’s a typical problem with IPOs – the sellers know when it’s a good time to sell.

There was a good article on the UK motor industry in the main section of the FT yesterday under the headline “forced into the slow lane”. Apart from the mention of the impact of Brexit, which the FT has been repeatedly promoting with negative articles and editorial in the last few months, much to my annoyance, it does explain why the motor industry is facing difficulties.

It’s not just Honda’s decision to close Swindon, which has nothing to do with Brexit, as a Honda executive spelled out, but there is a general malaise in the industry which is also affecting German car manufacturers. The abrupt policy change over diesel vehicles, which has made them unsaleable to many people, has tripped up many manufacturers such as JLR and the fact that the EU has now negotiated a tariff-free trade deal with the EU means that Japanese car manufacturers no longer need to bother with manufacturing in Europe. That is particularly so when their markets in the Far East are growing while Europe is shrinking (Honda’s production at Swindon has been declining).

Vehicle sales have been dropping in the UK in what is a notoriously cyclical industry. It’s one of those products that does wear out, but new purchases can always be put off for some months if not years if there is uncertainty about technological change. With vehicles lasting longer than they ever did, there is no reason for buyers to acquire new vehicles at present.

Perhaps the Government should ask Tesla or other new electric car manufacturers if they want a ready-made facility and reliable workforce that will become available soon? In a couple of years’ time, the market for vehicles may well pick up.

But John Murphy’s decision to stop owning a car as part of his downsizing is a sign of the times also. When I first knew him, he owned the revolutionary Citroen DS and subsequently owned Bentleys. It must be quite a change for him.

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

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Gooch & Housego and Sectors to Avoid

Today Gooch & Housego (GHH), a photonic components manufacturer, held its Annual General Meeting in Ilminster, Somerset. I would have attended as a shareholder except the time of 11.00 am would have meant a very early start. As it was, the trading update issued in the morning prompted me to sell my holding anyway.

The key negative in the announcement was this: “Looking forward, we believe timing and mix will result in a FY 2019 group trading performance showing low single digit growth compared to last year”. That compares to analyst’s prior forecasts of revenue growth of 14% and adjusted earnings growth of 48%. The share price promptly fell by 20% to about 1100p in the morning and it had already been falling in the last few weeks from a peak of over 1800p in October 2018.

Apart from the well-known problems in China of the manufacturing sector, the cause of the problem is assigned in the announcement to the cyclical nature of the microelectronics sector and the recent impact of the US/China tariff wars. It also comments on the “excess inventory” in the Chinese market taking longer than expected to normalise. However, the company does expect a “multi-year growth phase” in the hi-reliability fibre couplers market which may become apparent in the second half of the year.

But my experience tells me that electronic component manufacturers are notoriously vulnerable to wide swings in volumes and profits. If they are not selling in cyclical markets, or are vulnerable to stock holding changes, they are vulnerable to rapid product obsolescence and leapfrogging by competitors. This is normally a sector I avoid for those reasons. GHH seemed to be operating in a very specialised part of the market which I thought might make them less prone to these problems, but it seems not.

This is a case where my prejudices against a certain market sector are reinforced. Such companies need to be very cheap but Gooch & Housego has not been recently, being perceived as a high-growth tech stock with big ambitions.

The other concern is that the share price decline from October last year was not based on any published news from the company, although the fact that the CFO was declared as leaving in November might have been perceived as such. But in October 2018 the company said: “Overall G&H has a robust order book combined with greater diversification. The Board remains confident that the Group is well positioned to continue to deliver further progress in FY2019 and beyond”.

It would seem that some folks knew about possible problems at the company before me which always makes for tricky investment. With a relatively small shareholding which I had only held for a short time, it’s an example of when it’s best to sell and take a loss. The business might recover but such an experience tells me that it’s always likely to be vulnerable to such shocks.

The electronic hardware sector will therefore continue to be on my blacklist of sectors to avoid which includes oil/gas exploration and production companies, mining exploration, banks and other financial sector companies, insurers, gaming companies, fashion retailers, drug developers, etc, etc. You might call me opinionated but experience tells me that some sectors are just too tricky to invest in unless you have very specialised knowledge. I’ll probably be giving my reasons in detail for avoiding some sectors in a book I am working on as it will take longer to explain than can be covered in a short blog article.

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

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Plus500 Share Price Dive and Betting Against Your Customers

My last blog post mentioned my brief holding in Petrofac. Another company I held briefly was Plus500 (PLUS). Yesterday its share price dropped over 30% following a profit warning in a preliminary results announcement. The cause is simply that tightening regulations are impacting revenue.

Plus500 is big CFD provider. That fact that most “investors” in CFDs lose money is widely acknowledged and the Financial Conduct Authority (FCA) and EU regulators have been tightening up on the rules that apply to Contracts for Difference. The reality is that most such “investors” are ill-informed speculators.

The FT said today that the announcement was most revealing as it showed “for the first time how much its earnings relied on betting against its customers”. Columnist Lex also described it as a “risky business” and that is one reason I sold the shares and have not considered reinvesting since. There are some companies that are simply too dubious to hold – rather like Petrofac, particularly if you also have ethical qualms about how they operate.

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

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£400 Million Legal Claim to be Launched Against Petrofac

Keystone Law have announced that they are about to launch a legal claim against Petrofac (PFC). This is what the announcement says: “Keystone Law is getting ready to launch a claim on behalf of institutional investors who have suffered significant losses on their Petrofac investments since at least 2010. The team, led by senior litigators George Lambrou, Matthew Reach and Robert Lawrie, has joined forces with litigation funder, Innsworth, to mount legal action against the oil services company. The claim is centered on allegations that Petrofac was involved in bribery, corruption and money laundering, which first emerged in press articles in early 2016. Petrofac saw billions wiped off its value in 2017 when the SFO confirmed its investigation. The value of the shareholder claim is expected to be in excess of £400,000,000.”

Petrofac share price peaked at 1750p in 2012 but is now only 390p. The company admitted in an RNS announcement on the 7th February that a former employee had admitted bribery under the UK Bribery Act 2010 after a Serious Fraud Office (SFO) investigation.

At a prospective p/e of 5 and dividend yield of over 7%, is this a bargain one wonders? But one would need to be convinced that the company has changed its culture. Revenue and normalised earnings are also forecast to fall. It’s also a tricky sector as developing oil/gas production projects depends on the market prices of those commodities so can result in feast or famine for new business. The threat of a major law suit won’t help the share price either.

I did hold some shares in this company from 2009 to 2012 and attended at least one of their AGMs in 2012. It’s interesting to look back at what I said in a report on the meeting that I wrote at the time and which is available to ShareSoc members on their web site. Basically I complained about evasive answers and waffle from the directors. There were also negative press comments subsequently about £1 million spent on a private jet for the CEO, and lack of disclosure of that to investors. I concluded that I did not trust the directors of the company and sold my shares.

As I have said many times before, it’s always worth attending AGMs to get an impression of the directors – you can always learn a lot by doing so.

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

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