Removing Directors, Ventus VCTs, Rent Controls and HS2

Replacing the directors of companies by shareholders can be enormously difficult. Although I have been instrumental in the past in helping that process in several companies, it takes enormous effort and a lengthy timescale to achieve it. ShareSoc director Cliff Weight has published a very perceptive article on the problems of doing so at the Ventus VCTs.

Problems faced by shareholders who are unhappy with the directors of a company are a) communicating with all other shareholders now that many are in nominee accounts and the costly process of writing to shareholders on the register via post (and processing the register into usable format for mailing); b) the existing directors of a company using the resources of the company (i.e. shareholders funds) to campaign actively against any change including the use of expensive proxy advisors to contact shareholders via telephone; c) the role of IFAs who advise their clients or who manage their portfolios and who can influence the shareholder voting; and d) the inertia of institutional investors (or to quote someone from the FT today: about 60% of company investors are passive shareholders and ‘don’t care’).

In the case of the Ventus VCTs, some shareholders are unhappy with the management fees as no new investments are being made by the company and are unhappy with the actions of the directors. They have tabled requisitions for the Annual General Meetings at Ventus VCT and Ventus 2 VCT on the 8th August to remove all the directors and appoint new ones. Of particular concern is the current two-year termination notice on the management agreement which is now being proposed to extend further. It is never a good idea for investment trusts to have long termination periods in contracts with the manager.

You can read Cliff Weight’s blog article here: https://tinyurl.com/y2de9vaa . There is also an article covering this topic in this weeks Investor’s Chronicle under the title “Limits of Influence”. It’s well worth reading.

How to solve these problems? I suggest the following: a) a reform to put all shareholders (including beneficial owners) on the register of companies; b) put shareholders email addresses on the register so that communicating with them can be done at reasonable cost – it’s surely unreasonable in the modern age to only have postal addresses which adds to costs enormously; c) limit how much can be spent on proxy advisors to oppose shareholder requisitions; and d) exclude passive institutional investors who have no interest as owners from voting.

Rent Controls

The Mayor of London, Sadiq Khan, is intending to develop proposals for rent controls in London so as to “stabilise” or reduce property rents in London (or make them “more affordable” as he puts it). That’s despite the fact that he has no legal powers to do so and a Conservative government would likely block such proposals. But Jeremy Corbyn supports the idea. The Mayor clearly sees this as a vote winner for his re-election campaign next year as he claims 68% of Londoner’s support rent controls!

Some of my readers probably invest in buy-to-let properties so such proposals will worry them considerably. On the other hand, those who rent houses or flats in London are undoubtedly concerned about the cost of renting and the rapid rise in rents in London. Some are being forced out of London or have to move to smaller properties.

But rent controls never work and create all kinds of negative side-effects, or unintended consequences. When I moved to London in the 1960s, rent controls were in place and had been since 1945 in various forms (there is good coverage of the history of rent controls in London on Wikipedia). In the 1960s, unfurnished properties were almost impossible to find or were horribly expensive as landlords had withdrawn from the market. Rachmanism to force tenants out of rent controlled properties was also rife and what property there was available for rent on the market was often in very poor condition because landlords simply could not justify spending money on maintenance. We definitely do not want to return to the 1960s despite Jeremy Corbyn’s desire to put us there!

Rent controls are not the answer, as many studies of such schemes has shown. The Mayor needs to do more to tackle the housing problem in London by ensuring more home are built, encouraging movement of people out of London, and discouraging new immigration into the capital from elsewhere. But you can read the Mayor’s press release here if you wish to learn more about his plans: https://www.london.gov.uk/press-releases/mayoral/to-tackle-affordability-crisis

HS2 and Brexit

The latest report that HS2 may cost an extra £30bn, meaning it could cost as much as £85bn in total, surely makes it even less justifiable. Enabling a very few people to save a few minutes on the train journey time from London to Birmingham at that cost makes no sense, although there might be more justification for expanding capacity and speed on routes in the North of England. However, it would surely be much better to spend that kind of money on an improved road network where the benefits are much greater. The Alliance of British Drivers has just published an analysis of road expenditure versus taxation which includes a comparison of road versus rail expenditure. It’s well worth reading – see here: https://www.abd.org.uk/road-investment-and-road-user-taxation-the-truth/ .

Now the Office of Budget Responsibility (OBR) have recently suggested that a “no-deal” Brexit would blow a £30bn hole in the public finances. Even if you accept that is true, and many do not, there appears to be a simple solution therefore. Cancel HS2 just to be on the safe side.

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

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Pay at HSBC and Santander, Net Worth, Duplicate Dividends and Persimmon

Apparently bankers still live in an unreal world so far as most of us are concerned, even after the financial crisis of ten years ago when their remuneration was attacked. The Financial Times covered two stories on the pay of bankers in today’s edition (16/7/2019). The first was on the opposition to pay at Standard Chartered and comments from the CEO, Bill Winters, on it after a vote of almost 40% against their pay policy in May. The concern is mainly about his pension arrangements which will mean he gets a pension allowance of £474,000 this year which is about 20% of his overall pay. But that includes bonuses when usually pensions are related to base salary only.

Mr Winters comments on his pay were quoted as “I think it’s quite appropriate for the board not to ask me to take a pay cut. And they didn’t – I don’t think it ever occurred to them to ask”. Is that not most amusing. Perhaps the FT coverage might remind them to consider the matter.

The other article was on the pay offered by Santander to Andrea Orcel as an incentive to join the company as CEO. It included a €52 million figure as a “joining bonus” including partly cash and partly in shares to offset the loss of deferred pay from him leaving UBS. In fact the offer was subsequently withdrawn and Mr Orcel is now suing but it just shows how bankers’ pay is still in fantasy land.

As it’s a quiet time of year I thought I would take a look at my and my wife’s “net worth” (we jointly manage our financial affairs). Over 20 years ago one of my US business associates talked to me about his net worth which was something new to me and ever since then I have reviewed it occasionally. It’s something everyone should do to tell whether you are getting richer or poorer, separately from your stock market speculations. How do you work it out? You simply list and add up all your assets and debts – like this:

Assets:

  • Cash in your bank accounts
  • Value of your investment accounts
  • Your cars – market value
  • Market value of your home
  • Value of Business interests
  • Personal property, such as jewelry, art, and furniture
  • Cash value of any insurance policies and pensions

Liabilities (outstanding balances):

  • House Mortgages
  • Car loan and other loans secured against assets (e.g. H/P agreements).
  • Credit card balances
  • Student loans
  • Any other debts

The Net Worth is simply the Assets less liabilities. If it is growing from year to year you must be doing something right. If you are getting poorer every year, then you need to do some hard thinking. It gives you a “reality check” on your overall financial position. However there are clearly periods in your life when you are likely to be building up wealth (such as the CEOs of banks mentioned above) but in later life you might be consuming it or giving it away. At least that’s the conventional assumption.

How did we do in the last year? Net worth was up 7% which rather surprised me as UK stock markets have been down over the last year in capital terms and our house (in London outer suburbs) was not revalued as the market is static. We must donate some more to charity.

Dividends do help of course, particularly when a company pays them out twice! This morning I received duplicate cheques from Pets at Home (PETS). I contacted the company and have spoken to their registrar. They will let me know whether to present the cheques or not. I suspect they may want to cancel all the dividend cheques they have issued. This is the first time this has happened to me, and it simply looks like the same cheques have been printed twice. I suggest other holders of shares in this company await advice, not that many people receive their dividends in cheque form these days.

Persimmon (PSN) shares were down slightly today which is not surprising after the documentary about the defects in their newly built houses on a Channel 4 Despatches programme last night. It highlighted the poor quality of the houses while Persimmon was raking in money from the Government “Help to Buy” scheme which encourages house buying and has probably contributed to rising house prices. Persimmon has been making a profit of £66,000 on each home sold on average, and it was suggested that they paid more attention to the profits of the company than to their customers. Such profits also enabled enormous bonuses to be paid to their management.

I used to hold Persimmon shares but no longer. I have been concerned for some time about the future of the Help-to-Buy scheme and the general unaffordability of houses which may get a lot worse if interest rates rise. House builders are certainly looking cheap on fundamentals at present but can the bonanza continue much longer is the question investors need to ask themselves. A few more programmes like that on Channel 4 and the Government may decide there are better ways to help those without houses.

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

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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 )

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ShareSoc Seminar – Ideagen, Zegona, LoopUp and Anexo

Some brief notes on the ShareSoc Seminar I attended yesterday (10/7/2019). There were four companies presenting:

Ideagen (IDEA): This company has presented many times before to ShareSoc members and those who invested after the first such event will have done very well indeed (I hold the stock). This time we had CEO Ben Dorks presenting rather than Exec Chairman David Hornsby and Ben did a good job explaining their buy and build strategy for this software company. They now have 4,700 customers including many big names and 7 out of 10 UK audit firms – not that this seems to have solved most of the poor audit quality I commented on in a previous blog post probably because box ticking does not help when “judgmental” issues and failing to challenge management seem to be the big problems there.

Organic growth might be slightly reduced this year due to transition to an SAAS model but they plan to add £30 million in revenue from acquisitions. There were some interesting comments on how they integrate acquisitions – they “ideagenise” the companies, the people and the products!

A question arose concerning the apparent low return on capital of this company (as reported by Stockopedia et al). I have looked at this in the past and the key is to look at the cash flows and return on cash invested, as David Hornsby suggested.

Zegona (ZEG). This is an investment company that is investing in European telecoms operators where they think there are opportunities for consolidation. In essence a “buy, fix and sell” strategy. Their main investment at present is in Spanish company Euskaltel.

The financial ratios may look attractive but I doubt I can keep track of European telecoms operators and their regulatory environment so this looks like a “special situation” to me that is for the experts in this area only.

LoopUp (LOOP). This company provides teleconferencing services. I hold a very few shares in this company whose value has halved after a recent profit warning related to forecast sales revenue falling. It was therefore particularly disappointing that the Co-CEO who was due to present did not appear due to sickness. Instead we have Gareth Evans from Progressive Digital Media who provide research reports on the company. He covered the business well and he mentioned they use LoopUp themselves.

Recent problems allegedly relate to the slow build-up of new “pods” (sales teams), diversion of experienced sales staff into training and “general economic factors”. But I thought the general economy was doing well so I doubt that the latter is a good explanation.

One thing not mentioned in this presentation was the announcement on the same day that SFM UK Management (a subsidiary of Soros Fund Management) had acquired over 8% of the company so someone still has faith in it.

Progressive did supply their latest analysis of the company that shows forecast adjusted eps of 6.2p for this year and 8.5p next year which makes them not expensive on a p/e basis. I think this is one to monitor to see if there is no more bad news in which case it may be an opportunity to acquire a business with many positive characteristics.

But the share price fell again this morning. But that’s just following the trend in small cap technology stocks over the last few days – Ideagen included. That’s after a good positive run in such companies in the last few weeks. Small cap stocks are suddenly out of favour it seems and that’s nothing to do with Brexit as companies such as LoopUp and Ideagen will not be affected in any way and actually might benefit from the falling pound that has resulted from nervousness over Brexit.

Anexo (ANX). This is an interesting company that I had not come across before. It provides litigation and courtesy cars to impecunious drivers who have no-fault accidents. The company maintains a stock of vehicles to provide as courtesy cars but that includes a large number of Mercedes cars so not all their customers can be impecunious.

They mainly get their business from introductions from small vehicle repair shops, and claim a success rate of 98.5% in recovering from insurers. The latter consistently ignore claims until they are taken to court and just before a court hearing.

The management spoke well in their presentation and clearly have ambitions to grow the business substantially – they claim only 2% market share at present. But they do have to fund the cost of vehicle provision and legal costs before a claim is settled.

The business may be at risk of changes to the law on what can be recouped from third parties but it certainly deserves closer examination.

Just one general comment on the event. It is disappointing that several of the powerpoint presentations were poor. Too many words on them in too small a font and with not enough graphics to make the points they are trying to get across. This seems to be a common failing in small cap company presentations. The slides should support what the speaker is saying with a few key messages, not distract from the spoken words.

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

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ProVen VCT AGM Report

I commented on the results of ProVen VCT before their AGM on my blog. I said: “Total return to shareholders was 10.3% last year, but the fund manager did even better. Of the overall profits of the company of £18.6 million, they received £7.7 million in management fees (i.e. they received 41% of the profits this year). That includes £5.6 million in performance fees. Studying the management fee (base 2.0%) and the performance fee, I find the latter particularly incomprehensible. I will therefore be attending the AGM on the 3rd July to ask some pointed questions and I would encourage other shareholders to do the same. I am likely to vote against all the directors at this company”.

I did attend the AGM on the 3rd July in London, but so far as I could tell there were only two other ordinary shareholders present. No presentations and it was a hot day in London that might have deterred some from attending. In essence picking a summer day for an AGM and not providing any special reason for them to attend is a good way to put off shareholders from doing so.

But I did meet with the Chairman, Neal Ransome, and two representatives of the fund manager before the AGM commenced to go through the performance fee figures. The performance incentive fees are based on a very complex calculation which is essentially based on the growth in net assets of the fund plus dividends paid out, i.e. on Total Return. The manager gets 20% of any excess over a hurdle rate. The hurdle rate is the higher of a 25% uplift on initial net asset value or the initial net asset value compounded by base rate plus 1% per annum. That is on top of a “base” fee of 2.0% of net assets per annum payable to fund manager Beringea.

If one is going to have a performance incentive fee, that is not an unreasonable system. But I had already told Neal that I considered all performance incentive fees should be scrapped and a simple base fee used instead (as for example Amati AIM VCT use and other VCTs used before performance fees became common). Performance fees do not improve performance because managers have a good incentive to perform to the best of their ability anyway – if they do and the fund grows they get higher fees.

One complication in the calculation of the performance fees is that they are actually calculated separately on each of seven tranches of the funds that have been raised on previous years. There is also an additional PIF performance fee related to two specific investments. In essence, the calculation is so complex that no investor in the shares of this company could ever work it out or check that it is reasonable. I hope the auditors can do so.

The reason for the exceptionally high performance fee last year was explained as being due to the very high dividends paid out, which primarily were driven by the exceptional realisations during the year. Plus some “catch-up” from previous years having passed the hurdles. VCTs cannot generally hold on to cash because the VCT rules require them to reinvest the cash quickly which can be very difficult to do so and shareholders like the tax-free dividends anyway.

Investors have done reasonably well from this VCT (comparing them with generalist VCTs reported by the AIC), but over the last 10 years the average percentage of the year end net asset value represented by overall management and administration fees is 5.5% so the manager has done very well indeed.

The AGM was a fairly trivial event with only I and one other shareholder asking any questions. I voted against the reappointment of Malcolm Moss as I don’t like fund manager representatives on boards of trusts and told the board so – he was not present in person. All the directors should be independent in trusts which he is clearly not.

I asked whether there was any difficulty with the new VCT rules which requires a focus on earlier stage companies. Response was no but there was lots of money in the market so there was lots of competition for new deals and so pricing tends to be high.

I also asked about two of the holdings that suffered large write downs. Due to reduced market multiples on retail and ecommerce companies and underperformance respectively was given as the explanation.

Another shareholders asked about a possible merger of the two ProVen VCTs but it was said there are advantages in keeping them separate – for example it enables shareholders to sell from one trust and immediately reinvest in the other when if they did that in the same trust they would lose tax reliefs.

All resolutions were passed on a show of hands vote, with no significant proxy votes against any of the resolutions except for the remuneration report (4.9% against).

Are shareholders likely to revolt over the high levels of fund management fees at this company? I doubt it, but I think the directors should tackle this issue because the fees are unreasonable. The relatively good performance of the fund manager, which may be partly from chance, tends to end up in the hands of the manager rather than the shareholders. But if the fund underperforms it’s only the shareholders that will suffer.

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

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Renold Accounts, Audit Quality and Abnormal Price Movements

Chain maker Renold (RNO) has provided the latest example of sloppy accounting work. On the 9th July it reported that it had identified accounting issues in the three years ending March 2017, 2018 and 2019. Assets and profits were overstated and liabilities were understated in the Torque Transmission division. In total adjusted operating profits were overstated by £1.8 million. As a result the AGM is being postponed to give time for revising the Annual Accounts. Their auditors are Deloitte.

The Financial Reporting Council (FRC) have reported on their latest assessment of audit quality and it makes for dismal reading. Their target for assessed audits is 90% being “good or requiring limited improvements” but only 75% of FTSE 350 audits met that target. Overall there has been no improvement on last year.

Grant Thornton and PwC came in for particular criticism. Scrutiny of Grant Thornton has been increased and PwC is required to take “prompt and targeted action” to address their decline in performance. KPMG also continues to be subject to increased FRC scrutiny. The FRC suggests that all audit firms suffer from failing to challenge management sufficiently on judgmental issues, and need to work harder to solve this problem.

Comment: this has certainly been a long-standing issue that is driven by the desire of audit firms to reduce their prices to win business and reluctance to challenge management. Renewal of audit contracts with the same firm over many years contributes to the problem. The only way to break this system is to change how auditors are hired. At least that’s my personal opinion.

But the good news for investors is that the Financial Conduct Authority (FCA) have reported that abnormal price movements before deals are announced were down last year. In other words, market abuse has fallen by 12% and is now at its lowest level since 2006.

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

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Fascinating Ocado Interim Results Presentation

I watched a fascinating on-line presentation from Ocado (OCDO) this morning. The financial results are difficult to interpret due to heavy investment in new CFCs (Customer Fulfillment Centres, i.e. warehouses), the exceptional costs of a fire in their CFC at Andover and the time lag on new CFCs becoming operational. Key points though are that retail revenue was up 9.7% and Solutions Revenue up 20.6%. The Solutions business is that part of the group that builds and operates CFCs for other people. But the statutory loss increased substantially and the adjusted group EBITDA fell 46%.

The interesting aspect is more their future business plans. As the CEO, Tim Steiner, said “2019 has seen a shift in the centre of gravity of Ocado Group. We have pivoted from being a pure play online grocer in the UK with a separate Solutions business to being a technology-led global software and robotics business providing a unique end-to-end solution for online grocery”.

They are also investing in Karakuri which provides robotic meal preparation, and Jones Food that operates automated vertical farms. They also covered the Ocado Zoom service which promises delivery within one hour, and averages 30 minutes. They suggest this will be profitable even with delivery charges of only £1.99 or £2.99 and will compete with food delivery services such as Deliveroo, most of which lose money.

Ocado clearly has ambitions to revolutionise the retail food market and they have the funds to do so it would seem with no need for more fund raising required in the short term. But valuing the business is not easy.

The share price is up 5.7% today at the time of writing.

The presentation can be viewed here: https://www.ocadogroup.com/investors/reports-and-presentations/2019.aspx

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

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