Arron Banks on Leave.EU, Smithson and Patisserie

The Andrew Marr interview of Arron Banks was all good knock-about stuff but there was no knock-out blow inflicted. Andrew Marr was interviewing Arron Banks about his £8 million funding of the Leave.EU campaign. The Electoral Commission have recently asked the National Crime Agency (NCA) to investigate the matter as they apparently do not believe his story about the source of the funding. The suggestion has been made that the funding came from Russian sources or from a company registered in the Isle of Man (Rock Holdings) which would not have been permitted under electoral law.

You can watch the full interview here: https://order-order.com/2018/11/04/arron-banks-marr-interview-full/

Mr Banks made it clear that the money came from Rock Services Ltd and strenuously denied it came from other sources. Andrew Marr suggested Rock Services was a “shell” company and that neither that company nor Mr Banks had sufficient financial resources to cover the £8 million in funding.

It is of course a simple matter to look at the accounts of Rock Services Ltd at Companies House (it’s free to do so – go here: https://beta.companieshouse.gov.uk/search?q=rock+services+ltd ).

Rock Services Ltd hardly looks like a “shell” company which is normally used to describe a company with no revenue and no assets apart from possibly some cash. Rock Services had Turnover of £50 million for the year ending December 2017 but little in the way of profits or net assets. But it did have fixed assets of over £1 million. This is hardly a “shell” company in the normal usage of the word. The “Strategic Report” says the company’s “principal business activity is that of performing a recharge function for services for the Group and other related parties”. The profit of the company is generated from service charges added to costs and salary recharges.

Aaron Banks has been running motor insurance companies for many years and is involved in a group of companies which includes Rock Services, Rock Holdings and UK registered Eldon Insurance. I vaguely recall he was involved in a company called Brightside I held shares in from 2012/2014 which was publicly listed before being taken over. The accounts of Eldon Insurance can also be read at Companies House and indicate revenue of £77 million and profits of £1.8 million in 2017. Another substantial company in the Group is Southern Rock Insurance which is based in Gibraltar. You can see a complete list of group companies and their transactions through Rock Services Ltd on page 15 of their accounts.

In summary the allegation that Mr Banks or his UK companies did not have the financial resources to make the donation to Leave.EU is not reasonable, and Andrew Marr and his researchers should have looked into the background more before making the allegations he made.

As Mr Banks said in the interview, other donations were made to the remain campaign from subsidiaries of foreign companies. Why were they not being investigated? It certainly looks like a witch-hunt to me. It would seem to be more about politics than election regulation.

Note that Companies House is an invaluable source of information on companies and their directors. All investors should be familiar with it. It can be useful in other ways – for example I recently obtained a bid from a company to provide web site development work. That was done from the email address of a company that was different to that from which they suggested would do the billing. When I looked the former company up at Companies House it had actually changed name a couple of years ago and under its latest name had got appallingly bad references on the internet. Needless to say I decided not to do business with them.

Smithson Investment Trust (SSON) is now trading at a remarkable premium to net asset value of 7.4% according to the AIC after its recent IPO. Bearing in the mind the state of the market and the fact that it can hardly have yet invested the money raised (one might call it a “shell” company), it would seem investors are putting a high premium on the name of Terry Smith and his involvement in this trust. There must be investors out there who are purchasing shares at that premium to maintain this “discount” but that seems very unwise to me when most investment trusts have historically traded at a discount. The reason for this is quite simple – investment trusts incur costs in management and administration which reduces the yield and returns on the underlying shares they hold. Investors can always buy the underlying shares directly to avoid those costs. In the recent bull market and recognition of late of the merits of investment trusts, some have been trading at small premiums but a premium of 7.4% when the company has no track record and will be mainly holding cash seems somewhat unreasonable.

As I said when reviewing the IPO, it may be best to wait and see what transpires for this trust.

Patisserie (CAKE) and the recent General Meeting have been covered in several previous blog posts. I have previously mentioned that I was not happy that Luke Johnson did not answer my questions – he ruled them out along with a lot of others. When can a Chairman refuse to answer questions in a General Meeting? It was always judged to be matter of common law that questions should be answered but that has now actually been put into a Regulation.

I have written to Mr Johnson and my letter includes these paragraphs:

  1. As regards the conduct of the General Meeting, I suggest you not only handled it badly as Chairman but that refusing to answer my questions was a breach of The Companies (Shareholders’ Rights) Regulations 2009. There are valid grounds on which you can refuse to answer questions at General Meetings but the reason you gave for not answering mine (refusal to answer any questions that might prejudice the investigations) was not a valid one.
  2. Holding a meeting a 9.00 am is also not good practice. This note published by ShareSoc (and partly written by me) gives guidance on how to run general meetings, and includes references to the law on the subject: https://www.sharesoc.org/How_To_Run_General_Meetings.pdf

If you study the aforementioned regulations, you will see that the directors can refuse to answer questions that would require disclosure of confidential information or “if it is undesirable in the interests of the company or the good order of the meeting that the question be answered”. That may be quite broad but it hardly covers the questions I posed and the answers to my questions would certainly not have prejudiced any investigations.

I have therefore asked him to answer the questions in my letter. He may have other things on his mind, but all company directors should be aware of the law, or take legal advice when required.

Shareholders should not allow directors to ignore their responsibility to answer reasonable questions.

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

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Earthport Accounts, City of London IT and Patisserie

Earthport (EPO) is the latest AIM company to report that its past accounts are not all they should have been. Following a review by the new CEO and CFO, it seems there have been errors in reporting of forward foreign exchange transactions. This will result in fair value adjustments and a reduction of £6.3 million to £16.6 million in the net assets of the group at June 2017. Likewise adjustments are required to previous years. Reported earnings are also reduced although there is no cash impact.

This is a payments business which has been consistently loss making despite growing revenue. The former Chairman and CEO (who was still on the board as a non-exec director) have departed “with immediate effect”. This is surely yet another case of audit failure. Who were the auditors? Answer: RSM. But it’s worth reading their audit report in the 2017 Annual Report where they highlight some problems in the same area.

I do not currently hold shares in Earthport and this latest news is hardly likely to inspire confidence in the company from investors. After many years, the company has not proved it has a business model that can generate any profits.

Pressure of business meant I missed attending the City of London Investment Trust (CTY) Annual General Meeting on the same day as the Patisserie General Meeting. This is one of my most boring holdings as it’s mainly invested in large cap UK companies. But no problem in not attending the AGM in person because there is a recording of it available here: https://www.janushenderson.com/ukpi/content/trustslive?o_cc=c3926 . That even includes the question/answer session which was omitted in a previous year. If you watched it while it was taking place you could also submit questions. This approach is to be highly commended.

The interesting comment I noted from fund manager Job Curtis was that they had recently put more money into the market and were gearing up. He clearly perceives there are value opportunities in the market after recent declines. Others seem to agree with him because the market is now picking up.

Just one postscript on the Patisserie (CAKE) General Meeting. Lombard in the FT (Matthew Vincent) questioned this morning whether placings were the only option. He suggests the company could have delayed and done a rights issue. This is basically the same issue that was raised at the Meeting by some shareholders. But it’s very unrealistic to suggest that was a viable option. In reality I think the appetite for a rights issue would have been very low because of the lack of financial information on the current position of the company. I certainly would not even have participated in the placing! Undertaking a rights issue when there was great uncertainty about the level of support would hardly have been recommended by any advisors. In addition it would have taken a lot longer to do that than it took to do the first placing. Time is of the essence in the circumstances the company faced and looking for bankers to fill the delay hardly looks realistic to me either.

I suggest Luke Johnson took the only reasonable steps available and he should be thanked for saving the business. Shareholders should be very glad that the company did not get stuffed through a pre-pack administration which is what I rather expected would happen, in which case they would have lost everything.

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

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Patisserie General Meeting – No Excitement But Few Questions Answered Either

I attended the General Meeting of Patisserie Holdings (CAKE) this morning at the ungodly time of 9.00 am – presumably chosen to deter attendance. An announcement earlier from the company will also have deterred attendance as it said no questions on past events would be answered so as not to prejudice investigations by “multiple regulators and authorities”. But there were about 20 shareholders present, including some institutional representatives.

This GM was to approve the second tranche of share placings and I expected it to be voted through which it was on a poll by more than 90% of shareholders. To remind you this company was on the brink of going into administration after the board discovered the accounts were false and the claimed cash on the balance sheet non-existent. In fact it was stated in the meeting that net debt was more like £9.8 million rather than as previously stated. Executive Chairman Luke Johnson kept the company alive by giving it an interest-free loan and arranging an emergency placing. As I said in the meeting, I considered the company had no better alternative to the actions taken having been involved in other similar problem situations before. I think shareholders (including me) are very lucky that Mr Johnson chose to take the steps he did. Mr Johnson reiterated there was no viable alternative several times in the meeting because there was no time to arrange anything else. He indicated later that he had not participated in the placings because he did not want shareholders to think he was acquiring shares cheaply and hence his interest in the company will now be diluted (he’s now down to 28%).

However there were several shareholders who expressed their unhappiness at the turn of events as one might have expected. There was one particularly vociferous shareholder who suggested that shareholders will lose 88% of their value as a result of the placings and that there should have been a rights issue instead. The shareholder said it was immoral, and unfair.

Mr Johnson opened the meeting by thanking shareholders for the messages of support he had received in the recent dark days. The board was doing everything it can to safeguard the company. There was potential fraud and a miss-statement of the accounts. Those errors are likely to have affected previous annual accounts.

He said that regulatory authorities including the SFO were investigating so he could not comment further. He believed it was a business worth saving and he had committed to reduce his other activities (in response to a question later he said he no other roles now).

Chris Boxall from Fundamental Asset Management asked if those supporting the placings had access to more information that others, i.e. other than that publicly disclosed? The answer was no. Comment: they must have faith in Luke Johnson because with so little information available it is very unclear what the future profitability of the business might be and there are big potential liabilities.

In response to other questions he said current trading had not been affected, although two sites had been closed. They are recruiting new staff when asked about management changes.

I tried to ask two questions:

  1. Is it possible the company could become liable to compensate shareholders for the “market abuse” related to the issue of false accounts [on which basis some investors will have purchased shares]? This is surely a similar situation to the case of Tesco where the FCA instructed the company to pay compensation. Shareholders taking up the placing shares might be interested in the answer. Mr Johnson refused to answer the question.
  2. Have you appointed lawyers to pursue claims against the former finance director (Chris Marsh) in respect of the fraud or to recover the value of share bonuses paid to him and the CEO (Paul May) on the basis of the false accounts? Mr Johnson refused to answer that question also.

Note that as this was a General Meeting there was no good reason not to answer those questions as they could not possibly prejudice the investigations by the legal authorities. This is an abuse of company law and I will be making a complaint about it.

What can shareholders do at this point? Not a lot but just await the results of the investigations and possible subsequent actions by the legal authorities. This might take many weeks, months if not years from past experience. The shares will remain suspended for the present. But I suggest shareholders should do the following:

  1. Write to Luke Johnson requesting that the company takes all possible legal steps to recover loses to the company that have resulted from the fraud from those who perpetrated the likely fraud, and in addition take steps to recover the value of shares issued to former and current directors under share option schemes that were based on the false profits that had been declared. In addition the company should examine the role of the auditors as it appears that they may have failed to pick up the accounting errors and failed to check all relevant bank balances and hence there may be a claim against them. Note: it is a lot easier for the company to sue former directors or auditors than it is for shareholders, however much they may wish to forget about it and move on.
  2. Write to the Financial Conduct Authority stating you were induced to invest in the shares of the company based on false accounts and encourage them to pursue legal actions against those at fault accordingly. In addition as this was a case of market abuse (similar to that at Tesco), request that the company be forced to compensate the affected investors accordingly. You should also encourage them and the SFO to move as fast as possible in their investigations as they are not known for speed in such matters.

So that’s a summary of the meeting held on a gloomy wet day in London – which probably matched the mood of the shareholders present. There were members of the press there getting their views no doubt for publication in the media later.

To look on the bright side, as I have an enormously diversified portfolio I found on exiting the meeting that my overall portfolio had risen more that morning than my potential losses on Patisserie simply as the overall market picked up. I may therefore be more sanguine than others. There is a lesson there of sorts for investors, but I also consider myself relatively lucky.

As someone said to me in the meeting, this was a company where there were no warning signs that investors could easily pick up in respect of the accounts. Investors cannot blame themselves for investing in what appeared to be a sound, profitable company from the accounts. Fraudulent accounts can fool even the most experienced investors.

Picture below is of Patisserie café in King’s Cross station take on my way to the General Meeting.

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

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Patisserie Cafe 2018-11-01

Bad News from Crawshaw and ULS, Ideagen AGM, Victoria Doubts and Other News

The real bad news today is that butchers Crawshaw (CRAW) is going into administration, “in order to protect both shareholders and creditors”. They hope the business will be sold as a going concern but it is unusual for shareholders to end up with anything in such circumstances. The shares have been suspended and the last share price was 2p. It actually achieved a share price of 3425p at its peak in 2005. Revenue have been rising of late but losses have been also.

I never invested in the company although I do recall seeing a presentation by the company when it was the hottest stock in the market but I considered it to be a business operating in a market with no barriers to entry and likely to suffer from competition once the supermarkets had woken up to what it was doing. That’s apart from the difficulties all high street retailers have been facing of late. Well that’s one disaster I avoided at least.

Another AIM stock I do hold is ULS Technology (ULS) who operate a conveyance service platform. A trading statement this morning for the first half year said the revenue is expected to be up 3% and underlying profit up 5%, despite a fall of 4% in the number of housing transactions across the UK market. But the sting in the tail was the mention of a slowdown in mortgage approvals which “may well be short lived but is likely to have some impact on the Group’s second half results”. The share price promptly dropped 20% this morning. It’s that kind of market at present – any negative comments promptly cause investors to dump the shares in a thin market.

One piece of good news for the housing market which I failed to mention in my comments on the budget was that the “Help to Buy” scheme is not being curtailed as some expected, but is extended for at least another two years to 2023.

Yesterday I attended the Annual General Meeting of Ideagen (IDEA), another company I hold. It was unexciting with only 4 ordinary shareholders in attendance so I won’t cover it in detail. But boring is certainly good these days.

It was the first AGM chaired by David Hornsby who is now Executive Chairman. One pertinent question from a shareholder was “what keeps the CEO awake at night?”. It transpired that the pound/dollar exchange rate was one of them simply because a lot of their revenue is in dollars (their US market seems to be a high growth area also). I suggested they might want a “hard Brexit” when the pound would collapse and improve their profits greatly. But the board somewhat ducked that issue. Note that this business is moving to a SAAS revenue model from up-front licence fees which may reduce organic growth slightly but increase revenue visibility. The point to bear in mind here is that even on a hard Brexit it is unlikely that trade tariffs would impact software income because there are no “goods” exported on a SAAS model.

Another question asked was about financing new acquisitions which the company does regularly. These are generally purchased for cash, and share placings are done to raise the funds required. Debt target revenue is only one times EBITDA so debt tends to be avoided.

It is worth comparing that with Victoria (VCP) a manufacturer of floor coverings who issued a trading statement on the 29th October which did not impress me or anyone else it seems. Paul Scott did a devasting critique on Stockopedia of the announcement. In summary he questioned the mention of a new debt being raised, although it was said that this would be used to repay existing debt, when there were few other details given. He also questioned the reference to reduction in margins to maintain revenue growth. The share price promptly headed south.

The company issued another RNS this morning in response to the negative speculation to reassure investors about the banking relationships, covenants and credit rating.

I have held a few shares in Victoria since the board bust-up a few years back and attended their last AGM in September when I wrote a report on it here: https://roliscon.blog/2018/09/11/brexit-abcam-victoria-and-the-beaufort-case/ . The share price was already falling due to shorters activities and my report mentioned the high level of debt. The companies target for debt was stated to be “no more than 2.5 to 3 times” at the AGM which is clearly very different to Ideagen’s!

I did have confidence in Geoff Wilding, Executive Chairman, to sort out the original mess in Victoria but the excessive use of debt and a very opaque announcement on the 29th has caused a lot of folks to lose confidence in the company and his leadership. Let us hope he gets through these difficulties. But in the current state of the stock market, the concerns raised are good enough to spook investors. It’s yet another previously high-flying company that has fallen back to earth.

One more company in which I have a miniscule number of shares is Restaurant Group (RTN) which I bought back in 2016 as a value/recovery play. That was a mistake as it’s really gone nowhere since with continuing declines in like-for-like sales. At least I never bought many. Yesterday the company announced the acquisition of the Wagamama restaurant chain, to be financed by a rights issue. The market reacted negatively and the share price fell.

I did sample some of the restaurants in the RTN portfolio but I don’t recall eating in Wagamama’s so it’s difficult to comment on the wisdom of this move. All “casual dining” chains are having difficulties of late as the market changes, although Wagamama is suggested to have more growth potential. The dividend will be rebased and more debt taken on though. With those reservations, the price does not look excessive. However, while they are still trying to get the original business back to strength does it really make much sense to make an acquisition of another chain operating in the same market? Will it not stretch management further? I will await more details but I suspect I may not take up the rights in this case.

One other item of news that slipped through in the budget announcements was the fact that in future Index-linked Saving Certificates from NS&I will be indexed by Consumer Price Index (CPI) rather than the Retail Price Index (RPI). This is likely to reduce the interest paid on them. But it will only affect certificates that come up for renewal as no new issues have been made of late. These certificates are becoming less and less attractive now that deposit interest rates are rising so investors in them should be careful when renewing to consider whether they are still a good buy. I suspect the Chancellor is relying too much on folks inertia.

At least even with the bad news, my portfolio is up significantly today. Is the market about to bounce back? I think it depends on consistent price rises in the USA before the UK market picks up, or a good Brexit deal being announced.

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

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Budget Summary – Austerity Coming to an End

Philip Hammond’s budget today can be summarised as:

  • More money for the NHS.
  • More money for the MOD.
  • Money for schools.
  • More money to fix potholes.
  • More money for housing.
  • More money for the Universal Credit scheme.

Yes “austerity” is being relaxed. Changes to taxation are relatively minor, but there will be a new tax on “digital platforms” which is clearly aimed at large companies such as Facebook and Alphabet (Google) who generate large revenues from their operations in the UK but pay very little tax on the resulting profits. There will also be a new tax on plastic packaging (comment: that could have been tougher if the problem of plastic pollution is to be tackled). These new taxes may be at relatively low rates initially but once a new tax regime is in place, the rates tend to go up if history is any guide.

Fuel duty is frozen, beer and cider duty are frozen, spirits duty is frozen but wine duty will rise to match the increase in the cost of living. Tobacco duty will rise also.

There will be a new Railcard for the 26-30 age group to help the millenials.

Personal income tax allowances will rise in April 2019 – £50,000 for higher rate taxpayers. And capital gains tax allowance will rise to £12,000.

All the suggestions about changes to pension tax relief, inheritance tax and AIM tax advantages seem to have been ignored, so there is little to dislike about this budget for stock market investors.

In summary a confident performance from Mr Hammond with an avoidance of unnecessary changes to taxation which helps with longer term planning.

More information available from the Treasury here: https://www.gov.uk/government/news/budget-2018-24-things-you-need-to-know

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

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Which Way Is The Market Headed?

Whenever one meets with other investors of late, a question they ask is “”Which way do you think the market is headed?”. One of my sons also asked me that question and I said to him that I had no real clue, although it might continue in the same direction. I give my reasons in this article.

The weekend papers are full of explanations of the recent market declines, and prognostications about the future, by experienced financial journalists. This was no doubt at the behest of their editors who understand that readers are looking for simple answers. When the markets are in rout, the key thoughts of investors are likely to be should I sell, to protect my portfolio value by moving into cash, or should I buy now that shares are becoming cheaper and possible bargains appearing?

FTSE Chart

Having been through more than one boom and bust in my investing career (chart of the FTSE All-Share in that period above showing percentage change in capital value from 1997), I only make predictions about the market in extremis, i.e. when it looks ridiculously expensive or ridiculously cheap. You can see that so far there has only been a minor correction in the last few weeks. Incidentally that chart shows that the FTSE All-Share is up about 70% in that period while my own portfolio is actually up 270% which I track in a similar way.

Some of the influences that are currently being talked about are the trade wars between the USA and other countries, the impact of Brexit, the ending of QE and higher interest rates, the view that shares had become too expensive, and general despondency. When markets are in decline, all news tends to be treated as bad news. So when the US economy is reported as continuing to grow strongly, this is viewed as negative as it means higher interest rates will come in sooner.

The fact of the matter is that markets are driven by expectations and emotions as much as hard facts. It is undoubtedly true that most investors portfolios are showing very healthy returns in the last few years so everyone is holding on to large profits. That is still true even after the carnage of the last few weeks. But just reading a few tweets issued by investors tells you that many are now showing a loss on the year to date. This makes them nervous.

It’s also true that the long, uninterrupted bull run has pulled many people into stock market investment who think it might be an easy way to make money when cash earns little on deposit and the housing or buy-to-let markets are no longer attractive.

There is one truism though. Once markets start moving in a certain direction, then they tend to continue in the same direction, driven by emotion. Just as share prices of individual companies show high short-term correlation, so do share prices in general. They can both be driven by “momentum” traders now that everyone knows that momentum is a key aspect of successful investment strategies.

Just considering the UK market, where most of my readers are probably invested, it’s also true that UK market trends are dictated by US market trends and other international markets over night. What happens in the morning on trading days in the UK tends to follow what happened in the USA the previous day/night. It’s always worth keeping an eye on the S&P 500 to check that – see this web site for a useful chart of a daily view (or longer periods): https://www.bbc.co.uk/news/topics/c4dldd02yp3t/sp-500

Will that tell you which way the UK market is headed? Only in the sense that trends tend to persist, until they reverse and are driven by international dynamics. Trying to guess which way it’s headed is a waste of time, and effort.

As a result, some folks take the stance that they’ll hold their portfolios unchanged through thick and thin. If you are an institutional investor, where you are paid to invest client’s money in shares, not in cash and your earnings depend on portfolio value commissions, you may not have much choice. But private investors do.

My view is that trying to be contrarian in market declines makes no sense except in extremis. Following the trend is sensible, until there are obvious highs and lows where reversals might take place. So I sell on the way down, and buy on the way up, while trying not to over-trade (i.e. not react to short term moves which tend to be expensive in terms of spreads and broking charges). I also take into account the nature of the stocks and any capital gains tax liabilities that might result, i.e. I will sell those showing a loss or hold those where tax would be incurred. That also means I prefer to sell those in my ISAs and SIPPs where tax consequences can be ignored. The current market is also a good time to rationalise my portfolio which has too many stocks in it and is overdiversified.

In relation to the nature of the stocks, those hardest hit by any general market decline are those that are small and speculative so they are the first to go. In a market rout everyone starts looking at whether the company is making real profits, generating cash and paying dividends in the short term, not to a sunlit horizon in the future.

That’s not to say that I have suddenly fallen out of love with growth stocks. But there is good growth and there are speculations. Companies that have good technology, good business models, and are generating good returns on capital are still the ones I like to own. The recent figures from Amazon and Alphabet (Google) were seen as negative because the growth in sales and profits appeared to be slowing – but they are still growing at a very brisk rate in comparison with old economy stocks. They are both now very big companies so at some point growth was likely to slow, but there are many smaller technology companies who can achieve great growth rates irrespective of the overall state of the economy.

At this point I do not see that we are near a turning point, but neither do I try to predict one. Shares look neither ridiculously expensive or ridiculously cheap unlike say back in 2008 for example when doom and gloom pervaded everywhere. There is no good reason to pile back into bonds with short term interest rates still low and the UK and US economies looking healthy.

To track the trend while managing cash I follow a simple rule – if my overall portfolio falls by £10,000 I sell £10,000 worth of shares and put the resulting cash on deposit. That way assuming you have an unleveraged portfolio you can never go bust. If my portfolio and the market start to rise, I’ll move the cash back into shares.

In summary, I am following market trends and in the meantime am just looking to hold good quality companies and buying more where there are suitable buying opportunities, while disposing of the dogs. I don’t try to bet against market trends.

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

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Standard Life UK Smaller Companies AGM, WPP and Tesla

For those folks who invest in smaller companies, it’s always educational to attend the Annual General Meeting of Standard Life UK Smaller Companies (SLS) which I did today. This investment trust has been managed by Harry Nimmo and his team for many years and he has consistently beaten the company’s benchmark (currently Numis Smaller Companies Plus AIM index).

Harry’s presentation highlighted that smaller companies were a “great place to be until the last 4 weeks”. He said that we often see sharp setbacks toward the end of the economic cycle. One tends to see bursts of selling in the high performing stocks with profits being taken (one example being Fevertree he mentioned). There are some concerns in the market about the US prospects, rising interest rates, Brexit and other worries. But he suggested investors need to have a long-term perspective and hold the shares for 6 years or more.

The investment process followed is unchanged. They use a proprietary stock selection process focused on quality, growth and momentum. See pages 12/13 of the Annual Report for details. Valuation is secondary, i.e. they don’t buy “cheap” stocks. New purchases for the portfolio were Gooch & Housego, Alpha Financial Markets, Safestore, Blue Prism and Gym Group (note: I have bought a couple of those recently also). As an aside, Blue Prism still looks relatively expensive to me although it’s down 35% from its peak share price in the recent market crash.

There were a number of questions on the merger with Dunedin Smaller Companies Trust which was recently voted through. I voted against it because I could see the benefit for the Dunedin holders and for the manager but not for SLS shareholders. The benefits were argued to be “reduction in on-going charges” and “enhanced liquidity”, but when I asked what the actual reduction in charges might be, nobody seemed able to supply an answer. I also have doubts about the liquidity argument as Dunedin was substantially smaller than SLS, i.e., the extra assets acquired won’t add a great deal. The disadvantage of a larger trust, particularly in the small cap sector, is that it makes the manager less nimble, i.e. more difficult to get in and out of stocks. I remain to be convinced that this merger made sense for SLS holders but it may not be too damaging.

One somewhat irate shareholder berated the board for paying out too much in dividends (most of the “income” received) when the company is supposed to be focused on capital growth. I supported the board because in fact only a very small proportion of the overall profits are paid out in dividends. The current dividend yield according to the AIC is only 1.6% and many shareholders do like dividends. Trusts that don’t pay any or have very small dividends tend to have larger discounts to NAV.

Another interesting question was on the investment in AIM shares and the risk to AIM from changes to Inheritance Tax Relief (IHT). Harry said the AIM market had improved considerably in the last 6/7 years, from being full of rather “dodgy” companies to being a broad spectrum of growth stocks. He suggested this was important to the UK economy and it both creates wealth and jobs. The Chancellor would likely be careful on withdrawing tax benefits. Comment: I don’t judge that as a big risk and even if IHT relief was withdrawn any substantial decline in AIM share prices might simply draw in other investors to replace those only interested in IHT relief.

I asked Harry Nimmo a couple of questions after the formal meeting finished. How did he avoid investing in Patisserie shares? It seems they did not altogether and mentioned the company met their investment criteria, based on the false accounts. I also asked him about the changes to the Abcam remuneration scheme, a company they hold. It seems their corporate governance team had made representation on the subject to Abcam (see my previous blog post on that subject).

In summary, a useful AGM to attend, as many are. This is a very good trust to hold in my view if you don’t wish to speculate in individual small company shares. But smaller company shares can be more volatile in times of market panics, so SLS is down 18% since late September. That’s certainly not been helped by profit taking in such shares as Fevertree (their biggest holding at the year-end), First Derivatives, Dechra, etc, although the company had often reduced their holdings below their target maximum of 5% of their portfolio before the recent crash.

Bad news today in a trading statement from WPP the advertising agency business. This was brought to my attention by one of the attendees at the above AGM as I don’t hold it. I suggested the likely problem was the advertising world is becoming digital, bypassing the traditional agency model. In addition there were few barriers to entry in the advertising agency world. New businesses could be created by two men and a dog (or two women I should probably have said to be PC). The share price of WPP is down 14% today. This is what I later discovered the company had said: “As previously stated, our industry is facing structural change, not structural decline, but in the past we have been too slow to adapt, become too complicated and have under-invested in core parts of our business. There is much to do and we have taken a number of critical actions to address these legacy issues and improve our performance”. On a prospective p/e of 9 and yield of over 5%, I think following Harry Nimmo’s policy of not buying stocks just because they are cheap is probably good advice.

But let’s talk about good news for a change. Tesla have declared a profit in the third quarter. Cash flow also improved and is expected to be positive in the fourth quarter. So the doomsayers about this company might have to change their stance. There may still be risks associated with this business, particularly the management style of Elon Musk, but they are rapidly changing the auto industry through new technology. Traditional car makers are facing major disruption to their business, or as the FT put it in a headline to a long article yesterday: “German carmakers face their i-Phone moment”. Even Dyson is getting into the electric car business and opening a plant in Singapore to produce them. Technology is changing our world more rapidly than ever, and the pace of creative destruction in business continues to rise. Smaller companies tend to be leaders of such changes, in the advertising world, in car manufacturing (relatively) and in many other fields.

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

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Yu Group Crashes, Patisserie Holdings LTIPs and Audit Quality

The latest example of defective accounts in small cap companies is Yu Group (YU.) who announced this morning that accrued income had not been recognised correctly, that trade debtors need impairing and gross margins will not be as expected. The result will be a £10 million reduction in profitability when compared with current market expectations so there will be a loss for the current financial year. The shares are down over 80% at the time of writing.

Yu Group are a utility supplier to SMEs and listed on AIM in 2016. It would seem likely that these problems go back into past years. The auditors are KPMG.

The latest announcement from Patisserie Holdings (CAKE), after a note published in the FT yesterday on directors’ share options and their exercising is a clarification of the LTIPs. It ends by saying that “The Company, as part of the on-going investigation, is seeking to understand why the grant of options relating to 2015 and 2016 have not been appropriately disclosed and accounted for in its financial statements”. So that looks like another bit of bad news as one might expect now that everyone is looking very carefully at the past reporting by this company. But this is surely another matter that should have been picked up in the last audit.

It’s not just small companies that have audit problems. BHS and Carillion are recent examples of large companies where the reported accounts were suspect. How to improve the quality of audits? One big issue in my view is the fact that audits are often priced as low as possible to get the business. Companies tender for audit services and they are likely to pick the lowest cost bid, thereby relying on regulations to ensure that the standard is acceptable. Most company directors believe their internal systems are good and their staff trustworthy, so why should they spend a lot of money on an independent review of same? Meanwhile audit firms use audits as a loss-leader to build a client relationship that enables them to obtain much more lucrative consultancy work.

One change that would improve matters would be to ban audit firms from taking on non-audit work from the same client.

Another improvement would be to have someone else than the directors appoint the auditors. It has been suggested that an independent body be set up to do that, but perhaps the best solution is to have shareholders select and appoint the auditors via a shareholder committee. Shareholders have the most interest in seeing accurate accounts published and shareholder committees have many other advantages, as has been advocated by ShareSoc of late.

Regulation only ensures adherence to high standards if the penalties for getting anything wrong are severe. But that is not the case at present. Very few cases of defective accounts ever result in the auditors being severely penalised because they have numerous possible excuses for not discovering what was wrong. The Financial Reporting Council (FRC) needs to get tougher and be less dominated by the audit profession.

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

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Meeting with Link Asset Services

I recently attended a meeting with Link Asset Services who claim to be the largest UK share registrar. In addition to me there were two senior managers from Link and two ShareSoc directors (Mark Northway and Mark Bentley). ShareSoc and I do of course have a long-standing interest in ensuring shareholders can and do vote their shares at General Meetings. Other matters discussed were the problems created by nominee accounts, in the Shareholder Rights Directive (SRD), in the Central Securities Deposit Regulation (CSDR), in dematerialisation, and many other issues related to shareholder’s rights. I hope that rather technical, long-winded sentence does not put you off reading this note because there were many important issues discussed.

We first discussed one of the personal issues I had raised with Link – namely the issue of paper proxy voting forms not being issued by many companies. See previous blog post on that subject at one company here: https://roliscon.blog/2018/09/20/worldwide-healthcare-trust-agm-but-no-proxy-voting-form/ . One of the reasons we are getting poor corporate governance and wildly excessive director pay in some companies is because private shareholders generally do not vote at General Meetings.

It was explained that one reason for this change is that it does actually increase the percentage of shareholders who vote. It seems if investors receive a paper proxy card, they often put it aside to deal with later but never do, or perhaps can’t be bothered to go to a post box. Link’s experience is that investors are more likely to vote when prompted to do so by email (even more so, if SMS can be used).

Link gave us some figures on proxy voting which as we already knew are astonishingly low. For shareholders on the register only 5.5% actually voted in the last year, out of 5.6 million holders. The percentage of shares that were voted was much higher at 63% but that is probably because institutional investors do vote more reliably.

The low turnout of individual shareholders I would guess is for a number of reasons. Some think they have no influence on the outcome which will be determined mainly by institutional shareholders so don’t vote except on critical events, those on the register may be long-standing holders of one or two paper share certificates, but the big problem by far now is the number holding their shares in nominee accounts where the broker does not provide an easy to use proxy appointment system. More on this issue later.

I did express an aversion to using the Link app (SignalShares) to vote but was assured it was easy to use and I would still get paper annual reports if requested. However, I have since tried to register for the app and as a Personal Crest member it’s damn difficult. It asks several questions which were difficult to answer. It not just requires your Investor Code (which will be on dividend payments, IF the company pays a dividend). But it also asks for your Crest Id, which no Personal Crest member normally ever needs to know and I could not easily find, and your Crest Member Account Number and I have no idea what that is at all. So I gave up. I still feel that paper proxy voting forms should therefore be sent to shareholders, particularly Personal Crest Members. If a Notice of a General Meeting is being posted, as is legally required, it’s not much more cost to include a proxy voting form.

I have had problems with registering for voting services with other registrars so I still feel it is unsatisfactory to remove paper proxy voting forms. Suggesting you can phone up to get one if necessary is not a satisfactory solution. Just time wasting. Even if I could manage to register for their app, that would still leave the problem of having multiple accounts and multiple log-ins for different holdings. It’s just too complicated. I might have to use my own form as I have previously suggested if Link and the companies that employ them persist with this approach – see https://www.roliscon.com/proxy-voting.html . Link stated that they were perfectly happy with this (as they are legally required to do), as long as the form was filled in clearly.

If all the registrars could get together and provide a common electronic voting system for all share holdings that was easy to use, and register for, then I would welcome it. But at present it’s a dog’s breakfast of a system.

Other matters discussed with Link were:

Impact of Brexit. One issue here is that companies listed on the Irish stock exchange are currently registered within the Crest system but that would no longer be approved if the UK exits, particularly on a “hard” Brexit. There may need to be an alternative clearance system put in place for Irish listed companies.

Dematerialisation: Nothing is happening, as usual no progress it seems. It would be required if we had stayed within the EU or agree regulatory compliance of financial services with them, but the Government has other things on its mind at present.

Ensuring all shareholders in nominee accounts are enabled to vote via their nominee operator. This requires a simple change to the Companies Act which again is not likely to happen in the near future. Note that some brokers do provide an easy to use service in this regard – e.g. the Share Centre with their own system and others via Broadridge. But investors still have difficulties with AIM companies and knowing when a vote is due. It was suggested it would be helpful if registrars or nominee operators could advise shareholders when a vote was due via email. Even those nominee operators who don’t offer a voting service legally have to do so for ISA accounts under the ISA regulations. It was agreed that it was key to getting people to vote that they be notified by email or text message when a vote was due, although personally I would not be keen on text messages.

An alternative is for all nominee accounts to be uploaded to the share register before a vote takes place and then registrars could solicit votes from everyone. But there are potential timing issues here.

Improving voting turn-out. Another reason why many shareholders do not vote, in addition to the reasons given above, is because they do not understand the resolutions on AGM agendas, or cannot easily decide how to vote. For example, Remuneration Reports can now run to many pages. Will private shareholders spend the time to read that part of the Annual Report and understand it? Unlikely particularly as many will not even see the Annual Report. ShareSoc is working on an initiative to tackle this problem which is for them to provide a proxy advisory and voting service that will actually vote an investor’s shares based on ShareSoc recommendations if they register for the service.

The impact of the CSDR. This is being implemented in UK law. The problems at Beaufort were discussed and the fact that nominee holdings are generally “pooled”, i.e. undesignated and hence there are no individual holdings recognised in the Crest system. This means there can be problems when a broker collapses because the shares held by clients may not have been recognised in the pooled share registrations. In fact this did not seem to be a significant problem at Beaufort whose records were generally accurate but has been at other failed brokers. There needs to be some regular reconciliation of client holdings to pooled Crest holdings it was suggested. Needless to say this would not be a problem if designated (i.e. personal named) accounts were used, which are supported by Crest already. One aspect that might help is that one of the new CSDR regulations (38.5 was mentioned) requires an account to be designated if the client requests it. But will the brokers even tell their clients about this?

The trend in share registration was discussed. The numbers of individual shareholders on share registers is not falling apparently, which contradicts what I was told by one broker a few years ago when he said that dematerialisation will not become a problem as soon all paper share certificates will disappear. That appears not to be the case. We do need dematerialisation, i.e. a new electronic share registration system. But Personal Crest members are declining rapidly as brokers are now actively discouraging the use of that system and withdrawing it.

Attendance at General Meetings. Not only are the number of proxy votes submitted by shareholders low but attendance at AGMs is also low. In small cap companies there are often no ordinary shareholders present – and that’s not just companies who hold their AGMs at inconvenient times or inconvenient locations. It was generally agreed that “hybrid” AGMs were the way to go, i.e. having both a physical meeting and on-line interactive web-cast where you can ask questions. In the short-term just web-casting an AGM can be helpful to some investors.

Regulation of share registrars was discussed. This is something I have advocated recently. Registrars are a key component in the UK financial system so it is odd that they are not regulated. I suggested that possibly some informal code of practice could be developed – perhaps sponsored by ICSA – as a step in the right direction.

In summary it was a useful meeting and no doubt some of these issues will be discussed in future meetings.

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

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Alliance Trust Savings Sold

Alliance Trust (ATST) has sold its Alliance Trust Savings (ATS) subsidiary to privately-owned company Interactive Investor. The ATS investment platform was always a peculiar business for a traditional investment trust to be holding. It was also consistently loss-making and reported an operating loss of £19.3 million in 2017 after a big write down of intangible assets. The directors valued the ATS business at £38.3 million in the 2017 accounts and Interactive Investor are paying £40 million for it but it looks like they are getting the Dundee offices of ATS valued at £4.9 million in addition.

The ATS business will continue to operate from Dundee as will Alliance Trust itself. But there will presumably be some rationalisation of IT systems in due course so clients of ATS may need to learn new software eventually. Charges might also presumably be harmonised also. Interactive Investor charge a fixed quarterly fee of £22.50 which covers some trading fees. Otherwise trading charges are £10 per trade, or less for frequent traders. This structure means that charges do not rise as your portfolio grows and is particularly well liked by those with larger portfolios.

The disposal of ATS was always on the cards after the revolution and board changes a couple of years ago at Alliance Trust. This looks a good deal for both Alliance Trust and users of the ATS platform. It completes the dismantling of the empire built by former CEO Katherine Garrett-Cox.

It is also another step in the consolidation of the “investment platforms” market which is certainly a trend as a lot of them aren’t making much in the way of profits at present (other than Hargreaves Lansdown covered in the previous blog post).

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

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