Mothercare Downfall – A Breakdown in Trust?

Mothercare (MTC) have announced that its two UK operating subsidiaries are going into administration. The company services over 1,000 stores worldwide, and apart from the UK they report a profit. But losses in the UK more than offset profits in the rest of the world if you read the last annual report. The share price has fallen 30% today at the time of writing.

There were clear warning signs here. For example this is what it says in the Annual Report published in May under “What went wrong” after mentioning “an acceleration of events”: “the difficult situation was further fuelled by a fracture in the relationship between the non-executive and operating executives, a break-down in trust with key shareholders and the appointment of an array of increasingly expensive professional advisers”. That’s a very unusual thing to actually say to shareholders! It hardly inspires confidence does it.

It is also noticeable that even if overseas sales were profitable, there were declines in like-for-like sales both there and in the UK. And needless to point out perhaps that this is one company that is most likely to have been affected by changing shopping habits. Do mothers with children or young babies really want to be dragging them around the High Street? No they will order what they need on-line. A quick look at the Mothercare web site says they do offer free delivery on orders over £50 but why bother when other on-line sites will do it for much less.

Mothercare has always had a great “brand” but has never seemed able to turn it into a profitable business – at least in the UK.

Note that only the UK operations have gone into administration but it’s difficult to see how the parent holding company is going to avoid major problems as a result as debts are probably secured against all the assets and there may be substantial intercompany debts.  And what about the pension scheme and the sale and leaseback of the head office which means future costs? I have not researched the company enough to advise further but almost everything I read in the Annual Report puts me off the business.

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

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Patisserie and Interserve Administrations, plus Brexit latest

Yesterday the administrators (KPMG) of Patisserie (CAKE) issued their initial report. It makes for grim reading. The hole in the accounts was much worse than previously thought with an overstatement of net assets of at least £94 million. That includes:

  • Intangible assets overstated by £18m;
  • Tangible assets overstated by £5m;
  • Cash position overstated by £54m;
  • Prepayments and debtors overstated by £7m;
  • Creditors understated by £10m.

The accounts were clearly a total fiction. It is uncertain whether there will even be sufficient assets to make a distribution to preferential and unsecured creditors. As expected ordinary shareholders (who are not creditors) will get nothing. You can obtain the KPMG report from here: http://www.insolvency-kpmg.co.uk/case+KPMG+PJ12394136.html

KPMG suggest there may be grounds for legal action against various parties including Patisserie auditors Grant Thornton by the administrator, but as Grant Thornton are the auditors of KPMG they are suggesting the appointment of another joint administrator to consider that matter.

Otherwise it looks a fairly straightforward administration with assets sold off to the highest bidders and reasonable costs incurred.

Another recent administration was that of Interserve (IRV). This was forced into a pre-pack administration after shareholders voted against a financial restructuring (effectively a debt for equity swap) which would have massively diluted their interest. But now they are likely to get nothing. Mark Bentley of ShareSoc has written an extensive report on events at the company, and the shareholder meeting here: https://tinyurl.com/yy7heunl . He’s not impressed. I suspect there is more to this story than meets the eye, as there usually is with pre-pack administrations. They are usually exceedingly dubious in my experience. As I have said many times before, pre-pack administrations should be banned and other ways of preserving businesses as going concerns employed.

Brexit. You may have noticed that the stock market perked up on Friday. Was this because of some prospect of Mrs May getting her Withdrawal Agreement through Parliament after all? Perhaps it was. The reasons are given below.

There were two major road blocks to getting enough MPs to support the deal. Firstly the Irish DUP who had voted against it. But they are apparently still considering whether they can. On Thursday Arlene Foster said “When you come to the end of the negotiation, that’s when you really start to see the whites of people’s eyes and you get down to the point where you can make a deal”. Perhaps more concessions or more money for Northern Ireland will lubricate their decision.

Secondly the European Research Group (ERG – Jacob Rees-Mogg et al) need to be swung over. Their major issue is whether the Agreement potentially locks in the UK to the Irish “Backstop” protocol for ever. Attorney-General Geoffrey Cox’s advice was that it might, if the EU acts in bad faith. I have said before this legal advice was most peculiar because nobody would enter into any agreement with anyone else if they thought the other would show bad faith. Other top lawyers disagree with Cox’s opinion. See this page of the Guido Fawkes web site for the full details: https://tinyurl.com/y4ak6q3c

Mr Cox just needs to have a slight change of heart when his first opinion must have been rushed. He has already said that the Vienna Convention on international treaties might provide an escape route so he is creeping in the right direction.

Mrs May will have another attempt at getting her Withdrawal Agreement through Parliament, assuming speaker Bercow does not block it as repeat votes on the same resolutions are not supposed to be allowed in Parliament.

It was very amusing watching a debate at the European Parliament over Brexit issues including whether an extension of Article 50 should be permitted – the EU can block it even if the UK asks for it.  The EU MEPs seemed to have as many opinions as UK MPs on the issues. The hardliners such as Nigel Farage wish that it not be extended so that the UK exits on March 29th. Others are concerned that keeping the UK in will mean they have to participate in the EU elections in May with possibly even more EU sceptics elected.

It’s all good fun but it’s surely time to draw this matter to a close because the uncertainty over what might happen is damaging UK businesses. A short extension of Article 50 might be acceptable to allow final legislation to be put in place but a longer one makes no sense unless it’s back to the drawing board. But at least the proposal for another referendum (or “losers vote” as some call it) was voted down in Parliament. Extending the public debate is not what most of the public want and would surely just have wasted more time instead of forcing MPs to reach a consensus.

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

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Labour’s Plans For Confiscation of Shares and Rail System Renationalisation

Jeremy Corbyn made it clear in a speech last night that the rich will be under attack if Labour gets into power. John McDonnell, Shadow Chancellor, will present his plans today to give 10% of shares in all larger companies to employees over a period of years. The Daily Telegraph described it as a Marxist plot to control businesses while Carolyn Fairburn of the CBI attacked it as a “new tax that adds to the impression that Labour sees business as a bottomless pit of funding”. The proposal seems to be based on setting up a trust for employees into which the shares would be deposited and from where dividends would be paid to employees.

Comment: It will certainly dilute existing shareholders so readers of this blog might find they and the pension funds that invest in shares are proportionally poorer. Although it sets a bad principle, if the numbers being proposed are enacted it might not have a major impact on companies or investors. Enabling employees to have a financial interest in the profits of a company is quite a sensible idea in many ways. But it might simply encourage companies to take their business elsewhere. If they are registered in another country, how will the UK Government enforce such legislation?

Last week Chris Grayling, Transport Secretary, announced a review of the privatised rail system. That follows the recent problems with new timetables where the regulator concluded that “nobody took charge”. John McDonnell said that he could renationalise the railways within five years if Labour wins the next election – it’s already a manifesto commitment. Perhaps he thinks he can solve the railway’s problems by doing so but this writer suggests the problem is technology rather than management, although cost also comes into the equation.

The basic problem is that the railways are built on inflexible and expensive old technology. There has never been a “timetable” problem on the roads because there are no fixed timetables – folks just do their own thing and travel when they want to do so.

Consider the rail signalling system – an enormously expensive infrastructure to ensure trains don’t run into each other and to give signals to train drivers. We do of course have a similar system at junctions on roads – they are called traffic lights. But they operate automatically and are relatively cheap. Most are not even linked in a network as train signals are required to be.

Trains run on tracks so they are extremely vulnerable to breakdowns of trains and damage to tracks – even snow, ice or leaves on the line cause disruption – who ever heard of road vehicles being delayed by leaves? A minor problem on a train track, often to signals, can quickly cause the whole line or network to come to a halt. Failing traffic signals on roads typically cause only slight delays and vehicles can drive around any broken-down cars or lorries.

The cost of changes to a rail line are simply enormous, and the cost of building them also. For example, the latest estimate for HS2 – the line from London to Birmingham is more than £80 billion. The original M1 was completed in 1999 at a cost of £26 million. Even allowing for inflation, and some widening and upgrading since then the total cost is probably less than £1 billion.

Changes to railway lines can be enormously expensive. For example, the cost of rebuilding London Bridge station to accommodate more trains was about £1 billion. These astronomic figures simply do not arise when motorways are revised or new service stations constructed.

Why invest more in a railway network when roads are cheaper to build and maintain, and a lot more flexible in use? At present the railways have to be massively subsidised by the Government out of taxation – about £4 billion per annum according to Wikipedia, or about 7.5p per mile of every train journey you take according to the BBC. Meanwhile road transport more than pays for itself and contributes billions to general taxation in addition from taxes on vehicle users.

So here’s a suggestion: scrap using this old technology for transport and invest more in roads. Let the railways shrink in size to where they are justifiable, or let them disappear as trams did for similar reasons – inflexible and expensive in comparison with buses.

No need to renationalise them at great expense. Spend the money instead on building a decent road network which is certainly not what we have at present.

Do you think that railways are more environmentally friendly? Electric trains may be but with electric road vehicles now becoming commonplace, that justification will no longer apply in a few years’ time, if not already.

Just like some people love old transport modes – just think canals and steam trains – the attachment to old technology in transport is simply irrational as well as being very expensive. Road vehicles take you from door-to-door at lower cost, with no “changing trains” or waiting for the next one to arrive. No disruption caused by striking guards or drivers as London commuters have seen so frequently.

In summary building and managing a road network is cheaper and simpler. It just needs a change of mindset to see the advantages of road over rail. But John McDonnell wants to take us back to 1948 when the railways were last nationalised. Better to invest in the roads than the railways.

It has been suggested that John McDonnell is a Marxist but at times he has denied it. Those not aware of the impact of Marxism on political thought would do well to read a book I recently perused which covered the impact of the Bolsheviks in post-revolutionary Russia circa 1919. In Tashkent they nationalised all pianos as owning a piano was considered “bourgeois”. They were confiscated and given to schools. One man who had his piano nationalised lost his temper and broke up the piano with an axe. He was taken to goal and then shot (from the book Mission to Tashkent by Col. F.M. Bailey).

Sometimes history can be very revealing. The same mentality that wishes to spend money on public transport such as railways as opposed to private transport systems, or renationalising the utility companies such as National Grid which is also on the agenda, shows the same defects.

The above might be controversial, but I have not even mentioned Brexit yet. Will the Labour Party support another referendum as some hope and Corbyn is still hedging his bets over? I hope not because I think the electorate is mightily fed up with the subject. In politics, as in business, you should take decisions and then move on. Going back and refighting old battles is not the way to succeed. All we should be debating is the form of Britain’s relationship with the EU after Brexit.

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

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Whitewash at Gordon Dadds AGM, and Insolvency Warnings

I attended the Annual General Meeting of law firm Gordon Dadds Group (GOR) this morning. The company was tipped as a buy in Investors Chronicle on the 3rd August so I bought a few shares. It’s always good to go to the AGMs of new investments to get an impression of the management and ask a few questions. This is one of only three listed legal firms (the others being Gateley and Keystone which I do not hold).

This AGM was very unusual in that both on the “show of hands” vote and the proxy vote counts, there were no votes against at all, i.e. exactly zero on all resolutions. That is exceedingly unusual for a public company. As I said to the Chairman, he managed to achieve that by not having a share buy-back resolution on the agenda as I normally vote against such resolutions. Likewise no resolution to change to 14 days notice of general meetings. I congratulated him on that and a well run AGM where questions were taken first before the formal business.

There were about a dozen shareholders present, some of whom might have been staff. I questioned the increase in overheads in the last year – they are working to bring that down but it was increased as they “set up to expand” – and the high debtors. Although they bill work in progress monthly, it seems their corporate clients are slow payers. Another shareholder asked how work in progress was valued, and it’s at cost apparently. Otherwise I did not pick up any concerns although the legal market does seem fragmented and it is not clear to me how they are differentiated from others although they do have some specialisations. One might see it as a market ripe for consolidation with too many small firms and Gordon Dadds seem to have acquisition ambitions.

The company only listed on AIM a year ago so it’s early days as yet.

Interesting that the national media failed to pick up on the changes to the insolvency regime announced by the Government last Sunday. Perhaps not surprising on a Bank Holiday weekend although I covered it here: https://roliscon.blog/2018/08/26/insolvency-regime-changes-a-step-forward/

Perhaps private investors were not concerned because they think they can bail-out before such events unlike institutional shareholders who frequently have such large holdings that they can’t place them on the market at any price. But you cannot always do so. I have been caught twice in over twenty years of investing by unexpected administrations of retailing companies who often appear to have lots of revenues and positive cash flows. But a retail market turn-down can catch them unawares when they have high fixed costs (staff and property rentals). The result is often a cash flow problem when quarterly rent payments are due, or an unexpected tax bill appears, or suppliers’ insurers simply get nervous and withdraw cover.

A simple ratio to look at to pick up businesses at risk of insolvency is the Current Ratio which I like to see above 1.4. Remember business only go bust when they run out of cash. However, retailers often pay their suppliers after they have sold the goods to their customers so the Current Ratio is not a reliable measure for retailers. Likewise it tends to be unreliable when looking at software companies where they might have deferred support revenue in their current liabilities which should really be ignored as it will never be paid.

The Current Ratio is easy to calculate (it’s Current Assets divided by Current Liabilities). A better measure but a more complex one is the Altman Z-Score. This was very well covered in this week’s Investors Chronicle where it was argued that it was also a good measure of the overall performance of companies. It’s not foolproof in terms of predicting insolvency but it’s certainly a good warning indicator – the big problem is that accounting figures on which it is calculated are often out of date.

The Z-Score can be obtained from a number of sources as it’s a bit tedious to calculate it yourself – for example Stockopedia display it on their company reports.

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

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House of Fraser Pre-Pack – Is It Such a Great Deal?

The acquisition of House of Fraser by Sports Direct is a typical “pre-pack” administration. In administration one minute, sold the next. The national media promptly welcomed it as the rescue of everyone’s favourite department store, the protection of 17,000 jobs and just what is needed to help save Britain’s High Streets.

Mike Ashley of Sports Direct trumpeted this as a great deal. All the stores and stock were purchased for £90 million when gross assets were £946 million and the company made a profit last year of £14.7 million – more on the financial numbers below. He plans to turn House of Fraser into the “Harrods of the High Street”.

But is it such a great deal? I have written many times in the past about the iniquities of pre-pack administrations. How creditors and shareholders are dumped, and pension schemes likewise. The administrators save themselves the hassle of winding up the business or looking for a buyer of the business as a “going concern” while collecting large fees for little work. I think the insolvency regime should be reformed.

The figure of £946 million of gross assets given by Sports Direct is from the last published accounts of the parent company House of Fraser (UK & Ireland) Ltd for the year ending January 2017, which is the last set of accounts filed at Companies House. The truth is that the company had net assets of £111 million with trade creditors of £365 million and long-term borrowings of £284 million. Debts including short terms borrowings probably grew substantially since then. Although Mr Ashley is paying the administrators £90 million for the assets, it would appear that both the trade creditors and the lenders will be very substantially out of pocket.

That’s not to mention the property companies who are the store landlords who face a default on their leases. Mr Ashley is unlikely to want to keep half the stores, so many of the jobs will be lost and he will no doubt want to renegotiate the leases on other stores downwards. So any property companies you may have invested may be damaged.

The company will have got shot of its defined pension schemes (approximately 10,000 members) which will be taken on by the Pension Protection Fund. That’s a public body that is funded by a levy on all pension schemes, so basically someone else will be paying if there is any shortfall. Although the pension scheme may be in surplus at this time, in such circumstances pensioners usually face a substantial cut in their future income as there will be no more contributions from the company.

Now House of Fraser might have been a retailing basket case with excessive debt, but surely a more equitable solution was possible? Indeed the Mail on Sunday today called it a “Fix” because there was an alternative offer on the table from retail billionaire Philip Day who allegedly offered £100 million for the company including taking on the pension obligations. The Mail suggested that the bankers and bondholders forced acceptance of the Ashley proposal in their interests. This is not unusual in pre-packs.

Sir Vince Cable suggested an investigation by the BEIS Department is required followed by reform of the pre-pack system. I agree with him. There are better solutions to how to deal with companies that run out of cash or become insolvent due to excessive debt which could protect the interests of trade creditors, employees and pensioners.

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

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Stopping Another Beaufort Case

Readers are probably aware of the administration of stockbroker Beaufort, how PwC are running up enormous bills to the disadvantage of creditors and how they also claimed to be able to charge the bills against client assets under the Special Administration Rules. See here for more information if you are not familiar with this debacle: https://www.sharesoc.org/campaigns/beaufort-client-campaign/

I hope all stock market investors have already written to their Members of Parliament on this topic, not just to get the Special Administration Rules changed but to get a proper and full reform of the share ownership system in the UK. If you have not, please do so now.

But another way to get the Government’s attention is to get enough people to sign a Government e-petition. One of the people affected by the Beaufort case has created just such a petition which is now present here: https://petition.parliament.uk/petitions/222801 . Please sign it now!

The Special Administration rules that apply to financial institutions (banks and stockbrokers for example) are helpful in many ways and were well conceived following the banking crisis in 2008. But rule 135 which allows client assets to be filched by an administrator, even when they are held in trust, seems to have been snuck in without notice and without consultation. It means anyone who holds shares in a nominee account (as most people do nowadays) is at risk of substantial losses if the broker goes bust. That’s a more common occurrence than most people realise mainly because most brokers operate in a highly competitive and low margin market.

SO MAKE SURE YOU SIGN THE PETITION TO ENSURE YOUR ASSETS ARE SECURE

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

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Protecting Yourself Against Administrations

Investors now know that when your stockbroker goes into administration, your assets are not secure (or “ring fenced” as your contract with them often says) because they can be seized under the Special Administration Regulations by the administrator to pay their costs. This has become clear from the Beaufort case. That means many investors are facing losses because Beaufort client accounts, like most stockbroking accounts now, were nominee accounts with the shares registered in the name of Beaufort.

There are two possible ways to protect your assets: 1) Hold your shares in the form of paper share certificates – not the most convenient format for trading and expensive to do so even if you can find a broker still willing to handle them; or 2) Hold your shares in a personal crest account, i.e. a “Sponsored Crest” account where your broker acts as the sponsor but the shares are registered in your name and traded electronically.

Some doubts arose in my mind about whether the latter would actually provide the protection required. For example, would an administrator be able to transfer the shares into their name, or stop the transfer of the account and hence the holdings to another broker? So here are the answers provided by Killik & Co who. It provides some reassurance:

In order for a participant to change Sponsor, CREST require:  

  • For those Participants that are already Sponsored, 3 letters as follows – – One from the existing Sponsor stating they are happy for the Participant(s) to move away from them on a set date. – One from the Participant(s) requesting to move Sponsors on a set date. – One from the new Sponsor stating they are happy to take over sponsorship of the Participant on a set date.
  • However, our understanding is that, where the Sponsor is in administration, a letter is not required by the existing Sponsor.  We believe it would be possible therefore, for the sponsored member to instruct another Sponsor to take on the sponsorship of the account.  Note that CREST is not a custodian or a depository and the shares are actually held by the Sponsor, but in the name of the legal owner. 

Regarding the question of the ability of the administrator to issue instructions on the stocks or transfer them into their own nominee name, our understanding is that the administrator has no rights over the securities held in the name of the legal owner as specified on the legal register. 

This information is provided by Killik & Co to the best of their knowledge and belief. For more information contact Gregory Smith on 0207-337-0409.

There are few brokers that still offer personal crest accounts (Killik & Co are one of them), but that still leaves the problem that ISAs and SIPPs have to be held in nominee accounts. Until the administration legislation is reformed, the only solutions for them are to open multiple broker accounts so that no one of them contains assets worth more than £50,000 (the limited covered by the Financial Services Compensation Scheme) or to pick a broker which is large enough and with a balance sheet that is strong enough that it is unlikely to go into administration. Having multiple broker accounts can be wise for other reasons than the risk of administration even if it can make life very complicated and possibly less secure – for example IT meltdowns in financial services companies are not uncommon (RBS and TSB are examples). It can be very frustrating not to be able to trade even for a few minutes (as happened this morning with the LSE due to a technology problem) let alone days or even weeks as Beaufort clients are suffering.

It is perhaps unfortunate that these risks might make for an anti-competitive stockbroking market. Folks may be very reluctant to sign up with new brokers who have a limited track-record.

But we really do need some reform of the insolvency rules to stop administrators grabbing client assets, a new electronic “name on register” system that protects ownership to replace the nominee system (something I have been campaigning on for years), and the ability to hold ISA and SIPP holdings in our own name.

ShareSoc are running a campaign on the Beaufort case (see https://www.sharesoc.org/campaigns/beaufort-client-campaign/ ) and have also asked anyone who is concerned about this issue, as all stock market investors should be, to write to their M.P.s. Please do so. Only that way will we get political action on these issues. ShareSoc can provide a template letter you can use.

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

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