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 )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Brexit – Now a Supportable Deal

Mrs May’s latest agreement with the EU is surely a satisfactory outcome – at least for everyone except those who wish the UK to depart with “no deal” or oppose Brexit altogether. She has agreed very much what I suggested at the end of January when I said “She is getting near a clear mandate from Parliament which will help in the battle with EU bureaucrats and politicians who are adamant they won’t renegotiate the Withdrawal Agreement. But they will have to if they don’t want the UK to exit without one, which would threaten a lot of EU country exports. Come March 28th, it will be time for a face-saving compromise – no change to the Withdrawal Agreement – just the addition of a codicil providing alternatives to the Backstop.”

And it’s not even March 28th yet, but whether she will get this agreement through Parliament remains to be seen. Later today the vote will decide, but it may not be a final resolution.

Why does the latest “update” to the Withdrawal Agreement provide a satisfactory outcome in my view? Because many people wished to retain uninhibited trade with the EU – at least for a transition period. That did require adherence to some common standards. That is what the Withdrawal Agreement provides and which primarily covers a 2-year transition period. After that the relationship is subject to negotiation and mutual agreement. But there was an issue with the Irish “backstop” that might have prevented the UK from ever exiting the EU fully. That is what many people objected to and what caused MPs to previously vote it down.

The Withdrawal Agreement may not be perfect in all other regards but it is a reasonable compromise and should now be supported. At least that’s my view but I can see some folks disagreeing on this.

You can read the latest legal “codicil” to the Withdrawal Agreement here: https://ec.europa.eu/commission/sites/beta-political/files/instrument.pdf

Postscript: It has been disclosed that Attorney-General Geoffrey Cox does not believe the aforementioned “codicil” as I called it ensures that Britain will not be trapped in the Irish Backstop. He has said so in a 3-page letter to Mrs May – see https://tinyurl.com/y58jzzev . In summary he suggests that the “clarifications and amplified obligations provide a substantive and binding reinforcement of the legal rights available to the United Kingdom in the event that the EU were to fail in its duties of good faith and best endeavours” but he ends by saying that legal risks remain, particularly if the EU shows bad faith.

This seems excessively negative if you read it carefully. If bad faith is shown by either party to an agreement, then it fails. One or other party simply walks away. But Mr Cox’s comments will certainly not help the Prime Minister.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Luxembourg Regulators Inept?

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

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

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

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

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

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

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

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

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

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

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

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

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

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

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Cloudcall Placing, Patisserie News, Brexit and Momentum Investing

I reported a week ago on a “Capital Markets Day” at Cloudcall (CALL) – see https://roliscon.blog/2019/01/18/cloudcall-investor-meeting-sophos-rpi-and-brexit/ . There was much discussion on whether the company should raise more finance, via debt or equity. I suggested they needed more equity. This morning they announced a placing of 2.4 million shares at 100p to raise (the share price last night was 109p. It represents about 10% dilution for other shareholders. The placing was completed in minutes so they had clearly lined up existing investors in advance. The cash will be invested (i.e. spent) on sales and marketing.

But they are also refinancing and extending their debt facility. Let us hope they don’t have to use it.

More bad news from Patisserie (CAKE). A report in the Guardian, based on sight of the information sent to bidders by the administrator, suggests that the accounts were false as far back as 2014. That’s when the IPO on AIM took place. In addition, sales in established stores had fallen by 4% in the last two years and the remaining 122 stores were on course to make a £2 million loss in the year to September 2019.

The Guardian report mentioned a number of possible bidders for some of the outlets, but generally few of them. So the chance of a major realisation for the benefit of creditors in such a “fire sale” process seems unlikely.

Brexit. After last night’s votes in the Commons, the battle lines between Theresa May and the EU look to be drawn up. She is getting near a clear mandate from Parliament which will help in the battle with EU bureaucrats and politicians who are adamant they won’t renegotiate the Withdrawal Agreement. But they will have to if they don’t want the UK to exit without one, which would threaten a lot of EU country exports. Come March 28th, it will be time for a face-saving compromise – no change to the Withdrawal Agreement – just the addition of a codicil providing alternatives to the Backstop.

Momentum Investing. Are investors falling out of love with Momentum Investing? Momentum investing has been one of the most attractive investing strategies in the last few years. If a share price was going up, you just bought more, regardless of fundamentals. There were many academic studies showing that it was a very effective strategy. In ten years of rising shares prices, it was relatively foolproof. But when share prices are going down, as in the last part of 2018, it does of course work in reverse. You have to sell shares as the prices drop.

Just reviewing a few model portfolios run by investment magazines and on-line portals suggests to me that momentum investing is no longer working as the 5 year and longer returns generated are worse than the market as a whole. The moral is that there are no simple solutions to achieving superior investment returns. Once everyone is aware of a successful strategy, its benefits disappear as they are traded away.

It looks like we will have to revert to the hard work of doing financial and business analysis of companies rather than simply following shooting stars.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Cloudcall Investor Meeting, Sophos, RPI and Brexit

Yesterday I attended a “Capital Markets Day” for Cloudcall (CALL), a company in which I hold a few shares. But not many because it has been one of those technology companies with fast growing revenue but it has been slow in actually reaching profitability. The result has been multiple share placings, the last one in October 2017, to plug the negative cash flow hole. So cash flow was no doubt on investors minds at the meeting, as you will see.

The company sells unified communications technology to businesses using CRM systems. A couple of their major partners are Bullhorn (a recruitment/staffing software business) and Microsoft with their MS Dynamics product and there were speakers from both companies at the meeting. They helped to explain the attractiveness of the product to their customers, which I do not doubt.

CEO Simon Cleaver covered the latest product enhancements which will potentially enable them to integrate with 4 or more new CRM products in 2019. It will also include broadcast SMS messaging and mobile support which their customers need. Apparently there will be an increased focus on the US market, but the company is also looking at the APACS region and Brazil from later comments, where there are obvious opportunities. Pete Linas from Bullhorn made an interesting comment that the company has been missing out on business growth due to lack of finance – suggesting perhaps that a more aggressive strategy be adopted as per early stage US technology companies, i.e. ignore the losses and negative short-term cash flow and raise more finance.

CFO Paul Williams, covered the recent trading statement which was positive. Group revenue up 29% but cash burn was £1.5m in H2 2018, i.e. still consuming cash rather than generating it. Cash available was given as £2.75m. Paul also covered how the growth in users converts into revenue and future profits but they seem to have a relatively high churn rate for this kind of business, i.e. customers dropping out subsequently. It was not made clear why they lose some customers/users and what the customer contract durations actually are. However in response to one of my questions it was stated that forecast revenue growth for this year will be 40% (that’s higher than analyst’s forecasts so far as I can see).

Paul also said cash burn was reducing and Simon said that it was down to £240k per month, with sufficient cash to break even, if the sales numbers are met. He suggested that if more cash was needed (e.g. to fund US expansion) then they could raise their existing debt level from £1.8m to £3.0m and the board would prefer to raise the debt than more equity. The impression was given that conversations around that had already taken place and Paul Scott questioned whether the bankers would want to lend to a loss-making business – it seems they might. Comment: they might but at a hefty cost and with tight mandates. I simply don’t believe that companies like this should be financed via debt. Equity is what is needed for early stage, high-risk technology companies as I said to Simon later. But another placing may not be enthusiastically welcomed by investors at this time.

One interesting comment from the audience questioned whether the company was charging too little for the product. But it appears that they need more functionality to be able to charge more, and that would require more investment of course. But will the company ever become such an essential part of the customers’ business operations that they cannot do without, or even more to the point switch to a competitor? That was not really clear.

Concluding comment: The company is making progress and Simon communicates his enthusiasm well, but I suspect the business will continue to burn cash and financing that with debt makes no sense to me.

Sophos (SOPH) is another technology company that issued a trading statement today. The good news is that it has reached profitability and revenue has increased by 14% year-to-date. The share price promptly dropped by more than 25% in early trading! The reason was no doubt the lackluster growth in “billings” (i.e. invoiced sales) of 2%. Why is that different to the revenue figure? Probably because the revenue includes some accrued from last year on subscription billings. It otherwise looks like it is likely to meet the year-end targets forecasts of analysts. With the share price fall it’s starting to look relatively cheap for a high-growth software business so the key question investors have to ask is whether growth will return? It was no doubt exceptional last year because of IT security scares and new product releases, but is it simply nearing market saturation? An article in Shares magazine has questioned whether the cause of billings slowing is increasing competition from new market entrants so that’s certainly an issue to look at also. There is more explanation of the reasons for billing trends in the audio presentation available here: https://investors.sophos.com/en-us/events-and-presentations.aspx . I have a small holding in Sophos and bought more on the dip today.

RPI concerns. A House of Lords committee has apparently questioned the continuing use of the “discredited” Retail Price Index (RPI) when CPI is a more accurate reflection of inflation. RPI is still used for many purposes, such as rail fare costs, and for index-linked savings certificates and gilts. Personally having just signed up to extend my investment in savings certificates even with minimal real interest on them, I would be most concerned about any change and I would not have done so if the index used changed to CPI which typically gives a much lower figure.

Brexit. Everyone else is giving their views on Brexit so why not me? Here’s some.

Firstly, in case you have not noticed, MPs have apparently been advised that it might take over a year to organise another referendum. So those who are calling for another one are surely misguided. Putting off the EU exit that long, with the uncertainty involved surely makes no sense. And most people are fed up with debating Brexit even if the questions in a new referendum could be decided. Parliament and the executive Government alone need to come up with a solution.

Should we rule out a “no-deal” Brexit? No because it would not be a nightmare as remainers are suggesting. As I was explaining to my wife recently, grapes and bananas might become cheaper because EU tariffs would be removed on food from the rest of the world. What about UK farmers who would face problems in exporting to the EU? Well that just means that beef would also become cheaper in the UK. Secondly to rule out a no-deal Brexit would totally undermine our negotiating position to obtain a good Withdrawal Agreement with the EU. Only the threat of a no-deal Brexit with the risks to exports from the EU to the UK (where of course the trade flow is in their favour at present) will focus the minds of EU politicians. So Jeremy Corbyn’s insistence on ruling out “no-deal” before he will discuss the matter just looks like an attempt to throw a spanner in the works in the hope of getting a general election.

Can Mrs May get enough support for the Withdrawal Agreement as it stands? Undoubtedly not. She has to go back to the EU with proposals for substantial changes to meet the concerns of MPs and the public, e.g. over the Irish “backstop”. If she acts quickly and decisively, I think that could achieve success. If she cannot do so then surely someone else who can provide the required leadership needs to take over – including someone willing to support a no-deal Brexit if required. The current Withdrawal Agreement is not all bad, but contains some significant defects, probably because it appears to have been written by EU bureaucrats rather than as the result of mutual negotiation. It needs revising.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

 

FCA Views of the Financial Landscape

The Financial Conduct Authority (FCA) have published a document entitled “Sector Views” giving their annual analysis of the UK financial landscape and how the financial system is working – see https://tinyurl.com/yc492lkt . For retail investors there is a chapter on “Retail Investments” which is particularly worth reading.

But we also learn that the “FCA continues to plan for a range of scenarios regarding Brexit” which is good to hear. I somehow doubt it will be settled tomorrow in Parliament – I continue to forecast March 28th. We otherwise learn that cash is still king as a payment method with 40% of payment transactions, albeit falling; that 44% of consumers say nothing would encourage them to share their financial data (that has been encouraged by recent regulatory changes); that car insurance premiums are rising even though mine just fell which very much surprised me; that the ageing population presents a considerable challenge for pension savings and that mortgage borrowers are getting older (39% will have mortgages maturing when they are older than 65).

Cash ISA subscriptions continue to exceed Stock/Share ISAs by a wide margin, although the number of new cash ISA subscriptions fell last year. But only one third of the UK population hold any form of investment product. It looks like the rest are replying on pensions, state support or housing wealth to keep them in retirement.

They claim the investment platforms market is working well “in many respects” despite the fact that their use of nominee accounts for investors has disenfranchised retail investors. You can send them some comments on that via an email to sectorviews@fca.org.uk . But they do at least highlight the difficulty of switching platforms and they note that comparing pricing is also difficult.

Assets under management by the investment management sector grew to £9.1 trillion in 2017 with 20% managed for retail investors. The proportion of passively managed assets rose to 25% which continues the past trend.

Overall this review shows the size and complexity of the UK financial sector. At 36% of European Assets Under Management, it is much larger than any other European country. The next largest is France at 18% and Germany is only 9%. Let us hope it stays that way after Brexit.

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

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.