Tag: Brexit

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 )

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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 )

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Share Tips, Debenhams, Jaguar (JLR) Layoffs and Brexit

Private Eye published its annual review of national press share tips this week. It makes for amusing reading and rather shows that financial journalists are no better than you and me at picking winners – indeed worse in most cases. The Guardian was noted as remaining “keen to empty its readers’ pockets”. It’s top ten share tips underperformed the FTSE100 by 28 percentage points, repeating the same dire performance as in 2017. One big loser was Footasylum (FOOT) which was down 90%. The Sunday Times was also mentioned as a provider of duff tips including Faron Pharmaceuticals, Clipper Logistics and William Hill. Also collecting brickbats were the Independent and Mail on Sunday. The moral is that relying on share tips from newspapers is not a sound investment strategy.

Several big stories in the national media today and yesterday are worthy of note. Debenhams (DEB) have lost their Chairman when he got a majority of votes against him after Mike Ashley of Sports Direct voted their 29% stake against him at the AGM, with support from another major shareholder. The new CEO, Sergio Bucher, also failed to get elected to the board but retains his executive job which is somewhat unusual. The company is clearly in need of refinancing as it is being overwhelmed by debt of £520 million. The share price is now down to 4p valuing the business at less than £50 million – not much for a business with revenue of £2.3 billion! But trading over Christmas and before was dire – see the trading statement issued on the date of the AGM. Mike Ashley has offered to refinance the business in return for more equity but has been rebuffed by the Debenham’s board. Comment: Can traditional department stores survive even if they dump their debt and reduce their property costs by a CVA? John Lewis still seem to be doing reasonably well but reported challenging trading and may cut their staff bonus this year. But most traditional department stores disappeared years ago. Debenhams do have a good on-line web site but will shoppers think of them and go there? Men’s shirts at 70% off, i.e. for £11.70, look good value but what margins are they making on those one wonders. Damn all I would guess. Some retailers like Dunelm do seem to be achieving a change to on-line customer service but Debenhams will be hobbled by its financial structure unless some vigorous action is taken. But it may simply be too late.

There has been much teeth gnashing over the thousands of job cuts announced by Jaguar Land Rover (JLR Group). Is that due to Brexit or other reasons? In fact it’s been hit by facing the unpopularity of diesel vehicles with a car product range that has very few petrol or hybrid/electric models unlike other up-market car makers. It has also been hit by a slow down in sales in China and by the fact that a new production plant has been built in Slovakia with state aid, i.e. jobs have moved there to a lower cost venue. That decision was taken before the referendum on Brexit in the UK. Jacob Rees-Mogg apparently drives one of their vehicles and said “Brexit has not happened. The reason it is making all these cuts is because it produces too many cars with diesel engines and its top of the range cars are not as reliable as you would want them to be”. As a Jaguar driver I agree with the first part but not the second

On the issue of the Brexit Referendum it is worth noting that the City of London Corporation Council have voted 60 to 31 against the suggestion of a second referendum – or “people’s vote” as some call it when the people already voted. This seems to be a very unpopular idea in general mainly because most “people” are rather fed up with the politicking over Brexit. And would just like to see the matter concluded.

Another big story in the media yesterday was that of the lady who had received two hand transplants (Corinne Hutton). She lost all her hands and feet from sepsis. I can understand her desire for the operation but I am not sure it is at all wise. Transplant recipients of any organs (and I am one) need to take drugs that are nephrotoxic to suppress the immune response, i.e. they damage the kidneys long-term. This means that they may need a kidney transplant after a few years and there is also a high risk of short-term graft failure. I know this not just from my knowledge of the field but from meeting a heart transplant patient in hospital who had also subsequently had to have a kidney transplant. Let us hope it works out well for Corinne though. But for the wealthy investors who read this blog, bear that in mind before you start shopping for new body parts.

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

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IC Share Tips, National Grid, Brexit and the Audit Market

This week’s Investors Chronicle edition (dated 28/12/2018) provides lots of food for thought. One of the most educational is their review of the share tips they published as “tips of the week” in 2018. Unlike some investment publications, who simply forget about their past tips that go nowhere, while lauding their hits, the IC is open about their performance.

They issued 173 “BUY” tips and 24 “SELL” tips in the year. That is quite some achievement by itself as I rarely have more than a very few good new investment ideas in any one year and tend to hold most of my investments from year to year.

How did their tips perform? Overall the “BUYs” returned minus 11.5% which they calculate as being 0.9% better on average than the relevant index. Hardly worth the trouble of investing in them bearing in mind the need to monitor such individual share investments and the transaction costs. The “SELLs” did better at -18.0% versus an index return of -8.8%.

The BUYs were depressed by some real howlers. Such as tipping Conviviality shortly before it went into administration, although they did reverse that tip to a “SELL” before it did so. The result was only a reported 12% loss. As a consequence they are making some “fundamental changes to the way we recommend shares”.

But with so many share tips, the overall performance was not impacted by one or two failures and tended to approximate to the overall market performance. Which tells us that you cannot achieve significant over or under performance in a portfolio by holding hundreds of shares.

I don’t work out my overall portfolio performance for the year until after it ends on the 31st December so I may report on it thereafter. That’s if it’s not too embarrassing. With many small cap technology stocks in my portfolio, I suspect it won’t be good. I always look at my individual gains and losses on shares at the year end, as an educational process. As Chris Dillow said in the IC, “Investing like all our dealings with the real world, should be a learning experience: we must ask what we got wrong, what we got right, and what we can learn. The end of the year is as good a time as any for a round up…”.

One BUY tip they made was National Grid (NG.) in May 2018 on which they lost 11.8%. There is a separate article in this week’s IC edition on that company which makes for interesting reading as a former holder of the stock. I sold most of my holding in 2017 and the remainder in early 2018 – that was probably wise as you can see from the chart below (courtesy of Stockopedia).

National Grid Share Price Chart

National Grid has a partial monopoly on energy distribution and always seemed to be a well-managed business. Many investors purchase the shares for the dividend yield which is currently about 6%. But the IC article pointed out that proposals from OFGEM (their regulator) might limit allowed return on equity to 3%, which surely threatens the dividend in the long term. The share price fell 7% on the day that OFGEM announced their proposals. Bearing in mind the risks of running an electricity network, and the general business risks they face, that proposed return on equity seems to be completely inadequate to me. That’s even if one ignores the threat of nationalisation under a possible Labour Government.

Another IC article in the same edition was entitled “Brexit and the UK Economy”. That was an interesting analysis of the UK economy using various charts and tables. One particularly table worth studying was the balance of trade between the UK and our main trading partners. We have a big negative balance (i.e. import more than we export) to Germany, Spain, Belgium, Holland and Italy but positive balances with Ireland and the Rest of the World – particularly the USA. The article makes clear that our trade with EU countries has been declining – exports down from 55% in 1999 to 44% of all exports. But imports have not fallen as much so the trade gap has been widening. Meanwhile our exports to Latin America and China, which have been good economic growth areas, have remained relatively small.

The conclusions are simple. EU economies such as Germany would be severely hit by any trade disruption on Brexit. But opportunities in rapidly growing markets are currently being missed, perhaps hampered by inability to negotiate our own trade deals with them, and that might improve after Brexit.

Audit Market Review

The Competition and Markets Authority (CMA) have published an “Update Paper” on their review of the audit market. It contains specific recommendations on changes to improve competition and asks for comments. See https://assets.publishing.service.gov.uk/media/5c17cf2ae5274a4664fa777b/Audit_update_paper_S.pdf .

It mentions a long list of audit failings on pages 12 onwards including banks before the financial crisis of 2008, BHS, Carillion, Autonomy (covered in a previous blog post) and Conviviality which was mentioned above.

This paragraph in their executive summary is worth repeating: “Independent audits should ensure that company information can be trusted; they provide a service which is essential to shareholders and also serves the wider public interest. But recent events have brought back to the surface longstanding concerns that audits all too often fall short. And in a market where trust and confidence are crucial, even the perception that information cannot be trusted is a problem.”

One problem they identify is that “companies select and pay their own auditors” which they consider an impediment to high-quality audits. In addition choice is exceedingly limited for large FTSE companies, with the “big four” audit firms dominating that market.

Their proposals to improve matters are 1) More regulatory scrutiny of auditor appointment and management; 2) Breaking down barriers to challenger firms and mandatory joint audits; 3) A split between audit and advisory business within audit firms and 4) Peer reviews of audits.

Their review of FRC enforcement findings suggests that the most frequent findings of misconduct include:

(a) failure to exercise sufficient professional scepticism or to challenge management (most cases);

(b) failure to obtain sufficient appropriate audit evidence (most cases); and

(c) loss of independence (three out of a total of 11 cases).

That surely indicates a major problem with audit quality, and that is backed up by the FRC’s own analysis of audits that they have reviewed with only 73% being rated as “good or requiring limited improvement”.

Auditors are primarily selected via audit committees and there is a noticeable lack of engagement by shareholders in their selection. But that’s surely because large institutional shareholders have little ability to judge the merits of different audit firms.

Would more competition improve audit quality, or simply cause a focus on the lowest price tenders? The report does not provide any specific comment on that issue but clearly they believe more competition might assist. More competition does appear to drive more quality for a given expenditure in most markets however so it is surely sensible to support their recommendations in that regard. The report does emphasise that the selection and oversight of auditors would ensure that competition is focused on quality more than price which is surely the key issue.

A previous proposal was that auditors be appointed by an independent body but that has been dropped, partly due to shareholder opposition. The new proposal is for audit committees to report to a regulator with a representative even sitting as an observer on audit committees where justified. In essence it is proposing much more external scrutiny of audit committee activities in FTSE-350 companies and decisions taken by them.

The end result, at some cost no doubt, would be that both auditors and audit committees will be continually looking over their shoulders at what their regulators might think about their work. That might certainly improve audit quality so for that reason I suggest this proposal should be supported.

The requirement for “joint” audits where two audit firms including one smaller firm had to be engaged seemed to be opposed by many audit committee chairmen and by the big four accounting firms. Some of their objections seem well founded, but the riposte in the report is that evidence from France, where joint audits are compulsory, suggests they have a positive impact on audit quality. Moreover, it would clearly increase competition in the audit market.

In summary, the report does appear to provide some sound recommendations that might improve audit quality. But investors do need to respond to the consultation questions in the report as it would seem likely that the big audit firms will oppose many of them.

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

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Political Turmoil, Investor Confidence and Brexit

With the latest news that Theresa May faces a leadership challenge and recent events in Parliament, it’s worth commenting on the impact on the stock market. These gyrations have generated an enormous amount of uncertainty among investors. The result is that few investors are buying even after share prices have fallen substantially.

The general trend in the UK market is down, the pound is falling and overseas investor confidence (which is key to prices of large cap stocks) must have been damaged by the headlines that they see. Will the UK face a “hard” and damaging Brexit, or even a change to a Labour Government? Overseas investors will have even less of a handle on those risks than UK investors so are running scared.

The fall in the pound should help the profits of many UK listed companies. But even the shares prices of those companies who might benefit have been falling. That applies particularly to small cap companies. Many small cap stocks have limited liquidity and the liquidity provided by private shareholders has been disappearing as those with limited stock market experience have suddenly realised that the markets are not a one-way system where you consistently make money after ten years of positive market trends. They are taking their profits and sitting on their hands.

We are in a “negative momentum” situation where falling share prices drive further falls as trend followers ignore fundamental valuations and sell regardless. This will not change until share values start to look very cheap. The decline in US markets has also undermined investor confidence generally, and has a big influence on the UK market.

There could be a sharp recovery in share prices if confidence returns – after all the UK and worldwide economies are doing well. But confidence will not return until there is some sight as to how the Brexit problem will be resolved.

Theresa May has certainly got herself and her party into a very difficult situation. She signed up to an agreement with the EU over withdrawal that many in her party, and in the DUP who she relies upon for votes, do not like at all. Instead of simply telling the EU that the deal has to be renegotiated, as any firm leader would have done, all she has been doing is going around Europe asking for “reassurances” on the back-stop. The EU bureaucrats (Juncker et al) might have said that they won’t renegotiate it – so would I knowing that Mrs May does not have enough support to take a firm position and time is rapidly running out. But the EU needs a deal to protect its economic interests. They might hope that Britain will reconsider and stop the Brexit process altogether but that is not consistent with the views of the majority of the UK population so is unlikely to happen. Even if a general election was called over the issue, it is not clear that Labour would run on a manifesto committing to rejoin the EU as a lot of their traditional supporters do not like the EU and are affected by the unlimited immigration that has resulted from free movement of people.

The answer therefore is to replace Mrs May with someone who can provide firmer leadership including taking a risk on a “hard” Brexit with no withdrawal agreement if necessary. The latter would not nearly be so damaging as some predict and would put the UK in a very strong position to negotiate a trade deal that is in our interests (and with no complications over Northern Ireland as that issue could then be simplified to avoid a hard border).

My view is all deals are renegotiable if either party no longer supports it. Therefore we need to “withdraw from the withdrawal agreement”, i.e. repudiate it and start again. There are many aspects of the EU Withdrawal Agreement and the proposed future relationship that make sense, but some aspects of the former need changing.

Well those are my views on the political situation. Others might disagree. But so far as investors are concerned, improving confidence in the future economic and political landscape is the key to improved share prices. That seems unlikely to happen under Mrs May’s leadership however much one recognises that she has been trying her best in difficult circumstances.

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

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Autonomy, FRC Meeting, Retailers and Brexit Legal Advice

The big news last Friday (30/11/2018) was that former CEO Mike Lynch has been charged with fraud in the USA over the accounts of Autonomy. That company was purchased by Hewlett Packard who promptly proceeded to write off most of the cost – see this blog post for more information: https://roliscon.blog/2018/06/02/belated-action-by-frc-re-autonomy/. As this was a UK company, are we anywhere nearer a hearing in the UK over the alleged “creative accounting” that took place at the company and the failure of the auditors to identify anything amiss? That’s after 8 years since the events.

As I was attending a meeting held by the Financial Reporting Council (FRC) for ShareSoc and UKSA members yesterday, I thought to review the past actions by the FRC on this matter. In February 2013 they announced an investigation but it took until May 2018 to formally announce a complaint against auditors Deloitte and the former CFO of Autonomy Sushovan Hussain who has already been convicted of fraud in the USA. On the 27th November, the action against Hussain was suspended pending his appeal against that conviction, but other complaints were not. But why the delay on pursuing the auditors?

The FRC event was useful in many ways in that it gave a good overview of the role of the FRC – what they cover and what they do not cover which is not easy for the layman to understand. They also covered the progress on past and current enforcement actions which do seem to have been improving after previous complaints of ineffectiveness and excessive delays. For example PWC/BHS was resolved in two years and fines imposed are rising rapidly. But they still only have 10 case officers so are hoping the Kingman review of the FRC will argue for more resources.

It was clear though that audit quality is still a major problem with only 73% of FTSE-350 companies being rated as 1 or 2A in the annual reviews when the target is 90%. The FRC agreed they “might be falling short” on pursuing enforcement over poor quality audits. So at least they recognise the problems.

One useful titbit of information after the usual complaints about the problems of nominee accounts and shareholder rights were made (not really an FRC responsibility) was that a white paper on the “plumbing” of share ownership and transactions will be published on the 30th January.

There were lots of interesting stories on retailing companies yesterday. McColl’s Retail Group (MCLS) published a very negative trading update which caused the shares to fall 30% on the day. Supply chain issues after the collapse of Palmer & Harvey are the cause. Ted Baker (TED) fell 15% after a complaint of excessive hugging of staff by CEO Ray Kelvin. This may not have a sexual connotation as it seems he treats male and female staff similarly. Just one of the odd personal habits one sees in some CEOs it seems. Retail tycoon Mike Ashley appeared before a Commons Select Committee and said the High Street would be dead in a few years unless internet retailers were taxed more fairly. He alleged the internet was killing the High Street. But there was one bright spark among retailers in that Dunelm (DNLM) rose 14% after a Peel Hunt upgraded the company to a “buy” and suggested that they might be able to pay a special dividend next year. There was also some director buying of their shares.

Before the FRC meeting yesterday I dropped in on the demonstrations outside Parliament on College Green. It seemed to consist of three fairly equally balanced groups of “Leave Means Leave” campaigners, supporters of Brexit and those wishing to stay in the EU – that probably reflects the composition of the Members in the House across the road. You can guess which group I supported but I did not stay long as it was absolutely pelting down with rain. There is a limit to the sacrifices one can make for one’s country.

But in the evening I did read the legal advice given to Parliament by the attorney-general (see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/761153/EU_Exit_-_Legal_position_on_the_Withdrawal_Agreement.pdf

Everyone is looking very carefully at the terms of the Withdrawal Agreement that cover the Northern Ireland backstop arrangements. The attorney-general makes it clear that the deal does bind the UK to the risk of those arrangements continuing, although there is a clear commitment to them only lasting 2 years when they should be replaced by others. There is also an arbitration process if there is no agreement on what happens subsequently. However, he also makes it clear that the Withdrawal Agreement is a “treaty” between two sovereign powers – the UK and the EU.

Treaties between nations only stick so long as both parties are happy to abide by them, just like agreements between companies. But they often renege on them. For example, the German-Soviet non-aggression pact in 1939 was a notorious example – Hitler ignored it 2 years later and invaded Russia. Donald Trump has reneged on treaties, for example the intermediate nuclear weapons treaty last month. Similarly nations and companies can ignore arbitration decisions if they choose to do so.

What happens after 2 years if no agreement is reached and the UK insists on new proposals re Northern Ireland? Is the EU going to declare war on the UK? We have an army but they do not yet have one. Are they going to impose sanctions, close their borders or refuse a trade deal? I suspect they would not for sound commercial reasons.

Therefore my conclusion is that the deal that Theresa May has negotiated is not as bad as many make out. Yes it could be improved in some regards so as to ensure an amicable future agreement but I am warming to it just like the Editor of the Financial Times recently. He did publish a couple of letters criticising his volte-face when previously he has clearly opposed Brexit altogether, but changing one’s mind when one learns more is just being sensible.

Note: I have held or do hold some of the companies mentioned above, but never Autonomy. Never did like the look of their accounts.

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

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Blue Prism, GB Group, Gooch & Housego, Greggs, IDOX, Pets at Home, Victoria, Brexit and Pre-Pack Administrations

Lots of results and trading statements this morning of interest. Here’s a few brief comments on some of them in alphabetic order (I hold some of these stocks), with the share price movement on the day at 14:00 hours (at the time of writing):

Blue Prism (PRSM) – down 12.3%. This was one of the ultimate go-go technology stocks until mid-September when it started a sharp decline like many other such stocks. It has some very interesting technology to automate business processes which is why everyone wanted to buy the shares. The trading statement had some positive comments about sales and cash flow (without giving any specifics which is annoying), but it also said “The EBITDA loss is expected to be larger than current expectations due to continued investments into the Group’s growth strategy and increased sales commissions arising from the strong fourth quarter”. With rising losses already forecast and no prospect of a profit in sight, the share price predictably fell. This company has a market cap of over £1 billion when revenue in the current year might be £55 million. I have seen technology companies before (e.g. in the dot.com boom era) that managed to grow sales at a terrific rate but with rising losses. Often they never did manage to show they had a profitable business as competition eroded their USP before they got there.

GB Group (GBG) – up 5.0%. Half year results much as expected taking into account the big one-off deal in the previous half year. Like Blue Prism the share price was down by 30% since early September in the technology stock rout. The valuation is now back down to a more sensible level and with revenue growth of 9%, cash up by £14.5 million and a positive outlook statement there seems to be little to be concerned about. The company provides on-line id verification and location services which is clearly a growth area at present and accounts for the consistently high valuation of the company.

Gooch & Housego (GHH) – down 1.8%. The share price fell sharply after the market opened but that seems to be a frequent occurrence after announcements by small technology stocks as a few insiders take the opportunity to sell. But the new chairman bought a few shares today. The shares in the company are also thinly traded which means they tend to be volatile. The preliminary results were slightly better than forecast on an “adjusted” basis although the reported accounts of this company are heavily distorted by the number of exceptional items including a large write-off of goodwill, restructuring costs (including a site closure) and transaction fees on acquisitions. The share price has been declining like other technology stocks and the announcement today about the departure of the CFO, but not until summer 2019, may not help the share price. The company has moved into a net debt position due to heavy investment in property, plant and equipment and an acquisition but it’s still quite lowly geared.

Greggs (GRG) – Up 11.6%. The share price jumped after the company reported sales up 9.0% in the last eight weeks – no particular reason was supplied. Also forecasting profits to be substantially ahead of forecasts. Greggs went through a share price dip in the middle of the year probably due to poor figures after bad weather hit this “food-on-the-go” seller. But it seems junk food is still a growth market if you adapt to sell it in new locations and less on the High Street, and the weather is good – not that Greggs are not into selling healthy options now of course.

IDOX (IDOX) – up 1.6%. A year-end trading update showed declining revenues even ignoring the disposal of the loss-making Digital business which will have a negative impact on the final results. The company is in cost-cutting mood so as to increase profitability and so as to “align the cost base more directly with its re-focused business model”. There was a new Chairman appointed recently with a very relevant industry background. The business should at least report a profit this year unlike last, and the valuation is lowly due to past problems. But investors may be getting impatient for better results.

Pets at Home (PETS) – down 0.1%. Interim results reported good like-for-like growth in both the retail business and the vet practices but a restructuring of the vet business is going to result in very substantial write-downs including cash costs of £27 million. The reason the share price did not fall is probably because of the positive trading figures and a commitment to hold the dividends both for the interim and future final ones. It’s on a prospective yield of 6.5% at present. With a new management team this may be a good share for those who like “value” plays but being in the general retail sector which is a bloodbath for many such stocks does not help.

Treatt (TET) – Up 5%. This manufacturer of flavourings issued very positive final results – revenue up 11% and adjusted earnings up 10%, with positive comments about likely future results in addition. This is one of John Lee’s favourite stocks and no doubt he will have been talking about it in the last couple of days at the Mello London conference. Unfortunately I could not attend that event, which is one reason for this long blog post today.

Victoria (VCP) – up 1.6%. Interim results were generally positive and they look to be on target to make the full year estimates. But Exec Chairman Geoff Wilding probably summed it up well with this comment: “Finally, I am acutely aware that Victoria’s share price is not where I believe it should be given our current trading and prospects. As one of the largest shareholders, you can be assured that I, and the other directors and management, are focused on building the confidence of investors and delivering the financial results expected of Victoria. It is important to remember, together we own a very robust, well-managed, and growing business with over 3,000 employees who manufacture and sell some of the finest flooring in the world. The events of the last couple of months have not distracted management from delivering and for that reason I am highly confident of Victoria’s continued long-term success”. The events he refers to were the growing concerns about the level of debt in the company and the aborted proposal to convert bank debt into a bond. Floor-covering businesses can be somewhat cyclical, as results from the Australian subsidiary in these figures indicate. Investors can get nervous about high debt and what will happen when it is due for repayment. You need a lot of confidence in Geoff Wilding for him to steer through this situation to buy the shares even at the current level.

It is remarkable looking back over these results and the share price performance of the companies over the last few months that share prices seem to have been driven by emotion and trend following even more than usual. Brexit also seems to be making investors nervous and overseas investors particularly so. That explains why the dividend yield on the market overall is at record levels. Current yield is not everything of course as future growth is also important to market valuations which depends on profit growth. But apart from Brexit there are few clouds on the horizon at present.

Brexit. Mrs May is apparently trying to sell her agreed Brexit deal directly to the general public, i.e. over the heads of politicians. But with no unanimity in the Conservative party nobody sees how she can get the Withdrawal Agreement through Parliament even if she manages to persuade the DUP to support it. It’s not easy to see how even a change of leader would help unless they can tweak the Agreement in some aspects to make it acceptable to the hardliners. That might just be possible whatever the EU bureaucrats currently say but otherwise we are headed for a “hard” and abrupt exit in March. Am I worried about such a prospect? Having run a business which exported considerably into Europe before we joined the Common Market, the concerns about the required customs formalities are exaggerated. The port facilities may suffer temporary congestion but it is always remarkable how quickly businesses can adapt to differing circumstances. For those who think we should simply go for a hard Brexit and stop debating what to do there is an on-line Parliamentary petition here: https://petition.parliament.uk/petitions/229963/signatures/new . With the Brexit Withdrawal date set for March 29th 2019, I confidently predict that the matter will be settled by March 28th or soon after, probably based on Theresa May’s Agreement which actually does have many positive aspects. It’s just the few glaring stumbling blocks in the deal that are annoying the Brexiteers.

Incidentally Donald Trump was incorrect in suggesting that the current Agreement would prevent the UK signing a trade deal with the USA. See https://brexitfacts.blog.gov.uk/2018/11/27/response-to-coverage-of-the-uks-ability-to-strike-a-trade-deal-with-the-us-when-we-leave-the-eu/ . There’s just as much fake news from politicians than there is from digital media platforms these days.

Pre-Pack Administrations. There was an interesting article on the subject of Pre-Pack Administrations in the Financial Times yesterday (26/11/2018). I have covered this topic, many times in the past, always negatively. For example on the recent case of Johnston Press – see https://roliscon.blog/2018/11/19/johnston-press-trakm8-and-brexit/ where creditors were dumped and a payment into the pension scheme due in just days time was not made with the result than the Pension Protection Fund is likely to pick up the tab. That not just means pensioners in the Johnston scheme will suffer to some extent, but the costs fall on all other defined benefit schemes so you could be contributing also.

They are not the only losers though. The FT article pointed out that one of the biggest losers are HMRC as it seems some pre-packs are done to simply avoid paying tax due to them. There is now an advisory group called the “Pre-Pack Pool” that was set up to try and stop the abusive use of pre-packs, but it is reported that even when they gave a pre-pack proposal a “red card” many were put through regardless. This looks another case where self-regulation does not work and abuses are likely to continue.

That’s not to say that all administrations could result in a better return to trade creditors and the taxman than zero, but a conventional administration with proper marketing and the sale of a business as a going concern is much more likely to do so. The insolvency regime needs reform to stop pre-packs and provide better alternatives.

Have I got a bee in my bonnet about pre-packs because of suffering from one or more? No, but I know people who have even though they are relatively rare in public companies. But I just hate the duplicity and underhand shenanigans that go along with them.

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

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Majestic Wine, Brexit, Proxy Voting and Inheritance Tax Simplification

Majestic Wine (WINE) issued their interim results yesterday (22/11/2018). I no longer hold the shares but I am a customer of theirs. The financial results were disappointing with adjusted earnings down 63% and reported profit turned into a loss from a £1.5 million profit in the previous half year. Their explanation is increased marketing expenditure particularly on Naked Wines. Revenue overall was up 5.4% but what is the point in generating more revenue at a loss? As a customer I seem to be receiving fewer marketing communications from the company. No pre-Christmas promotion so far for example. Does this explain part of their difficulty?

Their “adjustments” that enabled them to report adjusted profits are, shall we say, interesting. It includes an adjustment for “en primeur” orders where title has not passed to the customer as it has not even shipped from the supplier so cannot be recognised as a sale. They also throw in a whole mass of acquisition and restructuring costs in their adjustments.

Needless to say, they are burning cash at a great rate, including putting more into inventory (see below), so I am not convinced they have a sound strategy. The share price dropped on these results despite the announcement being full of positive comments about the future.

One might call this “reporting dissonance” where the fine phrases and positive comments about future prospects do not match the hard financial facts.

Brexit

One interesting comment in the Majestic results was that they are stockpiling wine above their normal levels “to mitigate any supply chain Brexit disruption in March 2019”. That should really annoy the chattering classes in London if their booze supplies are disrupted and they cannot obtain their favourite tipples.

But we do now have an expanded (7 pages to 26) publication explaining the proposed UK’s relationship with the EU after the Withdrawal Transition period. You can find it here: https://www.gov.uk/government/publications/progress-on-the-uks-exit-from-and-future-relationship-with-the-european-union .

You’ve probably heard the phrase “gesture politics” which refers to how politicians make grandiose gestures with little real impact. This “Political Declaration” as it is called is surely one of the grandest of all gestures. It commits neither side to anything very specific although there are lots of fine words in there.

But it does cover some areas that I complained about in the Withdrawal Agreement. It’s the kind of political statement that is aimed to appeal to all sides of the political debate in the UK over Brexit plus EU bureaucrats and politicians. But it does not resolve clearly and unambiguously the issue of no border controls in Northern Ireland and our future trading relationship with the EU, or the Gibraltar issue that Spain is complaining about. Mrs May might just get where she wants to be at this rate, but whether she can do enough to win the support of the electorate, and even more importantly, the votes in Parliament, remains to be seen.

Proxy Voting

As a past shareholder in US companies, I always used to think their proxy voting system worked well. But apparently not according to an article in the FT this week. Under the headline “SEC urged to shake up proxy voting system” it reported that it was expensive, complex and prone to error. It actually took two months to calculate if a proxy vote on a board appointment at Procter & Gamble was won or lost. I was aware that the US system was prone to “over-voting” where more shares are voted that the company has in issue, but just as in the UK the turnout of retail investors in the vote is now very low at 29%. Companies, or people fighting a proxy battle, cannot get through to the end investors or beneficial owners and lending of shares by institutional investors also causes many shares not to be voted.

In summary the system is too complex and prone to error. The SEC is to undertake a review on how it could be improved. We surely need a similar initiative in the UK and the solution is a well-designed electronic system where every shareholder is on the register of a company, including those holding shares in nominee accounts.

Inheritance Tax

I mentioned in a previous article that the Office of Tax Simplification (OTS) is looking at Inheritance Tax. They got a lot of submissions to their public consultation apparently and have now published a “first” report on the subject. See: https://www.gov.uk/government/publications/office-of-tax-simplification-inheritance-tax-review . Here are some initial comments:

It is surprising to read that the average amount of tax paid, as a percentage of an estates value, increases up to the £2 million level and then levels off at about 20%. But if your estate is worth more than £8 million then the percentage decreases. In other words, the very wealthy pay less tax. These figures are explained by high levels of exempt transfers to spouses but particularly for the rich, the extensive use of reliefs. This is surely a case of the very wealthy employing clever tax advisors while the middle classes whose wealth can reside mainly in expensive houses find it more difficult to avoid. This just demonstrates that the tax is not exactly rational nor equitable.

The OTS received many negative comments about the complexity of IHT returns and these on the issue of Lifetime Gifts:

  • The various gift rules and exemptions can be complex and confusing and are not always well understood, especially those relating to the tapering of the tax rate for gifts given in the seven years before death.
  • The financial limits for the various exemptions have not kept pace with inflation (it being recognised that increases would have an Exchequer cost).
  • For many, it is difficult to either maintain or reconstruct records of lifetime Gifts.

The complexity of the Inheritance Tax forms that executors are expected to complete is acknowledged as an issue and the recommendation is that these should be replaced by a digital system. Pending such a system being implemented the current paper forms should be changed and the guidance that is provided simplified.

At present inheritance tax must be paid within 6 months but forms only need to be returned within 12 months. There is also the problem of having to pay the tax before the assets may have been realised. All the OTS says on these issues is that HMRC should explore potential solutions.

They also suggest some possible simplifications of the IHT regulations for Trusts. But in general this report only suggest relatively modest changes to the administration of estates rather than a proper simplification of this area of taxation. Perhaps there will be more in future reports.

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

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Johnston Press, TrakM8 and Brexit

Over the weekend, Johnston Press (JPR) was put into administration and immediately sold to a new group of companies controlled by the company’s bondholders. In other words this looks like a typical “pre-pack” administration where a company does not go through a proper administration process with an open sales process but is flogged off to in a fire sale to those who already know the business and see an opportunity to collect a bargain.

Trade creditors will lose their money, shareholders will lose everything and the pension scheme is being dumped – and is likely to need bailing out by the Pension Protection Fund.

One investor in the company who wished to revive the business was Norwegian Mr Ager-Hanssen who on Saturday accused the board of thwarting efforts to turn the group around and a “sham” sales process. He is probably right from my experience of what happens in pre-pack administrations. Pre-pack administrations are an anathema as I have said many times before as they undermine a proper process when a company is in difficulties.

Johnston Press does have some very valuable media titles such as the Scotsman and Yorkshire Post but had managed to accumulate an enormous amount of debt by going on an acquisition spree. It also had a big pension deficit. The company put itself up for sale recently but now states that the offers were insufficient to repay the bonds so the company has concluded the equity is worthless. Or perhaps it was simply an example of where the prospective buyers could see it was cheaper to do it via a pre-pack.

I have never held shares in Johnston Press although I looked at it a few times as a possible “value” play. But high debt is a killer when the market in which a company operates is facing strategic problems. With newspaper circulations dropping, and advertising revenue being impacted by changes to media usage – particularly a move to internet advertising – the company failed to cut its debt rapidly enough while revenue was falling and profits disappeared.

Another disaster area on Friday was AIM-listed Trakm8 (TRAK) whose shares fell by 66% on the day to a new low of 22p. This was after publication of their half-year results and a trading statement. Group revenue fell by 38% and a very large loss was the result. The company provided numerous excuses for this and a very negative short-term outlook. But it suggests the market for the company’s solutions “will be robust in the longer term”. Anyone who believes the latter statement must be an eternal optimist.

I did hold this company’s shares briefly in early 2016 when it was the darling of many private investors and the share price peaked at over 360p but I rapidly became disillusioned with the management. Peculiar acquisitions made subsequently, poor cash flow (rather suggesting profits were a mirage of fancy accounting) and generally over-optimistic statements being issued. Warren Buffett has always emphasised the importance of trust in the management of companies in which he invests, and when I lose trust I sell in short order.

Brexit is a topic one can hardly avoid talking about at present. I gave my personal analysis of the draft withdrawal agreement here (yes I have read it): https://roliscon.blog/2018/11/16/brexit-agreement-is-it-a-fair-deal/ . On reflection it seems to me that Mrs May is attempting to meet the demands of both brexiteers and remainers with a compromise deal that keeps us partly in the EU in many regards. The result is that she has pleased few people – the right wing of her own party, the Labour Party and Jeremy Corbyn who is stirring the pot like mad to gain political advantage, the DUP who May relies on for votes, and many others. Even her cabinet seems split counting only those who remain. The concept of the “chequers” plan might have made some sense, but the detail of the proposed agreement is simply not acceptable to many people. I suggest she needs to reconsider, sooner rather than later.

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

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Brexit Agreement – Is it a Fair Deal?

I promised in my last blog post to read all 585 pages of the proposed Brexit agreement before commenting. I got to page 365 before concluding I had got a reasonable understanding of it. The “draft” agreement is certainly one of the longest and most complex documents I have ever read. It reads like a lot of documents that come out of the EU – generally incomprehensible to the layman. Indeed, it could have been written by an EU bureaucrat – perhaps it was.

The agreement covers primarily the immediate withdrawal issues and the two-year transition period, but it actually extends many years past then in some provisions. It’s hardly a clean break from EU regulations and bureaucracy.

If you don’t wish to read the 585 pages, there is a much shorter document, only 7 pages, that is an “Outline of the political declaration setting out the framework for the future relationship between the European Union and the United Kingdom” – available on the web. This spells out that the intention is to ensure close adherence by the UK to EU policies on customs and product regulations, on state aid policies, on financial services regulations, on intellectual property rules, on transport regulations, and many other areas. The draft agreement itself also ensures compliance on such matters as state aid and environmental policies. Just one example of this is the fudge over fishing in our future territorial waters where we should have control but will not – rules on that have to be agreed with the EU.

The claim by Government Ministers is that the agreement ensures there will be no disruption in the free movement of goods, thus protecting our industries, and it will enable us to regain control of our borders and the movement of people. But in reality we will still be subject to EU regulations in many areas, and some in perpetuity it seems.

The Irish border problem and the proposed solution is a complete fudge. I respect the desire of the Irish to ensure no hard border between North and Southern Ireland – as there has not been ever since we were both part of the EU and the 1998 Agreement to promote the peace process – but the basic problem is that Northern Irish politicians wish to have their cake and eat it. They want to remain full members of the United Kingdom which all that entails in terms of no customs barriers within but some at the borders and conformance to UK regulations while retaining free movement with southern Ireland.

Even though the proposal for what is effectively a “customs union” embodied in the agreement may be attractive to business, it effectively cedes control to the EU of what goods are permitted to be traded within the UK. At least that’s the way I read it. The EU has taken great care to ensure there is no “unfair competition” from the UK after Brexit by binding us to EU rule conformance.

Let’s just take one example which is the recent GDPR regulation enacted by the EU. Under Article 71 of the agreement. The United Kingdom is binding itself to “ensure a level of protection of personal data essentially equivalent to that under Union law” in perpetuity. So the EU could invent even more daft regulations than the current GDPR ones and the UK would have to adopt them with no say in the matter.

Another example is the issue of Competition Law and State Aid. New state aid in the UK can be challenged by the EU up to 4 years after the transition period (see Article 93). Is that a trivial matter? Hardly because for example the European Court of Justice (ECJ) just issued a judgement stopping the UK from paying for power plants to stay open so as to provide emergency power when required. This was providing certainty of supply and minimising price peaks in severe weather conditions. The ECJ can also interfere in interpretation of the agreement for 8 years after the transition period (see Article 158).

In summary the withdrawal agreement is far from being a “declaration of independence” for the UK as Brexit supporters wanted. It will not enable us to set our own rules and regulations on social policies, labour regulations or environmental standards. In effect it’s a Brexit in name only.

Surely it would be much better to have cut out this bureaucracy and save a lot of the money we have promised to pay the EU under the withdrawal agreement by pushing for a clean break followed by a free trade agreement with the EU. That is what the Leave-means-leave campaign (see https://www.leavemeansleave.eu/ ) are pushing for and that makes more sense to me also than accepting this very poor deal negotiated by weak politicians. This hardly seems to be the best deal that could have been negotiated as the Prime Minister is claiming.

Postscript: After writing the above I read this morning’s Financial Times. It seems their writers agree with me in an article headlined “Accord leaves Britain bound to Brussels”. It not just points out the problems in the “transition period” but on such matters as “state aid” where it says “the UK authority must take ‘utmost account’ of commission advice on all decisions, and can be overruled by Brussels or the ECJ”. Similarly their writer Philip Stephens headlines an article with “Parliament should reject a rotten deal”. Looks like the FT journalists may have actually read the agreement also. I certainly agree with Mr Stephens.

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

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