Brexit Prevarication, The Company, Sarbanes-Oxley and Patisserie Holdings (CAKE)

Prevarication definitions: delaying giving someone an answer, or avoiding telling the whole truth. Theresa May’s suggestion for an extension of the Brexit transition period surely smacks of prevarication and all sides of the Brexit debate saw it for what it was. The result is some furious back-peddling by the Prime Minister. Putting off decisions usually does not make them any easier. It is not at all clear what the PM’s strategy is here. Was she perhaps hoping to put off Brexit negotiations until after the next election when she might have a bigger majority and will not have to rely on the DUP? As the EU has been saying, she needs to spell out what arrangements the UK wants and preferably ones that are likely to be acceptable to the EU – otherwise gear up now for a hard Brexit.

One of the problems with a hard Brexit would be the likely tariff barriers to both exports and imports. The economy might quickly adapt to those but it was interesting reading a book named “The Company” by John Micklethwait and Adrian Wooldridge – I am doing some research on the way joint stock companies developed to see how we got to where we are, which the book covers well. One interesting paragraph covers what happened after the first world war when protectionism rose and the US and UK introduced tariff barriers on certain goods. That is why Ford and GM set up car plants in the UK which was a strategy to get around those barriers. So if we have a hard Brexit, we might see the same response – UK companies will set up European subsidiaries and vice-versa. Smart businessmen are experts at getting around political problems!

The book “The Company” is highly recommended as an easy read on the development of companies, but it is not very complimentary about the amateur UK management in comparison with the professional managers of big US, German, Japanese, etc, companies. Competent and well-trained professional management seems to be a lot more important than particular legal or corporate governance structures.

Another section of the book covers the debacles of Enron and Worldcom which were massive frauds hidden by defective auditing (which also caused the collapse of Anderson) after which a new Act was passed in the USA – the Sarbanes-Oxley Act. This required not just rotation of audit partners, but to quote from the book: “The law also requires CEOs and chief financial officers to certify the accuracy of their financial reports, and it creates a new crime of securities fraud, making it punishable by up to twenty-five years in jail”. It also enabled claw-backs of executive compensation for misconduct.

Although there has been some criticism of Sarbanes-Oxley in the USA for adding onerous obligations on companies, and hence adding to costs, perhaps that was a result of the way it was implemented that was over-zealous. But surely it is this kind of legislation that is required in the UK if we are to clean up the financial reporting and auditing of companies after so many recent failures. Making the publishing of false accounts a criminal offence with severe penalties would be a good starting point.

One such recent example is of course the small company Patisserie Holdings. There was an interesting article in Shares Magazine this week where the Editor pointed out that the case was similar to that of Tesco. In 2017 the Financial Conduct Authority (FCA) forced that company to compensate certain shareholders for publishing false accounts on which basis they had invested. See https://www.fca.org.uk/publication/final-notices/tesco-2017.pdf for the FCA Notice on the matter. This decision was based on the fact that it was considered to be market abuse to make false announcements, and hence a false market was created. Although Patisserie is an AIM company, it is probably covered by the same market abuse regulations. So this issue might be a question for the General Meeting of Patisserie on the 1st November. Will Patisserie need to provide for such financial compensation before the FCA forces them to, which could be substantial if the alleged financial fraud had been going on for many months? The answer might not just interest past investors but those who are purchasing shares in the placings.

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

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Fishing Republic, Pattiserie and Smithson Trust

Fishing Republic (FISH) shares have been suspended and it looks like it’s run out of money with folks unwilling to finance it further. A new CEO was about to join but now is not. I have never held shares in this company so I just had a quick look at the history of its listing on the AIM market.

It listed in 2015 with an initial market cap of £2.7 million – yes it always was a small business. The share price rose as high as 46p as it went for growth, but was 5.22p when suspended. The last interim results looked terrible – loss of £2.5 million on revenue of £3.4 million. The company suggested its problems were down to competitive pressures and tough market conditions, but it looks to me more a simple case of mismanagement. Was there really a big market for fishing tackle where fishing enthusiasts would pay good money for such kit in any case?

This is probably going to be just the latest poor-quality business, or ones with unrealistic ambitions, to disappear from the AIM market which has been shrinking. It’s now down to 937 companies when it was nearly 1,700 in 2007. That near halving in the number of companies has probably improved the overall quality of the market with an emphasis on larger companies now. That’s probably good for investors.

Hindsight always makes the problems look obvious of course. In the case of Patisserie Holdings (CAKE) I have seen it said that the cakes were boring, the shops often empty and it seemed odd that they could make good profits in such a competitive sector. The first two I discounted because that was not my experience of visiting their cafes (I always try to sample the wares of companies I invest in). As regards the latter issue, we await more information, but Whitbread have just flogged off their Costa coffee chain for an enterprise value of £3.9 billion, representing a multiple of 16.4 times FY18 EBITDA. That’s a rich price for a similar business in a competitive sector with no obvious barriers to entry is it not?

Shareholders in Patisserie Holdings can attend the General Meeting at 9.0 am on the 1st November to approve the second share placing, and ask some questions. That’s a very inconvenient time for many shareholders and is certainly not “best practice”.

The UK stock market seems to have stabilised somewhat after recovery in the US. It’s always worth having a quick look at the S&P 500 to see how it is trending if you wish to know where the UK market is going to go. This should bode well for the launch of the Smithson Investment Trust which raised its fund-raising limit and will be the biggest ever UK investment trust launch at £822 million. Dealings will commence on the 19th October, but best to wait and see how it performs longer-term in my view. There’s obviously some short-term enthusiasm for another fund from the Terry Smith stable regardless of having no track record.

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

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Patisserie – Hidden Overdrafts but Where’s the Other £18 Million?

The Sunday Times ran some articles on Patisserie Holdings (CAKE) today including an interview with Chairman Luke Johnson. It seems the one big hole in the accounts was hidden overdrafts with Barclays and HSBC totaling £9.7 million. But where’s the rest of the £28 million that was claimed to be held as cash in the interim balance sheet?

Mr Johnson is quoted as saying “There was criticism that I was stretched too thin – fair criticism”. He has promised to reduce his commitments and will even stop writing his column for the Sunday Times.

There is currently speculation about the value of the company and what the share price might be when listing is restored. It’s not difficult to work out what the earnings might be from Mr Johnson past comments about current trading, but there will be one enormous write-down likely in the Annual figures which may well be reported late with previous years restated. The big unknown is what else is unknown. Also existing shareholders may sell in droves as once investors lose confidence in management, they often dump their shares as a way of forgetting the trauma. It might take a long time, even years, to restore confidence in the company and it’s very unlikely to trade on a p/e of 25 which is what it was at before the suspension.

Forecasting likely earnings and hence the share price in future is a mug’s game at this point in time so I will not even attempt to do so. Any new investors keen to pick up the stock will simply be speculating. Those who already hold the stock will need to consider carefully whether they want to wait long enough for a possible recovery.

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

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Patisserie Rescue Bid and Closing Accounts

It looks like Luke Johnson’s reputation will not be totally trashed after all after he announced a way for the company to be rescued today. It is proposed to do a placing at a heavily discounted share price of 50p (last price before suspension was 429p). This will raise £15 million from the issue of 30 million shares. The current shares in issue are 104 million so that implies substantial dilution although I have seen worse.

It will take some time to organise the placing as it requires a General Meeting to authorise the full number of shares required. In the meantime Mr Johnson is to loan the company an immediate £10 million on a three year term and interest free (that is generous is it not). In addition he will provide a further immediate bridging loan of £10 million which will be repaid out of the placing.

The directors estimate the current revenue run rate at £120 million per annum with EBITDA of £12 million although that is clearly based on only an initial review so is subject to doubt.

Apart from the usual problem that most placings are not open to private investors, this looks a good deal and much better than the likely alternatives. If this is pulled off, it seems my small holding in the company won’t be totally worthless after all.

There has been much hand wringing among financial commentators about the fact that the fraud was not obvious from the accounts of the company. That’s assuming the cash was not stolen in the last few months which seems unlikely although at this point in time we do not know. But false accounting is often not obvious. It could be many months before we find out what the source of the problem was, and whether the auditors fell down on the job or not, but it’s good to hear that the company’s finance director, Chris Marsh, was arrested by the police. It looks like prompt action by the regulatory authorities is being taken which is often not the case.

Recently I had a call from Cornhill who I am registered with for placings. They wanted to go through a long conversation to confirm my KYC details even though I had only given them very comprehensive information eighteen months ago and I was happy to confirm that nothing had changed. After a lot of pointless debate, I told them to close the account (and the linked account with Jarvis – total cash held £1,600 and no shares). This they refused to do initially unless I provided more evidence of who I was and the bank account I wanted the money sent to (which was the one already known to them). I had to threaten then with a complaint to the FCA and the Financial Ombudsman for wasting my time before they eventually backed down.

This is compliance gone mad. It’s difficult enough to open an account now, but it should not be that difficult to close one.

Anyway I might be missing out on any placing for Patisserie as a result but I feel life is too short to waste time on tedious KYC checks.

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

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CAKE (Patisserie), Foresight 4 VCT AGM, Payment Companies and Dunelm

More bad news from Patisserie Holdings (CAKE) today – well at least you can’t say the directors are not keeping you informed about their dire situation which is not always the case in such circumstances.

Yesterday the company announced that its major operating company had received a winding-up petition from HMRC, of which the directors had only recently become aware. Today the company said after further investigation the board has reached the conclusion that without an “immediate injection of capital, the Directors are of the view that there is no scope for the business to continue trading in its current form”.

The directors could possibly try to do a quick placing at a deep discount no doubt, borrow a pile of cash at extortionate rates or they could put it into administration. The big risk is that Exec Chairman Luke Johnson will put it through a pre-pack administration. I hope he does not because that won’t do his reputation any good at all. He needs to try and engineer some sensible solution if his reputation in the financial world is to remain intact. That is particularly so after he wrote an article for the Times in September on “a beginner’s guide to tried and tested swindles” suggesting how you can spot them. Clearly he was not taking his own advice. Whatever happens, the outlook for existing shareholders does not look good.

As another commentator said, the Treasury should not reduce the generous tax reliefs on AIM companies because they need to realise that it is a risky market.

But there was some good news on cake yesterday when the Supreme Court decided after all in an appeal from the lower courts that a cakemaker can refuse to bake cakes where the proposed wording in the icing is objectionable to them. A victory for common sense and liberty.

Today I attended the Annual General Meeting of Foresight 4 VCT (FTF). There is one advantage to owning VCT shares. They barely move when the stock market is otherwise in panic mode. They are one of the few “counter-cyclical” investments to public companies as they invest in private equity. There are some disadvantages of course. Illiquidity in the shares, and often disappointing long-term performance as in Foresight 4. But it may be improving.

I won’t cover the meeting in detail but there were a couple of interesting items in fund manager Russell Healey’s presentation. He mentioned they are still having problems with long delays on HMRC pre-approval of new qualifying investments – can still delay deals for a few months it seems. More representations are being made on this.

He also covered the performance of their top few investments. Datapath, the largest, was valued down because EBITDA fell but revenue is still growing and the fall in profits arose from more product development costs. Ixaris, the second largest, is growing strongly (I knew this because I have a direct holding in it and had just read the December 2017 accounts they filed at Companies House). From my recollection that’s the first year they have made a profit since founding 16 years ago. Russell couldn’t remember how many funding rounds the company had launched – was it 6 or 7, and me neither. That’s venture capital in early stage companies for you – you have to be very patient.

However, in response to a question from VCT shareholder Tim Grattan it was disclosed that VISA are tightening up on the rules regarding pre-payment cards. This might affect a significant part of Ixaris’s business. I suspect it will also affect many other pre-payment card offerings by payment companies, some of whom are listed. Particularly those that are using them to enable payments into gaming companies which Visa does not like.

It was another bad day in the market today, although Dunelm (DNLM) picked up after a very positive trading statement with good like-for-like figures. They are moving aggressively into on-line sales but their physical stores also seem to be producing positive figures so perhaps big retail sheds are still viable. They are not in the High Street of course.

While the market is gyrating I am doing the usual in such circumstances having been through past crashes. Will the market continue to go down, or bounce back up? Nobody knows. So I tend to follow the trend. But I also clear out the duds from my portfolio when the market declines – at least that way I can realise some capital gains losses and reinvest the cash in other shares that are now cheaper. I also look carefully at those stocks that seem to be wildly over-valued on fundamentals – those I sell. But those that suddenly have become cheap on fundamentals I buy, or buy more of. In essence I am not of the “hide under the sheets” mentality in the circumstances of a market rout as some are. But neither do I panic and dump shares wholesale. This looks like a short-term market correction to me at present, after shares (particularly in the USA) became adrift from fundamentals and ended up looking very expensive. But we shall no doubt see whether that is so in the new few days or weeks.

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

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