Epidemic Over? Unable to Trade and Chrysalis VCT Wind-Up

The news that the Pfizer vaccine for Covid-19 appears to work (at least 90% of the time) and has no negative side effects gave stock markets a good dose of euphoria yesterday. It suggests that we might be able to return to a normal life in future, but exactly when is far from clear. Actually producing and distributing the vaccine is going to be a mammoth task and it is very clear that it will only be given to certain people in the short term – the elderly and medically vulnerable. Some people might not accept the vaccine and transmission of the virus may still take place. It is clearly going to be many months before we can cease social distancing and wearing face masks – at least that is the situation if people follow sensible guidance which they may not. Some countries may not be able to afford to immunize everybody so how this good news translates into reality is not clear. In summary, the epidemic is not over.

But the good news did propel big changes in some stocks such as airlines, aerospace industry companies and the hospitality sector which have been severely damaged by the epidemic. Rolls-Royce (RR.) share price was up 44% yesterday for example, although I wouldn’t be buying it until it can show it can make a profit which it has not done for years. In the opposite direction went all the highly rated Covid-19 diagnostic stocks such as Novacyt (NCYT) which I hold. There have probably been way too extreme movements both up and down in the affected stocks as sentiment was only one way.

The big problem faced by many investors though was that platforms such as Hargreaves Lansdown and AJ Bell Youinvest actually ceased to function. It is reported that their customers were unable to log in and trade. But this is not a new problem. See this report in December 2019 when there was a previous bout of euphoria that affected the same two brokers: https://roliscon.blog/2019/12/16/euphoria-all-around-but-platforms-not-keeping-up/ .

They clearly did not learn their lesson and should have done better “load testing”. Perhaps the moral is don’t put all your eggs in one basket by relying on one broker (I use 5 different ones and spread my holdings over them).

For those with an interest in Venture Capital Trusts (VCTs) it has been pointed out to me that Chrysalis VCT (CYS) is putting proposals to wind up the company to its shareholders. I used to hold the company, but sold out in 2018 at prices ranging from 62p to 66p – the current share price is 35p. I had big concerns then about the shrinking size of the company (NAV now only £14.9 million) as cash was returned to investors. The other major concern was the holdings in the company, particularly that in media company Coolabi and the valuation thereof (last filed accounts were to March 2019 and showed a loss of over £7 million).

VCTs that shrink too much, even if they are good at returning cash to shareholders, can get themselves into an unviable position as costs of running the VCTs sooner or later get out of proportion. As the announcement by the company makes clear, in such a situation a VCT has the following options: a) merge with another VCT; b) change the manager and raise new funds; c) sell the company or its portfolio; or d) wind it up.

But raising new funds under the tougher VCT rules that now apply might not be easy, while mergers with another company might be difficult. Who would want to acquire a portfolio where 29% of the current valuation is that of Coolabi – even if you believe that valuation!

The directors give numerous reasons why a wind-up is the best option after they got themselves into this difficult situation. They correctly point out that some investors will be prejudiced by this move as some original investors will have claimed capital gains roll-over relief. They will get their tax liability rolled back in after the wind-up and the ultimate cash cost might be more than what they obtain from the wind-up. Ouch is the word for that. But the directors are going to ignore those investors on the basis that a wind-up “best serves shareholders as a whole”.

The other problem is that a wind-up of a company with holdings of private equity stakes takes a long time and there is no certainty that the value they are held at in the accounts can actually be obtained. Investors in Woodford funds will have become well aware of that issue! Who would actually want to buy Coolabi for example, or some of the other holdings?

Another VCT I held in the past that got into the situation of returning cash to shareholders while finding no good new investments and not raising funds was Rensburg AIM VCT. They managed to escape from it after a lot of pushing from me by merging with Unicorn AIM VCT. But I fear Chrysalis VCT have left it too late and hence the choice of the worst option.

But if I still held the shares, I might vote against the wind-up and encourage the directors to take another path. It is possible to run VCTs on a shoestring if a big focus on costs in taken. In addition, the directors say that they did have some discussions about fund raising, possible mergers or the acquisition of the company but have rejected those for various reasons. But I think they need to look again, after a more realistic view of the values of the existing portfolio holdings has been obtained.

One change that should certainly be made if the company chooses not to wind-up is a change in the directors and fund managers who allowed the company to get itself into this unenviable situation. Regrettably there often appears to be a tendency for directors and fund managers to want to keep their jobs and their salaries long past when tough decisions should have been made.

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

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Horizon Discovery AGM and Chrysalis VCT

Yesterday I attended the Annual General Meeting of Horizon Discovery Group (HZD) in Cambridge. This is a new holding for me, and I don’t often buy shares in companies that are not reporting profits, but I thought it was worth going along to learn some more about the business. The company’s primary focus is on cell manipulation tools (gene editing, gene modulation) which they sell to drug development companies et al. I am not sure I have great understanding of the science but they recently had an offer for the business from Abcam who should understand it, particularly as they shared a non-exec director, Jonathan Milner, until recently. The offer from Abcam was rejected on the basis it was not good enough. The board of Horizon thought it was worth twice as much on a revenue multiple basis looking at comparable companies so the offer was withdrawn. Analysts forecasts are for near breakeven on an adjusted basis this year so it is making progress, but it’s still valued at more than seven times revenue.

However, I shouldn’t need to tell you that this area of medical science is a rapidly developing one with great prospects for innovatory cures of genetic defects and more focused drugs to match a person’s DNA profile.

With minimal shareholders present, it was a short meeting and only I asked any questions, so it will be a short report. One question I asked is why the company loses money on services but makes a profit on product sales. See segmental breakdown on page 66 of the Annual Report. As I said at the time, normally it’s easier to lose money on product sales because with services if they are not profitable you can simply stop providing them. In other words, this was an unusual profile. The Chairman, Ian Gilham, initially denied they lost money on services (it’s over £10 million excluding even “leveraged R&D”), but the CFO then explained that the services are often development projects for customers where they retain the IP, i.e. the customers are paying to some extent to develop the products. That is always a good business model.

I asked why the former CEO had recently left and the only answer I got was that he probably wanted to work for a smaller company while Horizon is now quite large after the recent acquisition of Dharmacon. That will transform the financial numbers. The new CEO is Terry Pizzie who has worked for the company since February 2017.

I was favorably impressed on the whole but I did comment that even if it is an AIM company they could do with having a Remuneration resolution on the agenda. Their pay scheme is actually quite a simple one, and bonuses last year were quite limited, so I would have voted in favour of it anyway.

A long-awaited announcement yesterday on what they plan to do to tackle some strategic issues was from Chrysalis VCT (CYS). This venture capital trust has been somewhat unusual in being self-managed and having no discount control mechanism, i.e. no active buy-back policy. As a result of the latter combined with decent fund performance the trust was offering a very high dividend yield to those investors brave enough to buy shares in the market (like me). Some of the directors took advantage of that situation in the past, although not recently. However the company is facing some possible problems in that the size of the trust is tending to run down due to the high dividends paid out, and the changes to the VCT rules might make it difficult to follow their past investment strategy.

So yesterday they announced that they were implementing an “active buy-back” policy with a target discount to NAV of 15%. The share price rose on the day as a result. Even after that the yield is 7.6% (tax free) according to the AIC. The buy-back policy might help if they wished to raise more investment funds, but they also say they are likely to make “further distributions of capital” so it looks like the fund will run down further in size instead.

The half year results given in the same announcement were somewhat pedestrian (NAV up 1.6%) like many VCTs I hold of late. But anyone considering the shares needs to look at the large holding of Coolabi in the portfolio.

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

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Chrysalis VCT AGM Report

Last week (27/2/2018) I attended the Annual General Meeting of Chrysalis VCT Plc (CYS) in the City of London. Here’s a brief report on the event. There were about half a dozen ordinary shareholders present, the three directors and fund management representatives despite the difficult travel conditions.

Chrysalis is of course a venture capital trust but somewhat different to many VCTs. It has a good performance record in recent years but does not undertake share buy-backs. As a result the shares trade at a high discount to NAV (about 20% at the time of writing). With a dividend yield of about 8% (and no tax on VCT dividends), many of the current shareholders may have purchased their shares in the market although some of my holdings date back to the year 2000 when I claimed capital gains roll-over relief.

The company is relatively small in size for a VCT, and the new VCT rules which require such companies to focus on early stage investments are causing the board some concerns apparently. There is reference in the Annual Report to “a review of the options available to the Company” and there was considerable discussion on that topic at the AGM.

Should the company wind-up? Or simply become an ordinary investment company rather than a VCT? Or perhaps look for a merger with another VCT? As regards the latter possibility, this company seems to be getting into the same situation as Rensburg AIM VCT which eventually merged with Unicorn but rather late in the day and after a lot of encouragement from me to take action. I likewise encouraged the directors of this company to make decisions fairly soon on the future of the company.

One matter discussed at the AGM was the company’s large investment in Coolabi where they hold debt repayable in 2020. Having looked at the Annual Report of that company available from Companies House before the meeting, I have a pretty jaundiced view of the value of that business. Although Chrysalis increased the valuation of their loan in the accounts, they actually wrote down their equity stake to zero it transpired (holders of Edge VCT who have a big equity stake in Coolabi should note). However, fund manager Chris Kay did make some very positive comments about the value of the intellectual property in Coolabi.

Chris also commented on the difficulty of making new investments at present with small companies now valued very highly and lots of competition for the good ones. The new VCT rules are making it more difficult and it seems that there are still long delays on getting pre-approval (advance clearance) from HMRC (now 3 to 6 months).

Obviously what the company decides to do affects different shareholders in different ways, depending on their tax status, whether they claimed roll-over relief on investment, and their desire to convert their holdings into cash. The company may do a survey of shareholders but they are not sure they will get a good response.

Those present gave their views on the situation and there were some differences. I plan to write to the Chairman giving my views in more detail. For example, I will probably suggest a “shareholder committee” that might act as a consultative group.

If you are holding shares in Chrysalis, are interested in discussing the future of this company, or would like a copy of my letter to the Chairman, you can contact me via this web page (my company’s web site): http://www.roliscon.com/contact.html

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

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