Chancellor’s Statement, EIS Funds and EMIS Results

The Chancellor’s Spring Statement yesterday was generally positive but there are some aspects that it’s worth talking about. Mr Hammond was right to be cautious because although new Government borrowing is falling, the total debt is still rising. It’s only forecast to fall as a proportion of national income by 2020-21 because of rising GDP. There is “light at the end of the tunnel” as the Chancellor put it, but it’s still some distance away.

GDP is only rising slowly and it is forecast by the Office of Budget Responsibility (OBR) to be rising at near 1.5% in the next few years which is not exactly rapid. The OBR also forecast that we will have to pay £41 billion to the EU after Brexit as a settlement of our obligations, although it will also free up £3bn or more per year that can be spent on other things, i.e. they suggest in the long term we will save money but the impact of changes in migration and trade terms might be more significant.

The Labour party wants the Chancellor to free up the purse strings and increase expenditure on the NHS and other areas. The Government could only do that by borrowing more which would not only increase the cost of their debt but would seem unwise given the economic outlook and the uncertain impact of Brexit. Because of an ageing population, but a growing one, more money will need to be spent on local authorities and the NHS anyway but the growth in productivity remains poor which ultimately determines the wealth of the nation.

Will the estimated figures have an impact on likely future interest rates (which have a significant impact on stock market investment)? Interest rates might need to rise somewhat to make Government debt continue to be attractive but it is not obvious that the economy is overheating as yet – inflation seems to be driven more by rising import prices as the pound has fallen rather than wage rises. The Government will no doubt be keen not to increase the cost of its debt, even if it has only indirect influence on the rate. Interest rates lower than real inflation are a good way for the Government to reduce its debts however much it prejudices savers.

One interesting mention for investors was a mention of a consultation on EIS funds that includes several options for more tax reliefs to encourage investors to put money into early stage “knowledge-intensive businesses”. That might include tax free dividends (only available on VCTs at present), or capital gains exemptions. I may write some more on this topic after reading the full consultation document which is here: https://www.gov.uk/government/consultations/financing-growth-in-innovative-firms-enterprise-investment-scheme-knowledge-intensive-fund-consultation . Investors interested in this subject should of course respond to HM Treasury’s consultation.

Some Venture Capital Trusts (VCTs) have fallen in price today. Perhaps because they might be perceived as less attractive to investors if such new EIS funds were introduced. But they would surely be very different beasts even if they might provide more competition for new investor subscriptions.

Comment: having invested in both EIS funds and directly in EIS qualifying companies in the past, I have vowed only to do the latter in future. Finding an experienced fund manager in early stage companies who can pick out the good EIS businesses is not easy and the lemons they pick ripen quickly (a common VC adage) while the good investments can take years to mature. If there is very generous tax relief (at a level where investors ignore the merits of the underlying investee companies because the tax reliefs are so generous it looks like they can’t lose money), then this will encourage all kinds of dubious promoters to enter the field.

One company that is sensitive to Government spending on the NHS is EMIS Group (EMIS). They announced their Final Results this morning. They previously warned in January that they had breached their service level obligations to the NHS and the cost might be “in the order of upper single digits of millions of pounds”. I commented on the company then and still hold some shares in it. The actual damage is a provision of £11.2 million in these accounts for a “financial settlement and costs to remedy past issues”. The share price rose today perhaps in relief that the news was not worse.

Few more details of the contract breach are provided and when I talked to my GP who uses EMIS-Web and used to be active in their user group, he knew nothing about any service failures. All rather odd.

Even excluding that item which is being treated as an exceptional cost, the figures were disappointing though. Revenue was only up 1% and adjusted earnings were down 4%. The CEO commits to a “robust management of legacy matters” and a commitment to being “more performance-led with greater accountability, improved operational execution and an increased focus on our customers”.

Dividend has been increased though which suggests some confidence in the future, putting the shares on a yield of 3.5% and a possible forecast p/e of 16, but the company certainly needs to show better signs of growth if the share price is to get back to where it used to be a couple of years ago.

The Government might spend more in the Autumn budget, but whether EMIS will see much benefit remains to be seen.

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

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More on EMIS Profit Warning

A few days ago I commented on the announcement by EMIS Group that warned about a failure to meet customer service levels and a possible hit to profits as a result of up to £10 million. As I said at the time, I wrote to the Chairman and asked several questions. Today I received a response by letter from Peter Southby, CFO. He has been there since 2012 it is worth noting.

The letter was the typical “brush-off” that individual investors tend to receive – for example it commenced: “I am afraid we are not able to respond to questions from individual shareholders on this matter for standard reasons around customer confidentiality and commercial sensitivities”. So I phoned him up and reassured him I was not seeking inside or price sensitive information. He then proved more amenable. This is what I learned:

The failure was to meet service level agreements with NHS Digital for the GP software (EMIS Web). The current contract was signed in 2014 but there was a previous similar contract.

EMIS discovered the problem themselves, following a review of customer services, rather than the client reporting it. The issue is a “low level” service issue, and not a critical item to the customers who have not been impacted significantly. The problem was not known to senior management until it was recently reported (certainly the CFO was not aware of it). It is not currently known how long the failure to meet contract terms had been running. They are working to get back within the contract terms as soon as possible. As regards the past failure and associated financial liability, it is possible the customer will accept an alternative rather than a cheque – for example, provision of software enhancements. But that is subject to negotiation.

EMIS have an active “user group” and the problem has apparently been discussed with them already.

In my original note I suggested auditors KPMG might have been at fault for not picking up this problem in their last audit, but it does sound as though that might not have been possible. However I suggest that is a question to be revisited later and it still leaves the issue of major risks not being noted in the Annual Report.

In conclusion, the problem may be less serious than first apparent, although there is still a risk in this kind of situation that more issues may be discovered the more investigations are performed. Will have to wait and see for the moment.

One thing I am certain about though, which is why I like the company. The GP end-users would hate to switch to another software product. Admittedly EMIS will have to negotiate their way out of this difficulty with NHS bureaucrats rather than end-users but when an on-going relationship of some years standing is in place, then some horse trading is the usual outcome. I’ll have to ask my GP what he knows about this problem next time I see him.

Just one final point: If you get the kind of response I got, then it’s always worth a phone call. Personal contact can make the difference.

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

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