The Impact on Investors of the Labour Party’s Plans

I commented briefly yesterday on the plans by John McDonnell of the Labour Party to give employees shares and possible future nationalisations – see: https://roliscon.blog/2018/09/24/labours-plans-for-confiscation-of-shares-and-rail-system-renationalisation/

More information is now available on the share scheme and the more one studies it the more one realises that whoever devised it does not understand much about business and the stock market. In other words they were typical politicians with no experience of the real world I would guess.

The scheme would apparently operate by companies with more than 250 employees being forced to hand over 10% of the shares in a company to an employee trust fund. That would be over a period of time – possibly ten years – and presumably that would be by the issuance of new shares rather than confiscating existing shares, but it still means 10% dilution for investors.

Shareholders normally get a vote on the issuance of new shares but presumably that could be legally subverted. Otherwise the scheme would cover about 11 million employees. However, foreign owned companies would not be covered so that excludes perhaps a third of the employees (the Labour Party apparently admits they would not be and it is difficult to see how legally any such law could be enforced on them).

One simple way for companies to avoid the scheme would be to move their country of registration elsewhere – no need to change where their shares are listed, just move domicile. We could see a host of companies re-registering in such places as Panama! An unintended consequence that I am sure the Labour Party would not like.

The shares accumulated in the trust fund would pay dividends to the individual shareholders out of the dividends paid to the fund by the company. But there would be a cap of £500 per employee. Any amount payable above that cap would revert to the Government. It is estimated this might generate £2 billion a year to the Government after 5 years – another large tax hike in addition to proposed increases in Corporation Tax the Shadow Chancellor is promising.

Employees could not buy or sell the shares held on their behalf, so presumably could not take them away when they leave or retire. So in practice those companies with high staff turnover would see the dividends accumulating for the benefit of the Government, particularly if the £500 cap remain fixed, i.e. unindexed.

But the company could avoid paying out this windfall to the Government simply by not paying dividends. Many companies don’t pay dividends anyway. Alternatively they could pay a dividend in shares (a “scrip” dividend), or offer to buy back shares occasionally via a tender offer or market share buy-backs– these would not be dividends and hence would be excluded.

Another problem with the scheme is that companies who had a few less than 250 employees could decide not to expand and hence become subject to this scheme, i.e. this would discourage companies from growing which is not what the Government wants. Alternatively they could create new separate companies owned by the same shareholders to expand their business and avoid it that way.

Apart from the 10% dilution that will hit not just direct investors but those investing via pension schemes, you can see that this scheme is not just daft because of its unintended consequences and likely avoidance, it’s an insidious way to raise taxes on companies and investors very substantially.

The only good aspect of the scheme is that it would help to give employees a stake (albeit indirect) and hence interest in the company they work for. It might also ensure some representation of their interests because the trust fund would be controlled by employees and could vote the shares. But there are much better ways to provide both those benefits.

In conclusion, the idea of an employee trust fund sounds attractive at first glance but it has not been properly thought through. A lot more consideration needs to be given to come up with a workable scheme that does not prejudice companies and their investors. Any foreign investor who saw such a scheme being imposed on his UK investment holdings would promptly run a mile – and don’t forget that most of the UK stock market is now owned by foreign investors. The impact on the Uk stock market, and the economic consequences of investors taking their businesses and investment money elsewhere beggars belief.

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

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Labour’s Plans For Confiscation of Shares and Rail System Renationalisation

Jeremy Corbyn made it clear in a speech last night that the rich will be under attack if Labour gets into power. John McDonnell, Shadow Chancellor, will present his plans today to give 10% of shares in all larger companies to employees over a period of years. The Daily Telegraph described it as a Marxist plot to control businesses while Carolyn Fairburn of the CBI attacked it as a “new tax that adds to the impression that Labour sees business as a bottomless pit of funding”. The proposal seems to be based on setting up a trust for employees into which the shares would be deposited and from where dividends would be paid to employees.

Comment: It will certainly dilute existing shareholders so readers of this blog might find they and the pension funds that invest in shares are proportionally poorer. Although it sets a bad principle, if the numbers being proposed are enacted it might not have a major impact on companies or investors. Enabling employees to have a financial interest in the profits of a company is quite a sensible idea in many ways. But it might simply encourage companies to take their business elsewhere. If they are registered in another country, how will the UK Government enforce such legislation?

Last week Chris Grayling, Transport Secretary, announced a review of the privatised rail system. That follows the recent problems with new timetables where the regulator concluded that “nobody took charge”. John McDonnell said that he could renationalise the railways within five years if Labour wins the next election – it’s already a manifesto commitment. Perhaps he thinks he can solve the railway’s problems by doing so but this writer suggests the problem is technology rather than management, although cost also comes into the equation.

The basic problem is that the railways are built on inflexible and expensive old technology. There has never been a “timetable” problem on the roads because there are no fixed timetables – folks just do their own thing and travel when they want to do so.

Consider the rail signalling system – an enormously expensive infrastructure to ensure trains don’t run into each other and to give signals to train drivers. We do of course have a similar system at junctions on roads – they are called traffic lights. But they operate automatically and are relatively cheap. Most are not even linked in a network as train signals are required to be.

Trains run on tracks so they are extremely vulnerable to breakdowns of trains and damage to tracks – even snow, ice or leaves on the line cause disruption – who ever heard of road vehicles being delayed by leaves? A minor problem on a train track, often to signals, can quickly cause the whole line or network to come to a halt. Failing traffic signals on roads typically cause only slight delays and vehicles can drive around any broken-down cars or lorries.

The cost of changes to a rail line are simply enormous, and the cost of building them also. For example, the latest estimate for HS2 – the line from London to Birmingham is more than £80 billion. The original M1 was completed in 1999 at a cost of £26 million. Even allowing for inflation, and some widening and upgrading since then the total cost is probably less than £1 billion.

Changes to railway lines can be enormously expensive. For example, the cost of rebuilding London Bridge station to accommodate more trains was about £1 billion. These astronomic figures simply do not arise when motorways are revised or new service stations constructed.

Why invest more in a railway network when roads are cheaper to build and maintain, and a lot more flexible in use? At present the railways have to be massively subsidised by the Government out of taxation – about £4 billion per annum according to Wikipedia, or about 7.5p per mile of every train journey you take according to the BBC. Meanwhile road transport more than pays for itself and contributes billions to general taxation in addition from taxes on vehicle users.

So here’s a suggestion: scrap using this old technology for transport and invest more in roads. Let the railways shrink in size to where they are justifiable, or let them disappear as trams did for similar reasons – inflexible and expensive in comparison with buses.

No need to renationalise them at great expense. Spend the money instead on building a decent road network which is certainly not what we have at present.

Do you think that railways are more environmentally friendly? Electric trains may be but with electric road vehicles now becoming commonplace, that justification will no longer apply in a few years’ time, if not already.

Just like some people love old transport modes – just think canals and steam trains – the attachment to old technology in transport is simply irrational as well as being very expensive. Road vehicles take you from door-to-door at lower cost, with no “changing trains” or waiting for the next one to arrive. No disruption caused by striking guards or drivers as London commuters have seen so frequently.

In summary building and managing a road network is cheaper and simpler. It just needs a change of mindset to see the advantages of road over rail. But John McDonnell wants to take us back to 1948 when the railways were last nationalised. Better to invest in the roads than the railways.

It has been suggested that John McDonnell is a Marxist but at times he has denied it. Those not aware of the impact of Marxism on political thought would do well to read a book I recently perused which covered the impact of the Bolsheviks in post-revolutionary Russia circa 1919. In Tashkent they nationalised all pianos as owning a piano was considered “bourgeois”. They were confiscated and given to schools. One man who had his piano nationalised lost his temper and broke up the piano with an axe. He was taken to goal and then shot (from the book Mission to Tashkent by Col. F.M. Bailey).

Sometimes history can be very revealing. The same mentality that wishes to spend money on public transport such as railways as opposed to private transport systems, or renationalising the utility companies such as National Grid which is also on the agenda, shows the same defects.

The above might be controversial, but I have not even mentioned Brexit yet. Will the Labour Party support another referendum as some hope and Corbyn is still hedging his bets over? I hope not because I think the electorate is mightily fed up with the subject. In politics, as in business, you should take decisions and then move on. Going back and refighting old battles is not the way to succeed. All we should be debating is the form of Britain’s relationship with the EU after Brexit.

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

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Lehman Collapse, Labour’s Employment Plans, Audit Reform Ideas and Oxford Biomedica

There was a highly amusing article in today’s FT by their journalist John Gapper explaining how he caused the financial crisis in 2008 by encouraging Hank Paulson, US Treasury Secretary, to resist the temptation to rescue Lehman Brothers. So now we know the culprit. Even more amusing was the report on the previous day that the administrators (PWC) of the UK subsidiary of Lehman expect to be left with a surplus of £5 billion. All the creditors are being paid in full.

Why did Lehman UK go bust then? They simply ran out of cash, i.e. they were cash flow insolvent at the time and could not settle payments of £3bn due on the day after their US parent collapsed. Just like Northern Rock where the assets were always more than the liabilities as also has been subsequently proven to be the case.

Perhaps it’s less amusing to some of the creditors of Lehman UK because many sold their claims at very large discounts to third parties rather than wait. Those that held on have been paid not just their debts but interest as well. So the moral is “don’t panic”.

Lehman’s administration is in some ways similar to the recent Beaufort case. Both done under special administration rules and requiring court hearings to sort out the mess. PWC were administrators for both and for Lehman’s are likely to collect fees of £1billion while employing 500 staff on the project. It may yet take another 10 ten years to finally wind up. Extraordinary events and extraordinary sums of money involved.

An editorial in the FT today supported reform of employment legislation as advocated by Labour’s John McDonnell recently. He proposed tackling the insecurity of the gig economy by giving normal employment rights to workers. I must say I agree with the FT editor and Mr McDonnell in that I consider that workers do have some rights that should be protected and the pendulum has swung too far towards a laissez-faire environment. This plays into the hands of socialists and those who wish to cause social unrest. Even the Archbishop of Canterbury suggested the gig economy was a “reincarnation of an ancient evil” and that it meant many companies don’t pay a living wage so employees rely on state welfare payments. A flexible workforce may give the country and some companies a competitive advantage but it takes away the security and dignity of employment if taken to extremes. The Conservative Government needs to tackle this problem if they wish to be certain of getting re-elected. If you have views on this debate, please add your comments to this blog.

Mr McDonnell also promoted the idea of paying a proportion of a company’s profits to employees – effectively giving them a share in the dividends paid out. That may be more controversial, particularly among shareholders. But I do not see that is daft either so long as it is not taken to extremes. After all some companies have done that already. For example I believe Boots the Chemists paid staff a bonus out of profits even when a public company.

Another revolutionary idea came from audit firm Grant Thornton. They suggest audit contracts should be awarded by a public body rather than by companies. This they propose would improve audit standards and potentially break the hold of the big four audit firms. I can see a few practical problems with this. What happens if companies don’t judge the quality of the work adequate. Could they veto reappointment for next year? Will companies be happy to pay the fees when they have no control over them. I don’t think nationalisation of the audit profession is a good idea in essence and there are better solutions to the recent audit problems that we have seen. But one Grant Thornton suggestion is worth taking up – namely that auditors should not be able to bid for advisory or consultancy work at the same company to which they provide audit services.

Oxford Biomedica (OXB) issued their interim results this morning (I hold the stock). They made a profit of £11.9 million on an EBITDA basis. OXB are in the gene/cell therapy market. What interests me is that there are some companies in that market, at the real cutting edge of biotechnology with revolutionary treatments for many diseases, that are suddenly making money or are about to do so. That’s often after years of losses. Horizon Discovery (HZD) which I also hold is another example. Investors Chronicle recently did a survey of similar such companies if you wish to research these businesses. It is clear that the long-hailed potential of cell and gene therapy is finally coming to fruition. I look forward with anticipation to having all my defective genes fixed but I suspect there will be other priorities in the short term particularly as the treatments can be enormously expensive at present.

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

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