Burford, ShareSoc Seminar, Woodford Patient Capital and Patisserie

Burford Capital (BUR) have published a report by Professor Joshua Mitts over the alleged manipulation of their share price in early August, i.e. market abuse by “spoofing” and “layering”. It links it to the shorting attack by Muddy Waters and is fairly convincing.

They have also published a “witness statement” for an application in the High Court for disclosure of trading information from the London Stock Exchange so as to identify who was trading. In it they also appear to be suggesting that there may have been some “naked” short selling taking place, i.e. sales not covered by borrowed stock which they indicate is illegal under EU Short Selling Regulation 2012.

My opinion on the merits of Burford as an investment or who is going come out smelling of roses in this battle are unchanged – it could be neither. Incidentally I will be discussing the merits of Burford as an investment at some length in my presentation on my book “Business Perspective Investing” at the ShareSoc Birmingham Seminar tomorrow evening (Tuesday) – see https://tinyurl.com/yxryk2h2 . It’s not too late to register and it should be an interesting discussion.

Woodford Patient Capital (WPCT) issued their interim results this morning. Net asset value per share was down 26% on the previous year end. The share price removed unmoved but it was already at a discount of nearly 40% to the Net Asset Value and more write-downs in their portfolio have been made since the half year end. The discount is quite extreme for any investment trust. There have been more board changes and there is a lengthy article in the Financial Times this morning on the pressure faced by Neil Woodford to quit managing the trust. The article suggests the board has lost confidence in Mr Woodford and is courting other asset managers – but who would want to take it on?

I happened to visit a Patisserie Valerie café in York during my Northern vacation last week. Now under new management of course. But the service was absolutely dire, prices were high and there were few customers there when other cafes in the town were busy. One customer walked out because of the slow service. Looks like the new management have taken on a problem.

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

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Patisserie and Interserve Administrations, plus Brexit latest

Yesterday the administrators (KPMG) of Patisserie (CAKE) issued their initial report. It makes for grim reading. The hole in the accounts was much worse than previously thought with an overstatement of net assets of at least £94 million. That includes:

  • Intangible assets overstated by £18m;
  • Tangible assets overstated by £5m;
  • Cash position overstated by £54m;
  • Prepayments and debtors overstated by £7m;
  • Creditors understated by £10m.

The accounts were clearly a total fiction. It is uncertain whether there will even be sufficient assets to make a distribution to preferential and unsecured creditors. As expected ordinary shareholders (who are not creditors) will get nothing. You can obtain the KPMG report from here: http://www.insolvency-kpmg.co.uk/case+KPMG+PJ12394136.html

KPMG suggest there may be grounds for legal action against various parties including Patisserie auditors Grant Thornton by the administrator, but as Grant Thornton are the auditors of KPMG they are suggesting the appointment of another joint administrator to consider that matter.

Otherwise it looks a fairly straightforward administration with assets sold off to the highest bidders and reasonable costs incurred.

Another recent administration was that of Interserve (IRV). This was forced into a pre-pack administration after shareholders voted against a financial restructuring (effectively a debt for equity swap) which would have massively diluted their interest. But now they are likely to get nothing. Mark Bentley of ShareSoc has written an extensive report on events at the company, and the shareholder meeting here: https://tinyurl.com/yy7heunl . He’s not impressed. I suspect there is more to this story than meets the eye, as there usually is with pre-pack administrations. They are usually exceedingly dubious in my experience. As I have said many times before, pre-pack administrations should be banned and other ways of preserving businesses as going concerns employed.

Brexit. You may have noticed that the stock market perked up on Friday. Was this because of some prospect of Mrs May getting her Withdrawal Agreement through Parliament after all? Perhaps it was. The reasons are given below.

There were two major road blocks to getting enough MPs to support the deal. Firstly the Irish DUP who had voted against it. But they are apparently still considering whether they can. On Thursday Arlene Foster said “When you come to the end of the negotiation, that’s when you really start to see the whites of people’s eyes and you get down to the point where you can make a deal”. Perhaps more concessions or more money for Northern Ireland will lubricate their decision.

Secondly the European Research Group (ERG – Jacob Rees-Mogg et al) need to be swung over. Their major issue is whether the Agreement potentially locks in the UK to the Irish “Backstop” protocol for ever. Attorney-General Geoffrey Cox’s advice was that it might, if the EU acts in bad faith. I have said before this legal advice was most peculiar because nobody would enter into any agreement with anyone else if they thought the other would show bad faith. Other top lawyers disagree with Cox’s opinion. See this page of the Guido Fawkes web site for the full details: https://tinyurl.com/y4ak6q3c

Mr Cox just needs to have a slight change of heart when his first opinion must have been rushed. He has already said that the Vienna Convention on international treaties might provide an escape route so he is creeping in the right direction.

Mrs May will have another attempt at getting her Withdrawal Agreement through Parliament, assuming speaker Bercow does not block it as repeat votes on the same resolutions are not supposed to be allowed in Parliament.

It was very amusing watching a debate at the European Parliament over Brexit issues including whether an extension of Article 50 should be permitted – the EU can block it even if the UK asks for it.  The EU MEPs seemed to have as many opinions as UK MPs on the issues. The hardliners such as Nigel Farage wish that it not be extended so that the UK exits on March 29th. Others are concerned that keeping the UK in will mean they have to participate in the EU elections in May with possibly even more EU sceptics elected.

It’s all good fun but it’s surely time to draw this matter to a close because the uncertainty over what might happen is damaging UK businesses. A short extension of Article 50 might be acceptable to allow final legislation to be put in place but a longer one makes no sense unless it’s back to the drawing board. But at least the proposal for another referendum (or “losers vote” as some call it) was voted down in Parliament. Extending the public debate is not what most of the public want and would surely just have wasted more time instead of forcing MPs to reach a consensus.

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

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Metro Bank, Improving Accounts, Patisserie, Telford Homes and GoCompare

The latest example of a public company publishing misleading accounts is Metro Bank (MTRO). Both the FCA and PRA (the bank regulator) are looking into the “misclassification” of some loans which resulted in the bank overstating its regulatory capital. The result was that it has had to do an equity share issuance to bolster its capital.

There was a very good letter to the FT today on the subject of improving accounting and audits from Tim Sutton. He suggested the US Sarbanes-Oxley Act had improved the standards in the USA enormously so that revision of financial statements has been declining. To quote: “Section 404 requires management to assess and report annually on the effectiveness of the company’s internal control structure and procedures. In addition, the company’s external auditors must attest to the effectiveness of those controls”. As he points out that might have prevented the fraud at Patisserie (CAKE), and no doubt avoided the issues at Metro and other companies. It sounds an eminently good idea. I realise Sarbanes-Oxley did receive some criticism in the USA after it was first introduced due to the extra costs it imposed, but if that is the only way to ensure reliable accounts, I suggest it is worth paying. It was perhaps over-complicated in implementation in the USA but some of the key features are worth copying.

This morning Telford Homes (TEF) published a trading statement which was mostly bad news and the shares fell over 15%. This is a London focused housing developer which I used to hold but I got nervous some months ago about the housing market in the capital. You can read my acerbic comments made in last October here: https://roliscon.blog/2018/10/10/black-hole-in-patisserie-holdings-audit-review-telford-homes-and-brexit/

The latest announcement says that “the London sales market remains subdued”. Sales are being achieved but at a slower rate and margins are under pressure due to increased incentives and discounts. So they are putting an increased focus on “build-to-rent”. Other bad news is that contracts are being delayed on larger projects, partly due to planning delays. The result will be profit before tax for FY2020 will be significantly below FY2019.

Another announcement this morning was the preliminary results from GoCompare (GOCO). This is a price comparison web service, particularly focused on car insurance, but also covering utilities and other products. It is of course fronted by Italian opera singer Gio Compario in TV advertisements which I certainly prefer to the Moneysupermarket ones.

It was particularly interesting watching the results presentation – probably available as a recording on their web site. Results were much as forecast, with only a slight increase in revenue but a 20% increase in adjusted earnings. This is due to optimisation of marketing. You can see that these kinds of companies have to spend an enormous amount on marketing to catch customers when they are thinking of switching suppliers. GOCO spent £80 million on marketing last year, down from £89 million) to achieve revenue of £152 million.

They have made acquisitions to diversify revenue and this has led to an increase in debt, but the interesting news was about a new subscription service called WEFLIP. This automatically switches your energy supplier, among a panel of agreed suppliers, if you can potentially save £50. This will enable them to retain customers, with the suppliers paying the subscription fee. They plan to spend £10 million on marketing this in the coming year and have already done a “soft” launch to ensure the product and market are OK. Clearly though, this might be perceived as a bit of a gamble.

The market was unimpressed and the shares have fallen by another 5% today after a long decline in recent months. It’s now on a prospective p/e of less than 9 and yield of about 3%. I remain a holder at those levels.

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

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Accesso and Executive Chairmen

Yesterday the share price of Accesso Technology Group (ASCO) dropped over 35% after the company issued a trading update and also announced that Executive Chairman Tom Burnet was moving to become a non-executive director. This company has been one of the great growth stories on AIM after Tom took charge as CEO in 2010. Revenue has grown more than 6 times since then but profits and cash flow have been more variable. But Tom is a very persuasive speaker and the share price multiplied by more than 25 times to reach a peak of 2800p in September 2018 – it’s now 930p.

I first purchased the shares in 2012 when the business was selling a solution for theme park queuing and most of their revenue came from one customer. They have now developed the technology to have wider applications and have a wider customers base of “visitor attractions”. Acquisitions have also been made to broaden the product offering and the strategic plan of the business was to become a “consolidator” in the ticketing and other IT solutions to this sector.

Tom Burnet was made Executive Chairman in May 2016. That concerned me somewhat because he is clearly a very forceful person and I generally do not like Executive Chairmen unless there is a very good reason to have that kind of sole dictatorship such as the company being in dire difficulties – there did not seem to be such a justification here, and it is of course contrary to Corporate Governance guidelines for good reasons.

I sold most of my shares over 2016, 2017 and 2018 after the share price continued to ramp up driven by momentum and some investors apparently feeling that Tom could do no wrong. He seemed to think likewise when I prefer more humble personalities as CEOs. Institutional investors also piled in. But the financial numbers were not all that impressive – indeed I queried the poor return on capital and large increase in administrative expenses at last year’s AGM. Other commentators queried the revenue recognition, poor cash flow and high levels of software development capitalisation. Director share sales by Tom and others in 2018 were also a negative.

That’s the history, so what about the current valuation? The last published financial results were the interims for the 6 months to end June 2018 when I made a note that the prospective normalised p/e was 47! But Accesso’s interim results are usually very untypical of the full year figures as it’s a very seasonal business – not many people visit theme parks in the winter. But they did mention the impact of IFRS15 on revenue recognition where they had previously been recognizing the full value of tickets, not just their commission income. This is probably why current analysts’ forecasts show a fall in revenue for the 2018 year versus 2017, with a resumption of growth thereafter.

The latest announcement suggested the full year results will be “broadly” in line with market expectations – which is a bit tendentious bearing in mind we are now well past the financial year end already. It also mentions a one-off cost exceptional cost of $1.7 million on an acquisition which was aborted in October 2018. Why was there no announcement of this at the time as surely it was price-sensitive information?

Actually figuring out what the likely earnings will be for 2018, particularly as the new board might wish to take a bath and clean out any questionable capitalisations is almost impossible without more information.

My fall-back valuation method in such circumstances is to look at the market cap revenue multiple. Revenue forecast for 2019 is $138m which equates to £106m when the current market capitalisation is £254m. So the multiple is 2.4 which is relatively low for a high growth business, with good IP (protected by patents), high recurring revenue figures from existing customers and some profits rather than losses. The business might look very attractive to trade buyers who could strip out a lot of the overhead costs (which is why revenue multiples are important in valuing such companies).

There may be more bad news to come of course, but at least they now have a conventional board structure with a new non-executive Chairman (Bill Russell) who seems to have a very relevant background.

The dangers or having a dominant and forceful Executive Chairman have of course been reinforced by events at Patisserie (CAKE) where Luke Johnson had that role. Having a more conventional board structure might not have prevented the fraud there altogether, but it might have enabled the non-executive directors to more easily question the way the company operated, the internal controls and the information being provided to them. Indeed it might have ensured more questioning non-executive directors were appointed to the board in the first place. A separate Chairman might also have questioned whether Luke Johnson was spreading himself too thinly across his numerous business interests.

The corporate governance principle of having a non-executive Chairman is not something investors should ignore.

Postscript: I corrected the revenue growth figure and the market cap sales multiple figure a few hours after the above was first published after I identified some sloppy research, but the conclusions were unchanged.

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

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AssetCo, Patisserie, Stockpiling, Warehouses, Sheds, Brexit and Venezuala

A week ago, an award of damages of £21 million plus interest and costs was made against Grant Thornton for their breach of duty when acting as auditors of AssetCo Plc (ASTO) in 2009/10. See https://www.bailii.org/ew/cases/EWHC/Comm/2019/150.html for the full judgement. I understand Grant Thornton may appeal. These are the key sentences in the judgement: “It is common ground that in those years the senior management team at AssetCo behaved in a way that was fundamentally dishonest. During the audit process management made dishonest statements to GT, provided GT with fabricated and massaged evidence and dishonestly misstated reported profits, and provided GT with flawed and dishonest forecasts and cash flow projections. Outside of the audit process, management were engaged in dishonestly ‘overfunding’ assets (i.e. misleading banks as to the costs of new purchases etc so as to borrow more than was permitted), misappropriating monies, dishonestly under-reporting tax liabilities to HMRC, concluding fraudulent related party transactions and forging and backdating documents. GT accepts that it was negligent in a number of respects as the company’s auditor in failing to detect these matters…”

In 2012, AssetCo (ASTO) was forced to make prior period adjustments for 2010 that wiped more than £235m off its balance sheet. AssetCo was, and still is, an AIM listed company now operating in the fire and emergency services sector.

This is undoubtedly a similar case to Patisserie (CAKE). According to a report by Investors Champion, former Chairman Luke Johnson suggests it “has possible relevance for a claim against Grant Thornton” and he will be pushing the administrators to instigate similar action. Let us hope it does not take as long at ten years and millions of pounds in legal costs which administrators may be reluctant to stand.

According to a report in the FT, manufacturers are stockpiling goods at a record rate in anticipation of supply chain disruption from Brexit. Importers are also stockpiling goods – for example Unilever is storing ice-creams and deodorant such as its Magnum ice-cream bars which are made in Germany and Italy. There is also the increasing demand for warehousing by internet retailers, even for smaller “sheds” to enable them to provide next day or even same day delivery.

Big warehouses are one of the few commercial property sectors that has shown a good return of late and I am already stacked up with two of the leaders in that sector – Segro (SCRO) and Tritax Big Box (BBOX). On the 31st January the Daily Telegraph tipped smaller company Urban Logistics REIT (SHED) for similar reasons and the share price promptly jumped by 7% the next day wiping out the discount to NAV.

There has been much misinformation spread about Nissan’s decision to cancel manufacture of a new car model in the UK. They denied it was anything to do with Brexit. This was to be a diesel-powered model and as they pointed out, sales of diesel vehicles are rapidly declining in the UK. The same problem has also hit JLR (Jaguar-LandRover). One aspect not taken into account in many media stories was that Japan has just concluded a free trade deal with the EU. Japanese car manufacturers no long need to build cars in Europe to avoid punitive tariffs. Where will the new vehicle now be made? Japan of course!

There has been lots of media coverage of the politics of Venezuela and its rampant inflation. A good example of how damaging extreme socialism can be to an economy. Over twenty-five years ago it had a sound economy and I had a business trip scheduled to visit our local distributor there. But at the last minute the trip was cancelled after a number of people were killed in riots over bus fares. I never did make it and I doubt I will ever get there now.

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

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Staffline Issues, Audit Purpose and News on Patisserie

Yesterday Staffline Group (STAF) issued a statement first thing in the morning saying that the publication of results scheduled for that day would be delayed. The shares promptly dropped by about a third. Later in the day it stated that “the company can confirm that this morning concerns were brought to the attention of the board relating to invoicing and payroll practices within the Recruitment Division”. A full investigation was promised and the shares were then suspended. Is this yet another accounting scandal in an AIM company one wonders? Generally after such announcements, only bad news comes out.

Staffline is a recruitment/staffing and training business. It’s one of the largest AIM companies with revenue of nearly a billion pounds and reported profits of £71 million last year. It has been growing rapidly in recent years.

I have never held the stock although I did see a presentation by the company a couple of years ago. In general I don’t like employment businesses as they tend to follow economic cycles and the sector has few barriers to entry. I also considered the company to be at risk from regulatory and tax problems. The company also has considerable debt which is odd for this kind of business which generally have a “capital light” structure. Investors might have been concerned by the announcement on the 8th January that net debt had risen to £63 million at the 2018 year-end.

Investors will have to keep their fingers crossed for further news.

I covered in some previous blog posts the issue that audit quality is generally poor and that false accounts and outright fraud are regularly missed by audits – and it’s not just one or two firms – the whole audit industry seems to be incompetent in that regard. The Commons BEIS Committee held a meeting yesterday and one of the witnesses was David Dunckley, head of Grant Thornton, who audited the accounts of Patisserie (CAKE). He admitted that auditors did not look for fraud when auditing accounts and that there was an “expectation gap”. Committee members were not impressed.

Meanwhile Investor’s Champion revealed that Luke Johnson and Paul May, directors of Patisserie, owned a property that was leased back to a subsidiary of the company. As a related party transaction this should have been disclosed in the Patisserie accounts but was not.

The FT also disclosed that at least 30 shareholders had signed up to support a legal case with law firm Teacher Stern. But other investors are talking to other solicitors. In such cases it can be many months before the basis of a claim is clear and solicitors tend to jostle for the business of pursuing a claim in the meantime – one might call some of them “ambulance chasers”. Investors are advised not to spend money on such actions until the basis of a claim, and the ability to both finance an action and identify asset rich defendants is clear.

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

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Cloudcall Placing, Patisserie News, Brexit and Momentum Investing

I reported a week ago on a “Capital Markets Day” at Cloudcall (CALL) – see https://roliscon.blog/2019/01/18/cloudcall-investor-meeting-sophos-rpi-and-brexit/ . There was much discussion on whether the company should raise more finance, via debt or equity. I suggested they needed more equity. This morning they announced a placing of 2.4 million shares at 100p to raise (the share price last night was 109p. It represents about 10% dilution for other shareholders. The placing was completed in minutes so they had clearly lined up existing investors in advance. The cash will be invested (i.e. spent) on sales and marketing.

But they are also refinancing and extending their debt facility. Let us hope they don’t have to use it.

More bad news from Patisserie (CAKE). A report in the Guardian, based on sight of the information sent to bidders by the administrator, suggests that the accounts were false as far back as 2014. That’s when the IPO on AIM took place. In addition, sales in established stores had fallen by 4% in the last two years and the remaining 122 stores were on course to make a £2 million loss in the year to September 2019.

The Guardian report mentioned a number of possible bidders for some of the outlets, but generally few of them. So the chance of a major realisation for the benefit of creditors in such a “fire sale” process seems unlikely.

Brexit. After last night’s votes in the Commons, the battle lines between Theresa May and the EU look to be drawn up. She is getting near a clear mandate from Parliament which will help in the battle with EU bureaucrats and politicians who are adamant they won’t renegotiate the Withdrawal Agreement. But they will have to if they don’t want the UK to exit without one, which would threaten a lot of EU country exports. Come March 28th, it will be time for a face-saving compromise – no change to the Withdrawal Agreement – just the addition of a codicil providing alternatives to the Backstop.

Momentum Investing. Are investors falling out of love with Momentum Investing? Momentum investing has been one of the most attractive investing strategies in the last few years. If a share price was going up, you just bought more, regardless of fundamentals. There were many academic studies showing that it was a very effective strategy. In ten years of rising shares prices, it was relatively foolproof. But when share prices are going down, as in the last part of 2018, it does of course work in reverse. You have to sell shares as the prices drop.

Just reviewing a few model portfolios run by investment magazines and on-line portals suggests to me that momentum investing is no longer working as the 5 year and longer returns generated are worse than the market as a whole. The moral is that there are no simple solutions to achieving superior investment returns. Once everyone is aware of a successful strategy, its benefits disappear as they are traded away.

It looks like we will have to revert to the hard work of doing financial and business analysis of companies rather than simply following shooting stars.

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

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