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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Oxford Tech VCT3 and other VCTs, and the Coronavirus Bandwagon

One of my shareholdings, Oxford Technology VCT3 (OTT), fell 44% this morning. Am I concerned? No because I have only ever held 10 shares in the company. I cannot even recall why I bought the shares back in 2014 but it was probably to keep an eye on their interest in unlisted Ixaris Group Holdings Ltd. That company was a major part of their portfolio and was still 65% of the net assets at the 29 February. It is also held by other VCTs. To quote from the ITT annual report, issued today, “For OT3 the initial Covid-19 pain has been most strongly felt by Ixaris, a travel payments company as a result of knock on impacts from Thomas Cook’s failure and a decline in Asian travel. Subsequent to our year end the downward pressure has increased on Ixaris with major airline disruption”. It also discloses that Ixaris received an offer during the financial year which would have meant a major exit at an uplifted price, but it collapsed at the last minute.

As a former director of Ixaris, and a very minor shareholder still, I was aware of this bad news. It looks like they are almost back at square one. That is the nature of early stage venture capital. Two steps forward and one step back, or vice versa in this case. I always took a sceptical view of the value put on Ixaris by OTT and other VCTs as I always considered it a highly risky investment.

OTT also wrote down Orthogem as it was sold for a nominal amount. This is what they said about that: “Although Orthogem had made significant technical progress with the launch of its putty product and appointment of international distributors, it was unable to raise sufficient funding to be able to continue to trade.  The OT VCTs were willing to continue supporting the company, especially given we believed the company was very close to commercial success, but the VCT rules governing the age of companies and the use to which any new funds can be applied prevented us from doing so”. VCT rules are now preventing some follow-on investments.

OTT also has a holding in listed Scancell (SCLP) which OTT says has had a moderate uplift after announcing the start of its research programme to develop a Covid-19 vaccine. They also say this: “Scancell is our third largest holding and had a disappointing year of regulatory and clinical delays in its flagship melanoma trial and its share price fell over the course of the year. Its planned Phase 2 combination trial with their initial product SCIB1 ran into difficulties with the US Food and Drug Administration (FDA) due to the delayed approval by the FDA of the upgraded delivery device from 3rd party Ichor. In the event, the trials started in the UK later than expected. Subsequently the required US approvals were received but a year has been lost and results will now be correspondingly delayed. Post period end the UK trial went on hold as a result of Covid-19 risks. Nevertheless good data from these trials could represent a significant value inflection point for Scancell and are eagerly awaited”.

There were big hopes for Scancell a few years ago but that has long since evaporated and revenue has remained at zero. It’s a typical story of early stage drug development companies which I avoid for that reason.

The Net Asset Value of OTT fell by 33% from the previous year-end, and hence the share price drop on what is a very illiquid share, like most VCTs. Normally VCTs are immune to general stock market fluctuations but not in the current recession. Some of my VCT holdings have fallen sharply no doubt because of downward valuations of some of their unlisted holdings but also because of sharp falls in many AIM shares which are a significant proportion of some VCT portfolios. This has also been compounded by the halt to share buy-backs in some VCTs – the result is just a few shareholders selling causing a sharp fall in their share prices.

Are their opportunities in VCT shares appearing, or should I be selling also? Perhaps is the answer, but VCT shares I consider to be very long-term holdings with a lot of the value coming from their tax-free dividends. I only tend to sell when I have lost confidence in the board or the investment manager.

As with the mention above of Scancell, almost all biotechnology companies are now trying to get into the coronavirus space by developing interests in vaccines, antibody tests and diagnostic products. Such an entry does wonders for the share prices. This ranges from the very largest companies such as Astrazeneca and Glaxosmithkline who are both gearing up for vaccine production to the smallest start-ups. One example announced today is that of Renalytix AI (RENX) who announced a joint venture with the Mount Sinai school of medicine to produce Covid-19 antibody test kits. RENX are focused on renal diseases which is why I picked up this news as I have an interest in this area but I do not hold the shares – historically no revenue to date. But RENX will only have a minority interest in the joint venture. I would not get too excited about this, particularly as it is possible that the epidemic will die out and there are lots of people producing test kits. But the company may be of interest otherwise as it does seem to be making some progress in renal diagnostics. There are 40-45,000 premature deaths in the UK every year due to kidney disease so you can see that it is comparable to the coronavirus epidemic and with still no effective treatments.

The coronavirus epidemic is clearly creating a bandwagon for companies to jump on. That can be a minefield for investors. Or to put it another way, an enormous amount of venture capital is being put into research of treatments and diagnostic production. It may produce results sooner or later, but a lot of the investment might produce nothing.

Lastly, it’s worth covering the dire economic gloom. Unemployment has reached record levels and Rolls-Royce (RR.) are making 9,000 employees redundant as new aero engine demand will clearly be non-existent for some time – maybe years.

To quote from the FT: “Rishi Sunak [Chancellor] has warned that the economy may not immediately bounce back from the corona-virus crisis and could suffer permanent scarring, as jobless claims soared at a record rate to more than 2 million. The chancellor struck a sombre note on a day that saw the biggest month-on-month increase in out of work benefits claims since records began in 1971. A further 10 million are now precariously relying on the state to pay their wages. He said ‘We are likely to face a severe recession, the likes of which we haven’t seen, and, of course, that will have an impact on employment’”.

Some of my readers may be facing redundancy or soon will be. Clearly we are living in exceptional times, but on a personal note it’s worth mentioning that I have been out of a job more than once in my past career. Recessions tend to only last a short time so the answer short-term is simply to take any job going. Longer term the answer is to ensure you can never be fired in future is to set up your own business. CEOs rarely fires themselves, and there is the possibility that a new business might make you rich. So that is what I did a few years later.

I don’t come from a family of entrepreneurs but from people who worked in big businesses. But it is easier than ever to start-up from scratch and redundancy pay can give you the initial capital required. Recessions don’t make it harder to start a new business but easier in some ways. As companies lay off full-time staff that gives opportunities for others, and any service or product that saves a company money can be immediately attractive. So redundancy just needs to be faced up to with some energy and initiative.

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

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Abcam AGM, Cambridge Cognition, Ultra Electronics, Wey Education and IDOX

Yesterday I attended the Annual General Meeting of Abcam (ABC) in Cambridge as I often do as I have held the stock since 2006. Share price then (adjusted for consolidation) was about 50p and it’s now about 950p so I like most investors in the company, I am happy. Alex Lawson will be doing a full write-up of the meeting for ShareSoc so I will only cover a few points herein.

One shareholder expressed concern about the rising costs. The company is clearly making heavy investments in new infrastructure and more management. Although revenue was up 26.5% last year, earnings per share were only up 11.8% (unadjusted) and operating margin has been falling. Also Return on Capital Employed (ROCE) has been falling – only 12.3% last year when it used to be in the high teens.

Apart from opening a new building next year, they are implementing an Oracle Cloud software solution to replace their historic purpose-built legacy software systems. The total cost of that project is £44 million (see page 23 of the Annual Report) when profits last year were only £42 million post tax. In other words, all of last years profits could be taken to be consumed by this project. This project has been running for some time and I have asked questions about it in previous years. This year I asked: “is the project on schedule and on budget”. I did not get a straight answer. But it was said that initial cost estimates have expanded, and additional modules been added (for example warehouse management). It should “go live” in the current financial year. From those and other comments made, I got the impression that this is a typical IT project that is too ambitious and costs are escalating while delays have arisen. Those “big bang” IT projects rarely go according to plan, but management are often suckers for them.

Now it may be arguable that older systems need replacing (for example, the CEO mentioned it was impossible to bill in Swiss francs that at least one customer would prefer), and maintaining old code was clearly proving to be difficult. The massive investment in this area alone may be justified by the company’s ambitions to “double the 2016 scale by 2023 by investing in operating capabilities” as the CEO mentioned. The expectation is that growth will improve revenues and hence margins in due course.

One more way that costs have been rising is increased pay for management. CEO’s pay alone up from £614k to £1,378k in the last year (“single figure remuneration). In addition, I commented negatively on the fact that the LTIP target had been adjusted for the “scale and complexity of the transformational programme” of the new ERP system implementation, i.e. costs are much higher than expected so the LTIP target has been made easier to achieve!

At least Louise Patten (acting Chairman now after departure of Murray Hennesey for a proper job, and Chair of the Remuneration Committee) admitted later that LTIPs are often problematic but institutions like them. LTIPs at Abcam have rarely paid out, and management at many companies seem not to value them highly. There are better bonus scheme alternatives.

I also spoke briefly to a representative of Equiniti, the company’s registrar, about the difficulty of voting electronically. He is to look into it. Amusing to see the company slogan on his business card is “Our mission is making complex things simple”, exactly the opposite of my experience!

In the morning I also visited Cambridge Cognition (COG) who have offices in the village of Bottisham east of Cambridge. Although their offices are in what appear to be wooden huts, they are well furbished. The company specialises in cognitive health (brain function). Sixty per cent of its revenue comes from clinical trials for pharmaceutical companies, thirty per cent from research institutes and academia and ten per cent from healthcare and consulting.

On clinical trials they do about 15 deals a year so by their nature they are lumpy one-off deals. Total revenue was £6.8 million last year. Before last year revenue was flat but it grew last year and is forecast to grow this year.

A lot of pharma companies are actively researching alzheimers and other degenerative brain diseases, and developing products to assist – as the population ages such diseases are becoming more prevalent. Cambridge Cognition’s technology relies on historically well validated studies. The company provides a lot of consulting support in clinical trial sales.

Such deals include 30 to 40% of software which is billed and paid for on normal 30+ days terms, with the services paid for as provided. One issue that arose is that their accountants are likely to require them to change so as to allocate the software revenue over future periods due to IFRS 15 because they host the software. This is the same problem that Rolls-Royce have tripped up on, and it is also an issue at Ultra Electronics (ULE) according to a report in the FT yesterday. That company also issued a profit warning on Monday and the share price fell 19.5% on the day. I used to hold it but not of late. The FT writer suggested it was time to “exit”. Cambridge Cognition did suggest though that they would not need to restate last years accounts, and the change might actually smooth their revenue figures. IFRS 15 is an important correction to historic aggressive revenue recognition policies in some companies.

Otherwise Cambridge Cognition have some interesting technology – for example using smart watches to monitor brain function during the day, and using speech recognition to perform analysis. Whether these can be turned into profitable markets remains to be seen. One of the original ideas in the company was to provide their software on i-Pads for general practitioners to use in diagnosis but that never took off due to changes in purchasing arrangements in the NHS who of course are notoriously difficult to sell to (and budgets of late for technology seem to have been cut). If anyone wants more background on Cambridge Cognition you are welcome to contact me.

A few weeks ago I purchased a minute number of shares in Wey Education (WEY). Minute because although it looks an interesting business I thought the share price was way too high on any sensible fundamental view. This morning the company announced a share placing to make an acquistion. This will be at 22p which is a 33.3% discount to the price on the 14th November according to the company. Clearly advisors and institutions took the same view as me on the previous share price. Has the share price collapsed this morning as a result? It’s down but not by much so far. Wey Education does look like one to monitor (which is why I bought a few shares) but I think I’ll stand back from the speculation for the present while the market is so twitchy.

This looks like one of those hot technology stocks that are all the rage of late (the company provides education over the internet as an alternative to school attendance). But investors are clearly getting more nervous about many of those stocks in the last few days – it’s no longer “keep buying on momentum” as some share prices have fallen back from their peaks (Abcam is one example), so it’s now sell, sell, sell. And if a company indicates that the outcome for the year will not be as good as the optimistic broker forecasts suggest, as IDOX did mid-afternoon yesterday, then the share price gets hammered. Announcements mid-afternoon of this nature are never a good idea. Interesting to note that Richard Kellett-Clarke is to remain on the board after all as a non-executive. He was previously CEO. That might inspire more confidence in the business as these kinds of hiccups did not occur during his regime.

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

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A Quick Guide to New Issues, SMRs, Car Market and Brexit

In today’s Financial Times (11/11/2017) Neil Collins gave a quick guide to new issues which is worth repeating. This is what he said: “Do not buy into an initial public offering if most of the capital raised is going out of the business, or if it replaces existing debt (because the capital has already left). Do not buy if private equity is selling. Do not believe any forward-looking statements, because if the prospects really were that good, the vendors would wait and get a higher price. Do not buy any share that has been listed for less than a year. You will miss some bargains but you will avoid many more disappointments. Leave it to the professionals to lose other people’s money.”

Those are wise words indeed. He also made some ascerbic comments on small nuclear power stations which he says have been rebranded as “small modular reactors” (SMRs) to make them less scary. Rolls-Royce, who have produced such reactors for submarines, have touted them as a potential future business growth area for several years, but the FT’s in-depth review of the subject last week suggested that they are not likely to be put into production any time soon. Meanwhile the share price of Rolls-Royce is still below where it was in 2014.

Neil Collins also commented on the car market. You probably don’t need to be told that new car sales have slumped. The share prices of car dealers are cheap as chips and even my shares in Auto Trader are down substantially this year. Indeed one could apply Neil’s comments about IPOs to the company although it has taken a couple of years to reveal that the debt when listed is handicapping the company now. The car market is inherently cyclical which is one reason why car dealers are normally not valued highly, and they also show low barriers to entry with the car manufacturers controlling the market to a large extent and limiting the profits that dealers make. But Auto Trader is similar to Rightmove in the property market. High margins, dominant market position and a business with great network effects with the result that competitors find it difficult to muscle in on their market. I think I’ll stick with it for a while yet.

I am not convinced that we have reached “peak car” as some have suggested. There seem to be more cars on the road than ever although traffic volumes have slowed in London where most such commentators live. But that is as much about political policies that have limited road space and caused congestion, mostly irrational, than car buyers desires. Another good analysis in the FT recently was about how “green” various car types actually are. On total life emissions, some smaller petrol/diesel vehicles can beat “all-electric” cars. How is that? Because the manufacture and decommissioning of electric vehicles generate large emissions, and producing the electricity for them often does also.

With all these plugs I just gave for the FT, it is unfortunate that it coninues to publish such tosh about Brexit. Most of their writers predict the financial outcome will be calamitous. Whether that will be the outcome or not, I don’t have the space to provide a full analysis here, but most people who voted for Brexit did not consider the financial issue as conclusive. Consider an American colonialist in the year 1775, before their declaration of independance. No doubt with an economy very reliant on trade with Great Britain many people would have counselled against leaving the protection of their parent country. Did that deter them? No because they valued freedom more highly. They wanted control over their own affairs including that over taxes, and not to be ruled by a remote and undemocratic regime where they had minimal representation. That is the analogy that all the remainers should think about.

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

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