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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Tesco and Barclays Legal Cases; Rent Controls and Telford Homes

A few events transpired last week which I missed commenting on due to spending some days in bed with a high temperature. Here’s a catch-up.

The remaining prosecutions of former Tesco (TSCO) executives for the accounting scandal in 2014 that cost the company £320 million and resulted in the company signing a Deferred Prosecution Agreement (DPA) and paying a big fine has concluded. The defendants were found not guilty. The prosecutions of other executives were previously halted by the judge on the grounds that they had no case to answer. Under the DPA, Tesco were also forced to compensate affected shareholders.

Everyone is asking why Tesco agreed to the DPA, at a cost of £130 million, when it would seem they had a credible defense as no wrongdoing by individuals has been confirmed. The defendants were also highly critical of the prosecution on flimsy evidence that destroyed their health and careers. This looks like another example of how the UK regulatory system is ineffective and too complicated. The only winners seem to be lawyers.

Another case that only got into court last week was against former Barclays (BARC) CEO John Varley and 3 colleagues. This relates to the fund raising by the company back in 2008 – another example of how slow these legal cases progress in the UK. This case is not about illegal financial assistance given to Qatari investors as one might expect, those charges were dropped, but about the failure to disclose commissions paid to those investors as part of the deal and not publicly disclosed. The defendants deny the charges.

Comment: this long-running saga seems to stem from the Government’s annoyance over Barclays avoidance of participation in the refinancing of banks at the time. Lloyds and RBS ended up part-owned by the Government, much to the disadvantage of their shareholders. Barclays shareholders (I was one at the time) were very pleased they managed to avoid the Government interference, precipitated by the Government actually changing the capital ratios required of banks. Barclays were desperate for the Qatari funds of at least one £ billion with one Barclays manager saying “They’ve got us by the balls….”.

Will this case conclude with a conviction, after a few millions of pounds spent on lawyers’ fees? I rather doubt it. And even if a guilty verdict is reached, how severe will be the likely penalty? Bearing in mind that the damage suffered by investors as a result seems minimal, i.e. it’s purely a technical breach of the regulations, it seems both pointless and excessive to pursue it after ten years have elapsed. Again the only winners seem to be lawyers.

One amusing aspect of this case was the grim “mug-shots” of 3 of the defendants attending court that appeared in the Financial Times. It was clearly a cold day and one of them was wearing a beanie hat. Is this the new sartorial style for professional gentlemen? Perhaps so as my doctor turned up wearing one to attend my sick-bed. Clearly I may need to revise by views on what hats to wear and when.

One has to ask: Are the cases of Tesco and Barclays good examples of English justice? Prosecutions after many years since the events took place while the people prosecuted have their lives put on hold, their health damaged and with potentially crippling legal costs. This is surely not the best way of achieving justice for investors. Justice needs to be swift if it is to be an effective deterrent and should enable people to move on with their lives. Complexity of the financial regulations makes high quality justice difficult to achieve. Reform is required to make them simpler, and investigations need to be completed more quickly.

Investors might not have noticed that London Mayor Sadiq Khan is going to include a policy of introducing rent controls in his 2020 election manifesto. Rent controls have never worked to control rents and in the 1950s resulted in “Rackmanism” where tenants were bullied out of controlled properties. It also led to a major decline in private rented housing as landlords’ profits disappeared so they withdrew from the market. That made the housing shortages in the 1960s and 70s much worse. The current housing shortage in London would likely be exacerbated if Sadiq Khan has his way as private landlords would withdraw from the market, leaving tenants still unable to buy although it might depress house prices somewhat.

But the real damage would be on the construction of new “buy-to-let” properties which would fall away. Institutions have been moving into this market in London and construction companies such as Telford Homes (TEF) have been growing their “build-to-rent” business in London.

Sadiq Khan is proposing a policy that he would require Government legislation to implement, which with the current Government he would not get. No doubt he is hoping for a change in that regard. Or is it simply his latest political gambit to get re-elected? In the last election he promised to freeze public transport fares as a vote winner, so he clearly has learnt from that experience. But he’s probably already damaging the private rented sector.

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

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