NCC Group – All Credibility Gone?

NCC Group is a FTSE-250 company operating in the “cyber security”and “risk mitigation” areas primarily, and the former is surely one of the “hottest” sectors of the market at present. But it’s hotter in other ways for NCC at present it seems.

Yesterday at 4.16pm (always a bad time to make announcements) they issued the latest of a series of profit warnings. In addition they announced a “strategic review” and that the capital markets event scheduled for today was cancelled. The share price fell 30% before the market closed yesterday and was down another 30% this morning. The share price was about 365p last October. It’s now about 90p at the time of writing.

Looking back over the recent history of the company, the long-standing Chairman Paul Mitchell announced he was stepping down in January, and in the same month a new CFO was appointed. In that month the company also announced the sale of the “open registry” group of companies that was trying to establish the use of trusted web sites in which the company had invested a lot of money without success.

The company has made a number of acquisitions in the cyber security area including Accumuli for £55m and Fox-IT for £126m in 2015. These were expected to generate rapid growth in sales and profits and the forecasts have turned out to be optimistic while the cost base has grown and hence damaged margins. Indeed the latest announcements says that sales levels are “unlikely to utilise fully the cost base deployed across the Assurance Division in the current financial year”.

In October last year the company announced the loss of three large contracts and problems with retention of others. Clearly the company has acquired businesses that have lumpy revenues with large projects that are subject to cancellation or implementation issues.

Meanwhile the Escrow Division “continues to perform in line with expectations” according to the latest announcement. This side of the business is very attractive in that the customers are very “sticky” and a very large percentage will renew each year, so there is very high and reliable repeat revenue.

So in essence the company has appeared to make dubious acquisitions which have turned out badly. This is undoubtedly a massive management failure for which the long-standing and previously successful CEO Rob Cotton must surely take part of the blame. Is he the right person to sort out this mess? We shall no doubt see in due course but any shareholders who have an opinion on that might like to comment.

Note: I have to admit to holding this stock, but I sold most of my holding in January. Simply did not like the emphasis on EBITDA in the reporting and the large number of reported “adjustments”. It was also clear that the nature of the business had been changed substantially by the acquisitions, and the previous trading update in October gave a way too optimistic view of the future with comments such as the rate of growth of profitability “remains in line with the Board’s expectations” and that “we remain on course to sustain our double digit organic revenue growth”. This was surely pure hogwash in essence.

As Mr Cotton was presumably responsible for these announcements, I doubt many investors will continue to believe that he should lead the company.

Roger Lawson

Asset Management Market Study

I commented previously on the FCA’s Asset Management Market Study, which suggested there was weak competition in this market. Needless to say, most asset managers do not seem to agree.

ShareSoc has now submitted a response to the questions raised in that document which you can read here: http://www.sharesoc.org/Asset-Management-Market-Study-Response-2017-02-21.pdf

In summary, we agree with the general conclusions and support regulatory intervention where necessary. We also note that although the study does not address the issue directly of financial education, it is our view that this needs to be substantially improved if the public is to be able to engage with financial professionals and make their own informed decisions.

Please read our more detailed response for our answers to all the questions posed.

Roger Lawson

United Cacao – the Perils of AIM, and Fyffes

The Daily Telegraph ran a lengthy article yesterday covering the story of AIM listed United Cacao Ltd SEZC (CHOC) under the headline – “a bitter warning of the perils of AIM”. The company delisted from AIM on February 6th.

United Cacao were developing cocoa plantations in Peru under the persuasive leadership of Dennis Melka. I never held the stock but I did attend a presentation by the company hosted by ShareSoc in 2015 (the ppts are still available to ShareSoc Members on our Members Network). It was a typical “story” stock. Growing demand for cocoa when world supply was falling, cheap land and ideal climate in Peru, low taxes, and an experienced manager who had made money for investors before. But as the Telegraph article states, “the company ran out of money” and its Nomad resigned. Its problems were compounded by shareholder disputes and its inability to raise further funds, and ultimately Melka resigned.

Shareholders are left in a company where there is only a glimmer of hope although the “trees have not stopped growing” as the Telegraph puts it (it takes some time for Cocoa trees to come into production after planting).

So what is the moral of this story? There are very high risks when one invests in companies with no revenues or profits. This was essentially a start-up with an unproven business model, i.e. can cocoa be produced profitably in Peru? Nobody really knows. It also would not have rated highly on the AIM Scorecard published by ShareSoc – see http://www.sharesoc.org/scorecard.html . For example, registered in an overseas country, executive chairman, etc.

But in essence this company was an easy one to avoid when there are lots of other more mature companies available on AIM. It does of course bring into question whether such companies should ever be listed on AIM. Was this company suitable to be a publicly listed company when it had no track record and when it was in essence a risky speculation? I think not in essence.

You can make a lot of money by investing in good AIM companies, but United Cacao was the kind of company to avoid.

For example, if you wished to invest in a fruit business you might have considered Fyffes (FFY). A very long established business paying a dividend. That also recently delisted from AIM. The reason? The company was the subject of a bid from Sumitomo – a cash offer that represented about a premium of 50% to the previous share price.

Roger Lawson

Foresight VCT Incentive Fee

In addition to my recent comments on Foresight 4, it’s worth covering the latest news from the original Foresight VCT (FTV). They have announced a General Meeting on the 8th March to consider two matters:

  1. An offer to investors to raise up to £20 million by an issue of new shares (an offer document was enclosed with the notice to existing investors).
  2. The introduction of a new performance fee for the Manager (Foresight Group) and co-investment scheme.

As regards the former, the covering letter from the Chairman suggests that the VCT is “regarded as one of the best performing VCTs” and has “20 years of market leading performance”. That’s not my experience having held this VCT for almost 20 years. Just looking at the latest AIC figures for the company it shows an NAV Total Return of minus 4.9% over 5 years and minus 7.1% over 10 years. That compares with a comparative sector performance of generalist VCTs of plus 50% over 5 years and plus 73.6% over 10 years at the time of writing.

Foresight VCT did achieve one very good realisation in its early years which had a major influence on their reported performance subsequently. This was Yoomedia – it later transpired that they floated on AIM on the basis of fraudulent accounts.

In respect of the new performance fee arrangements (there is no existing one following the merger in 2015), this looks a particularly egregious one. I am not in favour of management performance fees (on top of the normal fixed percentage base fee), for any investment trust. But this one looks both easy to achieve and can result in perverse payments.

The proposed performance fee has two hurdles that both have to be achieved for a payout to be made. The first (Hurdle A) requires an NAV Total Return of 100p over 3 years, from a base of 88p. In other words a total return (capital plus dividends paid) of 13.6% over 3 years which is roughly equivalent to 4.5% per year. Hardly a great return is it?

In addition as it is partly based on dividends paid out it is open to manipulation as we have seen with other VCTs who paid performance fees based on dividends in the past.

The second hurdle (Hurdle B) pays out on individual investments which achieve a return of 4% plus RPI per annum (say 6% at present). Any companies exceeding that on a full or partial realisation cause a payment to be made of 20% of profits to the Manager.

Now the returns on individual investments within VCTs vary widely. Some will show losses, while others can produce returns of 5 times, ten times or even more from the initial cost. But this formula ignores the losses (so long as Hurdle A is met) so in practice large fees can be paid out on a few successful investments when the overall return on all investments is very pedestrian. It also means losses in one year can be ignored, while large profits are paid out in good years if there are just a few successful investments.

Paying out based on individual investments is not right – it encourages a search for lottery tickets. Shareholders only get a return based on the whole portfolio, so the manager shouldn’t be able to cherry pick returns out of that.

This is not a wise performance incentive arrangement even if the principle of even having one was accepted.

Shareholders are recommended to vote against the proposed performance fee arrangement.

Roger Lawson

Press Release – Response to Green Paper on Corporate Governance

ShareSoc has today issued the following press release:

How to fix the ills of the UK Corporate Governance scene? ShareSoc and UKSA have given their solutions in a response to the Government Green Paper on Corporate Governance Reform. We have emphasised that the following are the key issues:

  1. Engagement between shareholders and companies is not working. Shareholders are not exercising effective stewardship and control, and boards are failing to fulfil their fiduciary obligations to members. As a result, public trust in business is low. This is bad for business and for long term investors. It needs to be addressed.
  2. The ownership structure of public corporations is a problem. It means that beneficial owners’ interests and views are not represented adequately. The bulk of public company shares are controlled by institutions whose interests are often not aligned with those of the beneficial owners.
  3. Shareholder Committees: We strongly support the concept of Shareholder Committees, provided that they represent the interests of all shareholders, including private investors and investors in employee share plans.
  4. Problems in the voting chain: This is not highlighted in the Green Paper. The proliferation of shareholders who are not directly interested in the companies in which they own shares– for example, intermediaries, ETFs, tracker funds and other index-related funds – corrupts the governance and stewardship process and the associated governance checks and balances. This is exacerbated by stock-lending. This prejudices the concept of corporate governance based on shareholder oversight, and places too much influence over our companies in the hands of traders – the ultimate cause of short-termism.
  5. Disenfranchisement of individual shareholders: The Green Paper recognises the problem that most private investors are now obliged to hold their shares in pooled nominee accounts wherein shares are legally owned by an intermediary. The ability and rights of informed individual investors to influence the affairs of companies in which they have invested is fundamental to good governance.
  6. Complexity of boardroom pay: Systems of remuneration for directors have become excessively complex, as a result of the structural governance weaknesses identified in the Green Paper. The mechanisms for triggering bonus payments have become opaque, the quantum of the payouts is often impossible to predict, the true motivational impact has become questionable while the reporting to shareholders has become cumbersome and often obscure to the point of incomprehension.
  7. Weaknesses of long-term incentives: Boards and their advisors have taken advantage of the lack of voting integrity to implement complex LTIPs as a major part of the overall remuneration package. It is widely accepted that the longer a reward is deferred the less motivational impact it has on the recipient. It is also accepted that for performance incentives to work, the achievement of outcomes must be within the control of the recipient. The current system of long-term incentives fails both these tests. It can encourage perverse behaviour which we do not want from those who run our companies.

Shareholder Committees are a core part of the solution to the problems of corporate governance. There are many other elements of governance and control that can be improved and we have commented in our response on those where we have specific knowledge. However, without Shareholder Committees, and concomitant reform to restore the rights of individual shareholders, other changes to corporate governance are unlikely to produce meaningful change.

More Information

Our responses to the specific questions set out in the Green Paper are given here: http://www.sharesoc.org/ShareSoc-UKSA-Green-Paper-Corporate-Governance-Response.pdf  (the submission was a joint one from ShareSoc and UKSA).

Roger Lawson

Alliance Trust Press Release

ShareSoc has issued the following press release:

Alliance Trust have convened a General Meeting on the 28th February. It includes 4 resolutions covering the change in investment approach and the proposed share buy back of shares held by Elliott.

Our recommendation is that shareholders vote “FOR” all the resolutions.

ShareSoc is issuing this press release because we understand that some institutional investor advisory services have expressed some concerns about the proposals.

The Alliance Trust Shareholder Action Group which has been supported by ShareSoc is satisfied that the new Board of Directors has made good progress in revitalising the Trust since it was appointed. The steps taken have substantially closed the share price discount to net asset value (a long standing concern of many investors), the disposal of the non-core Alliance Trust Investments (ATI) subsidiary has been agreed and steps taken to make Alliance Trust Savings (ATS) both profitable and able to stand on its own feet. The board structure and corporate governance of the company have been changed and are now in a more conventional form for investment trusts.

The repurchase of the Elliot shares will avoid future pressure from them and the purchase appears to be at a fair price and does not favour them over other investors who can currently sell shares in the market at a similar price and will continue to be able to do so.

For those reasons we support the recommendation of the Directors to vote in favour of the resolutions. We encourage all shareholders to ensure that they vote on these important resolutions.

If the resolutions at the General Meeting were defeated then it would put the company back at square one and potentially create major problems. Investors need to consider the proposals bearing in mind the history of the company and the other options available. In other words, a holistic consideration of the proposals needs to be taken rather than taking issue with minor technical points.

More Information

See http://www.sharesoc.org/alliance.html for more background information on the Alliance Trust campaign.

Roger Lawson

VCT News – Baronsmead, Northern VCTs and Foresight 4

I attended the Annual General Meeting of Baronsmead Venture Trust this week (on 14/2/2017). It was not particularly well attended perhaps because of the early start time of 10.00 am. The Chairman, Peter Lawrence rebuffed the criticism of one shareholder and after I suggested a straw poll of investors present to see if they would prefer a later time, which showed many would, suggested they move it to 10.15 pm. That did not impress many present. The poll of course did not even include those who decided not to attend the meeting as it was too early.

ShareSoc has published a document on “How to Run a General Meeting” which is on our web site, and this is what it says on page 5: “Likewise timing should be set for 11.00 onwards because travelling in the rush hours of London or other locations is not ideal and as many private shareholders are retired it can ensure they can use cheap train fares. This is particularly important for shareholders who will have some distance to travel. If companies do not wish the expense of providing lunch, then set the time for 2.00 pm.” 

The Chairman and speakers also read from a script which he apologised for and said it was because of regulatory concerns. He certainly made some off the cuff remarks in the past but the new approach made his presentation very boring. Let us hope this does not become the norm unless he gets a better speech writer and rehearses it in advance. 

I will do a fuller write up of the meeting for the ShareSoc Members Network as soon as possible but there were some interesting points that arose of particular note. One was the lack of new investments in unquoted companies, so the VCT now has more investments in AIM companies than private equity. As one shareholder said, bearing in mind that in the past more returns were obtained from the latter than the former, this might be of concern. But it seems that AIM investments are becoming less risky and giving better returns of late. 

The new VCT rules and the risks of breaking those rules were discussed at length. A breach of the rules now means one can lose VCT status which would be disastrous for investors, i.e. one mistake in one investment could trigger it. As a result VCT managers are now asking for “advance assurance” on new investments which they can get from HMRC. But this takes a long time as HMRC do not have enough resources and it will be easy to let deals slip away as a result (indeed it seems Baronsmead lost two because the investees changed their minds recently). This could be a serious handicap for VCTs in future and is one of the reasons, apart from trying to understand the new rules, for the lack of new investments. It is surely an example of HMRC losing the plot and making such investments more difficult than they need be for no good reason.

Northern VCTs

A lot of investors in the three VCTs managed by NVM Private Equity will have been disappointed (including this writer) by the opening and closing of the recent fund raising for a “top-up” offer on the same day. This was an offer for only £4.3 million because of the need to avoid a prospectus, but even so investors who responded immediately the offer was open and sent off their cheques only to find that they had missed the boat because of the “first come, first served” process followed will not be happy. This possibly meant that those who physically delivered their applications the same day (to Newcastle), or whose forms simply got emptied out of the post-bag first, got their applications met in full, when everyone else missed out.  

There are surely better ways to do this  – for example by taking a ballot, or reducing applications pro-rata, as other VCTs have done in these circumstances. 

It would seem that there is some enthusiasm for the shares in the better performing VCTs such as Northern and Baronsmead because of the high tax-free dividends they have been paying of late. Whether these are sustainable under the new rules which require more investments in early stage companies is not clear, although their existing portfolios will be the drivers of fund performance and dividends in the short term.  

Anyway if you wish to learn more about the Northern VCTs or ask questions about the above, Tim Levett of NVM is presenting at the ShareSoc event in Altrincham on the 21st February – see http://www.sharesoc.org/altrinchamseminar.html

Foresight 4 VCT

Following their AGM in September where the directors only narrowly managed to get re-elected, a commitment was made to recruit new directors. The company has now announced the appointment of Michael Gray. Shareholders would have preferred any new director to be knowledgeable about VCTs (which are not conventional companies and are subject to complex regulations), experienced in investment in early stage companies which is what VCTs do, and be clearly independent, i.e. independent of the manager of the fund. 

Mr Gray does not obviously have the relevant knowledge or experience according to his background supplied by Foresight and he also seems to have business links to Foresight – for example he is a non-executive director of Triton Investment Management and Foresight has invested in Triton Solar 13 Fund. When there were other candidates interviewed for the position who had more relevant experience, this is surely disappointing. 

As there are some critical strategic decisions coming up at this company (e.g. the prospective merger), it is not a positive move and might well be challenged by shareholders at future general meetings.

Roger Lawson