Inheritance tax giveaway by the Chancellor

The announcement by George Osborne yesterday (29/9/2014), that a tax on pension funds is to be scrapped is a major giveaway for investors. It would seem we are already into the 2015 election campaign.

At present anyone holding a SIPP (the most cost effective way to hold your pension fund) or other defined contribution pensions (e.g. personal pensions), faces a hefty tax bill when they die after the age of 75, or earlier if the fund is already in “drawdown”, i.e. paying out to the beneficiary on a regular basis). That tax applies to the balance of the fund, and may also be subject to inheritance tax. After April 2015, those taxes will not apply and the fund can be transferred tax free – only when money is taken out by the inheritor will it be taxed as income at the recipients normal tax rate. This is exceedingly generous because it will enable substantial sums to be sheltered from inheritance tax, and pass down the generations tax free. It will encourage wealthy investors to put more into their pension funds for that reason.

At least the above attempts to provide a simple explanation of the current and future system, but in reality it’s more complex than that. Anyone considering their future tax position and the position of their beneficiaries is advised to take expert advice on this area and study the details of the new rules when they become available.

Roger Lawson

Globo Interims and evaluating software companies

Globo issued some Interim Results this morning (29/9/2014). The announcement created quite a debate on some bulletin boards because of varying interpretation of the results. It only merits some comments from me because ShareSoc has published articles on this company before, particularly after it came under attack from shorters who primarily questioned the poor cash flow, capitalisation of development costs and several other aspects of the company’s operations (see our November 2013 newsletter). That caused the share price to collapse from which it has not yet recovered.

The latest results appeared positive – revenue up 45%, EBITDA up 23%, free cash flow of €4.2m and a net cash position of €46 million. But the detractors on bulletin boards were not accepting the news was good.

Let me remind readers that I do have a small interest in this company but I do not actively trade the shares. I am going to comment on this primarily from the perspective of someone who has run these kinds of software businesses in the past. One of the good things about this company is that they are very open with shareholders and anyone could dial-into the results presentation this morning and hear what Costis Papadimitrakopoulos the CEO had to say (I give some notes on it below). It’s also worth looking at the results presentation slides which are available from their web site.

Forget the accounting issues for the present. Where exactly does this company stand in the BYOD space versus its competitors and how is it developing the market? Now the company very kindly enables you to download a recent Ovum report on this market segment and where its key product Go!Enterprise sits (Ovum are a major IT consultancy).  It’s clearly a very fragmented market as yet with lots of players battling for position, but growing rapidly (forecast to be $7bn by 2017 according to IDC). Ovum rates Globo to have a very well-rounded EMM solution with its MADP features a particular strength. But overall it still rates Globo as a “Challenger” rather than a market leader because it’s customer base is still relatively small, particularly in the USA where all the real action is taking place (as with any major new software market). The main threat is therefore that competitors will grow more rapidly.  Everyone interested in Globo should read the Ovum report.  But bearing in mind the history of Globo, it’s very positive that technically they score well in this report on several parameters.

How is the company tackling the competitor issue? By gearing up in the USA with more sales people, doing more direct sales, and the CEO has also moved to the USA to drive it forward (this will enable him to monitor the US market much more closely as all the major competitors are based there, as he pointed out).

This is all positive news, but building a successful US sales force will take time as I have said before. Progress is surely as good as can be expected bearing in mind where they started from (namely being a small Greek company – just getting included in the Ovum report is a major achievement).

In addition to investing in expanding the US sales operation, they also need to invest technically to round out their product (even though it already stands up well), and create the supporting infrastructure to be credible to major accounts in the US market and elsewhere. So it’s actually quite surprising to me that they can declare any profits at all in this phase of their business development. It is somewhat helped by the other businesses that the company has, but as the detractors pointed out there is a whacking big item on the cash flow statement in the interims of €12.7m for “purchases of tangible and intangible assets” – double the last interims figure. Without that, profits would be much lower. This is obviously mainly the capitalisation of software development costs.

Is it right to capitalise such costs, and if so does it reflect reality? According to current accounting rules you have to do so unless it is strictly “research” rather than “development”. In other words unless you consider it is purely speculative, and may have no certain value in future, you need to do so. That is undoubtedly the correct accounting treatment. As this company has raised questions on its accounting and audit practises in the past, I would be pretty certain that they have been quite careful about this.

I do not agree with those financial analysts that argue one should “adjust” the reported accounts to write off such capitalisation. It does reflect the reality of what the company is investing in assets (namely intangible software products) which are the core of its business. We know those products are saleable because they are selling them now, so it surely is justifiable to do so. Of course one needs to keep an eye on whether those developments are becoming worthless – obsolescent or unsaleable for any reason, but for a software company manager the accountants who set the current capitalisation rules surely made the right choice to ensure the accounts reflected a “true and fair view”, and likewise for investors. The market value of these businesses closely reflects their investment in intangible assets because that is what generates sales and profits. Regrettably some of the commentators on this issue do not seem to understand the dynamics of software companies and the underlying realities that are reflected in their accounts.

What else did Costis have to say on the conference call of interest? He mentioned market consolidation and that they might be doing more acquisitions in future. He said they were well positioned to exploit the market opportunities and said the second half will be particularly good in the USA. He argued that they were operating in a fragmented and difficult to understand market environment (this means there are no “gorillas” in this space which is good for Globo and means there is room for a number of companies to make decent profits). Even very large customers fail to understand the complexity and hence Globo provide services to assist implementation. Costis emphasised however that they are not becoming a service company, but are a product company (this and the de-emphasis on the Ingram relationship with most of the focus on direct sales is positive in my eyes because that’s how to make money in software businesses in my experience).

Another positive sign is they appear to have crossed over from simply selling to “early adopters” to more mainstream businesses, i.e. they have “crossed the chasm” – a famous phrase in the IT marketing world. Accounts are not everything when evaluating software businesses for investment and anyone who picks software companies for investment purely based on their accounting ratios is likely to be seriously misled. All successful investors try to understand the business models and markets of companies they invest in. If you don’t understand the business, don’t invest in it!

So Globo looks positive on a business perspective, but clearly as I have said before this company remains a “work in progress”. You need to consider the relatively low market value of the company from that point of view but certainly if I was sitting in Palo Alto among their competitors the possible trade price of the GO!Enterprise business alone (ignoring the rest of the revenue) looks very reasonable. I wonder if they have had any offers of late?  But they clearly can’t be in play because after writing this article I noticed that Costis just bought another 50,000 shares in the market which may tell you something.

Roger Lawson

The Tesco Board – fit for purpose?

There was a very good article in the Financial Times today by Luke Johnson. It covers the problems at Tesco and suggests that “the stewardship at Tesco has been woeful“.  A particular focus is on the experience of board members, of which only one is executive (recently appointed Dave Lewis). It says “Like every single other director on the main board, he has no executive experience as a retailer whatsoever“. Luke suggests they might have a wide and impressive set of skills, but ones not particular relevant to the business of selling groceries.

Now it’s possible that he read my June 2012 blog post, extracts of which I give below, but I doubt it. It’s just a case of two independent writers coming to the same conclusion after reading the Annual Report I would guess.

“The Board of Tesco – Is it surprising they are in trouble?

Posted by Roger Lawson on June 4, 2012 at 9:30

With a few days holiday over the Jubilee weekend, it’s possible to catch up on reading the Annual Reports of companies that pile through one’s letter box at this time of year. Tesco’s makes particularly amusing reading and might help to explain why they are in some difficulty.

The new Chairman’s introductory statement (from Sir Richard Broadbent) is a classic of management speak. Consider this sentence for example: “First, Tesco is a business with significant strategic optionality”. I think he means they have lots of strategic options. But does not any major company? More to the point perhaps is which options they intend to pursue which he does not say.

So what is the background of the new Chairman? Does he have a long career in major retail businesses? No experience in retail at all in fact. His main career seems to have been in the Civil Service (at the Treasury and HMRC) with a stint at Schroders. He has also served on the boards of Barclays and Arriva. 

The board of Tesco actually comprises 14 directors which is surely an unmanageable size. There are 8 non-executive directors. How many of those have any retailing background? None so far as I can see. 

Another oddity is that one of the Executive Directors, Lucy Neville-Rolfe (the only female executive director) has several other jobs which include Deputy Chair of the British Retail Consortium, Non-Executive Directorships at ITV and the Carbon Trust, Member of the London Business School’s Governing Body, of the China Britain Business School, the UK India Business Council and the Corporate Leaders Group on Climate Change. She joined the board from the Cabinet Office.

This board looks like that of many banks before they got into difficulties – where they were full of non-bankers who did not intrinsically understand the business but with high profiles in other respects, i.e. the “great and the good”. Not the kind of board that would have challenged Tesco’s CEO on his decision to venture to compete on the US West Coast which has proved very unwise.”

Now I understand that the board has been reduced in size slightly since those comments were posted, but Luke Johnson spells out that its characteristics have not changed in essence. After attending a subsequent AGM of Tesco, I sold my holding because that did not impress me either. So surely the moral for investors is read the Annual Report and attend AGMs – or of course become a ShareSoc member and read the ShareSoc newsletters and blogs, where you would have got this story sooner and at less cost than subscribing to the FT.

Roger Lawson

Barclays, Tesco and MoPowered

Barclays, Tesco and MoPowered – two big companies and one a typical new AIM company which has yet to show it can make a profit – but all three are under the weather in the last couple of days.

Barclays have today (23/9/2014) been fined £38m by the Financial Conduct Authority for failing to ensure that clients money in the investment bank was kept separate from the banks own assets. When I joked in my local Barclays Bank this morning that I hoped they were keeping my cash separate to their own, it did not raise a laugh. But there is a serious issue here. Barclays is the largest retail stockbroker in the UK, all of whose clients are in nominee accounts. I was also told today that the contract they have with their clients is one that no reasonable person would sign up to, but probably few people read it. Those who use such nominee accounts are reliant on the wording of their contract with the nominee operator (i.e. Barclays in this case), to protect their investment.

But when a really big bank can risk £16.5 billion  of client funds in this way, what certainty is there that they will adequately protect the assets of all their small investors in their retail stockbroking business? ShareSoc is of course holding a meeting on the 14th October to discuss this and other risks associated with the use of nominee accounts (see http://www.sharesoc.org/shareholder-rights.html).

Tesco

The Tesco share price fell 12% yesterday, and a further 4% today after announcing that the expected profits for the half year were going to be £250m less than previously indicated. This might be seen as a warning about a profit warning. The error seems to be down to some dubious accounting treatment of rebates due from suppliers and has resulted in the suspension of a number of staff. Of real concern though is the possible failure of the auditors to pick this up previously and it only came to light from an internal “whistleblower”. Interim accounts are not audited of course, but if this has been a long running error then auditors PwC might have a lot of questions to answer.

Investors do of course rely on the accounts of companies and any failure by the company to produce accurate financial information, or by their auditors, is of serious concern, even if it does not happen very often in large FTSE-100 companies. But it is not so uncommon in smaller companies. For example, HP are complaining that the audited accounts of Autonomy did not accurately reflect the underlying business before they acquired the company.

Now oddly enough the issue of trust in auditors came up at a seminar hosted by the BIS and FRC yesterday. Although the attendees seem to generally accept that auditors are trusted, one institutional investor pointed out that the financial crisis partly arose when many people became suspicious of the accounts of banks (and their stated assets). The debate as to whether they breached Company Law and did not present a “true and fair view” as required, and whether IFRS rules conflict with the former, has continued. I commented that trust in auditors is undermined when they are seen apparently to be acting in a way that favours the interests of their clients. When there is more than one way to present accounts, or questions of interpretation, there may be a tendency to do what the client wants rather than what investors might prefer to see. Of course the essence of this problem is that currently auditors are only responsible to their clients, i.e. the companies who pay them. The Caparo legal judgement overturned any previously assumed responsibility to shareholders in a company, more’s the pity. This was an issue that the seminar could have debated in more depth, but did not.

MoPowered

Mopowered is an AIM company that yesterday announced a placing to raise £3.5 million at a discount of 75% to the previous market share price. The market share price promptly collapsed to match and it’s now trading at about 6p at the time of writing. That’s down from the placing price of 100p in December 2013. So what you may ask? It’s just another AIM company that has failed to meet its sales targets in the business plan used to raise funds in the IPO and hence has run out of cash.

But MoPowered did present at one of ShareSoc’s Growth Company Seminars in March of this year, so it’s worth making a few comments on the business. In their presentation by CEO Dominic Keen at that meeting it looked an interesting product and some aspects of the business looked attractive (at least for someone like me who likes to invest in software companies). The product was selling well already and there were claims for significant unexploited demand. The product enables companies to create mobile versions of their web offering more cheaply and easily. All the company needed to do was accelerate their roll out plan by hiring more sales and marketing staff.

But in the interim results announced on the 19th September, it was obvious that sales were behind plan. As it said in there “the rate of new client acquisition has not grown at the pace the board anticipated at the time of the IPO“, but otherwise there were positive noises about future prospects. Costs were being reduced, but it was clear that cash flow was substantially negative (£2.1m flowed out in the period). Sentiment was not helped by the resignation of the finance director in July.

Now there are two questions worth posing here: 1) How to avoid investing in such companies at the IPO or soon after (i.e. could the failure to match objectives have been anticipated), and 2) Should ShareSoc allow such companies to present to our Members?

The answer to the first one is easy. I chose not to invest at the time (even though I liked the business in many ways) because investing in any new IPO is exceedingly risky. It is not uncommon for share prices of new IPOs to head downhill. The money gets raised, it is quickly spent as per the business plan, but revenues do not match the plan. In reality they may be achieved subsequently but effectively the plan runs late (anyone who invests in early stage companies knows this is the commonest failing). The result is negative cash flow and more fund raising required. Gearing up a sales force is also not easy. Good sales people are few and far between, and difficult to hire. It’s likely those hired will take many months to learn how to sell a new and innovatory product, and half of them will turn out not to be up to the job to begin with (I am speaking from experience here of running similar businesses). So I thought that although it was an interesting company back in March, I would wait and see what progress was made before I invested. I am of course still waiting for it to turn the corner. Private investors have that luxury, while institutional investors who participate in the IPO do not.

As regards whether ShareSoc should permit or encourage such companies to present, I still think we should because it enables our Members to learn about companies in their early stages even if they perhaps are not investable propositions as yet. Unfortunately we cannot tell Members whether to buy or sell companies, and some might wish to take a chance on the success of an early stage company anyway. All we can do is give the companies presenting an opportunity to convince our Members of their merits and for our Members to learn about a business, ask questions and make their own decisions on whether to invest. Anyone attending our seminar at which MoPowered presented will no doubt have perceived that there were risks in the roll-out, and perhaps taken a more sceptical view of the brokers forecasts for the company which is all some investors rely on before making investment decisions. The moral is surely make sure that you learn as much about a company as possible, and understand the business model, particularly of new and unproven AIM companies before investing by taking opportunities to do so such as we provide.

Roger Lawson

The dangers of share tips – Naibu (NBU) and Monitise (MONI)

Well respected stock picker Simon Thompson had to admit defeat with Naibu in the Investors Chronicle on Friday (19/9/2014). This Chinese maker of sportswear has, on an earnings basis, been ridiculously cheap for a long time, but some investors liked the high dividend yield. Simon picked the company for his share pick of 2014 in the Investors Chronicle – he tipped it at 58p in February with these words: “It’s not often you have the chance to buy shares in a company trading below cash on its balance sheet and at a third of its book value. It’s even rarer to find a company offering a near 10 per cent dividend yield and where net earnings for just one financial year equate to almost all of its market value. However, this is the tantalising investment opportunity in the shares of Naibu Global International (NBU), a Chinese maker and supplier of branded sportswear and shoes“.

There were glowing mentions of how cheap this company was in subsequent editions of Investors Chronicle since then, but on the 12th September in its Interim Results the company declared it was passing its dividend. Simon has noted how odd this is bearing in mind the stated cash position of the company and the profits it is generating. He said in the latest edition that this “makes it an even greater outrage that the company should treat minority shareholders in this way“. More followed in the same vein. There is clearly nothing like a share tipster defeated in his analysis, particularly after he had “averaged down” at 45p when the share price is at the time of writing 26p. He now recommends investors sell.

What can be learned from this debacle? One that share tips are dangerous both for tipsters and investors. That is particularly the case when one is making investment decisions primarily using financial analysis in a business in far away country and where it is not easy to talk to the management. Dangers were not difficult to spot – the company has an Executive Chairman, Mr Lin, who holds 52% of the shares – so in essence he can pretty well do what he wants. With a short track record as a public company, this is the kind of company this writer avoids. It would also undoubtedly score lowly on the “AIM Scorecard” we published last year (available on our web site).

Another lesson to be learned is surely that one should not “average down”, or go against the share price trend. To do so, as happened in this case, is surely a mistake. You have to be absolutely, absolutely sure there is nothing that other investors know that you do not before doing so.

Incidentally Simon Thompson also tipped Avation in his latest column. This company is presenting at our ShareSoc Growth Company Seminar on November 26th so it will be interesting to see whether what they have to say backs up his analysis (it’s not yet listed in our Events page – check in late October for details).

Another tip in the edition of Investors Chronicle issued last Friday was Monitise. This payments company was noted as “growing fast” – revenue is but losses are also growing – as much as £51.8m “adjusted” losses this year are forecast. The writer signed off with the words “Now’s not the time to back out” after noting recent share price declines.

Unfortunately the day before that edition of the magazine was on the streets (and hence too late to incorporate), the company announced that Visa (who are both a business partner and significant investor with a representative on the board) were assessing their stake in the business. There were hints that Visa, a key partner, want out. The share price promptly collapsed 33% on the day.

Now this writer has that well known German feeling of “Schadenfreude” – the pleasure that one has avoided damage while others have not. I sold my holdings in this company in April having become disillusioned with the business strategy, the continual fund raising required to support it, and the management approach. Dilution of investors share stakes can seriously damage your wealth, and the date when profitability was forecast continually moved forward. One might say that the management lost this investor’s confidence over a period of some months.

But my experience of running software companies also told me that it is possible to grow revenues by spending large amounts of money because some of our competitors used to do that. But whether you can ever turn those revenues into a profitable business is doubtful. The other problem with Monitise is that it is operating in a rapidly evolving sector. The landscape for payment systems is changing as new entrants move in (such as Apple), and although it is a growing market some of the valuations are plain daft (typically 10 times revenue, regardless of profits). By the time a business has conquered the market with heavy expenditure, it might simply find the battle has moved on to another country so it never achieves profitability.

Now Simon Thompson, and no doubt the writer of the article on Monitise, have had their past successes with share tips. But the moral for readers of any publication that tips shares is that you should never follow them blindly. You should do your own research to discover whether the story is credible or not, and be willing to change your mind as you learn more about the business.

Also this year’s wonder stock can be next year’s dog. When the valuation depends on future sales growth and earnings (as is certainly the case with Monitise), the share price can collapse at the slightest change in their prospects. High multiples of revenue, or earnings, in companies are ones to avoid because they are very sensitive to changing circumstances unless the business model is strong and they are generating cash rather than consuming it!

Note that I am not trying to deter folks from reading Investors Chronicle or looking at their share tips. It’s a very informative and educational publication in all respects. But one can certainly learn lessons from their occasional mistakes.

Roger Lawson

Diageo AGM and Scottish Independence Postscript

Yesterday I attended the Annual General Meeting of Diageo Plc. Being the day of the Scottish Independence vote, there were some questions on that issue for the board, but all the CEO said was that you can be assured we will fiercely fight for free trade, currency stability and no more tax and regulation. The Chairman said it was for the people of Scotland to decide, even though Diageo is headquartered in Scotland. You know the outcome by now and I guess at least our ShareSoc Chairman won’t have to get a new passport or choose his nationality.

The Diageo AGM was generally a disappointing meeting with the Chairman and CEO spouting lots of “management speak”. Shareholders were obviously unhappy with the performance of the company last year – as one shareholder said – “sales and profits down, and the share price down more than 10%”. He suggested it was like Tesco and the CEO had no chance of remaining unless it improves.

A full report will be on the ShareSoc Members Network as soon as possible.

One particular problem was that I turned up partly as a proxy holder for 230,000 shares on behalf of our fellow German Shareholder Association (DSW). But the registrars said they had not received the proxy appointment from Vidacos Nominees in time, so those shares were not voted.

This exact same problem happened to me at the National Grid AGM a few weeks ago. It seem likely that the nominee operators simply to do not submit the proxy forms in time and it’s yet another example of the problems created by the nominee system. It was disappointing to lose their votes against the remuneration scheme at this company, where bonuses can be as high as 500% of base salary. But this very high gearing did at least mean total remuneration was reduced last year.

Readers are reminded that we are holding a meeting to launch a campaign on the issue of nominee accounts and the difficulties shareholders have in exercising their rights on the 14th October – see http://www.sharesoc.org/shareholder-rights.html for more details – all are welcome.

I hope investors are happy with the outcome of the Scottish Independence vote. The only downside might be that the pound seems to be rising again as a result – this directly impacts the profits of many UK companies who export a lot or have major overseas operations.

British Country Inns

Today another General Meeting I attended was that of British Country Inns 2 – an EGM to change their Articles prior to listing on Asset Match. It and the position of the other associated EIS companies was described in our last newsletter. The new Articles contain a provision that enable the directors to refuse to register any share transfer at their absolute discretion, which I consider positively dangerous. But shareholders voted for it by a large majority. We shall see how this plays out in future. A fuller report will be put on the ShareSoc Members Network.

Roger Lawson

Oxford Technology VCTs and Scottish Independence

Today the two Oxford Technology VCTs that were threatened with withdrawal of VCT status have announced that the changes required by HMRC to enable them to retain VCT status have been achieved and accepted by HMRC. Presumably that has required the disposal of some of the Scancell shares that were the source of the difficulty and that has been confirmed in the announcements.

This therefore probably concludes the campaign on these VCTs that ShareSoc mounted as there has been an almost complete success. The only possible issue remaining is the historic poor financial performance of all the Oxford Technology VCTs.

I was amused to see the comments of Alex Salmond that the Treasury had leaked the news to the press of the proposed transfer of the registration of Royal Bank of Scotland to England if the independence vote was won. He complained it was “market sensitive” information which had not been announced in an RNS as it should be. Mr Salmond has demanded a formal “leak inquiry”, but he may find that is pointless as Jim Hacker famously did. The result will be so delayed, and the answer so fudged, that it will be a dead issue when any report comes out.

Now do I not recall such complaints before? Indeed yes. Shareholders in both Northern Rock and Bradford & Bingley complained about damaging leaks from the Treasury which depressed the share price and helped to force these companies into such a dire financial position that the Government had to nationalise them. Some of course considered the actions were such as to enable the Labour Government to start taking control of banks which they had always wanted to do. There was never proof of such leaks but the Governor of the Bank of England hinted that he knew where they probably came from.

The latest ShareSoc newsletter which contains some analysis of the Scottish independence issues is about to be issued. But on a straw poll of ShareSoc directors, not a single one would be in favour of it even if they lived in Scotland (albeit that only one of them is a Scotsman by birth). The financial press is also certainly supporting a No vote in general, as are a lot of major companies. But it may still be a close run thing.

Roger Lawson