HSS Hire and other IPOs

I am sometimes accused by my wife and colleagues of being a “wet blanket”. In other words immune to the excitement of new ventures or ideas. But when it comes to IPOs that’s probably the right frame of mind to have. I shall proceed to throw some cold water over the IPO of HSS Hire which is listing in early February if all goes according to plan – the prospectus for which is now available.

Academics Elroy Dimson and Paul Marsh have recently published an analysis of the performance of new small company listings in the UK. Since 1987 they have typically underperformed the market over the two years after their IPO.  Obviously there are exceptions, and often there is a short term gain to be made by selling in the market quickly, but in general IPOs are to be avoided. Dimson and Marsh also showed that investing in more mature companies gave much better returns.

HSS Hire operate tool hire shops and has been expanding at a good rate. Revenue has been growing rapidly although profits are more variable. They surely are in a market governed by the general level of economic activity in the country. With the prospective price range announced for the float, the market capitalisation will be approximately £365 million.

The “Announcement to Float” document which may be all retail investors bother to read is a masterpiece of the copywriters art. Here are some of the phrases in there that are designed to stimulate the interest of investors: “A leading player in a growing market“, “Distinctive and differentiated market position“, “market leading brand“, “integrated and scalable distribution network“, “nationwide branch network with significant growth potential“, “well diversified“, “end-markets with significant barriers to entry“, “capital efficient business model“, “drives premium returns“, “experienced board” and “high quality operational management“.

This comment in there from CEO Chris Davies sums it up: “HSS has outperformed the UK tool and equipment hire market in recent years by offering its customers a powerful combination of safety, value, availability and support, delivered by c. 2,900 well-trained and motivated colleagues with a passion for delivering outstanding service……“.

OK it sounds good, so lets just have a look at the detail in the Prospectus and the financial numbers.

Under risk factors (page 20) it says “The equipment rental industry is highly competitive and fragmented” and “The markets in which the Group operates are served by numerous competitors“. So much for the “barriers to entry” mentioned previously. Indeed page 45 tells us that there are 4,000 small and large players in this market. On HSS’s current revenue it appears to have about 5% of the UK market. Although the prospectus does provide evidence that the overall market is growing and it is possible that HSS is taking business from some of the smaller players by developing more local outlets, it is hardly a market with major barriers to entry.

Why are barriers to entry important? Because they are one of the few ways that one can obtain a superior return on capital.  Yes it is possible to grow revenue and earnings by investing more and more capital (what might be called the “Tesco syndrome”), which makes the management look good but it’s not something informed investors like. We’ll look at return on capital in HSS in a moment.

Page 93 of the prospectus shows the company currently has debt of £316 million, which you might consider high in relation to the revenue and profits profile of the business. Needless to say the reduction in debt by the issue of equity is one reason given for the IPO. About £85 million will be redeemed by the issue of new shares worth £103 million with the rest used for other business expansion activities. That will still leave the company relatively highly geared and with a large interest bill in relation to the profits.

What’s the return on capital at HSS?  Well the annualised latest pre-tax profits are £8.3 million. The capital employed might be measured on Net Assets. But that figure is minus £11.8 million which is somewhat unusual – there are no retained earnings and minimal share premiums (the company has clearly been financed primarily by debt). Using another measure of Return on Assets which is earnings divided by total assets (the latter being £406m mainly comprising intangible assets plus property, plant and equipment), gives a figure of 2.0%. Hardly adequate.

What’s the prospective EBITDA multiple or P/E based on the likely market capitalisation (they prefer to talk about EBITDA rather than earnings as it leaves out the interest figure and other nasty things).

Proforma income statements and balance sheets after the IPO are given on pages 8 to 10 of the prospectus. Adjusted EBITDA  of £67m gives a multiple of 5.4.  Or historic Adjusted Post Tax profits (using the standard Corporation Tax rate) of say £2.4m giving a P/E of 152.

Those figures ignore some hefty “exceptionals” including a £7.7m loss on an interest rate swap.

Other risk factors might be the susceptibility to poor weather and the continuing large stake by the existing major shareholder.

My analysis of this business concluded at this point because however bullish the prospects of this business might be (the company seems committed to a growth strategy), the historic profile of the business gives cause for concern.

No doubt other financial commentators will be publishing their specific recommendations over the next few days, so it might be worthwhile to keep an eye on whether enthusiasm for the stock makes it worth considering as a short term punt. But investors need to ask themselves: is this a quality business that would justify a long term holding?

Roger Lawson

Monitise crashes to earth

Monitise made an announcement yesterday (22/1/2015) that prompted the share price to crash. It’s 14p at the time of writing when it had been over 60p earlier in the year, and had been declining steadily over recent months. Questor in the Daily Telegraph said on the following morning that “A buyer may come out of the woodwork but we recommend taking what you can – Sell”. One cannot be blunter than that.

The company announcement indicated that revenue growth will be flat or falling this year when it was expected to rise substantially. They also indicated that they were undertaking a “strategic review” and declared they were in an “offer period” under Takeover Panel rules. It is clear the business is being put up for sale.

This company has never made a profit in the years it has been listed, but still expects to achieve “EBTIDA profitability in FY2016”. The market cap is still £320m and revenue is key when valuing this kind of company if profits are yet to appear.

ShareSoc Members might have been aware of some issues at this company because there were two reports from their past Annual General Meetings on the ShareSoc Members Network. In addition this writer made some comments in an article on share tips in October 2014. I said that I had “become disillusioned with the business strategy, the continual fund raising required to support it, and the management approach” of the company and had sold by holding in the company in April. I was also never happy with the remuneration levels of the executives including share options which they cashed in at an early opportunity rather than retained the shares.

It will be interesting to see whether they find a buyer for the business and at what price. But with the growth of competition in mobile banking solutions, it is not at all clear that they have any unique technology or unique market position that justifies even the current valuation (about 3 times revenue).

In summary, Monitise is yet another AIM shooting star that has crashed to earth. A great “concept” stock promoted by a persuasive CEO, but where it was never really clear that the business model would enable them to generate real profits. Even the business model changed recently to concentrate on subscriptions rather than licensing. It is a good example of the danger of investing in technology stocks unless you really understand what’s under the bonnet and the market environment.

Roger Lawson

Corporate Governance at Quindell, and news on Aero Inventory

I won’t even attempt to discuss the past history of events at Quindell in this article. But recent ones suggest that it is likely to remain a controversial company. After the departure of founder and former Executive Chairman Rob Terry, Richard Rose has been appointed as Chairman and Jim Sutcliffe has been appointed as Deputy Chairman and Strategy Director.

Shareholders no doubt welcomed these experienced hands to take charge of this company after past events. But there are a couple of problems here.

Richard Rose already holds Chairmanships in public companies AO World, Crawshaw Group, Booker Group and Anpario Group. Jim Sutcliffe is also currently Chairman of Sun Life Financial, Canada and a director of Lonmin plc and Liberty Holdings, South Africa.

Only last month ShareSoc published an article entitled “How Many Roles” written by one of our directors that covered the issue of directors taking on so many jobs that they are unlikely to be able to do any of them adequately. ShareSoc has also published some guidelines for non-executive directors and the number of roles they hold (see  http://www.sharesoc.org/policies.html)  and we suggested a limit of 4 to 5 jobs. That’s for non-executive jobs in general but for Mr Rose to take on 5 chairmanships when the obligations of a chairman of a public company are now so onerous and time consuming seems rather odd to say the least. Similar problems apply to the appointment of Jim Sutcliffe.

Even odder is that Both Mr Rose and Mr Sutcliffe have been awarded large numbers of share options which contradicts the UK Corporate Governance Code which suggests that non-executive directors should not benefit from incentive schemes as it prejudices their independence. Mr Sutcliffe should know this very well because he was Chairman of the Standards Committee of the Financial Reporting Council (FRC), which maintains the Code.  Although Mr Rose and Mr Sutcliffe are no doubt experienced and skilled directors, was it really necessary to drive a coach and horses through the UK Corporate Governance Code and “best practice” in this way? Jim Sutcliffe resigned from the FRC after his appointment at Quindell.

A Shareholders Action Group has been formed for Quindell shareholders. This group, and others, have written to the Financial Conduct Authority asking for an investigation into the affairs of Quindell and suspected market abuse. One might also question other aspects of this company’s affairs such as its underlying accounting policies, and past RNS announcements.  But the FCA has declined to provide other than minimal information even though M.P.s have also requested it. David Lawton, Director of Markets at the FCA, has refused to disclose whether there is any investigation into Quindell or the activities of short sellers in the shares of the company and simply refers inquirers to the short selling regulations.

Readers are reminded that Quindell is and was not just another tin-pot AIM company. It actually had a market cap of over £2bn at one point, was one of the largest AIM companies and its share price decline last year was one of the factors in the overall decline of the AIM index. Another large AIM company was Aero Inventory which reached more than £300m market cap before it went into administration in 2009. After four years of investigation the FRC has finally announced a formal complaint into the preparation and audit of the accounts of this company which collapsed after it was discovered that the assets have been grossly overstated. So the auditors and former finance director are under scrutiny. But the exact nature of the complaints against them have not been disclosed.

Comment: is it not ridiculous that such investigations take so long when there is such prima facie evidence that the accounts of Aero Inventory were grossly misleading. The lack of action, or unreasonable delays, by the FCA on this and other cases just demonstrates how ineffective they are at regulating auditors, the directors of companies and the stock market in general.

When even large companies such as Quindell and Aero Inventory seem not to attract adequate resources to investigate their affairs, it is obviously unlikely that smaller companies, or smaller transgressions, are ever going to merit attention by the FCA. This should be changed if we are to restore probity to the stock market.

Roger Lawson

Forex trading and the Swiss Franc

The abrupt change of policy by Swiss authorities to relax the limit on the value of the Swiss Franc against the Euro has caused substantial chaos in foreign currency markets. Alpari, one of the leading forex trading platforms in the UK, has gone into administration and others such as Saxo Bank admitted they would incur losses as a result. In the case of UK listed company IG Group it had some impact on their share price and they had to say that “The market exposure occurred where client positions were closed at a more beneficial level than the Company was able to close its entire corresponding hedge due to the market dislocation”.

These platforms also often offer trading in CFDs and spread betting. The result of the administration at Alpari is that clients have had their holdings frozen and it might take many months to sort out. Although client funds are normally kept separately, as always in this kind of circumstance it remains to be seen whether that was actually the case and that they cannot be claimed by the administrator.

There are likely to be hundreds of thousands of unsophisticated punters who have been caught out by these events (Alpari alone claimed 170,000 active clients). It has become clear that these platforms have been attracting gullible new investors by the promise of high leverage and instant riches. In other word, the punters are buying on margin and almost all of them lose money by the spreads and being closed out when price volatility occurs. Indeed you can tell this by looking at the turnover (“churn”) of clients in these businesses.

There was a very good analysis of the market for forex trading by Paul Murphy and others in the Financial Times on Saturday the 17th which should be required reading by all those tempted to speculate in forex. And yes there are many who are. This writer remembers talking to more than one person at trade exhibitions who when asked if they were experienced investors said something like “no I am just starting and am trying out some forex trading”.

According to the FT, retail forex trading now accounts for around 20% of the global forex market. There are no caps on the level of leverage in the UK or the rest of Europe, unlike in the US and other jurisdictions. So for example, leverage of 200 to 1 is possible, so you can trade $1million by putting up $5,000.

There is remarkably little regulation of forex operators. The Financial Conduct Authority (FCA) seems to take little interest and European regulators likewise. It’s rather as if they took the view that what does it matter if a fool and his money are soon parted – it might be an educational experience for the typically young and inexperienced speculators who are clients of forex trading platforms. It probably comes back to the question of how much one should protect investors from their own stupidity and ignorance.

But surely it would be wise to look at some minimal regulation and limits on leverage.

Roger Lawson

Pensioner Bonds on Sale

The new bonds available from National Savings & Investments (NS&I) went on sale today (15/1/2015). Technically called “65+ Guaranteed Growth Bonds”, they have been dubbed “Pensioner Bonds” by the media. You need to be 65 years of age or older to purchase these bonds but they do offer a very attractive interest rate in comparison with current bank deposit rates. Interest is either 2.8% per annum for a one year bond, or 4% for a three year bond. The maximum that can be invested in each of those two types of bond is £10,000 per person (i.e. £20,000 in total).

The interest is not paid out, but accumulates within the bond until maturity. The interest is taxable and tax is deducted before payment at the standard rate, but can be recouped by non-taxpayers. Those who pay higher rate tax would pay additional tax. The bonds incur a penalty if cashed in early so these are not for people who may need cash urgently.

It is expected that there will be high demand for these bonds so anyone interested should apply as soon as possible. Although doing so on the first day they were available has proved to be very difficult on-line. The NS&I web site seems unable to cope with the demand.

Roger Lawson

Naibu suspended

On Friday (9/1/2015) the shares of Chinese clothing company Naibu (NBU) were suspended  at the request of the non-executive directors “pending clarification of its trading position”. The CFO had resigned on the 31st December and the trading update on the 24th November hinted the dividend might not be paid and profits reduced.

The best comments on this event were probably those of Paul Scott who writes for Stockopedia. He has been consistently critical of Chinese companies listed on AIM and his words on this latest debacle included: “Chinese stocks are too risky to go near with a bargepole” and he concludes that “some of these stocks have been listed on AIM with the primary purpose being to relieve British investors of our money“. He suggests the balance sheets of many are a work of fiction and the earnings are a mirage.

ShareSoc commented on Naibu in a Newsletter article in October 2014 soon after it was indicated the dividend would be cancelled despite the company apparently having loads of cash on its balance sheet. This is what ShareSoc said then in an article on share tips “What can be learned from this debacle? One thing is 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 a 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.” As I said at the timeWith 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)“.

I also made some very negative comments about a similar Chinese company, Camkids, back in February 2014 after seeing a presentation by some of the directors which is available on the ShareSoc Members Network – it revealed many of the issues with such companies. The company is on a p/e of 0.7 at the time of writing so it looks like many investors do not believe their accounts either.

ShareSoc Members were certainly warned to be wary of such companies, but perhaps not as soon as would have been preferable.

Roger Lawson

Charles Stanley loses Finance Director

Charles Stanley announced yesterday (9/1/2014) that its Finance Director James Rawlingson was “leaving with immediate effect”.  This follows the appointment of a new CEO in December after the publication of a dire set of half year results at the end of November. Funds under management were static and revenue from the Financial Services Division and platform Charles Stanley Direct were up substantially but higher costs resulted in a loss before tax of £3.9 million. The dividend was maintained at the half year, but the abrupt loss of a CFO is rarely a good sign.

The higher costs resulted from a “major upgrade to our systems and processes” as a result of “rising expectations” among their clients and their regulator.

These issues potentially not just impact investors in the company, but also as a stockbroker it potentially affects their clients. A stockbroker in financial difficulties is never a pleasant experience for their clients, particularly those in nominee accounts.  There may not be any need to immediately panic but it would be surely advisable to keep an eye on their financial results and announcements. Several organisations provide such a service – for example InvestEgate from Financial Express which this writer uses.

Roger Lawson