John Lee, WPP and Optimal Payments

As usual there was a thought provoking article by John Lee in the FT Money edition on Saturday (4/4/2015). He discusses the “one that got away” in his past investment history, which was a small company called Wire and Plastic Products. He invested £9,000 in 1984 in this manufacturer of supermarket trolleys but sold his shares for £25,000 when an unknown person named Martin Sorrell bought a large stake and the shares rocketed. It went on to become WPP (market cap now £20 billion), although with some dilution along the way.

I pondered whether this was not another case of selling the winners, while holding the losers, which many private investors are prone to do. As soon as they see a good profit they sell all or some of their holding  – the latter is called “top slicing” which gives a respectable name to a somewhat irrational trading strategy. Top slicing in this writer’s view only makes sense if the holding is becoming excessive as a percentage of your overall portfolio, or you doubt the valuation now being put on the company by the market.

John Lee might of course have decided that WPP was becoming a different animal, with a different risk profile, when Sorrell got involved from what he had originally invested in and it did not meet his normal company selection criteria. But many other investors are happy to take the money and run as soon as it appears.

Now these thoughts came to mind when I was considering whether I had made the right decisions on Optimal Payments (OPAY). This was a company that presented at a ShareSoc seminar in October 2014 – the share price then was 455p. But soon after a storm blew up after the CEO, Joel Leonoff, entered into a “equity loan” agreement with Equities First Holdings. This was heavily criticised as being a share sale in reality by a blogger and the share price promptly declined to as low as 270p in mid December. See an article in our November 2014 Newsletter edition for more background and what Mr Leonoff said at the time.  I was buying the stock at that time as I considered this a low valuation from what I knew about the company and its prospects.

Optimal operates in the internet gaming sector via its Neteller division, and in payment processing via Netbanx. The former is a high risk sector because its key USP is that it enables people to pay into gaming sites while avoiding blocks from credit card companies. But it is very vulnerable to regulation changes and was almost put out of business like other on-line gaming companies a few years back when the USA introduced legislation banning such activities. Now there is a hope that such legislation will be lifted across the USA, as it has been in one or two states already, so everyone sees the prospects there as looking a lot brighter. But it is worth noting that this writer is not as optimistic as the company appears to be about the speed of change in that regard and businesses operating in the on-line gaming sector are generally not valued highly because of the risks associated with them (reputational, legislative, accounting, etc).

But regardless of that issue, the company has recently been uplifted and rerated by the announcement of the takeover of one of its main competitors named Skrill. The latter also has major activities in on-line gaming, which might be seen to increase the focus of Optimal on that sector, but Skrill also has some other payment sector products. The acquisition does at least diversify Optimal’s customer base which was very concentrated and should be earnings enhancing. The increased size of the business was suggested by some that it would enable them to compete with the likes of PayPal, the gorilla in the electronic payments space, and the company said it intended to move to a main market listing from AIM as soon as possible. As a result the share price rapidly moved up reaching a level of 572p on the 24th March, although it has subsequently eased back somewhat as initial enthusiasm for the deal seems to have faded.

One of the interesting aspects of these events is that the offer for Skrill is to be financed by a rights issue to raise £451 million. The good point is of course that this is a rights issue not a placing so private investors can participate. But the unusual aspect is that it is a heavily discounted offer which means that investors have to take up the rights if you wish to maintain your stake, or do a “tail-swallowing” exercise by selling some of the rights to finance share purchases.

But the deep discount of 60% to the previous closing price raises some concerns. This usually means that the company and the promoters of the shares needed to make them particularly attractive to enable them to ensure a good take-up. The rights issue that Royal Bank of Scotland undertook when they were in dire, but undisclosed, financial difficulties in 2008 comes to mind as a typical example and the law suit on that continues to roll along.

Given these facts, and what I considered the prospects of the company I decided to sell a major proportion of my shares in Optimal at the recent high price, while retaining others on which I will take up the rights. So yes I have done some “top-slicing” in effect to realise some profits which is contrary to my usual  strategy.

We will see in due course whether this is a wise move, based on the future outlook for the business and the associated risks.

Roger Lawson

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