Story Stocks and Purplebricks

Here is one New Year’s resolution which investors might wish to adopt: avoid those “story” stocks!

Paul Scott who writes a popular blog on small cap stocks for Stockopedia recently wrote “Above all, this year has taught me to stop chasing stories”. He suggested it was a “virtually guaranteed way to lose money”. He mentioned a few hyped up stocks that crashed back to earth in 2015 including Audioboom, Fitbug, Concha, Tungsten, Rightster and Torotrak. These are the kind of stocks that need repeated fund raisings, often via discounted placings that prejudice existing shareholders.

What are the characteristics of a “story” stock? They often have little or no sales or profits, but a story that is both attractive and plausible. They have a new product or service that sounds like it could be very alluring; or a new way of doing business that enables them to undercut existing market incumbents. The typical message is that they have invented a new paradigm that will change the world as we know it. If they can claim uniqueness, that there is a whole new market they can develop, or that it will devastate the cosy and very profitable businesses of current market leaders, so much the better.

Bearing the above in mind, let’s take a look at a company that just listed on AIM – Purplebricks (PURP). You can of course read the prospectus which is on their web site which tells you what their story is. I summarise it below.

Purplebricks is an on-line estate agent. You might say there are already a number of those who are claiming to sell houses for lower fees than traditional estate agents and you would be right.  The current market share of Purplebricks is not made clear in the prospectus. It says it is differentiated in that it is actually a “hybrid” model which they suggest is more attractive to customers – they “engage” local property experts (LPEs) to handle such matters as doing valuations which cannot be done solely in the virtual world of the internet. Most of these LPEs are franchised by the company.

The company claims to undercut the traditional estate agents’ fees that average £4,000 to sell a house with a fee that is more like £1,000.

Other claims are “first mover advantage” with their hybrid model, an improved marketing strategy focussed on TV advertising and higher spend on marketing, good market share momentum and a strong management team.

What do the financials look like for this investment (which is often the last thing people look at for “story” stocks)? To the five months ending September 2015 they achieved revenues of £5.7 million and an operating loss of £4.9 million. They spent £5.1 million on media costs alone! The comparable period in 2014 resulted in revenue of £598,000 and losses of £2,034,000 so you can see how they are ramping up the business by aggressive marketing. When will this business make a profit? Kate Burgess in the Financial Times suggests that analysts don’t expect it to turn a profit until 2018.

The directors of this company can of course argue that the existing estate agents market is quite fragmented with lots of small local businesses although there are some larger chains. These businesses are already generating a lot of their new inquiries via the internet – via Rightmove, Zoopla and others who will not be affected by these new entrants because they will be using the same “portals” to generate sales.

It is of course historically a market where trust is low. Estate agents typically rank only just ahead of used car salesmen in the public’s view of their trustworthiness, so perhaps there is room for a new business model that can change that perception.

And what was the valuation put on this business by the IPO? It was about £240 million. That’s about 13 times the likely revenue in the current financial year. That’s not bad for a business where the losses almost match the revenue, which are both growing rapidly, and where a clearly profitable business model has yet to be established. My experience tells me that it is easy to generate sales growth if you spend as much on marketing as the revenue generated, as in this case. Needless to say that from the placing of shares as part of the IPO, existing shareholders received a net £32 million with only £23 million being raised for the benefit of the company. You can expect other similar businesses to float in the near future as their founders see what valuations can be put on such unprofitable companies.

So if you are encouraged to jump on this bandwagon, just remember to get off at the right point.

Roger Lawson

The Audit of HBOS

One of the mysteries not adequately researched in the recently report into the demise of HBOS was the failure to examine the audits of the company that took place. The Financial Reporting Council (FRC) decided two years ago not to look into the audits of the bank by KPMG prior to its collapse and acquisition by Lloyds in 2008. But the Parliamentary Treasury Select Committee has now been looking into this further.

Andrew Tyrie, the Committee Chairman, has already suggested the FRC should reconsider its decision and called it a “serious mistake”.

This is what Tim Bush of PIRC has said on this matter: “In evidence to the Treasury Select Committee (‘TSC’) in December 2015, Andrew Bailey, Chief Executive of the Prudential Regulatory authority, revealed that the taking out of expected losses from accounting standards [IFRS in 2003] caused the assumptions unpinning the Basle I capital adequacy regime to fail.  

The manifestation of this in the specific case of HBOS is still under investigation by the TSC. The TSC has extracted that KPMG, HBOS auditors, was debating IFRS provisions of the order of £1-1.5bn, when the outcome was actually £53bn. Andrew Bailey confirmed that the true losses were in excess of shareholder funds and ‘bail-in capital’ (i.e. subordinated debt), in other words HBOS was bust before being taken over by Lloyds and bailed out by the UK taxpayer.”

In other words the defective accounting standard did not provide a “true and fair view” of the financial position of the company as required by law (see the last ShareSoc Newsletter for more background on this). The use of IFRS caused KPMG to grossly underestimate the impairments that HBOS would suffer and this contributed to the collapse.

Roger Lawson

Lloyds Bank ECNs and the FCA

Investors in Lloyds Bank Enhanced Capital Notes (ECNs) lost the second round of their battle to stop Lloyds redeeming them at par in the Appeal Court. They previously won the case in a lower court, and are now planning to appeal to the Supreme Court.

These ECNs are held by many retail investors, having been converted from PIBS issued by Halifax and the Cheltenham & Gloucester Building Society. Lloyds is apparently arguing that the wording of the conversion terms, on which basis investors voted for the conversion, contained an error. They suggest that instead of saying ‘Core Tier 1 Capital’ as written, it should have simply said ‘Core Capital’.

Investors stand to lose a very high interest investment (some of these bonds are paying 16% per year), but Lloyds stand to gain as much as £1bn if they win. You can see why it is being fought over by expensive lawyers through the courts.

But the key point for those not directly affected by this case is that the Financial Conduct Authority (FCA) is yet again failing to protect the interests of investors (retail or otherwise), and taking the side of the big banks and other financial institutions. If they get the wording of a contract wrong, then that is their mistake and they should bear the cost. As it stands Lloyds are trying to escape from their original obligations by sophistry.

Roger Lawson

Globo Administrators Report – There’s No Money Left

The Administrators of Globo Plc have published their initial report into the affairs of the company. It makes for depressing reading. In essence one might sum it up in the phrase “There’s no money left” which was the infamous wording of a note left by one UK Treasury Minister to his successor.

In this case, even the secured creditors (Barclays Bank in the lead), are unlikely to get paid in full and all unsecured creditors and shareholders will get nil. The assets held in subsidiary companies, where most of them were, appear to be of little value. Some of the subsidiaries are already closed down and others are being sold in a fire sale process as the Administrators have no cash to support them. The cash claimed to be held within the Group according to the audited accounts does not seem to be present.

The Administrators have already spent £303,000 and the final cost for the Administration may be double that, which just shows you how quickly the bills can be run up in such cases.

The key question is whether the Administrator is likely to pursue any claims against Grant Thornton or other parties. But the lack of any cash within Globo Plc itself (i.e. within the Administration), may well prejudice against that. Shareholders might therefore have to pursue such claims directly.

The Financial Reporting Council (FRC) has launched an investigation into Grant Thornton’s audits of the financial statements of Globo Plc for the years ended December 2013 and December 2014. This is of course not unexpected but will obviously take a long time to report as is normal in such cases.

Any shareholders in Globo who have not yet registered with the ShareSoc shareholder group should do so on this web page:

Roger Lawson

What to do with your NS&I 65+ Bond


Many readers might have taken out the Government’s offering of NS&I 65+ Guaranteed Growth Bonds a year ago when they were made available. They offered a very attractive rate of interest of 2.80% gross on the one year version, but these are now about to mature so investors have to decide what to do with them.

What are the options? You can cash them in. Or you can re-invest the proceeds in another one year term bond at 1.45%, and that’s not nearly as good of course. You can also reinvest for terms or 2 years, 3 years and 5 years when the interest rates are 1.70%, 1.90% and 2.55% which is more generous, but still not as attractive as the original bond.

Are any of those bond rates competitive? Yes they are in fact as interest rates are now so low there are few institutions that offer a better rate for a fixed rate bond. You can look at some comparable rates on for example, or look at the rates offered on bonds by the major banks. Will interest rates remain so low however, bearing in mind we are running at historically extreme figures and the US has just raised interest rates?

If interest rates do rise, and you have opted for any of the longer terms, there is one advantage of these bonds – you can cash them in at any time with a 90 day interest penalty. So if you are happy with the rates payable on the 5 year bond that might be more attractive than the one year bond.

How do they compare with current inflation? The late Retail Price Index (RPI) index rose 1.1% in the last year, but the Consumer Price Index (CPI) rose by 0.1% so at least you are getting a real rate of interest. Although those over 65 in age might argue that neither of those rates realistically reflects their personal cost inflation.

As these bonds were limited to a maximum of £10,000 invested, but with the new ISA season coming up in April, it might be worth cashing them in and holding the cash until April for reinvestment of most of it in an ISA (cash or share).

The interest on a new one year bond of £10,225 (net approx, carried forward) will be all of £148 so others might simply consider that this is altogether too much hassle for a relatively small return, and take the cash and spend it. The original 2.8% interest rate was attractive for a Government guaranteed savings account even if the maximum that you could put in was low. But the replacement options are much less attractive.

In summary those are the options open to you.

Roger Lawson

New VCT Rules and Knowledge Intensive Businesses

I attended the Annual General Meeting of Northern Venture Trust (NVT) yesterday – one of the more successful VCTs. Management representative Tim Levett gave us a briefing on the impact of the new “draconian rules” (as he called them) for VCTs arising from EU regulations. His criticism also arose from the fact that the legislation is effectively retrospective as it impacts both “old money” from past fund raisings and new money.

One particular oddity is that the amount of money than can be invested in a company depends on whether it is a “knowledge intensive business”. The rules on what qualify for that are quite complex, but one of them is that you should have a certain proportion of employees with higher education qualifications – or as Tim Levett put it, you just need to employee secretaries with M.Scs or PhDs.

What he did not point out but perhaps should have is that those well known business leaders of knowledge intensive companies Bill Gates, Steve Jobs and Mark Zuckerberg would not count as they were all college drop-outs. So Microsoft, Apple and Facebook might not be considered as such. It seems that software companies, which are often staffed by people with a mix of formal educational levels, might therefore be prejudiced in favour of those with a more traditional “scientific” focus. This is of course what happens when you get civil servants with little knowledge of the real world trying to devise complex rules to favour their own prejudices. But there is one thing for certain – the complexity of the rules will create enormous difficulty in interpreting and staying within them. Not exactly an “entrepreneurial” approach at all.

Otherwise it was an interesting meeting and it looks like traditional VCTs like Northern will be able to adapt to the new rules. A full report is on the ShareSoc Members’ Network.

Roger Lawson

When Brokers Go Bust

“When Brokers Go Bust” was the title of a fascinating article in Investors Chronicle on 11/12/2015. It covered the impact on investors when their stockbroker goes out of business. That’s pretty uncommon you might think. But it revealed the surprising fact that in the last five years alone more than 400 investment firms have gone belly up, based on data from the Financial Services Compensation Scheme (FSCS).

It spelled out two particular problems: 1) the difficulty in untangling pooled nominee accounts (which are the most common way shares are held nowadays); and 2) the risks of broker fraud or mismanagement. As the article says, “it may take the broker’s administrator several months to work out which shares belong to which client. This can quickly turn into a bureaucratic nightmare for clients who are unable to trade their shares and also bear the cost of the administrator’s fees”.

It gave some specific cases. For example, clients of recent failures Fyshe Horton Finney and Pritchard Stockbrokers have been waiting two and three years respectively to get their money back! The FSCS hardly protects you because it will only pay out £50,000 maximum in cases of default which for most investors is nowhere near enough.

The article is well worth reading, and quotes ShareSoc at length.

It is of course worth noting that this is a new problem introduced by the use of nominee accounts. If you hold shares via a paper share certificate, it does not matter at all if your broker goes bust because you can trade them through any other broker. The widespread introduction of nominee accounts is not just a dangerous practice but is also anti-competitive – we said this recently to the FCA on the subject of stockbroker transfer delays:

“It is also worth noting that the delays that are currently imposed by stockbrokers are anti-competitive in nature and deter investors from switching to lower cost brokers or those with a more attractive service. It is only in the last few years that the prevalence of the use of nominee accounts has created this problem. A shareholder holding a share certificate has no need for a broker to do anything because he can trade the shares via any broker. The widespread adoption of nominee accounts by stockbrokers, and their support in the ISA and SIPP regulations has introduced these obstructions and delays so giving shareholders some alternative system might help.” 

As regards many aspects, the modern world of pooled nominee accounts is a retrograde step, when it would be a simple matter to devise an easy to use electronic, name on register, system.

Roger Lawson