London Stock Exchange – Deutsche Börse Merger, and Brexit

More details were announced this morning of the proposed merger between the London Stock Exchange (LSE) and Deutsche Börse. Is this really a “merger of equals”, as it is being promoted, because such things are very rare in practice?

Deutsche Börse has a larger market capitalisation and their shareholders will end up with 54.4% of the combined group. We now learn the group will be domiciled in London but will have headquarters in both London and Frankfurt with listings on both the London and Frankfurt stock exchanges. Can a company really maintain two headquarters? Although the new Chairman will be from the British business, the new CEO will be Carsten Kengeter from the German company.

So far as users of the London Stock Exchange are concerned, such a merger would be unlikely to have any short term impact. But one would hope that the change of management might see a revolution in due course in the operation of the LSE’s AIM market which has developed a very poor reputation as a result of listing many poor quality companies and having poor regulation. Perhaps the introduction of some Germanic discipline into that market as opposed to the “anything goes” approach of the LSE might improve matters?

So far as investors in the LSE are concerned, this is probably an attractive offer as it makes the combined group even more dominant in Europe’s financial markets than before. Nick Train said at the recent Finsbury Growth & Income Invesment Trust Annual General Meeting that he likes the LSE because it is an effective monopoly. And he is surely right there because all exchanges tend to become natural monopolies as those with the greater transaction volumes and liquidity end up growing in size against any interlopers.

This mornings announcement recognises that “a decision by the United Kingdom electorate to leave the European Union would put the project at risk”, so they have formed a “Referendum Committee” to make recommendations on the ramifications of such a decision. But they believe it makes strategic sense regardless and would not be a condition for the merger.

In the meantime David Cameron has been lining up the big guns to support staying in the EU. A letter has been signed by 36 FTSE-100 companies, or their directors, and 162 other companies to the Times opposing Brexit. That included companies such as BAE Systems, Shell, Asda, Marks & Spencer, Vodafone and EasyJet. But other retailers such as Tesco and Sainsbury have declined to sign, perhaps from the risk of offending their customers. The spirit of the Conservative heartlands is probably best reflected in a vote taken by Councillors in the London Borough of Bromley (the writer’s home borough of course). The result was 23 votes to 7 to leave the EU. Councillor Fawthrop said “This is the first Conservative council to pass such a motion. It is a message to the people in this borough and the country as a whole that we should not take it for granted that the establishment is in favour of staying in the EU”.

ShareSoc conducted its own survey of our Members on Brexit which we reported on earlier. But the latest indication from stock market investors of how they might vote is the results of a survey of the customers of The Share Centre published today. The Share Centre are one of the largest retail stockbrokers. They report that 63% of personal investors would vote to leave the EU. As in the ShareSoc survey, most respondents did not think the deal negotiated by David Cameron goes far enough. It is becoming clear that the Referendum vote will be a hard fought contest particularly with Boris Johnson coming out in favour of Brexit. But the betting is still on a vote to stay in and where political votes are concerned, the gambling odds are often a good predictor. Stock market investors are not necessarily of course a good predictor of the mood of the public at large, even if they might be more informed than most on financial matters.

Roger Lawson

Earthport Hit By Apparent Fraud

I covered the position of Earthport (EPO) in the last ShareSoc Informer Newsletter in an article under the headline “Can these real dogs recover?”. The article covered several companies where profits had been negligible over the years resulting in investors becoming disillusioned but there were some signs of improvement. I said in concluding about Earthport (Monitise and Tungsten were the other companies) that “it’s fair to say that investors are losing confidence in Mr Uberoi (CEO) and are concerned about the bad news only dribbling out”. That was on the basis it was unlikely to meet earnings forecasts based on the latest revenue figures. But today (25/2/2016) there was some really bad news – the company announced that it had suffered a potential loss of up to £5 million at its subsidiary Baydonhill.

The announcement goes on to say: “The customer in question failed to honour pre-confirmed bank payment instructions, on the basis of which Baydonhill made payments on the client’s behalf in accordance with an established procedure which has been in place for over a year. Investigations were immediately initiated which indicated that the customer may have intentionally engaged in fraudulent activity. Additional enquiries found that the customer had filed notice to appoint an administrator. All relevant regulatory and law enforcement authorities have been informed and the Company plans to explore all avenues to recover this loss, but there are no assurances of any recovery.”

The company reassures investors that it has enough cash to cover the loss, but clearly with revenue last year of only £19.3m and no profits, this is going to have a substantial impact. The share price has been falling since mid January (did the news leak out one wonders), and at the time of writing is down 28% on the day. It surely demonstrates how tricky the “fintech” sector can be for investors.

Note that I have no holding in this stock at present although I used to have a small one.

Roger Lawson

The Non-Financial Reporting Directive

While the debate over the EU and its bureaucracy is so topical, it’s worth taking a look at the latest public consultation on an EU Directive that needs to be implemented into UK law. This goes under the snappy title of “The Non-Financial Reporting Directive”. It’s primarily about how companies report information to their investors and to the wider public on their strategy and operations – typically in their Annual Reports at present.

There is already a requirement in UK company law to report such matters for large listed public companies. But the EU Directive somewhat differs in content so our regulations have to be made consistent with it, and it also extends it to large “Public Interest Entities” (PIEs) that may be unlisted organisations. There may even be some smaller quoted companies in the UK who are currently covered by the UK strategic reporting requirement to which the EU Directive may not apply (the requirement could be either retained or dropped but complexity could result from having two different sets of regulations that apply to companies which might change as they changed). The Directive has to be implemented into UK law by December 2016.

The EU Directive allows companies to produce a separate report on non-financial disclosures, and possibly at a different time. In effect taking that material out of current Annual Reports and placing it in a separate document. In addition the possibility of putting that material only on-line is being considered in the consultation (there is no requirement to support a printed version in the EU Directive).

Does it make sense to permit non-financial reports to be published separately and on a different time scale (even if it puts pressure on companies to do so within the financial reporting deadlines)? Surely not because the non-financial matter can be prepared earlier anyway and if done on a separate timescale it could mean for example that it might not be available in time for the company’s AGM.

The consultation is also extending to the issue of whether companies need to provide the Annual Report in printed form which has come up repeatedly in the past, but is opposed by many investors. Some investors find it easier to browse or skim through documents off-line rather than on-line (not necessarily in their baths but there are lots of locations where it’s easier to read a paper version, and they object to companies passing the cost of printing on to them). In the UK the default is already for on-line communications, i.e. companies have the option to say you don’t get a paper version unless you specifically ask for it. Does that system not provide the best compromise and surely minimises the waste of paper and postage costs that used to apply?

Note that even institutional investors have opposed the fragmentation of Annual Reports and making them on-line only in the past because they are concerned about companies retrospectively updating them.

There are also some proposals to drop some of the current UK reporting requirements that are seen as unnecessary and they are collecting information on the costs of reporting incurred by companies.

The consultation is clearly aimed primarily at issuers (listed companies) and seems to bear in mind their complaints about the recent increases in the volume and complexity of reporting. But obviously these proposals affect those who read and rely on company reports so private investors do have a strong interest in this matter. Please let ShareSoc know if you have any views on the matter as we will be submitting a response to this public consultation. However you can of course also submit your views directly. More information on the consultation and an electronic response form can be found here:

https://www.gov.uk/government/consultations/non-financial-reporting-directive-uk-implementation

Roger Lawson

It Could Get More Expensive to Die

It could get more expensive to die for the wealthy, or less if you are poor. There are proposals to raise the cost of filing for probate substantially for larger estates. It currently costs £215 in Court fees to apply directly for probate, or £155 if filed through a solicitor. That is a flat fee which is the same for everyone, unless the estate is worth less than £5,000 when the charge is zero. But the Ministry of Justice is proposing that new fees will be as much as £20,000 for estates worth more than £2 million. Estates worth less than £50,000 will still be free, taking making estates out of charge, but they will rise on a sliding scale for larger estates until the £20,000 maximum is reached.

The Ministry says that they are not covering the costs of this service, and hence charges need to increase. The typical estate in the south-east of England where the price of houses is often a large proportion of the value of an estate will therefore face sharply rising charges, although that will be offset by the changes to Inheritance Tax that have been announced recently.

For more details and to respond to the public consultation on this matter, go to: https://consult.justice.gov.uk/digital-communications/fee-proposals-for-grants-of-probate

Many ShareSoc Members might be affected by this change, but when you are dead it’s probably only going to be of concern to your inheritors.

Roger Lawson

Dunedin Enterprise (DNE) to Wind Up

Back in August 2015, I commented on the high discount at which Dunedin Enterprise Investment Trust traded – about 38% at that time. I subsequently wrote to the Chairman suggesting some action be taken. Well they have finally decided to do something about it. Namely after the disposal of one of their large investments they plan to wind up the company (subject to shareholder approval of course).

This has caused the discount to narrow to 35% at the time of writing (according to the AIC). Is that a bargain? Perhaps but bear in mind that because this is a private equity investment trust with commitments to funds, the wind up could take a long time and the valuation of private equity investments can be uncertain.

But at least some decisive action is being taken bearing in mind that the performance of this trust has been disappointing for a number of years, particularly in terms of share price as investors lost confidence in the management. But investors need to examine whether the fund managers will be rewarded in any special way as they were when previous downsizing linked to tender offers was implemented.

Roger Lawson

Commercial Property and Brexit

In a previous article I discussed what might be spooking the commercial property market. Share prices of companies such as British Land and Land Securities are down by as much as 25% since last November. Was this due to the threat of changes to the tax allowances for debt finance? I surmised not. But there is one very good reason that has become apparent – namely the alleged threat of Britain’s exit from the EU (Brexit).

Capital Economics LLP have published a 30 page report (commissioned by Woodford Investment Management) on “The Economic Impact of Brexit” which is available on the web. I’ll cover what it says more generally later, but it does specifically cover the impact on the Property Market towards the end. It initially says for example that “It seems likely that leaving the European Union would hit the health of the City and it is plausible that a number of overseas institutions would close or scale back their London operations, putting a dent in occupier demand. That drop in demand could come at an unfortunate point in the development cycle. Over the next few years, the office development pipeline in central London is likely to run ahead of recent rates of net absorption, with the bulk of that surplus space destined for the City. A sharp drop in demand could see vacancy rates spike higher and rental values start to fall.”

Is that and similar forecasts what has damaged investors perception of such companies? The report later emphasises that even if the financial sector is negatively impacted by Brexit, that would not necessarily affect property demand as only 6% of new jobs that are being created are in financial services. Indeed it concludes by saying: “It is certainly possible to tell a story in which the damage done could be considerable but the role of the financial services sector in holding up the property market is probably overstated, leading us to believe that any negative impacts will be small, certainly at a macroeconomic level.”

On the whole the report is somewhat neutral about Brexit and discounts the extreme views of both supporters and detractors. For example it says: “It is plausible that Brexit could have a modest negative impact on growth and job creation. But it is slightly more plausible that the net impacts will be modestly positive. This is a strong conclusion when compared with some studies”. It is certainly worth reading as a balanced attempt to reach some conclusions on the financial issues, and for their comments on the commercial property sector.

ShareSoc Survey Results

We collected the views of ShareSoc Members on Brexit in a recent survey. The survey obtained a response of only 3% which suggests that most people might be somewhat apathetic on the issue or are fed up with being bombarded with news stories on the topic. But of those who responded 57% said they would vote now to leave the EU if asked, while 34% would vote to stay. Some 86% of respondents said that David Cameron’s recent proposals to the EU have not changed their minds and 68% said he should hold out for more concessions.

As regards the question as to whether leaving the EU would damage the investments they hold or the economy in general, 48% replied No versus 27% who replied Yes with a high 22% of “Don’t knows”. The main factors that are influencing their decisions were given as the General Economic Impact (73%), the EU Regulations & Sovereignty (73%) and Immigration Impact (51%). There were a lot of individual comments made so it seems that those who did respond to the survey often have strong views on the matter. For example: “The UK’s last best hope to keep out of a superstate”; “Voting for Brexit without knowing our subsequent relationship with the EU seems to me rather like diving into a swimming pool without checking whether there is any water in it”; “Very badly negotiated so far – but negotiating with 26 other countries and with bureaucrats in Brussels bound to be difficult”; “I do not believe we will get out. Project Fear will work for those too busy, too ill-educated, too ill-informed and just too frightened of change”; and “Cameron has really dug himself a big hole out of panic. IF we do vote out it might give the EU people such a shock they will change but I rather doubt it”.

It would certainly appear from the results of this survey (and particularly from the comments added) that respondents are more concerned about the general economic impact and the issue of sovereignty than the impact on their personal investments. Many made it clear that they did not wish to be part of a larger political union and were concerned about the EU’s bureaucracy and cost. The deal being negotiated by Mr Cameron does not contained enough certainty and rigour to assuage those who are concerned about those aspects.

Roger Lawson

Garrett-Cox leaves Alliance Trust

It was announced this morning that Katherine Garrett-Cox is to leave Alliance Trust. She had previously been demoted to be Chief Executive of its subsidiary, Alliance Trust Investments, but now she is departing altogether in one month’s time.

Despite the eulogies in the announcement on her contribution to the Trust over the past nine years it seems unlikely that many shareholders will regret her departure. Those 9 years have not been great ones for the Trust in terms of investment performance, leading to disillusionment among their many long-standing and typically conservative private investors.

She has been accused of empire building by investing large sums to make Alliance Trust Investments (ATI) an independent investment business rather than just looking after the Trust’s portfolio. In addition she has tried to turn Alliance Trust Savings (ATS) into a savings platform to compete with the giants in that sector. Neither have yet to show they can be profitable or provide a return on the investment made.

Her somewhat flamboyant style and high pay seemed to conflict with the traditional ethos of a company based in Dundee, but at least shareholders of Alliance will be relieved of the cost of her attending such events as Davos to hobnob with the great and good in future.

As this morning’s announcement indicates, the new board of directors seems to be moving swiftly to implement changes in the Trust. Long suffering shareholders will surely welcome that at the forthcoming AGM of the company in May. But the future of ATI and ATS, and how the costs of running them is accounted for, is not yet clear.

More information on past events at Alliance Trust and the campaign to achieve some reforms is present here: http://www.sharesoc.org/alliance.html

Roger Lawson