Expensive Dividends – National Grid and Electra Private Equity

National Grid (NG.) are returning some of the cash received from the sale of their stake in a gas distribution business to shareholders via a large special dividend. And some will be returned via market share buy-backs, the wisdom of which may be questionable. But the real concern for private investors is that dividends are taxed as income even though this is in essence a “return of capital”. It is not being paid out of operating profits, but simply from the sale of part of the business.

In the past, companies would recognise this fact and the tax problem faced by private investors by offering a “B” share alternative that could then be redeemed and turned into a capital gain (as capital gains are less highly taxed than income for many investors). But this was outlawed in the 2015 Finance Act – there is a good article in the Daily Telegraph today that explains this in more depth.

But consider the plight of retail investors in Electra Private Equity which is much worse. They recently announced a similar return of cash via a special dividend of 2640p per share. The share price the day before it went ex dividend was 5,110p so effectively half the value of the company is being returned as a dividend. One investor who contacted me invested £20,000 in the company many years ago, and his holding is now worth near £150,000 so he will receive an enormous income tax bill. Needless to say he is not happy.

A particularly iniquitous aspect is that a lot of the “profit” he is being taxed on actually simply results from asset price inflation over the years.

Could the company have considered alternatives? Spreading the return of more than one tax year may have helped, but another possibility would be to return the cash via a tender offer to shareholders. Those taking it would realise a capital gain, while those not doing so would see the value of their existing holding unaffected (the share price would adjust to reflect the lower asset value per share and the proportionally similar fewer number of shares in issue).

There may be other possibilities that a tax and accounting expert could advise on, but unfortunately it’s probably the impact on institutional investors that is driving this desire to pay dividends and private investors are being prejudiced.

I may raise this issue at the National Grid AGM in July, but it will be too late to affect this and dividends can be declared by a company’s directors without a vote of shareholders. Similarly on Electra Private Equity, it is too late to object as the dividend has been declared and so will be paid.

This is yet another example where the taxation of capital gains and dividends is irrational and deeply prejudicial to the interests of investors. The solution, without prejudicing the Governments need to receive tax, would be harmonisation of dividend and capital gains taxes. But the latter should be index linked to avoid taxing fictitious profits.

Roger Lawson

National Grid Share Consolidation – Who Are They Fooling?

Shareholders in National Grid (NG.) will have received a notice of a General Meeting to approve a share consolidation (at least that’s those of you on the register of the company, others in nominee accounts may be surprised later by the change in their holding).

This proposal is linked to the return of cash to shareholders following the sale of the company’s interest in a gas distribution business. There will be a large “special” dividend as a result – more on the tax implications of that in a later article.

But the company is also doing a share consolidation which they explain as taking place “in order to ensure that so far as possible, the market price per new ordinary share following the special dividend will be comparable to the price per existing ordinary share prior to the special dividend”. In other words, instead of the share price falling (to reflect the return of capital) and your shares remaining the same in number, the number of shares you hold will be reduced while the share price is maintained.

Who are they trying to fool by this sleight of hand? Do they really think investors are so stupid that they will not realise that the value of their shareholding has been reduced (offset by the dividend received to some extent, if not fully by dividend taxes on private shareholders)?

This consolidation will no doubt incur significant legal and advisory costs on the company, generate unnecessary work for share registrars and stockbrokers, and also create work for investors in adjusting their portfolio records.

I for one will be voting against this consolidation, and I suggest other shareholders may wish to do the same. That would not impede the dividend payment in any way of course.

Roger Lawson

Hornby Requisition Opposed

Investor Alexander Anton previously requisitioned a General Meeting of Hornby (HRN) to have Chairman Roger Canham removed from the board and get himself appointed as a director. Mr Anton has the support of the second largest investor in Hornby in New Pistoia, but the largest investor is Phoenix Asset Management. The long standing Chairman of Hornby, Roger Canham, is also Chairman of Phoenix which Mr Anton suggests is not a good arrangement so far as corporate governance is concerned. Hornby, the maker of train sets and toys, has had a poor financial performance in recent years with production difficulties and consistent losses. The company undertook a strategic review in early 2016 and has been working to a “turnaround plan” since then. The company has been reporting “good progress” against that plan, although the last interim results still reported a loss of £4.7 million on revenues which were down at £21.9 million. But debt was reduced. A pre-close trading statement for the March year end confirmed there would be a loss for the year but noted a positive cash position after stock reductions and disposal of the Margate site. There were also positive noises about current trading.

Mr Anton was involved in the board revolution at Victoria, the carpet company, a few years ago. That was very successful and the company has gone from strength to strength since then under the new leadership of Geoff Wilding. There are some similarities between the problems at Victoria and Hornby. Excessively large product range, very high stock levels in relation to sales, stagnant or declining sales (revenue is forecast to be £45m at Hornby this year when it was £65m five years ago) and management who seemed incapable or unwilling to tackle the issues vigorously although Hornby might say that they have now been doing so.

The company has now published a circular for the EGM to consider the requisition on the 16th May. As was not unexpected the company has recommended shareholders vote against the resolutions on the basis that the current strategy is working and there is nothing amiss as regards corporate governance. They also say they already have the committed and irrevocable support of 54% of shareholders to vote against, so it seems very unlikely the resolutions will pass. But even if they do not, if the company’s final results do not improve substantially that may not be the end of the matter.

Comments: Having spoken to both Mr Anton, and to David Adams, the Senior Independent Director at Hornby, these are my views:

One only has to look at the product range (Hornby trains, Scalextric cars, Corgi models, etc) to realise that the company seems to be stuck in the past. Do steam engines and World War II planes really appeal to kids nowadays? Or even to the parents that might buy them for their children? One can see exactly why sales revenues have been declining for many years and are likely to fall further with product rationalisation taking place, while the product range is still enormous. The web site which is now the key “shop-front” for most retailers also looks old-fashioned.

So this looks to be a company with major sales and marketing problems and possibly problems with its IT/ERP systems also. Now the new CEO is an accountant and it looks like he is doing a sound job of getting the company back into stable financial position. But is he the right person to otherwise revitalise the company and get revenue moving in a positive direction?

The key question for shareholders is what good or harm would a change of Chairman and the appointment of a new non-executive director do? As the current Chairman has been there 5 years and the decline in the company over that period has been substantial, it surely would be beneficial to have a change in that regards. Would he still be there without the support of Phoenix? As regards the appointment of Alexander Anton, having a new independent view on the board can surely do no harm and might do some good.

So as usual in these kinds of circumstances, the prompt rebuttal by the board of the proposed changes does not appear positive for the future of the company when this writer remains to be convinced that all the issues are resolved.

Roger Lawson

Why Companies Don’t Get Struck Off, and Maven VCT5

I have had two listed companies in my last 25 years of investing, that delisted and then became worthless. But the directors refused to put them into liquidation or ask for them to be struck off the register of companies at Companies House (which can be done if the company has ceased trading and no debts remain). In both cases the directors claimed they were going to revive the company with a new business but neither seemed very realistic to me and I thought this was a case where the directors did not want to be seen as being former directors of liquidated companies. Requests to Companies House to have them struck off were appealed against, although one of them finally did get removed. But having attended the Maven Income and Growth VCT 5 AGM (MIG5), I now know there may be another reason.

In response to a question, Bill Nixon of Maven explained why they don’t want investee companies to be struck off the Companies House register (they have quite a few “zombies”, the walking dead, still included in the portfolio list in the Annual Report). This is because the cost of the investment in them continues to be part of the “qualifying investments” pool under the VCT rules. Yes it’s all a bit daft is it not but this kind of thing always arises when rules are complex, as they certainly are in VCTs.

Two for the price of one, and my worst investment.

There is a full report on the MIG5 AGM on the ShareSoc Members Network – in fact two, because both I and Tim Grattan have written one. The extra stuff in mine shows how disastrous was my investment in this company some 17 years ago, offset to a large extent by the generous tax breaks. There are some lessons drawn from that debacle. I believe Tim might have been a lot wiser and bought the shares in the “second-hand” market years later which is a tactic to be followed in the VCT market when opportunities arise, although they are not as common as they used to be. It’s worth saying here that the performance problems at this VCT mainly arose in its early days and before the change of name and new management by Maven.

Roger Lawson

Finance Bill and Tax Changes

When a General Election is called, with the imminent prorogation of Parliament when all Bills that are passing through Parliament are effectively abandoned, the Government has to rush through any important Bills that it wants to get passed. That is what happened yesterday (25/4/2017) when only a few hours debate was available on the Finance Bill. That Bill contained many of the recent changes announced by the Chancellor in his Budget but many of them have been removed from the Bill so as to ensure its quick passage. It also avoids any politically embarrassing changes being implemented before the election. They may get revived in new legislation after the election in the new Parliament, reconsidered or quietly forgotten about. The latter being of course likely if there is a change in the political complexion of the Government or changes of Ministers.

These are some of the tax and other changes removed from the Bill:

  1. The reduction of the Dividend Tax Allowance to £2,000 from 2018. ShareSoc raised concerns about this and asked our Members to write to their MPs on the topic – see https://sharesoc.wordpress.com/2017/03/20/double-taxation-and-broken-promises/ . It was certainly a vote loser for anyone who receives substantial dividends and it would definitely be good to get this reconsidered.
  2. The reduction in the annual pension allowance from £10,000 to £4,000 from 2017 to stop “re-cycling” of pension contributions where pensions were already being taken is out. So you may have another year to use the higher amount.
  3. The “Digital Tax” plan to force smaller companies to submit quarterly tax returns electronically is dropped. This was a very unpopular move by HMRC among small businesses as it would have imposed major extra costs on them. This is likely to simply be deferred.
  4. The change to increase Probate Fees very substantially on larger estates has been dropped – see https://sharesoc.wordpress.com/2016/02/20/it-could-get-more-expensive-to-die/. This proposed change provoked a lot of criticism from the public including several ShareSoc Members. Again it would be good if this was reconsidered rather than simply postponed.
  5. Some changes to the rules on EIS and VCT investments and social investment tax relief are out.
  6. Corporation tax relief changes are out.
  7. Disclosure of tax avoidance schemes and penalties for enablers are out.

There are quite a lot of other clauses removed – one could say that a hatchet has been taken to the Bill to get it passed. But if you take the opportunity to ask questions of your prospective MPs in the hustings, you may like to pointedly ask them about their views on some of the above and whether their Party would revive these measures.

Roger Lawson

Shorting Shares – An Example of Motives

One of the most peculiar stories in the last week was the revelation that the attack on the Borussia Dortmund football team’s bus was not a terrorist attack after all. According to German police it was done by an individual investor who hoped to profit by shorting the shares. By killing or injuring their star players, he expected their publicly quoted share price to fall sharply.

Indeed the share price did fall by 3% but as the injuries suffered were relatively minor to one player, it did not fall further. But it was only luck that meant the injuries were not worse and there could well have been fatalities.

The perpetrator (named as Sergej W. by the police) bought 15,000 put options a couple of days before the event at a cost of 79,000 Euros while sitting in a hotel room overlooking the scene of the attack. Both that and suspiciously worded notes left at the scene led to his arrest.

Let us hope that this scenario is not repeated by others. But being able to sell short provides a lot of opportunities, not just for creating “fake news” which is of widespread concern at present, but as in this case of actually creating negative news. It’s a lot easier to create negative news than positive news. Was the BP Macondo oil well disaster (total cost over $60 billion) an accident or driven by someone shorting the stock? Conspiracy theorists need look no further for a good story.

Perhaps investors will need to look carefully at negative news in future.

Roger Lawson

Postscript 29/4/2017: Some readers of this blog post interpreted the last but one paragraph as a humorous reference which might be considered inappropriate bearing in mind the deaths in the BP Macondo disaster. Considering that there were potential deaths in the Borussia Dortmund attack, the post was intended to highlight the very serious aspects of the affair. It was of course not intended to be humorous in any way but was encouraging readers to think about the other potential consequences of similar attacks (and oil wells are very vulnerable to terrorist attacks as is well known). The reference to conspiracy theorists was just meant to indicate that I did not consider it likely that Deepwater Horizon was a malicious act. But that does not mean there won’t be such attacks in the future. In the brief literary form that is a blog, one cannot explain everything in detail but it was meant to encourage readers to consider all the aspects of this matter.      Roger Lawson

A General Election – What Should Be In the Manifestos?

There is to be a General Election on the 8th June in case you have not heard. That has the unfortunate consequence on freezing Government business, with the prospect of changes of Ministers thereafter. Any formal consultations – for example on improved Corporate Governance and remuneration restraints – will be deferred. So the key question now is what would we like to see in the manifestos of the leading political parties? Here’s my list:

  1. A commitment to ensure that private shareholders in nominee accounts are fully enfranchised by changes to the Companies Act and a low cost “name on register” system mandated to be provided by all brokers with specific warnings about nominee accounts.
  2. The mandating of Shareholder Committees to improve Corporate Governance and ensure there is more restraint on pay. In effect return some more control on some matters to the owners of public companies, namely the shareholders.
  3. To cancel the proposed changes to dividend taxation and stop the double taxation of company profits (i.e. revert to the tax credit system) and properly index link capital gains taxes.
  4. To stop the proposed changes to Probate Charges so they more properly reflect the service being provided. It should not be turned into a tax, i.e. a fund raising measure to subsidise other Government legal services as recently proposed.
  5. To reform the insolvency rules so as to stop the abuses arising from Pre-Pack Administrations and ensure administrations are not just about protecting the interests of bankers.
  6. To improve the oversight of the auditing profession and strengthen the FCA and SFO so that frauds and false accounting are vigorously pursued. To ensure that companies and their directors are also accountable to shareholders by reform of the Companies Act and removing the Caparo judgement from law.

Now that would be a manifesto that would get my support, and no doubt that of many other people. It is of course very much the manifesto adopted by ShareSoc when it was set up – see http://www.sharesoc.org/ShareSoc%20Manifesto.pdf, and other issues have been covered by our campaigns on Shareholder Rights, Remuneration and Shareholder Committees. But progress on achieving our aims do date has been slow. Here’s a good opportunity to move them along.

Roger Lawson