AO! That rating really hurts

AO World has changed the world of domestic appliance retailing. If your fridge-freezer dies, you can have the new model of your choice installed before the frozen pizzas start to melt. The company is a demonstration of how to marry the internet to state-of-the-art delivery. It’s hardly surprising that investors loved the story, scrambling over themselves to get stock when it came to market in March.

And yet…there are limits to the need for next-day delivery of cookers or washing machines, and a brilliant analysis by Shore Capital suggests AO is well over them. Michael Stewart calculates that if the company eventually sold every single domestic appliance bought in Britain, the shares at 267p would still cost 22 times earnings. But this is one tough market. As he puts it: “The consumer has limited brand loyalty, price competition is incredibly high and demand is elastic.”

Unfortunately for the bulls, this is just the half of it. The other half is the sort of product insurance that the banks used to add to their loans until they admitted mis-selling and paid £15bn in compensation  (and counting). AO doesn’t break out its profits from product protection, so Mr Stewart has tried to do it for us. He notes that AO has 150 people in a call centre devoted to selling protection, and his back of the envelope calculation says they generated one-third of the company’s latest profits.

Such point-of-sale insurance is almost always bad value. Accusations of mis-selling are never far away and appliances break down so rarely. AO has amitions to take its impressive business model across the Channel, but others like Amazon have similar ideas and depper pockets. The investors who failed to get any shares at 285p in the float can have as many as they like at 267p now, but it’s easy to see why they aren’t rushing in.

Balls up for CGT changes

If you don’t like the capital gains tax regime, then don’t worry. There will be another one along if you’re patient. This tricky tax has been a playground for chancellors ever since it was introduced half a century ago, and finding a fair, stable system has eluded them all.

It makes sense to tax short-term gains as income, since one looks much like the other. But last weekend my colleague John Lee reported how he will pay 28 per cent on the gain from his 40-year investment in Pochin’s (his saga reads like a financial version of Apollo 13 – successful lift-off, near-disaster, and an improvised rescue). This is less a tax on a gain than a capital levy through inflation, and is manifestly unfair.

The previous CGT regime had allowed for this, tapering the tax to reflect the time the investment was held. When one private equity boss pointed out that this meant he was paying a lower rate of tax than his cleaner, the government panicked. Rather than simply strecthing the taper to make things fairer, it imposed the current regime.

Now Labour, casting about for something which sounds business-friendly, is is looking at the subject again. The shadow chancellor likes the idea of long-term investment, so if he gets the chance, might bring back the previous regime – a Labour government design, after all – which cut the tax on long-term gains. Besides, get-rich-quick invites taxation, while get-rich-slow suggests building something of lasting value.

Let’s be more refined

Diesel should be cheaper than petrol, but it’s years since it was, thanks to the rise of diesel cars and oil refineries set up to maximise petrol output decades ago. Refining is a grim, almost profitless business, thanks to the shale boom and ban on crude exports from the US, so it was a surprise this week to see ExxonMobil preparing to spend $1bn beefing up its plant in Antwerp to produce more diesel.

As refineries close across the continent, Exxon plans to be (almost) the last man standing. Antwerp will also help its other plants across Europe stay open by taking their heavy fractions. It’s a real, long-term investment. Don’t expect Esso’s diesel to get any cheaper, but at least that irritating price premium should eventually disappear.

This is my FT column from Saturday

Not a national treasure

Astra Zeneca is not the National Trust. It’s a commercial organisation with billions of pounds of other people’s money at its disposal. The directors are playing up the value of research and development for all they’re worth, but the plain truth is that Astra really isn’t very good at it. Like most big drug companies, it’s good at exploiting promising compounds, getting them to market efficiently, and finding ways of extending the patents which produce the profits.

These skills are valuable, since the patent clock ticks fast, and complying with local rules on use of the drugs is essential. To exploit a treatment fully before the generics arrive to undercut the price requires the sort of reach and organisation that only a substantial multi-national company can sustain. For all the bluster about their research, these marketing skills are the big companies’ core competence.

Last week, in its first response to the Pfizer approach, Astra rather let the cat out of the research bag. Of the seven “mid-stage pipeline assets” which it said hold the key to its prosperity a decade hence, six were developed by companies which Astra itself had bought. All six further compounds showing “attractive optionality” were developed by others.

Astra’s in-house research may indeed be better than Pfizer’s – which is generally thought to have the worst recond of any major group – but it’s nothing to shout about. Measuring the wealth that a drug can produce over its lifetime is difficult, but both companies have spent tens of billions of pounds for diminishing returns.

Pfizer is proposing to pay two-thirds more than nearly all the City’s analysts thought Astra was worth six months ago. The harder question for the shareholders is not whether this modestly-increased bid is enough, but whether Pfizer paper is worth keeping. The 5 per cent fall in the price since the approach betrays the market’s doubts. The swift rejection of the raised offer is likely to infuriate Astra shareholders, who must either strong-arm the directors into changing their minds, or hope that all that drugs-in-the-sky hopes come to pass. It may be a very long time before the share price passes Pfizer’s offer.

As for the march of medical science, the overwhelming evidence is that smaller, more entrepreneurial businesses are better at research: measured in terms of successful drugs per dollar, there is no contest. Should Pfizer win Astra there will be wailing, gnashing of teeth and redundancies among the scientists in both companies. But many, perhaps most, of them will quickly find work in the next generation of R&D businesses, where their talents will be far more efficiently deployed. Just don’t expect any of the politicians to admit as much.

AO world of its own

The share price of AO World, on-line purveyors of fridges and washing machines, is looking a little better. It’s had a torrid time in the tumble dryer since flotation in February at 285p a share. So many investors thought that price absurdly low that it shot to 378p on its first day, followed by cries of foul play from some of the 300 institutions that failed to get stock.

Well, they could have all they want today, at the mid-season sale price of  245p. Perhaps they are not rushing because AO is still valued at £1bn, or nearly four times sales in the year to March. Profits? Don’t ask. This is an internet retailer, after all.

Shares in fuddy-duddy old Dixons Retail sell on less than 0.3 times sales, and the response to the well-flagged merger with Carphone Warehouse was 10 per cent off the share price. It’s not obvious that AO can really do anything that CarDix (or whatever) can’t, and AO’s price plunge might have been even worse without US-based Baron Capital, which has popped up as a 5 per cent shareholder. It claims to be a long-term investor in stocks with “substantial competitive advantages and barriers to entry”. Ah, that’s it: AO is obviously the next Amazon.

Irish decimal points

There are 523,438,445,437 Allied Irish Banks shares in issue. The (ESM) price is E0.1, which values the bank at E52bn. The Irish government owns 99.8 per cent of the equity. In its (relatively) cheerful trading update this week the board felt moved to add: “AIB trades on a valuation multiple of 8x 31 December 2013 net asset value. The bank notes that the median for comparable European banks is c.1x NAV.”

This is an updated version of my FT column