Babcock & Wilcox once made boilers, and not much money. Several reorganisations later, Babcock International manages complex engineering systems for the British Ministry of Defence, and the complexity seems to extend to its financial engineering, too.  Babcock has baffled the boffins at Morgan Stanley, who say “We lack conviction on the outlook for margin and returns given the rising capital intensity of the model” and “reported margins conceal a more volatile progression for the component parts, which also raises concerns over how profit recognition is decided.”

The comment follows RBC last month, which complained that “the group’s ability to guide the market has once again been shown to be questionable.” They are ever so polite, these analysts, yet despite Babcock reporting higher profits and a rise in the interim dividend last month, the price chart tells a brutal story. The shares have halved since the start of 2014, and the decline is accelerating. Babcock is now in the FTSE100 drop zone.

The problem for all these outsourcing companies is to work out how much money they are actually making from a contract – “revenue recognition” in the jargon. The margins on MoD work may look fat at the start, tempting the companies to book profits early, with the elevating impact on the share price and executive bonuses. The really expensive costs often do not emerge until years later. Bitter experience in this industry has taught investors that today’s declared profits are too frequently followed by tomorrow’s write-offs and re-statements.

For Babcock, the clue is in the description “complex engineering systems”. What could possibly go wrong? Morgan Stanley reckon the shares are very cheap, but can’t recommend a purchase until they see that there’s nothing nasty in the submarine pens. That “I am in difficulty” signal from the share price is too strong to ignore.

Still addicted after all these years

Can you name the FTSE100 company which has seen the biggest absolute increase in its market capitalisation since the turn of the century? You might have a better chance with naming the one which has destroyed the most wealth, by remembering that we were then at peak dot-com madness, so if you quessed BT, be grateful you don’t own them. Its market cap has shrunk by £70bn in 17 years.

The winner is BAT, by a country mile. Its value has risen by over £100bn since 2000, well ahead of HSBC (£75bn) SAB Miller (£70bn until it was taken over) and Diageo (£50bn). The worldwide oligopoly enjoyed by the big tobacco groups, coupled with confidence that no new players will enter the market, has overcome pressure from lobby groups to sell out of the stocks.

Something similar is as work in oil shares. Helped by its takeover of BG Group, Royal Dutch Shell shows the fifth-biggest increase in market value, again overcoming the selling pressure from those who argue that oil and tobacco are some sort of axis of evil. It seems we are still addicted to both.

Be careful what you wish for

Peter Burt claimed his ambition was to make banking dull. Bank of Scotland, where he was CEO, reflected that philosophy of unfussy competence. But confronted with what most of us considered a moment of madness when National Westminster Bank announced a takeover of Legal & General, he saw a once-in-a-lifetime chance for BoS to buy the much bigger bank.

He would have got away with it had his bigger neighbour not intervened. NatWest was effectively priced by what the suitors could pay, rather than what it was worth, and he was outgunned by Royal Bank of Scotland. As he put it at the time: “We offered icing on the cake, but Royal Bank put a cherry on the top.” His death last week aged 73 marks the passing of a fine, old-fashioned banker.

The deal he eventually did, to merge with Halifax, once Britain’s biggest building society, looked like a relationship on the rebound from disappointment. He was quickly sidelined by the non-bankers, and the merger sowed the seeds for the banking disaster that was HBoS. Having set out to make banking dull, he unwittingly made it  far too exciting.

This is my FT column from Saturday

 

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Pricing a new issue is an art, not a science. However diligent your research, your eyeballing of the management or your search for listed comparators, others may take a different view (and trade on it) and markets are fickle, even without outside shocks.

What you must not do, as a potential buyer of a forthcoming issue, is talk to your competitors about it. So onto the naughty step this week went Artemis, Hargreave Hale, Newton and River & Mercantile, for conversations about flotations of smaller companies in 2014 and 2015. Those conversations, says the Financial Conduct Authority, might have pushed down the launch price, to the detriment of the sellers.

Indeed they might have. However, no degree of collusion, and no matter how due your diligence, can ever match the knowledge that the sellers have of the business. If they don’t like the price the potential buyers are offering, they can try and persuade them to improve it. In extremis, they can pull the issue and wear the cost in embarrassment.

In practice, the buyers are more often abused than the sellers, when “unexpected” events suddenly arrive a few months after a successful listing, and the share price plunges. Investors who refuse to consider buying any share that has been listed for less than a year will miss a few bargains, but will save themselves many more disappointments.

Besides, floating a company is not like selling your house. A listed share is a currency. Experience shows that an underpriced sale means better liquidity and more enthusiastic shareholders, while a flop can haunt the business and effectively close the market for further issues of new shares.

Should the FCA want a clear and present abuse to investigate, it should concentrate on today’s informal but rigid cartel over rights issue costs. The banks now demand a deep discount to a market price which is already established, plus underwriting for a risk which is vanishingly small. No collusion necessary.

No fairytale ending for these Debs

They are sentimental little sagas, told expensively over 30 seconds on a telly near you. Yes, it’s Christmas commercial time again, made to win awards for the ad agencies, who compete to see which of them can get away with the smallest mention of the store that’s footing the bill.

It’s fatal to show weakness in retail. If the customers sense desperation, they run for the exit, or to someone else’s website; hence the lavish commercials. These are now as traditional as, say, Black Friday, another US import which has done for store margins what the grey squirrel has done to the native British red.

The strongest store brands can probably stand this November nuttiness, but down among the also-rans, life is increasingly grim. Long ago, before the debt crisis, shares in Debenhams cost over £2. This week, after a pasting from brokers Redburn, they are 38p, and the business increasingly looks like another victim of the shrivelling high street.

Debs’ particular problem is its long leases at painful prices. Its stores are neither destination nor convenience, and in common with most of its traditional competitors, it looks flat-footed against the new generation of on-line fashion and beauty businesses. The result is thinner margins and squeezed cash flow, with a dividend that it can’t afford, as the 9 per cent yield indicates.

It’s not alone in its travails. Another stranded department store chain is House of Fraser, privately owned but whose publicly-quoted debt trades at a significant discount. The new world for these old battleships looks too small for both to survive. Debs has tried to cheer up with its Christmas ad, a Cinderella-themed love story. Unfortunately, its 21 per cent shareholder in the bulky shape of Mike Ashley just doesn’t seem cut out to play the role of Prince Charming.

Bitcoin? We don’t give a nickel

From Wikipedia: In September 1969, the mining company Poseidon discovered nickel at Windarra in Western Australia. As the news spread, the shares rose from $0.80 to $12.30 on October 1. After this, on very little further information [my italics] the price continued to climb. The shares peaked at $280 in February 1970, multiplying 350 times in five months, before collapsing. Bitcoin’s barely started…

This is my FT column from Saturday

Christopher Hohn is cross. Well, not so much cross as spitting tacks at Donald Brydon, the chairman of the London Stock Exchange. His latest letter, warning that Mr Brydon could be exposed personally to a claim for damages, and demanding that the governor of the Bank of England (no less) intervenes, reads like that first, furious draft which you’re grateful the next morning you didn’t send.

The LSE’s failure to respond to Sir Christopher’s attack has allowed a riot of speculation of just what Xavier Rolet could possibly have done. With the LSE observing radio silence, we try and work out why the man who last year was happy to step down from CEO if the planned merger with Deutsche Bourse completed, is now (apparently) being pushed out against his will.

Like so many previous failed bids for the LSE, that deal was described here as a bad ‘un even before the Brexit vote provided the perfect excuse to ditch it. The Deutsche CEO and putative boss of the combined group subsequently lost his job, while the LSE share price carried on upwards.

One remarkable feature of this boardroom bust-up is the lack of any significant impact on the share price, which remains within spitting distance of its September peak. Whatever else Sir Christopher has to complain about, the performance of his investment cannot be faulted – which is, of course, why he is so keen to see Mr Rolet remain, to carry on the good work.

His latest letter surely makes that impossible. The threat of personal legal action has brought a rash of former boardroom colleagues out in support of Mr Brydon, while the BoE governor might even prefer to resume his much-mocked forward guidance than intervene in this spat.

Sir Christopher will get his explanatory circular and special meeting of LSE shareholders, but there may be more heat than light in both. Other shareholders are likely to oppose any no confidence motion he proposes; finding enough allies to make a majority looks a very tall order.

This dispute has gone too far to blow over. After a face-saving period, both Mr Brydon and Mr Rolet will have to go, accompanied by the longer-serving LSE non-execs who failed to see this coming. Sir Christopher, meanwhile, should count the profits on his fund’s holding and hone his letter-writing skills, lest he need them again.

An ‘Arrowing tale

Debt collection is big business. Credit has never been easier to get, but the banks providing it are under pressure to clean up their balance sheets rather than pursue the defaulters. The result is an industry which delicately describes itself as purchasing and collecting non-performing loans, aka putting the bite on usually poor consumers.

Earlier this month Britain’s largest firm, Cabot Credit Management, almost went public at a suggested £1bn valuation, before the issue was pulled. Its US owners produced the routine excuse of “market conditions,” which looked more convincing than usual because investors are getting cold feet about the firms’ collection methods and the way profits are reported.

The business model depends on raising debt, buying the defaulters cheaply, and getting good rates of recovery. The cost of buying the defaulters has risen, while recovery rates fall quickly after the initial burst. An analysis of Arrow Global by Grant’s Observer concludes that its tangible equity is just £63m, compared with a market value of £700m at today’s 401p a share. An alternative methodology produces an even bleaker result.

Last month’s results from Arrow oozed optimism, and CEO Lee Rochford followed up by buying more shares, perhaps as a riposte to the short sellers. Like cleaning the drains, debt collection is an important service, but profitability depends on acquiring more and more non-performing loans which can be made to perform. It looks more like a treadmill than a sustainable business.

4000 holes in Blackburn, Lancashire

There are 900,000 English potholes, and fill-’em-in-Phil is throwing an extra £45m into them to reduce the damage to the nation’s suspension. Such attention to detail! His £50-a-go Pothole Fund does not extend to Wales or Scotland. Motorists crossing the soon-to-be-free Severn bridge should brace themselves for a bumpy ride.

 

This is my FT column from Saturday

 

 

 

Lawson’s Law of taxation states that taxes should be simple, low and compulsory. If, like him, a chancellor can abolish one tax in every Budget, even better. Philip Hammond’s opportunity, if he cares to grasp it, is to tick all four boxes by attacking stamp duty (again).

His predecessors have made a simple tax complex and burdensome. They have also turned it into a £8bn a year earner for the treasury, so abolishing it, as a study from the London School of Economics suggests, would be more than one day’s work. Yet it is now a serious drag on mobility, both within the country and across age groups.

The true cost is hidden in transactions that do not take place. When the purchase of  a £1m house attracts £43,750 in stamp duty, as the excellent HMRC website calculator shows, there’s not much incentive to downsize. However, us owners of such houses who have been made millionaires by the housing boom know that our council tax bills are too low.

Radical reform of the system is hardly necessary when higher bands could be swiftly introduced.  Instead of painful payments to the state when the buyers can least afford them, the local authority would have a predictable income flow from the wealthiest owners. Unfortunately, if the leaks are to be believed, we will merely get stamp duty cuts for first-time buyers, adding another layer of complexity to what is already a very bad tax. Still, we can all dream.

Will Amazon stick the (gum)boot in?

Who’s afraid of Amazon? Just about everybody, it seems. Of all the sectors the brute might choose to disrupt next, providers of disposable cups, mops, plastic bottles, syringes and designer shopping bags are unlikely to be top of the list. Well, not according to Morgan Stanley, whose analysts fear for Bunzl’s business model.

Their argument knocked shares in the company, which has quietly prospered by providing these bits and bobs, down to their lowest since January. To which Shore Capital Markets replied: “Amazonian attack! Really? Are these businesses going to ditch Bunzl in favour of Amazon, which is possibly the greatest threat to the profitability of their own businesses?”

Well, maybe. The Amazonians are said to be preparing an assault on the medical supply industry in the US, while the Whole Foods chain, bought in the summer is now offering cut-price turkeys for Thanksgiving. The US supermarket groups are not joining in the celebrations. They are expected to make a profit and pay dividends, while Amazon’s price is driven by massive sales growth, (relatively) trivial profits, and no dividend for the foreseeable future.

The curiosity is that many investors hold shares in both, predator and prey, seeing no conflict in applying these contrasting criteria in their valuations.  As for the threat to Bunzl, Amazon may indeed become the store that ate the world, but it’s hard to believe that Jeff Bezos is going into the desperately fiddly business of supplying plastic cutlery, brooms or gumboots to customers who would rather concentrate on other things.

Careful what you wish for

Alas, poor Libor. Goodhart’s Law states (roughly) that putting too much pressure on an indicator will break it, in this case hammered out of shape by traders gaming the system. From January 2022, the central banks have decreed that the London inter-bank offered rate will no longer be the benchmark against which over $400tn of debt and derivatives is priced.

That’s the easy bit. Much harder is finding an adequate replacement. Libor’s cousin Sonia, the sterling overnight interest average, is a contender, as is the bruiser from America, BTFR, the broad treasury finance rate. The boffins at Bond Vigilantes, who worry about these things, point out that Sonia is unsecured, while BTFR is secured. And there’s apparently “still some confusion over how these overnight rates will be extrapolated to create a full curve.”

Of course. We may think we don’t need to worry our pretty little heads about this, but many thought the same about Mifid II and boy, was that the wrong decision, as we’ll find out in the New Year.

This is my FT column from Saturday

Much wailing and gnashing of teeth from Britain’s Society of Motor Manufacturers and Traders, as the wheels came off  new car sales last month. Claims that today’s diesels are really not at all like yesterday’s noxious Volkswagens have failed to bring in the buyers.

The salesmen reckon we’ll be back once we get over the wage squeeze. However, the numbers may be signalling something much more fundemental, that our love affair with the motor car is finally over. The market is evolving rapidly; buyers can hardy keep up, but more disconcertingly for the motor traders, may not want to.

The lure of the shiny new motor to the millennium generation appears to be fading. Where previous generations almost defined themselves by the car they drove, today’s twenty-somethings increasingly see them merely as a means of conveyance. The increasing hostility to private cars in cities, the arrival of Uber and the prospect of self-driving cars will only reinforce this view.

It hardly helps that government policy is driving into a cul de sac. The pledge to outlaw sales of non-electric cars by 2040 is the sort of over-the-horizon crowdpleaser like the Climate Change Act, gathering political plaudits and leaving a future administration to work out how to pay the bill. There has been no thought about how to replace £40bn a year of fuel duty or to re-engineer the national grid, far less a convincing case to show that electric cars are really cleaner. As an FT analysis of full life-cycle costs concluded, some of the “greenest” cars on the road are petrol-powered.

The real cost is currently disguised by subsidies for purchase, duty-free fuel and concessions on parking, supported by the fiction that electric cars do not cause congestion. When subsidies were withdrawn in Denmark, sales collapsed. There is also limited public enthusiasm for hanging around motorway service stations waiting for your car to recharge.

The traditional driver of new car sales is that the replacement is like your old car, only better, and that there’s a decent residual price when you sell. The carmakers have already exploited this heavily with their financing deals, but if the replacement looks more like a smartphone on wheels, second-hand cars will depreciate as fast. That’s if you want a car at all. Bob Lutz, the former vice-chairman of General Motors, reckons you won’t, and that his industry has no future. The SMMT can only hope he’s wrong.

 

A leak of nuclear material

Traditional nuclear power stations are an economic dead end, so the UK government wants to encourage the sort of generation used in nuclear submarines instead. You can tell how confident the proponents are, since the toxic word “nuclear” has been dropped in favour of calling them “small modular reactors” which sounds much less scary.

We’re promised taxpayers’ support to develop SMRs, which appear to offer a sensible alternative to wealth-destroying monsters like Hinkley Point. Unfortunately, leaks from a report into these bite-sized power stations suggest that the case for them is no better than for their overweight cousins.

This shouldn’t come as a complete surprise. Nuclear power has always been a race between improving technology and rising safety standards, even when the plants have been in isolated locations. The fans of SMRs claim the report is out of date, but since the business department commissioned it from EY in the first place, this looks pretty thin. And who wouldn’t welcome a nice little SMR in their back yard?

 

A quick guide to new issues

Do not buy into an Initial Public Offering if most of the capital raised is going out of the business, or if it replaces existing debt (because the capital has already left). Do not buy if private equity is selling. Do not believe any forward-looking statements, because if the prospects really were that good, the vendors would wait and get a higher price. Do not buy any share that has been listed for less than a year. You will miss some bargains, but you will avoid many more disappointments. Leave it to the professionals to lose other people’s money.

 

This is my FT column from Saturday

 

 

Martin Sorrell frets that brand owners are cutting back on advertising. Well, he would, as boss of WPP, the owner of the world’s biggest ad agencies. The carnivores snapping at the heels of the big herbivores have encouraged the likes of Proctor & Gamble and Unilever to look to the bottom line, and spending less on promotions is a quick fix.

We are, he complains, all short-termists now. The average big US company is paying out all its profits in dividends and share buybacks, and its CEO lasts less than seven years. As he puts it: “Management is abrogating responsibility for reinvesting retained earnings back to share owners.”

Well, up to a point, Sir Martin. Most major companies seem in rude financial health, while Amazon’s hugely successful no-profit business model is about as long term as commerce ever gets. Besides, worries about short-termism go back even further than his 31-year reign at WPP; they can be found in the Harvard Business Review in 1980, which argued that US companies were eating their seed corn.

WPP’s bigger worry today is how to make money in the brave new world of digital media, to get past the robot eyeballs and reach the human viewers. Yet this is not impossible. The ridiculous campaign to encourage still more claims for PPI mis-selling (a sort of QE for the masses) has encouraged 1.2m visits to the Financial Conduct Authority’s website. We do notice ads – if there’s something in it for us.

Killing ’em with information

HSBC rounded off the bank reporting season last week. Its statement runs to 58 pages – and that’s just for the third quarter. Some inside the bank, and even a few outside it, may understand the tsunami of information, but for most of us the words might as well have been written in mandarin, which would at least allow HSBC’s millions of Chinese customers to be baffled in their own language.

Shareholders might worry that the bank’s common equity tier one ratio fell slightly, or that IFRS9 will shave a little more off next year. They might value “management’s view of adjusted revenue” or the “transitional own-funds disclosure”, but above all, shareholders need confidence that advances will be repaid. So when finance director Iain Mackay says he has $10bn of “excess capital” looking for a home, they should pay attention.

Excess capital is a comfort to the bank’s supervisors and a terrible temptation for a banker. Sibley’s Law says that you know what a bank will do with too much money, even if you don’t know which wall it will water with it. For HSBC, handing it to the shareholders appears to be something of a last resort.

The latest dividend gets only a passing mention (it was declared last month) and the board is merely “confident of maintaining this level”.  There’s also a share buy-back programme to help mop up those shares issued to holders who opt for scrip instead of cash, and to provide fees for the bankers’ bankers.

In the bad old days when banks did not disclose profits, the level and direction of the dividend was the best guide to what was really going on in the marble halls. It’s not immediately obvious that today’s mind-numbingly detailed disclosure is much better.

When Peace reigns

Is John Peace a sell signal? Not so long ago he chaired three FTSE100 companies, in defiance of the compliance police. He’s now down to one, the rather accident-prone Burberry, which last week announced the departure of Christopher Bailey, the design guru whom the rest of us could see wasn’t cut from CEO material.

When Sir John took the chair at Standard Chartered in 2009, the bank appeared to have sailed through the banking crisis. It turned out merely to get into the mire later, and as this week’s results showed, it’s still struggling to get out of it.

His third chair was at Experian, the credit-checking business whose database has not yet been hacked. He stood down three years ago, since when the shares have done rather well. Perhaps there’s something to be said for rationing FTSE chairmanships, after all.

This is my FT column from Saturday

Yes, it’s the Hammond Horror Show, and it’s going to be a bloodbath in the public finances. The dollop of cream that Spreadsheet Phil had supposedly prepared by a combination of spending cuts and accounting sleight-of-hand for next month’s Budget has been turned sour by the Office for Budget Responsibility.

The cream’s gone off because, frankly, we’re just not pulling our weight. British productivity used to grow at a stolid 2 per cent a year, but in the last decade it’s hardly grown at all. The OBR, which had assumed a return to trend (as it has done ever since 2009) has now decided to abandon this assumption, a decision which wipes out two-thirds of the £26bn Budget wriggle-room the treasury had created for the chancellor.

If we want to get richer, we must be more productive, so there’s a “productivity crisis”. Never mind that unemployment is at a 42-year low, we are miserably unproductive compared to other countries, and thus doomed to stagnant standards of living. These figures imply that instead of getting more efficient, we are simply employing more people.

But what if we are measuring the wrong things? It’s simple to count cars from a factory (although less simple to capture model improvements) but in a service economy like Britain’s, measuring output is hard. Is a longer newspaper article more productive than a shorter one? What about making phone calls on the train? Search? Emails? Same day delivery? All short-circuit problems which took hours or even days to solve in the pre-internet era.

Charlie Bean, late of the Bank of England, wrote last year that “official statistics may be missing an important aspect of the contemporary economy”. Kevin Gardiner, global investment strategist at Rothschild, is also highly sceptical: “Product proliferation and complexity, quality change, innovation and altered delivery get in the way of determining ‘final’ output.”

For good measure, he also points out that the much-derided zero-hours contracts amount to just 3 per cent of the record 27m jobs in Britain. Most new jobs are full-time, in the private sector where the employer must believe they add value. So the productivity crisis is more of a productivity puzzle. Not that the OBR’s gloomy forecasts should concern the chancellor; he has his own job to worry about.

White elephant’s minders fight back

The Hinkley Point counter-attack is under way. Is the £20bn nuclear power station “risky and expensive” as the National Audit Office concluded? Goodness, no, the officials from the Department for Business, Energy and Industrial Strategy told the Public Accounts Committee.

Never mind that the juice will cost more than twice as much as today’s power prices, it’s critical for keeping the lights on in 2025. As the officials did not say, that’s because the rules essentially preclude the building of cheap, gas-fired power stations at a time when gas has never been more plentiful or widely sourced.

And it’s jolly unfair to compare the runaway cost of nuclear with the falling cost of windfarms, said Alex Chisholm, the department’s permanent secretary, because the wind doesn’t always blow. Thus the defence of this money sink will continue, long enough to ensure that too much money has been poured down it to stop the project.

One in the eye for corporate governance

Hooray for Diageo, Aviva and GKN. Boo to G4S, Carnival and GlaxoSmithKline, respectively the top and bottom companies in Ken Olisa’s FTSE100 corporate governance league table for the Institute of Directors. Returns to shareholders is just one of 47 “indicators” which include gender diversity, board structure, membership of do-gooding bodies, or whether there’s a fountain in the Head Office foyer (well, perhaps not quite).

Mr Olisa has useful, if bruising, experience here, as a director of ENRC until 2011, which crashed through the corporate governance guidelines before bludgeoning the minority shareholders to sell out in 2013.

One company that might have propped up the 2017 league table slipped out of the FTSE100 because it has returned £4.3bn to its owners. Despite having an executive chairman, no women executives on the board, not belonging to the IoD, and not signing the UN Global Compact, Melrose has turned each pound invested in 2005 into £17.79 today.

This is my FT column from Saturday