You run a vast international business with enviable margins, wonderful cash flow and a powerful market position. Yet you can see the spectacular growth of the previous decade is not going to continue. What do you do?

The conventional answer is to use the cash to build new businesses to keep growing and you are, of course, Tim Cook. The iphone has changed the world, earning Apple money beyond the dreams of avarice, but it seems likely that the future will be less exciting than the past on the hardware front.

Most of us are conscious that our pocket rocket can already do far more than we are likely ever to want, and peak iphone may not be far away. Mr Cook’s answer is to plunge into the entertainment business, reinventing Apple tv and taking on the likes of Netflix. Yet even with Oprah and Harry to help, the impact on Apple’s vast earnings from its existing business will be modest, and as Sony so painfully discovered, entertainment is a very different industry.

Peak demand may also be on the horizon for oil, another world industry dominated by a few giants. All the majors are scrambling to reinvent themselves away from the core business that built them, but here again, the diversification record has been, well, mixed.

Shell has no more special expertise in selling domestic gas than does Apple in television. Both companies are big enough to slug their way to a decent market share by throwing money at it, and besides, look how forward-thinking and dynamic we are!

Nobody wants to work for a shrinking business, which is why diversification trumps returning capital to its owners, however expensive it turns out to be. They pay lip service to shareholder value, but ambitious executives put their own interests first.

 

There’s money in them audits

It sounds like the dullest possible investment opportunity you could imagine: the chance to buy shares in an audit company. This Cinderella corner of the accounting profession has been turned into a loss-leader for the burgeoning business of consultancy, a means to get through the door to allow the smoother, slicker partners to offer expensive comfort and advice.

The failure of Carillion exposed just how useless today’s audits have become. The auditor’s report drivels on interminably. Nobody knows what it is for, while company accounts often give three or four versions of profit. The Competition and Markets Authority is on the case, sort of, proposing more regulation, more responsibility for audit committees, more oversight, more everything.

Paul Boyle, who formerly headed the Financial Reporting Council, considers the CMA’s remedy for the crisis wrong on almost every count. He acknowledges that should one of the four big firms fail, the result would be calamitous, and in a paper for think-tank CSFI, he argues that auditing needs more capital, not more regulation.

Considering how little profit there is in auditing today, this seems counter-intuitive, but freed from the current requirement for control by accountants, the business could be quite attractive. Auditing is a statutory requirement, so there is a captive market. The reputational damage to an audit-based business of a client turning into another Interserve is a powerful incentive to do the job properly, even at the expense of the client’s executives’ bonuses.

The cost of auditing would rise, perhaps dramatically, but the quality would be much improved by introducing competition and markets. Perhaps there should be an authority that promotes both. Oh, wait a minute…

 

Not bad for a dying breed

The British pub is doomed, killed off by supermarket booze, the breathalyser, minimum wage, food hygiene fascism… The survivors will have converted into gastropubs or (of course) ‘Spoons. Well, maybe. So here is the City Pub group, a half-pint specialising in pubs in cities, which this week reported a 22 per cent rise in revenues.

It is replacing a 3 per cent of profits payment to staff with a bonus scheme based on their pub’s weekly sales. Wannabe investors can only gulp at a valuation of £143m, three times sales, or an intoxicating 36 times adjusted pre-tax profits with the shares at 235p. Should be easy to get a drink at the pubs, though.

This is my rather weak column from Saturday

 

 

 

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Psst…wanna buy a nuclear sub, one careful owner, now surplus to requirements? Well, too bad, even though nuclear refers to the propulsion system rather than the armaments, and the UK Ministry of Defence has 20 of them in various stages of decay.

It is 24 years since the MoD pledged to scrap surplus boats “as soon as reasonably practicable” and, as the National Audit office has revealed, they are all still there, eating £12m each a year in storage, with the delay costing an extra £900m to date.

By the standards of the MoD’s usual fantasy financing, this is a third division problem. But one day, perhaps when the packed subs allow visitors to walk dryshod across Devonport dockyard, the boats will have to be properly dismantled, and Babcock International is the only organisation capable of doing it.

Babcock has scrapped an old boat of its own, now chairman Mike Turner is finally going. Having overseen an absurdly generous payoff to a former CEO, as well as the disgraceful bid defence of GKN a year ago, his departure after 20 years on the board is overdue.

The shares are back where they were when he took the chair a decade ago, as analysts worry whether Babcock has caught the creative accounting virus that has crippled other outsourcing businesses. The company says not, and now it has a new champion in the shape of Ruth Cairnie, a former Shell executive, to put up against the MoD.

At 506p Babcock shares yield 5.9 per cent after a small increase in the half-time dividend. That’s high enough to be attractive, but not so high as to ring alarm bells. If Ms Cairnie can charm the MoD and restore investor confidence, the shares’ long dive may be over.

No good deed left unpunished

Thames Water is a business we love to hate. The company has been stripped of the equity it inherited at privatisation, treated major pollution incidents as merely part of the cost of doing business, and lost more water in leaks than its domestic customers actually used. No wonder many customers quite like the idea of a Labour government taking back control.

It is a miserable backdrop for Thames’ chief executive, Steve Robertson. He inherited the result of cynical behaviour from Macquarie and the previous owners who took £1.16bn in dividends and added £6.6bn in debt over five years, while the infrastructure decayed. By the time the “Aussie squid” bank sold out, there was no money left to finance the Thames super-sewer.

Today’s owners, the Kuwaitis and non-UK pension funds, could be forgiven for suffering buyer’s remorse, even before the potential left-field problem of asbestos water pipes. Under pressure from the regulator, and as the scale of the infrastructure backlog emerged, they have been forced to consider Thames as a very long-term investment. They have taken no dividends for three years, and to make up for past misdemeanors, the regulator is screwing down the financial taps at the forthcoming pricing review.

Under chairman Jonson (“stop”) Cox, Ofwat might still do so. Its final decision is due in July, but Mr Robertson’s promises of good behaviour, (slightly) lower bills and greater efficiency have dramatically narrowed the gap between his proposals and Ofwat’s demands, to a bridgeable £900m.

Thames’ days as a rogue company are behind it. It seems to be striving to become a good corporate citizen, as if that would make any difference if Jeremy Corbyn comes to power.

 

LCF sinks FCA boss

The horror story that is London Capital & Finance, where it seems that four-fifths of savers’ money has been lost, has turned the spotlight onto the Financial Conduct Authority for missing the red flags before £237m had been extracted from innocent, if greedy, investors.

Had the FCA studied the 2016-17 accounts, when just £60m had been invested, it might have spotted that LCF was already technically insolvent and saved the latecomers’ pain. The inevitable prosecutions will not recover the money, and even if the perpetrators go to jail, the FCA will bear the public’s wrath. Its chief executive, Andrew Bailey, was a front runner to become Bank of England governor after Mark Carney departs. Not any more.

This is my FT column from Saturday

Amigo loans are a rum business. As the clever name implies, the company relies on dodgy borrowers finding a creditworthy mate to guarantee the debt they are about to take out. Strong word, “guarantee”. In this context it is rather more than a pledge that expires just before the washing machine breaks down.

The company claims to incorporate all sorts of health warnings to both borrower and guarantor, but the process still smells of moral blackmail. Your mate badly needs money, and you do not have to find it, so what’s not to like? Even at an attractive rate of interest, this is a friendship-breaking question, but Amigo charges up to 50 per cent despite your guarantee.

In another part of the sub-prime lending forest, Provident Financial is resisting a reverse takeover, and last week Amigo helped us all out by formally stating it was not going to join the scrap. For good measure, it also responded to  a shot across the bows of the “high cost lenders” from the Financial Conduct Authority, by telling us how transparent its business is.

None of this stopped the slide in Amigo’s share price. Since JP Morgan Cazenove brought it to market last June at 275p, James Benamor, the founder and controller of 61 per cent of the shares, has stepped down and finance director Simon Dighton has gone. The week’s low of 148p reflected the market’s worry that in tougher times, those guarantees will cause a lot more misery than a broken washing machine.

Give that man a bonus

Mark Wilson arrived as a breath of fresh air at Aviva. An attractive Kiwi, he was the man to make all the disparate bits of this insurance behemoth work together at last, along with a determination to improve the dismal performance of its fund managers.

It had seemed to be working, and then we were not so sure. Then last year a pair of appalling misjudgments effectively sealed Mr Wilson’s fate. Aviva attempted to redeem some preference shares at the wrong price on a technicality, before backing down in the face of widespread protest. Then Mr Wilson joined the board of Blackrock, a powerful competitor in the battle for investors’ money.

He had to go, and last October, he went. Now, with Aviva’s 2018 accounts, we learn all about it – except we don’t. Chairman Adrian Montague merely describes the preference debacle as a “disappointing episode”. The rem. com. under Patricia Cross is stuffed with gems like “the formulaic outcome against the 2018 bonus scorecard prior to downward adjustments was 137.8%  (out of 200%)”.

Ah yes, the “bonus scorecard”, that handy device without which no modern executive can feel properly motivated. Even though he was only there for the first nine months of last year, and that his departure was, well, sudden, Mr Wilson ticked enough boxes on the card for a £692,000 bonus, and total pay of £1,636,000, including the usual farcical “pension contribution .”

By the standards of those at the top of the big banks, these sums are almost reasonable, and a combination of the laws of libel and employee protection impose a sort of omerta on these departures. But Aviva shareholders endured a miserable 2018, and Morningstar records that today’s share price was first reached 27 years ago. So when Ms Cross explains that “at all times we have sought to ensure that executive pay is aligned with Aviva’s overall performance during the year” the shareholders can only weep into their insurance policies.

Temporal over-reach

So do you want permanent GMT or permanent BST? As the clocks go forward tonight, it seems that we cannot have permanent switching. The European parliament has decided that gaining or losing an hour is so traumatic that it should be outlawed. From 2021 member states must choose which fix they prefer.

It is unlikely that the UK will have a referendum on the subject, even if we have left Hotel California by then. Next, surely, comes the Solar Convergence Directive, which insists that all member states get the same amount of daylight every day (including the UK, of course). The current arrangement, where each state gets the same amount of daylight in a year, is just not acceptable in an ever-closer union.

This is my FT column from Saturday

 

 

 

Strange stuff, liquidity. One moment it’s there, the next it’s not. You hardly need it, except when you really do, probably when it is least abundant. It is the quality which allows you to sell an asset at a price close to that which a willing buyer would pay, and the dramatic decline of GAM Holding, documented in the FT, stands as a cautionary tale of how quickly it can evaporate.

The internecine strife at the Swiss-based fund manager hardly helped, but its funds’ holdings in illiquid bonds made things much worse. The main fund was open-ended, which meant that any holder could cash in at any time. The bonds, properly documented on the fund’s website, looked like a sensible slice of total assets, and helped juice up the yield.

The problems began with the suspension of the fund manager, causing nervous investors to sell. Forced to raise cash quickly, the funds’ more liquid investments were sold, raising the proportion of illiquid ones. As more holders ran for the exit, GAM had little choice but to shut the gate and lock them in. The funds are now being liquidated – a process that promises pain for investors.

It was the fear of something similar that drove Neil Woodford to swap some unquoted (and therefore very illiquid) shares in his open-ended equity income fund for new shares in his quoted (and therefore more liquid) Woodford Patient Capital Trust, with the fundholders taking a 15 per cent haircut on the way.

There is nothing they can do about it, short of taking their capital out of fund.

There is £1.2tn of investors’ capital in open-ended funds, and only £180bn in closed-ended investment trusts like WPCT, because there is more profit in selling funds, as your friendly investment adviser will not tell you. His profit is your cost, which is why investment trusts consistently outperform funds.

The dwindling band of Mr Woodford’s faithful could re-invest in Patient Capital at a 15 per cent discount to the value of its assets. If instead impatient holders decide to sell, that discount could widen further as market-makers cut the price. That’s liquidity: always there when you don’t need it.

It’s otiose, Osorio

The Lloyds Banking CEO took a £3,000 a week pay cut last year. Before you send him a food parcel, you should know that Antonio Horto-Osorio’s base salary, fixed share awards, benefits, group performance share, 2016 LTIPs and pension allowance totted up to £6,268,000, before a further £2,000 for “other remuneration.”

‘Tis the season for such disclosures, as the remuneration consultants find ever-more imaginative ways to reward top executives. Apparently, Mr Horto-Osorio did frightfully well on his “balanced scorecard”, making “continued progress against Helping Britain Prosper targets” and much, much more besides.

The Lloyds report is beyond parody, but is no more absurd than those from most big companies. It is one of life’s mysteries why CEOs, and bankers in particular, need such a panoply of incentives, especially when so many recent examples demonstrate how little they know about what really goes on in the banks they lead.

The latest figures from the Office of Budget Responsibility show that the best-paid 0.1 per cent are pulling further away from the rest. So despite Mr Horto-Osorio’s pay cut, the inequality is getting worse. Restraint is not in their dictionary, and most have decided that a seven-figure reward beats a day’s bad headlines. Funny, that.

Give it up, Mike

How about half-price petrol? Or free butter with every loaf? We are not quite there yet, but the latest attempt from Mike Coupe, J Sainsbury’s CEO, to explain how wonderful the merger with Asda would be, betrays his desperation.

We’ll have the 10 per cent off promise independently reviewed! We’ll make all those beastly suppliers pay and pass the savings to shoppers! Oh, and by the way, the Competition and Markets Authority can’t do maths.

The maths that counts here is that two supermarket groups would have 60 per cent of Britain’s grocery market between them. Long after Mr Coupe has departed, that single statistic is enough to drive prices up and competition down. The CMA must finally kill off this ill-conceived deal, and Mr Coupe should get back to running the shop.

Is it a share? Is it a bond? Is it comprehensible to anyone not earning fees from it? The best answer to all three questions is No. It is Vodafone’s mandatory convertible bond, a chunky £3.4bn with more bells and whistles than a one-man band, and a magnificent example of the investment banker’s art.

Vod is gasping for cash, as was pointed out here last month. Everywhere in the empire there are demands for money, from spending on upgrading the mobile networks and bidding for more spectrum, to finding €19bn to pay for Liberty Global’s cable network in Germany.

Once upon a time, convertible bonds were issued with a yield that exceeded the dividend on the underlying shares, with the option to convert at a premium to the current price. Buyers would sacrifice capital gain for a higher income and better security.

This bond turns the equation on its head. The coupons are expected to be under 2 per cent, against the near-10 per cent (historic) yield on the shares, so why would anyone buy the bonds? If you have to ask, then they are definitely not for you. They are aimed squarely hedge funds, and the designers have thrown in an “option strategy” to allow the boys to have fun exploiting anomalies and timing differences, or inventing derivatives to trade.

This is pretty desperate stuff. If converted, the bonds would add just under 10 per cent to the issued share capital, the maximum allowed without shareholder approval, and they run only to 2022. To reassure shareholders worried about dilution, share buybacks are planned, “funded from the issuance of hybrid securities, depending on credit market conditions”.

This smacks of borrowing from Peter to pay Paul. The company’s global ambitions may be admirable, but this issue looks like financial prestidigitation. The bonds get Vodafone round the next corner, and the shares actually rose slightly on the news, getting up from their 10-year low, but the next thing to go will surely be the €15c dividend. Even with this tinkering from the City’s finest engineers, Vod cannot afford to pay it.

My trust, or your fund?

Neil Woodford is having a bad patch. His stockpicking touch has deserted him, and to compound his woes, an asset swap between Woodford Patient Capital Trust and the £4.8bn open-ended equity income fund he also runs has raised questions of conflicts of interest.

The deal swaps £73m of unlisted investments (at outside valuation) from the fund to the trust in return for almost 10 per cent of new trust shares. Both vehicles were already holders of the unlisted stocks. The new shares are valued at net asset value, rather than the 15 per cent discount at which they currently trade.

The holders of fund units must just swallow the £9.5m paper loss, while the board of the trust provides extra reassurance that the deal is in shareholders’ interests. Valuing unlisted investments is partly guesswork, but Iain Scouller at brokers Stifel reckons that the choice of those being transferred “may provide some pointers to future corporate activity and potential gains”, and that with the trust shares at 80p, Mr Woodford’s luck may be about to change.

 

Oiling the wheels

There is a respectable case for arguing that Norway’s wealth fund should not hold shares in the world’s oil majors: if the crude price does collapse, then the nation suffers twice, from lower tax revenue and capital losses on the shares. That approach would have suggested not buying them in the first place, so the latest recommendation from the Norwegian government looks like pure politics.

When political motives trump the investment case, the outcome is seldom a good one. Even if we are approaching peak oil demand, it will power the world for decades yet, and predicting the price has consistently defeated the experts. A decade ago, nobody had heard of fracking for shale oil. The technology of exploration and production is constantly advancing, while the costs are falling.

The majors, meanwhile, have proved themselves capable of adaptation, and BP’s recovery from the Macondo disaster demonstrates their vast financial resilience. Norway’s move, if it does damage the share prices, will merely make the shares better value for other investors.

It’s been an uncomfortable fortnight for Godfrey Cromwell, Brendan Pellow and Aidene Walsh, the trio with the agreeable task of dishing out £775m in free money. The sum, from Royal Bank of Scotland (majority shareholder, HMG), is a sort of penalty exacted by the European Union to punish the UK for using state aid to rescue the bank.

The sum replaced an earlier deal to hive off a slice of RBS. That proved too difficult, so it was replaced with a fund to help small banks compete with those beastly big ones, and the winner is…Metro Bank! Here’s £120m!

Oh dear. Someone seems to have opened the wrong envelope. Even as the judges at Banking Competition Remedies were revealing the results, Metro was on the skids. A month earlier, it had revealed that some loans had been wrongly categorised, precipitating a profit warning which almost halved the share price in a day. It has carried on down.

Far from challenging the big banks, Metro itself faces the challenge of an unpriced rights issue, and a capital hole rather deeper than £120m. The BCR have said only that Metro would be “invited to enter into a Capability and Innovation Fund agreement”.

Metro’s innovation is hardly in doubt. From its glitzy branches, expensively designed by the chairman’s wife, to its dog- and human-friendly approach, it makes the big banks look clunky. It has majored on safe deposit boxes, after the money laundering rules scared off the competition.

But now Metro’s capability is in serious doubt. Expansion needs cheap permanent capital which it can no longer find. The BCR cash machine may decline to disgorge the £120m, but that would hardly answer the question why, a month after Metro’s mistake came to light, our trio carried on with the award as if it were challenger banking as usual.

 

Wanted: even more non-execs

Another spin at the home for superannuated bankers, industrialists and fashionable appointments that is the Barclays boardroom. Gerry Grimstone left last week, and Reuben Jeffery and Dambisa Moyo will not seek re-election. Since 1970, this bank has seen 65 non-executive directors through its revolving doors, along with 40 executive directors.

Philip Augar has done the math in The Bank that Lived a Little, a shocking book whose sequel is currently being played out at Southwark Crown Court. The bank now has a new chairman (the ninth since 1971) in Nigel Higgins, who will doubtless spin the doors again, although he may stop short of inviting the awkward squad, in the shape of Edward Bramson, into the parlour.

Barclays are the least loved shares in an unloved sector, at 164p close to their post-crisis low a decade ago. It’s easy to see why, but with or without Mr Bramson’s irritations, unloved is the usual place to look for hidden value.

Never mind the share price…

“Cases of corporate failure and shortcomings litter the histories of stock markets around the world…Pension funds and other investors in these companies suffered heavy losses.” Thus did Keith Skeoch greet readers of FTFM this week.

Mr Skeoch says business must regain public trust, and that fund managers, rather than pushing to maximise profits, should consider “a thoughtful approach to creating sustainable value.” After all, he adds, “the legitimacy of asset managers hinges on what they deliver for savers.”

The savers with their capital invested in Standard Life Aberdeen will know what he means. Mr Skeoch is Hardy to Martin Gilbert’s Laurel, the double act at the top of Staberdeen, and they are forever telling us how well they get on. The shareholders, not so much.

In the two years since the merger of Standard Life and Aberdeen Asset Management, the duo has turned a business valued at £11bn into one worth £6bn (plus £1bn handed back to shareholders). At 241p, the yield on the shares is nudging 10 per cent, a level that says the dividend is unsustainable.

Stab’s new chairman, Doug Flint, knows about value destruction. On his watch at HSBC, the bank bought Household, a subprime lender in the US which destroyed value on an epic scale. He might consider this subject a more pressing concern than Mr Skeoch’s touchy-feely stuff about companies’ place in society.

This is my FT column from Saturday

Amidst the wailing and gnashing of teeth at Sainsburys, there was one simple question: did they really expect to get away with creating a duopoly in Britain’s food supply? The answer, of course, is yes because so many people involved with the merger with Asda stood to make so much out of it.

The idea that the bankers, lawyers, brokers and public relations people would look beyond their magnificent fees is laughable. Suggesting that senior executives were not motivated by still bigger rewards, either for staying to run the combine or paid handsomely to go away is risible.

Beneath all the technical arguments and gobbledegook like where the line should be drawn for the “gross upward pricing pressure index”, the deal was an attempt to cut competition. It was designed to allow two companies to control 60 per cent of Britain’s most important consumer industry, dressed up as a defence against big beasts from abroad.

The jump in the Sainsbury share price when it was announced last year gave the game away as surely as the slump following the Competition and Market Authority’s verdict. Despite all the guff about lower prices, there was never any doubt about who would pay the bill.

The petulant response from Sainsbury CEO Mike Coupe looks ill-judged, and rather than launch a – surely futile – legal action against the CMA, the Sainsbury management would be better occupied in fixing the problems in this business. Brokers Exane even see the “possibility” of a rights issue. Still, a market share of 16 per cent, more than Aldi and Lidl combined, is not a bad place to start.

Intu the void

The statement this week from shopping centre group Intu is a peach. Headed “Winning destinations drive a resilient operational performance in a challenging market” chairman John Strachan boasts of a “strong underlying individual centre performance” while his CEO David Fischel highlights the group’s “winning destinations.”

The destinations may be winning, but the shareholders are not. As brokers Stifel put it: “We had expected Intu’s financial results to be poor, and they have not disappointed”. The shares at 108p are now the same price as they were in 1992, according to Morningstar, and Stifel reckons they are still too dear.

It’s hard to disagree. Intu is in a hole deeper than the foundations of its Lakeside shopping centre. The dividend is gone, making it the first significant property company to trigger a tax bill as a result of a move designed to save tax. Read past the pair of Polyannas at the top and the picture is grim indeed.

Intu shares have parted company with the management’s estimate of asset value, reflecting the chance that debt will overwhelm the business. Far down the statement is a table showing that should the value of the portfolio fall 25 per cent from today’s figure, debt would rise to 71 per cent of assets. Considering the financial mauling in the malls, that is all too plausible.

Let’s have more consultants

Oh, to be a consultant, now that spring is (almost) here. It really is nice work if you can get it, whether for London’s fantasy “garden bridge”, Anglesey’s Wylfa nuclear power station, or hitting the jackpot with HS2, the railway line which might one day go from Birmingham to somewhere quite near London.

As HS2 makes its way down the track, so to speak, we are now being fed little gobbets of how the consultants dream it could look. There’s going to be a booking app! Simply turning up and getting aboard is so 20th century.

Before a rail has been laid, HS2 has cost £5.5bn, spent on buying land, paying employees and, yes, those ubiquitous consultants. No project can be considered without them, and they are not cheap. Meg Hillier, the chairwoman of the public accounts committee, described a £3.5m Wylfa contract with Arup, a design engineer, as eye-watering.

In contrast, the risks for those for actually doing the work are real and high. Building the Aberdeen by-pass almost brought Galliford Try to its knees, Kier needed an emergency rights issue, and Carillion collapsed. It seems that consultants get paid, while contractors go broke.

This is my FT column from Saturday

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