UK INVESTOR MONEY // SHARES // INTERVIEWS
ISSUE 10 // MARCH 2016
Beware the coming crash Profiting from EIS shares CEO Interview: Peter Hambro Three shares to sell
UK Investor Magazine — 1 — March 2016
Intro INSIDE 4 The Next Crash
David Scott
8 Perception vs Reality Mike Franklin 10 Primary Bid launches 11 Peter Hambro interview Tom Winnifrith 13 EIS investing Nigel Somerville 15 Three shares to sell for March Tom Winnifrith 17 Company of the Month: Safestyle UK Steve Moore 18 The House View
CONTACT US UK Investor Magazine 91 - 95 Clerkenwell Road London, EC1R 5BX E: info@ukinvestorshow.com W: www.UKInvestorShow.com EDITORIAL Tom Winnifrith Editor
A Message from Tom Winnifrith Welcome to the March edition of the UK Investor show magazine - spring is in the air and Easter is almost upon us and in that seasonal vein Nigel Somerville opens the batting in this issue by explaining why before April 6 you should all be looking at EIS investments as part of your tax planning. They say that there are only two things in life you can’t avoid: death and taxation. That’s true but while the former is on the front cover the latter can be made less painful if you plan carefully. Folks on the left sometimes miss this point but tax minimization ( paying as little as you can by using the rules) is not the same as tax avoidance. Google and Starbucks engage in the former, MPs fiddling their expenses almost certainly engaged in the latter. Guess who the MPs pushed the HMRC to enquire into? We are under no moral duty to pay more tax than the legal minimum and, indeed if you are running a corporation you have a duty to shareholders, to the owners of that company, to pay as little as possible. I my view the big US Corporations who have “volunteered” to pay more tax than they should have in the UK have been derelict in the duty to their investors in doing so. Away from Nigel’s tax tips this issue contains the usual mix of company profiles, interviews as well as buy and sell ideas for shares. We hope that there is something for everyone in this edition. We continue to build up to our annual UK Investor Show - our one day conference in London which is on April 30 2016. As ever we have a range of star speakers who simply do not speak at any other event, folks such as the UK’s top small cap fund manager Mark Slater, son of the late and great Jim, Britain’s Buffett Mr Nigel Wray and the Queen of UK tech stocks Vin Murria. And there will also be more than 100 PLC CEOs present manning stands throughout the day and in nearly all cases doing a 20 minute presentation as well. We have some really big name companies attending this year including Optibiotix, Boohoo and Petropavlovsk, a sign that perhaps this show has come of age. We have 25 free investor class tickets for the show to give away this week. Just go to www.UKInvestorshow.com and enter the word MAGUKI in the box marked promotional code when booking and we will look forward to seeing you on April 30. Meanwhile we hope that you enjoy this edition of the magazine.
Winnifrith UKTom Investor Magazine — 2 — March 2016 Editor
UK Investor Magazine — 3 — March 2016
This next crash will be far worse and more dramatic than any that has come before Warns David Scott
B
ack in the 1970’s as recession gripped the world for a decade, stocks stagnated and commodities crashed, investor Jim Rogers made a fortune and his understanding of markets, capital flows and timing is legendary. As crisis struck in late 2008, he did it again, often recommending gold and silver to those looking for wealth preservation strategies and warned that the crash would lead to massive job losses, dependence on government bailouts, and unprecedented central bank printing on a global scale. Now, Rogers says that investors around the world are realizing that the party is over and Stocks are over bloated and central banks will have little choice but to take action again. But this time, says Rogers in a recent interview, there will be no stopping it and people all over the world are going to feel the pain, including in China and the United States. “We’re all going to suffer… I can think of very few places that won’t suffer. But most people are going to suffer the next time around. Central banks will panic. They will do whatever they can to save the markets. It’s artificial… it won’t work… there comes a time when no matter how much money you have, the market has more money. I don’t know if they’ll even call it QE (Quantitative Easing) in the future… who knows what they’ll call it to disguise it… they’re going to
try whatever they can… printing more money or lowering interest rates or buying more assets… but unfortunately, no matter how much P.R. or whitewashing they use, the market knows this is over and we’re not going to play this game anymore. The entire world is about to get hammered and the average person on the street is the one who will pay the price, as is usually the case.” Investors worried about the damaging impact of ultra-cheap money on banks and global markets may need to prepare for key interest rates around the world falling well below zero, according to economists at JP Morgan. In a paper the other day they argued that limited benefits of further bondbuying stimulus and forward guidance means that continued weak growth and low inflation may force even the U.S. Federal Reserve and Bank of England to adopt negative rate policies (NIRP). Negative interest rates are potentially damaging for banks’ balance sheets and net interest margins, a concern that has contributed to current global market turmoil, but the rates’ lower limits are far below what many have assumed, the JP Morgan report concludes, suggesting that banks could absorb the extra fall more easily than currently feared. For the former rate, the Fed could in principle go as low as -1.3 percent, Britain down to -2.5 percent, the euro zone to -4.5 percent and
UK Investor Magazine — 4 — March 2016
Japan to -3.45 percent, economists Malcolm Barr, Bruce Kasman and David Mackie wrote in a note published the other day. In a world of negative interest rates, the lowest rate charged on deposits at the central bank effectively becomes the default reference point for markets, they said. Bank of England studies have put a rough limit to negative central bank rates at about minus 0.5 percent - the point below which banks would find it cheaper to hoard physical cash than pay fees for depositing it. “Our analysis suggests that the use of these schemes could allow for considerably lower policy rates without undue pressure on bank profitability,” the economists wrote. “Central banks are likely to move cautiously into NIRP as they are sensitive to the uncertain consequences of these policies on local markets,” Barr said. But even the Fed might consider it if U.S. recession risks were realized. The Fed raised rates in December to 0.25-0.50 percent, the first hike in almost a decade, but futures markets have priced out any further increase this year. The ECB’s benchmark refinancing rate is 0.05 percent and its deposit rate is -0.3 percent, while the BoE’s base rate is 0.5 percent. Worries about Deutsche Bank’s financial position sent its shares tumbling earlier last month and has put the spotlight on so-called CoCo bonds, a financial instrument which has only existed for around three years. Contingent convertible bonds were introduced after the 2008 financial crisis, to give banks an extra layer of protection if they face renewed strains on their balance sheet. Financial regulators also wanted to prevent a repeat of what happened during the crisis, when taxpayers pumped billions into struggling banks while bondholders mostly saw their investments repaid. The bonds allow banks to miss interest payments without defaulting, and can be converted to shares or written down if a bank runs into financial difficulties. Investors in CoCo bonds would therefore see huge losses, but in return for taking the risk, the interest rate payments are higher at up to 7% compared with normal senior bank debt which pays around 1%. Although the market is only around three years old, it is now an important source of financing for banks, and is estimated to be worth around €95bn globally. The BBA, the UK banking trade body, says an estimated €40bn of CoCo’s were issued by European banks in 2015, while Bank of England data shows that the main UK banks issued around £4.5bn during the second and third quarters of last year. Because The CoCo market is relatively new and untested, current price volatility has raised concerns that banks may struggle to pay the interest on the bonds, or that they may not buy them back as soon as investors expected or even become worthless in a crisis. There are strict regulations governing the bonds, including the trigger points at which
they convert to equity or are written down, which are linked to the bank’s overall capital position. For example, to make interest payments on CoCo’s, banks have to calculate their available distributable items. Deutsche Bank is seen as having less leeway than other large banks, which has helped prompt the current volatility. It insisted last month that its payment due in April was safe, but investors are concerned it may struggle with its 2017 liabilities. Deutsche Bank’s coco bonds were downgraded by credit ratings agency Standard and Poor’s last month after turmoil that saw the bank’s bonds and shares crash. It and the market fears that there is a risk the bank could struggle to pay the interest due on those bonds in coming years, because rules mean that only income from a very narrow range of sources can be used to pay them. Investor’s fear that Deutsche Bank could potentially struggle to pay the coupons while it is making substantial losses, the bank reported a €6.8bn loss for 2015. S&P said that strict German accounting rules means that the bank could only pay the interest out of available distributable items (ADIs), an unusually narrow set of financial resources. Although S&P is not worried about Deutsche’s ability to pay the interest this year, it has joined market concerns that future coupons could be in doubt if the bank suffers any more unexpectedly bad financial results. In just the first few weeks of 2016, the prices of many bank stocks have suddenly dropped to deeply distressed territory. And the price of insurance against default on the bonds of those banks is now spiking. While we don’t know exactly what ails these banks and, if history is any guide, we probably won’t find out until after this next crisis is well underway but we can tell from the outside looking in that something is very wrong. Despite being given the opportunity to re-think their strategy in the wake of the 2008 credit crisis, the world’s central banks instead did everything in their considerable power to create conditions for the most rapid period of credit accumulation in all of history. In today’s hyper-interconnected world of global banking, if one domino falls, it will topple any number of others. The points of connectivity are so numerous and tangled that literally no human is able to predict with certainty what will happen. Which is why the action now occurring in the banking sector is looking very similar to 2008 all over again. The shipping industry is in crisis with sector giant AP Moeller-Maersk recently reporting plunging profits and its boss saying conditions are now tougher than after the global financial crash. The Danish-based business reported that annual profit’s had collapsed, falling 84% after its oil unit was hit by lower energy prices and its container division battles anaemic growth in global trade and overcapacity in the market. “It is worse than in 2008,” said Nils Anderson, chief executive,
UK Investor Magazine — 5 — March 2016
speaking to the Financial Times. “The oil price is as low as its lowest point in 2008-2009 and has stayed there for a long time and doesn’t look like going up soon. “Freight rates are lower. The external conditions are much worse but we are better prepared.” The Baltic Dry Index, a benchmark for the health of the global shipping industry, has recently plumbed all-time lows. Europe’s leaders agreed in June 2012 to break the “vicious circle between banks and sovereigns” but Germany, Holland, Austria and Finland later walked away from this crucial pledge, so the costs of rescuing banks still falls on the shoulders of each sovereign state. Unfortunate so many politicians reflexively think easy money “helps” but Lessons from repeated speculative collapse haven’t been learned. We are now in the third bubble collapse this century- all created by central banks who have sold out to vote chasing and short term politicians. The world has taken on far more debt than can ever be repaid. As the European banking sell-off is already signalling, creditors are in for a brutal awakening and this is all happening just as sovereign wealth funds from the commodity bloc and emerging markets are being forced to liquidate foreign assets on a very large scale, either to defend their currencies or to cover spending crises at home as revenues dry up. Whilst economists it is quipped have predicted nine out of the last five recessions, the current turbulence has an ominous precedent. Over the last 45 years, the S&P500 has suffered a loss of more than 12.5% on 13 occasions. Six of these have given way to a recession in the US, providing a near 50% probability that a global downturn is just around the corner. We are hostage to a dysfunctional monetary system, run by people who don’t understand how it works in the first place, No wonder the global economy is faltering and finance markets are in retreat mode. Global financial and economic imbalances are bigger than 2008 and are at even more precarious extremes. Bubbles inflate both perceived wealth and future expectations. But, in the real economy Bubbles work to destroy wealth. Mal-investment, over-investment and the associated wealth destruction remain largely concealed as long as financial asset inflation persists. This is true as well for wealth redistribution. The unfolding adjustment process will deflate bubble asset prices to reflect the deteriorating underlying economic fundamentals. By falling for the false materialistic narrative of having it all today, millions of Global consumers have enslaved themselves in trillions of debt. The US and the world has been living a Big Lie since the day Nixon closed the gold window in 1971, eliminating any vestiges of constraint upon central bankers and politicians. Consumers have been lied to by bankers and politicians while wilfully buying into the lie of living for today and
funding it with debt. The global economy has become dependent upon exponential debt expansion, and as soon as the credit is turned off, economic growth crashes. A growing number are accepting the harsh reality that the world is sinking back into crisis, the one that we doubled up on in 2008 and which has set us up for an ever harsher readjustment. Greece is back in recession. Italy is barely growing. Portugal expanded but only at half the expected rate. The very vulnerable and bad debt riddled Italian banking system is starting to look unsustainable and investors are increasingly unwilling to give it the benefit of doubt. The message could hardly be clearer, the next phase of the Eurozone crisis is about to begin. The Lehman Brothers meltdown was just a staging post in a global credit super-cycle, that has been running unchecked particularly since 1971 and since then policy makers have regularly doubled up in the hope of avoiding the reset. McKinsey has calculated that between 2007 and 2014, global debt, public as well as private, outstripped economic growth, rising from $142 trillion to $199 trillion, or from 269% of global GDP to 286%. In Italy, the banks are estimated to be carrying 18% non-performing loans (according to the IMF)and an additional double digit percentage of ‘marginally performing’ or impaired loans. Taken together, these this time it looks like the trouble is likely to begin in Europe, where the woes of Deutsche Bank) have been known for a while. loans represent more than 20% of Italy’s GDP, which is hugely problematic. Many think that The Italian banking sector may have upwards of 25% to 30% bad or impaired loans on the books. That means the entire banking sector and country is bust because it is Insolvent, only printed ECB money has kept it alive and hidden the truth. in a fractional reserve banking system operating at a 10% reserve ratio, (that is for each 1 pound on deposit it lends 10 pounds out) when a bank’s bad loans approach its reserve ratio, it’s pretty much out of business. By 15% you are out of business and by 20% you just need to figure out how you can lie your way out of the social disorder, that is inevitable and keep your head. At 25% or 30%, you disappear in the dead of night before the implosion, hoping never to be traced. If you ever believed there was a recovery after 2008, or even that it was theoretically possible for that matter, you’re going to have a much harder time understanding what is happening now and you will pay a high price for all that money printing. But if you’ve long since grasped that all that happened over the past 8 years of QE and central bank hot air was really “debt passed off as growth”, your wealth will be better protected. David Scott works for investment Manager Andrews Gwynne
UK Investor Magazine — 6 — March 2016
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ukinvestorshow.com UK Investor Magazine — 7 — March 2016
Perception vs reality By Mike Franklin
Research Analyst, Beaufort Securities
T
hese are interesting times for investors, both private and professional but the concept of ‘interesting times’, according to Wikipedia and other sources, is that it originated as part of a Chinese curse. However, this view is not conclusive and the nearest equivalent translation from Chinese is thought to be “Better to be a dog in a peaceful time, than to be a human in a chaotic (warring) period”. What this example demonstrates is that the reliability of source material is important although, in this case, the sense of what is meant is more important than how it is expressed. It is actually a reverse of classic Marshall McLuhan, the communication theory philosopher of ‘Global Village’ fame who coined the insightful phrase ‘the medium is the message’ and, perhaps, this is an exception that proves the rule. Anyway, I hear you ask, what if anything does all of this have to do with investment? Every day we are bombarded with seemingly mutually exclusive views from the macro to the
micro, on the outlook for markets to the arguments around the Brexit Debate. The investment scene is overwhelmed with noise – a veritable Tower of Babel – so it is important that investors develop a sense of the underlying truth in everything they consider. Wikipedia, for example, can be an extremely useful resource for gaining a broad overview on a topic but, depending on the quality of its contributors, its reliability could on occasions be compromised. It is worth noting that Wikipedia is not typically cited as a source for academic research reports. At this point, just for good measure, we drift into the area of Behavioural Economics and Cognitive Biases, in particular, Confirmation Bias which is the tendency to interpret information in a way that confirms one’s preconceptions. Whilst being open-minded about the sources of markets and
UK Investor Magazine — 8 — March 2016
stocks information that they consume (probably not a good idea, subject to available time, to restrict sources), the challenge of this effect for investors is the need to be aware of how we may be processing the information. In other words, what we should be striving for is ultimate objectivity. So how might this work in practice? Essentially this usually boils down to experience and some luck. Investors may try to build a record of their investment activity linked to the prompts that led to their decisions. In evaluating stocks and markets it is worth remembering that, for all the theorising about value, they are finally only worth what someone will pay you for them. In the last analysis, no matter how much they are defined in financial mathematics, investments are subject to confidence and the laws of fear and greed, and, in both directions, herd instinct. Along with confidence, another fundamental concept in investment is ‘return on capital invested’, adjusted for risk and inflation and the cost of capital amongst other relevant variables. When markets or stocks appear to overshoot, it is typically the herd instinct at work. A return to more normal valuations usually comes when the fundamental financial considerations such as reliable yield reassert themselves. So far, this piece has been about investment theory which you may or may not (in your recharged objective approach) choose to accept. Consequently, now is probably the time to introduce an element of the real world to show that we at Beaufort operate there. Firstly, a test of objectivity is to look at the February edition of UK Investor in which readers
were treated to ‘Three Sells for February’. The stocks in question were Petroceltic, the price of which duly fell from 21p to 10.25p, LGO Energy and Tungsten Corp. In the investment arena, we all live in glass houses so we tend to be careful not to cast the first stone. However, another case in point is the view expressed in The House View of having been bearish on equities for ‘two years’. Using the FTSE 100 Index as a proxy, the ‘bear market’ could be said to have started at the 27th April 2015 peak which was ten months ago. Consequently, for the record, 24 months of bearishness would have been, (at least in index terms) 14 months too early but then, who’s counting? To show that Beaufort is also prepared to ‘walk the talk’, here is a sample portfolio of stocks for yield-seekers. The list has been stressed to try to avoid the risk of dividend cuts despite reasonable earnings-to-dividend cover. In general, the shares of companies with exceptionally high gearing have been excluded bearing in mind that UK interest rates are expected to rise eventually. Subject to all the uncertainties being thrown at companies at the moment, those on the list are expected to achieve at least moderate earnings growth to be able to maintain their dividend levels. In addition, the stocks have emerged from a technical screen of the FTSE 350 Index constituents. This provides readers with a chance to monitor Beaufort’s recommendations which are intended to be considered suitable for someone investing on a one-to-two year view. Consequently, the prices could encounter wild swings in the interim but, if the dividends are maintained, they should tend to act like bonds moving towards maturity over the indicated term.
Short Name Curr Px Mkt Cap Dividend Yield Earnings-to-Gross % Dividend cover HSBC HLDGS PLC 432.90 87,386,738,035 8.18 1.29 FOXTONS GROUP 156.00 429,850,611 7.75 1.22 CARILLION PLC 269.80 1,140,174,767 7.48 1.58 BERKELEY GROUP 3199.00 4,439,991,876 6.50 1.73 INTERSERVE PLC 410.30 597,964,390 6.20 1.38 LEGAL & GEN GRP 213.40 12,677,043,628 6.10 1.47 VODAFONE GROUP 211.45 56,139,678,104 5.93 1.92 GALLIFORD TRY 1376.00 1,136,686,256 5.50 1.65 ROYAL MAIL 441.80 4,494,000,000 5.27 1.55 BRIT LAND CO PLC 644.50 6,638,692,002 4.33 6.13 Based on data from Bloomberg
At Beaufort Securities we offer a bespoke advisory service. Our people are dedicated to the markets day in and day out for one reason and one reason only - to help our clients profit. To discuss your strategies with a broker, please call us on 020 7382 8384. Beaufort Securities Ltd is authorised and regulated by the Financial Conduct Authority, registered number 155104 and is a member of The London Stock Exchange and ISDX.
UK Investor Magazine — 9 — March 2016
PrimaryBid, the online investment platform focused on AIM companies, launches service
P
rimaryBid, the online investment platform (the “platform”) that allows private investors to gain access to placings, fund raisings and IPOs of AIM-listed companies, is pleased to announce the formal launch of the platform today, 3rd March 2016.
more than 20 years’ experience in technology companies, including senior marketing and operational positions at Amazon (Head of Business Development in the UK), Yahoo (Head of Commerce, Yahoo Europe) and StepStone (Marketing Director).
PrimaryBid allows private investors to bid for participation in fund raising exercises for AIMlisted companies in a way that market structure has made difficult in the past.
Commenting on today’s launch, Dave Mutton, COO, said:
The platform has been operating in beta mode for the past 12 months and now has an updated website, free registration and includes every AIMlisted company. The Company is also pleased to announce that it recently successfully closed a Series “A” fund raising round of £500,000 underpinned by key strategic and institutional investors. In addition, the Company has appointed Dave Mutton as its Chief Operating Officer. The Series “A” fund raising will enable PrimaryBid to further develop its offering, build market position and boost awareness of its unique technology-led investing platform. The fund raising has been backed by a number of key brokers and institutional investors, including Shore Capital, finnCap, Arden Partners, high net worth individuals Dave Mutton is an experienced marketer with
“We are excited to be now formally launching PrimaryBid and being in a position to announce the successful Series “A” fund raise. It is critical to PrimaryBid’s success that we gain the trust of individual investors and the support of the City community. The fund raising has shown that brokers and other institutions support the concept of allowing private investors to gain the same access to investing opportunities in AIM-listed companies that they currently enjoy. Indeed, we would expect institutions to also use the platform alongside individual investors, helping us create a service that will become an integral part of any new share issue on AIM.” Sam Smith, CEO finnCap added: “We believe it is important to offer the same investment opportunities to investors of all types. We are therefore delighted to be working with PrimaryBid to provide access to fundraisings for retail investors. It brings a simple crowdfunding approach to IPOs and fund raisings, and this could also improve market liquidity.”
UK Investor Magazine — 10 — March 2016
Petropavlovsk plc An interview with chairman,Peter Hambro
By Tom Winnifrith, a loyal shareholder
Tom Winnifrith: The gold price shows signs that perhaps gold is not a barbarous relic after all. Do you see gold making further gains and what is your assumption for 1 year, 3 years and 5 years out? Peter Hambro: Yes, I do see the gold price gaining further ground. My view is based on the very heavy buying by the governments of China and Russia and the buying by the residents of China and India. The buying of physical is the story here. These investors do not care for “paper” gold (that is only another promise) YTD, gold is up 18% and I think that we will see a steady increases of $1-200 per annum going forward. TW: And what gold price do you use when budgeting for Petropavlovsk? PH: We base our planning on a spot-based gold price because that is the only thing that we know to be certain. TW: Do you see any downside for Petropavlovsk from Brexit? PH: We are not affected by Brexit itself but our £
based share-price and our $ based earnings make us a good hedge TW: How will you be voting and why? PH: Personally, I am finding it hard to make a reasoned decision but, if I had to vote today, it would be to stay in TW: There have been a couple of share transactions announced by your CEO Dr Pavel Maslovskiy, which some have interpreted as an EFH style disguised share sale. What are your critics missing? PH: We have a number of watchers who look for bad news wherever they can invent it. Since both Pavel Maslovskiy’s stock-lends call for the return of the same number of shares at a pre-determined time in the future I cannot see how it could be thought of as a sale. I don’t know what EFH is. TW: You seem to be on the hook to underwrite a very large loan taken out by the Chinese company IRC. PH: Yes we are. But it is a contingent liability and IRC is in the process of renegotiating its financing and construction contracts.
UK Investor Magazine — 11 — March 2016
TW: How large is this loan and what happens if you are called upon to pay up?
underground mining and the pressure oxidation of refractory ore from the Malomir deposit
PH: The original loan was US$340m at LIBOR+2.8%, of which c. US$275m remains as at YE 2015 following scheduled repayments by IRC.
TW: For how many years, based on current reserves, can you continue producing gold at projected 2016 levels?
If it is called, we would have to pay. What form that takes depends on many things, as does the likelihood that it is called. Discussions are still ongoing.
PH: Assuming that we can achieve the joint-venture on the POX plant, we have 9Moz of reserves so, without any further exploration success, 18 years at 500Koz / p/a
If we do have to pay up we will, in some way, end up owning IRC assets.
TW: At what stage does private equity start buying into your sector thus giving it the spark of life from corporate action?
TW: Your own YE debt at 31/12/15 was down to $610 million. At various gold prices what might it be at Christmas 2016 and how soon can you clear it?
The arrival of Mr Viktor Vekselberg’s company on the register with 15% of the shares, I think that private equity has arrived
PH: This, sadly is not public information yet
TW: Is a weak rouble an issue for you?
TW: At what point does it make sense to buy back shares (given you appear to be valued on an EV/EBITDA of c3) rather than repay debt?
PH: 75% of our costs are rouble based so a weak rouble is good for our margins
PH: The banks dictate that at present. When and if they decide that we have repaid enough we can reconsider this agenda TW: What is your output guidance for this year? PH: As per our Q4/FY 2015 trading update, we expect gold production of between 460 – 500Koz in 2016 TW: If the gold price increases might you edge that number higher? PH: Higher profit margins on our production will help; but the growth will come from future
TW: Would you - ceteris paribus - rather own a mining business operating in Russia or in the EU? PH: I have been an investor and manager in both. In one EU country the General Manager’s house was bombed by an irate local and in another I was temporarily convicted of corporate manslaughter, when an employee had a heart attack in the shower. Luckily the General Manager was not hurt and the case against me was expunged from the records because the State Prosecutor said it should never have been brought. We have not had anything like that in Russia, touch wood.
Hot Stock
ROCKETS Stocks Ready to take off hotstockrockets.com UK Investor Magazine — 12 — March 2016
EIS Investing – tax breaks but beware the pitfalls By Nigel Somerville
E
IS investing should be on the radar for the longer term investor interested in small caps and early stage companies because of the generous tax breaks on offer. It can be done either by getting in on an EIS-qualifying share issue by an individual company, or via an EIS fund which does the leg-work for you. Going for an individual company has its advantages: you retain control over the shares and you can do your own anoraking at Companies House and check out RNSs if the company is listed. Alternatively it could be a company you already follow and are happy to pony up a few more readies. Via a fund you don’t really have much (if any) control over what the cash goes into or over events if things go wrong. There will also be charges – initial fees, commissions, ongoing management fees, performance incentives, administration and so on. On the other hand you are likely to get a spread of investments which should even out some of the risk. Get a good manager and with a following wind you’ll do very well but in my view you really have to do your homework on those into whose hands you entrust your cash – and the details of the way it is all set up. There are two EIS schemes currently in operation. The standard one offers a tax break up-front of
30% of your investment to be deducted from your tax bill, provided you have enough of a tax bill to cover it. The newer SEIS scheme offer an up-front tax break of 50% of your investment although the companies which qualify are smaller, younger and therefore more likely to fail. Should the fine enterprise into which you invested your cash go bust, or you clock up a loss on disposal then you can set the cost (net of the tax break) against income for tax purposes. There is also an inheritance tax exemption which kicks in after the shares have been held for two years, and chargeable capital gains can be deferred by reinvesting those gains into an EIS qualifying share issue. The chargeable gain won’t go away because it is re-crystallised when you sell the EIS investment after three years or more. But it could be in a year in which you can use the CGT allowance and/or defer it again into another EIS investment. You have to hold on to EIS shares for three years from issue to keep the tax breaks, and the company has to remain engaged in a qualifying business during that time. All being well, if you dispose of your EIS shares after the 3 year period and make a gain it is exempt from CGT. Dividends, however, are not exempt from tax (although given the type of company which qualifies for the scheme this is unlikely to be a consideration).
UK Investor Magazine — 13 — March 2016
Thus on the standard EIS scheme, if you invest £1000 then it knocks £300 off your tax bill and your net cost of investment is then £700. Even if you eventually sell for the £1000 originally invested, it has only cost you £700 and thus you’ve just clocked up a 43% gain. Under SEIS selling for the £1000 would mean a 100% gain after taking the up-front tax relief into account. Tax relief on losses is also a consideration. Under EIS a total write-off would have cost you a net £700 on your £1000. But that can be set against income and thus a 20% taxpayer can claim a further £140 of tax relief (provided there is enough taxable income to set it against) to bring the net loss down to £560. A 40% taxpayer would reduce the loss further, to £420. Under SEIS a total write-off would have cost £500. Setting that against taxable income sees our 20% tax-payer suffer a reduced loss of £400 and 40%-ers are down to just £300. That is quite a bit of protection from the grateful taxpayer, with the possible further benefits offered by capital gains roll-over. But the upside is all yours. So what can go wrong? Unfortunately there is plenty. 1) The company you invested in could divest or close its qualifying business before the three years are up. You’ve just lost all the tax breaks. 2) The company could go bust. You keep the tax
breaks but you’ve still lost money. You might be Warren Buffett but in the world of start-ups and early stage companies this is going to happen to a fair number of EIS-qualifying investments. If you invested via a fund then there is plenty more to go wrong (quite apart from the fees). You may have followed the fund manager and trust him/her. But what if there is a change? You will probably have signed a contract which leaves your remaining cash tied in to the fund and you might not like the new regime. You could find yourself disenfranchised at a critical time too. What if the manager left and cash found its way into a failing enterprise which then proposed to divest or close all of its qualifying activities before the three year period was up? What if, just before the crucial vote, the fund was closed and so votes which would have defeated the proposals overwhelmingly (and thus forced insolvency but preservation of the tax breaks, instead of only a near wipe-out but loss of EIS qualification) were not cast, and to cap it all you only found out about the closure AFTER the vote had taken place? It sounds fanciful, but these things happen. It happened to me. The EIS and SEIS schemes are a great way to gain exposure to early-stage investing by offering a good degree of capital protection from the tax breaks, with enormous tax-free upside if all goes well.
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UK Investor Magazine — 14 — March 2016
Three Sells for March By Tom Winnifrith
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ince my last column of bearish spite in this publication, equities have rallied strongly. The FTSE 100, last seen , was back above 6,100 and no doubt some folks out there will once again be in full bullish mode. The worst is over, they cry. China has not crashed, base rates are not going up, blah, blah, blah. Most such folks were the same buffoons who told you that once the FTSE 100 breached 7,000 then a rapid re-rate to 8,000 was inevitable and imminent. Whatever happened to that? The reality is that the most violent movements in bear markets are the up days (and weeks).They give short term comfort to the perma-bulls as they once again chant BOTD. But they are but brief respites in a trend that remains consistently bearish. We bears are still very much in control. There is no point in me once again re-hashing the bear macro case and as it happens David Scott (Page 4) does so in a very eloquent manner. He is, in fact, rather more bearish than I am but he says enough there which appears impossible to argue with and that makes me more sure than ever that share values are, at best, fully and at worst overvalued.
And so what to sell? At the risk of repeating myself PetroCeltic (PCI) at 9.5p is just free money as a short. You simply cannot go wrong here. The Irish oil junior has borrowings of c$220 million and sod all free cash. It has breached its banking covenants and so the lenders could pull the plug at any time. But they will not as they know full well that selling this company’s assets at this time would not realise anything like the amount needed to clear the debt. And that is why debt can be bought in the market at 35 cents in the dollar. 29.6% shareholder Worldview has put in a 3p per share cash offer. It stresses that it, like me, regards the equity as worthless and could just go to the banks direct but in order to make things smoother
it will write a cheque for c£4 million to buy the other 70% of the company. So there are only two outcomes. First is that the bid goes through in which case you sell at 9.5p to collect at 3p. That is the worst case scenario - as a bear. Amazingly some shareholders - egged on by clueless broker Cenkos - wish to reject the bid and they could well block it. In which case Worldview just buys the debt and pulls the plug meaning that shareholders get nothing. 0p.
There is no other outcome and this is simply free money if you can get borrow and short the stock. My second sell is Eden Research (EDEN), an AIM listed company which has been committing fraud for years. I have demonstrated clearly on ShareProphets that this company booked bogus revenues in 2011 by signing a deal with a company that did not actually exist at the time (Terpenetech) and that it continued to record those revenues as “trade receivables within 12 months” in its 2011, 2012, 2013 and 2014 calendar accounts even though Terpenetech was not actually doing any business of note and could not pay. That is fraud. As a bonus in August 2015 Eden booked £600,000 of sales to Terpenetech (which had no money) but then invested £920,000 in Terpenetech ( valuing a company with no money, no balance sheet, sod all sales and which was run out of Eden’s own offices) at £3.1 million. Terpenetech then sold those Eden shares as fast as it could. The net effect is that Eden has now banked the £600,000 plus the 2011 cash and so is not yet insolvent. Without this panama pump securities fraud it would have gone bust by September last year. Amazingly the Nomad Shore Cap seems not to
UK Investor Magazine — 15 — March 2016
care about the fact that its client has committed five years of fraud. As it happens I exposed this company for lying in releases and committing fraud back in 2005 so it has “form”. It is also almost out of cash once again, still has sod all real revenues and at 13.5p the company is capitalised at £21 million. On a NPV basis, because it is almost bankrupt and because it has committed fraud fair value is 0p. It will get there either because it runs out of cash or because the UK Regulatory authorities - for once - actually do something.
has a market capitalisation of £151 million. This company has featured here before but really could be a zero by mid year. And at the current market cap you can get borrow and go short. Last week the credit rating’s agency S&P flagged up that it was planning a downgrade to the status of Avanti’s bonds which currently trade on a junk on steroids yield to redemption. In essence S&P was just confirming what the market was telling you - Avanti needs to raise more debt fast even though it is drowning in the stuff as it has just failed to deliver sales on its existing HYLAS satellites as promised. And it is now pissing away the cash that it does have on launching more tin cans into space. It is the space equivalent of digging yourself ever deeper into a hole. Avanti is not generating cash after interest & PLC costs now and if it somehow manages to take on even more debt then it has just not got a prayer of generating free cashflow. That means that when its debts start to fall due for redemption in 2010 it does not have a hope in hell of being able to repay.
Finally I turn to another company that I have asked my pals at the Financial Reporting Council to investigate for serving up dodgy accounts, Avanti Communications (AVN) which at 102.5p
If Avanti is going to raise more debt it is also going to have to raise stacks more equity - why the hell should debt providers take a distressed equity risk for a debt return? I am not sure that this is refinanceable at all. Whatever happens the shares are going to crash. The only issue is whether they have a residual value of pennies or no value at all. Either way Avanti is a stonking sell.
Tom Winnifrith’s
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newsletters.advfn.com/tomwinnifrith UK Investor Magazine — 16 — March 2016
company of the month
Safestyle UK plc
A ‘safe as houses’ investment on AIM? By Steve Moore
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hares in this company which describes itself as “the leading UK-focused retailer and manufacturer of PVCu windows and doors for the homeowner replacement market” were a January recommendation on our ‘Nifty Fifty’ subscription website at a 245p offer price. They are already up to 285p with positive momentum following a 2015 year-end trading update, but is this a ‘safe as houses’ investment on AIM? Safestyle (SFE) has grown from its 1992 founding to a last-reported 32 sales branches, 11 depots and making-to-order at manufacturing facilities in Yorkshire. The year-end trading update noted data showing “the company has continued to increase market share from 8.48% as at 31 December 2014 to 9.46% as at 31 December 2015”. This update added that “profit before tax has shown good progress and is anticipated to be in line with consensus market expectations” as “the expected strong performance in the second half saw double digit growth in both sales and profit”. Additionally it reported that “cash flow has continued to be strong and we ended the year with cash of £16.5 million”. This suggests a pre-tax profit of £17.6 million on revenue not far off £149 million (2014: £136 million), with the cash up from £8.5 million a year earlier and £14.9 million at the half year stage. Earnings per share should come in at more than 17.5p, up from a prior year 16.5p, and a dividend per share of more than 6.5p be announced – taking the total for the year to 10p+ (2014: 9.3p). This is with the order book stated to be 1.2% up on the prior year and CEO Steve Birmingham noting “a strong start to 2016 and are confident of building
on the progress made in 2015”. However, this is not to say the outlook is troublefree. The company noted “a weaker market in 2015”, with its growth against this backdrop helped by “the successful rollout of our enhanced consumer finance offer”, though this impacting operating margins. It admits that it “operates in a competitive market which is very exposed to the UK’s economic performance and general consumer confidence” and thus these are certainly things to monitor here. However, for now, the trading trajectory looks positive – with further earnings, cash and dividend progress currently forecast for 2016. It would likely take a share price of comfortably above 300p to take the current-year dividend yield down to 3.5% and thus we presently hold for more in the Nifty Fifty Income portfolio ahead of the 2015 results statement scheduled for 17th March. CEO Steve Birmingham has more than 30 years’ experience of the replacement window industry in senior management positions and joined Safestyle in 1999 as Operations Director. He stepped up to the leading management role in 2007. Chief Financial Officer Mike Robinson has more than 30 years’ experience in operational finance roles in a range of manufacturing and distribution businesses including 13 years, and 3 as UK Finance Director, at Fortune-500 company RR Donnelley. He joined Safestyle in 2008. Chairman Steve Halbert took the role on the company’s AIM IPO in December 2013. He worked as a corporate finance partner at KPMG for 15 years until 2008, including as UK head of M&A and Chairman of US operations within KPMG’s corporate finance business.
UK Investor Magazine — 17 — March 2016
the house view Brexit really will not effect your portfolio
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here is no point in pretending that the editorial team here is anything other that hard line Eurosceptic. Whatever deal David Cameron came back with from the faux negotiations with other EU leaders was irrelevant to us , we were outers anyway. As it happens Cameron went to Brussels asking for little, came away with even less and then told blatant lies in pretending otherwise. And the lies of the “in camp” have continued ever since as they embarked on project fear. One lie is that the stockmarket will crash. That is demonstrably unprovable. The vast majority of earnings from London listed companies come from outside of the EU, i.e. in the UK or the Rest of the World. So even if the EU ( which runs a trade surplus with the UK) commits hari kiri and starts a tariff war the impact will be muted. Meanwhile we are also told that Sterling will crash if we leave the EU. We rather suspect that the recent weakness of the pound has more to do with George Osborne warning that his economic growth forecasts were - as we suggested at the time - total fantasy and that Government spending would have to be cut/base rates would not go up than to do with fears of Brexit. But let us humour the Euro loons from Project Fear and say that
Sterling will slide on Brexit. Who does that benefit and benefit big time? Yes. Exporters, which means the vast majority - on a weighted basis - of London listed companies. If we do see Sterling slide you can thus expect to see corporate earnings race ahead at rates we just could not have hoped for. Mr Cameron and his coliars cannot have it both ways. The reality is that if the UK does vote for Brexit as we hope that it will because it makes both political and economic sense for the country to do so, the effects on the stockmarket will be short term and immaterial. We are always told that General Elections will have a big effect on shares. They do not. Look back at a long term chart of the FTSE 100 and - if we remove the dates on the bottom line - we challenge you to spot the micro-blips that mark General Election campaigns. They are truly irrelevant. No doubt brokers want you to churn your portfolio ahead of Brexit because it makes them money. But it will not make you a cent. Brexit is at least a stockmarket irrelevancy in the greater scheme of things. At most, since it would be of enormous benefit to the British economy by reducing the fiscal take and the regulatory burden on business, it would be a reason to buy shares.
UK Investor Magazine — 18 — March 2016