Be wary as private equity backed IPOs may be about to return
This article first appeared in Aimzine, www.aimzine.co.uk
With some reluctance, I went on my first ever cruise this month. My reluctance wasn’t the fear of being on a large piece of floating steel in the calm waters of the Med for a week, but rather the thought of being captive in a mobile hotel with a very large number of Americans. I suspect that like most Brits, there are certain things about America that I love such as its energy, optimism and vibrancy but there are other things which cause me, at best, concern and at worst total dismay. Putting aside serious matters such as the possibility that a Soccer Mom might become the next President, the unquestioning support by successive American governments for brutal dictatorships and the huge amount of US government debt which will one day cripple the global economy, my greatest concern and dismay right now is over the import into the UK of the US concept of the Prom Party. This phenomenon is growing massively in the UK with more and more schools every year organising these over-glamorised school-disco celebrations of insignificance.
The Prom Party is good news for some people though; most notably retailers. Rob Templeman, soon-to-depart Chief Executive of Debenhams says that for his company it is now the second largest sales peak of the year, second only to Christmas. That’s probably little comfort for his shareholders who have seen the Debenhams share price fall from 195p at IPO in 2006 to around 70p currently.
Large dividends
The IPO price although at the bottom end of the range at the time still delivered a good return for the private equity firms which had originally taken Debenhams private in 2003. CVC, Texas Pacific and Merrill Lynch tripled their £600m investment during the three years the company was in private equity ownership, partly through selling properties, increasing the company’s debt and taking out large dividends.
Since the company listed on the stock exchange with shares being bought by reputable institutions there have been numerous questions raised about the growth prospects for Debenhams, even before gloom descended on the high street. Strong sales growth was essential to service the debt that had been foist on to it by the private equity firms, as well as to meet the largely fixed costs of a retail business. However, that sales growth hasn’t come through with the last reported figures showing like-for-like sales excluding VAT being down by 1.5%. Moreover, after repeated profits warnings and dividend cuts the Chairman admits that the current outlook is “no real change in consumer confidence”.
So for institutional shareholders who bought shares at the IPO it has been a fairly torrid time made worse by knowing that the previous shareholders managed a phenomenal return on their investment.**
I was reminded of the Debenhams saga during the month as another private equity backed clothing retailer New Look revealed that it wouldn’t be seeking an IPO in the near future. Looking through the results they announced for the year to March 2011 that was hardly surprising as like-for-like sales were down by 5.5%. This downturn in revenues contributed to a fall in Operating Profit from £162m last year to £98m; quite a problem when the company has net debt of over £1 billion on its balance sheet. No doubt though that the current owners of New Look, the private equity firms Apax and Permira, will do what they need to do to prepare the company for IPO at some point in the future, and pass the problems on to some nice-but-dim fund manager.
Successes and failures
Of course, over the years, there have been some cases of private equity successfully improving performance in acquired businesses, including Halfords, the Automobile Association, Homebase and RHM. There have of course been notable failures, the most spectacular being the imminent failure this month of the care homes business, Southern Cross, previously owned by another private equity group, Blackstone. Southern Cross provides a further example of property sales followed by increased debt and massive dividends for private equity groups, ending up with an IPO, although in this case of course its failure has more serious consequences for its customers than a high street retailer disappearing into receivership.
Most recently this month, Aviva announced that it was selling its RAC roadside rescue business to the private equity group Carlyle for £1 billion. The managing director of Carlyle, Andrew Burgess, said he saw a “strong longer-term potential to grow the business by investing in new and innovative financial services offerings, such as motor and household insurance”. No mention of course of selling properties, increased debt or huge dividends for Carlyle. However, bank debt is becoming more available for these types of deals and is likely to be used in the RAC deal; infact JP Morgan which ran the sale process for Aviva is also making finance available for the successful bidder which will put debt on to RAC’s balance sheet of up to seven times the company’s operating profit.
What is certain is that at some point RAC will come back to the public markets along with other PE-backed companies such as Merlin, the owner of tourist attractions including Madame Tussauds, Phones4U, and numerous other companies being lined up for IPO. Ernst & Young, a leading accountancy firm estimates that there are fifty private equity backed companies intending to IPO in the near future and looking to raise around £10 billion in aggregate.
The question for investors both institutional and private is if by the time they get on board the party will still be going on or whether it will be about to fizzle out leaving the new shareholders to do the clearing up.
** For anyone wanting to understand the fascinating case study of Debenhams from its purchase by private equity in 2003 through to its profit warnings and dividend cuts as a public company, contact me on the email address below for an excellent academic research report.
Tuesday 5 July 2011
Saturday 7 May 2011
Are you free Mr Lucas?
Shareholders are getting more information but do they feel they are being served?
This article first appeared in Aimzine, www.aimzine.co.uk
I’m not sure why but I look back on the 1970’s with a degree of nostalgia. It could be the three day week resulting from the miners’ strike, or the country declining to the brink of bankruptcy or the ever present threat of nuclear annihilation. I suspect though that, as a child at the time, part of the nostalgia is down to having shared experiences such as most of the country simultaneously watching programmes like “Are You Being Served?”. So it was with some momentary sadness that I read of the death last month of Trevor Bannister who played Mr Lucas in the series. Another 70’s great passes away even though most of us probably never realised he was still alive.
Roll forward to the late 1980’s and the miners had been defeated in the return leg of the strike fixture, the economy had been brutally beaten into shape and as the USSR disintegrated, nuclear annihilation suddenly became further into the future than just four minutes. It was around that time that I was approaching graduation and wondering what I could do with my life to avoid practising my degree subject of pharmacy. I started to consider accountancy amongst other things, and one of the ladies I worked with in Boots during my pre-registration training suggested I have a chat with her son, Chris Lucas, who had joined Price Waterhouse a few years earlier. I met with Chris and his enthusiasm for accountancy was a key factor in my subsequently joining the profession, albeit with the slightly cuddlier firm of KPMG.
I haven’t seen Chris Lucas since but to be fair to him he hasn’t really been free. He’s been busy firstly rising to partner at what is now PricewaterhouseCoopers, then to Head of PwC’s Banking Practice, being the lead partner on the Barclays Bank audit, and then more recently becoming Group Finance Director of Barclays.
Close monitoring
With an audit partner becoming the Finance Director of a client, there is always, quite rightly, a closer monitoring of the individual’s role and whether the gamekeeper turned poacher has any implications for corporate governance and financial reporting. In this case, to their credit, Barclay’s dealt with the potential issue by appointing Sir Michael Rake as a non-executive director not long after. Sir Michael was previously Chairman of KPMG International and is one of the biggest hitters in accountancy circles.
We don’t know what impact Sir Michael has had on the governance of Barclays. In fact, shareholders seldom know what is happening behind the scenes in a company. Annual Reports and trading updates often refer to business activities in a rather perfunctory way. Although, regulators have tried to change this by requiring companies to discuss business operations and risks in more detail there has seldom been any discussion about why the numbers reported are as they are.
That box-ticking landscape began to change recently because Sir Michael as head of the Audit Committee of Barclays wrote a few paragraphs in his Audit Committee report about certain judgements the Committee discussed with the auditors. Whilst not very long this section highlights five issues which could have been accounted for differently and, if so, would have had a material impact on the numbers that Barclays subsequently reported for 2010.
Although shareholders cannot work out what financial impact there would have been if the issues had been accounted for differently they do provide an invaluable insight into the prudence applied or otherwise in preparing the accounts. This is the type of information which hitherto never went beyond the audit committee, board and auditors.
Methods and judgements
No doubt Sir Michael’s decision to introduce this improved reporting may be connected to a document issued by the Financial Reporting Council on Effective Company Stewardship (1) which is well worth a read and, amongst other things, highlights the reliability of financial statements being increasingly dependent on matters such as “the methods and the judgements made in valuing assets and liabilities”. In Barclays case for example, whether the fall in value of its investment in the fund manager Blackrock (to which it sold Barclays Global Investors) should be charged against reserves or go through the profit and loss account and hit earnings per share. Not surprisingly, Barclays chose to take it through reserves and not through the P&L, but at least it was highlighted and there was a rationale given for that decision.
Unfortunately, the significance of this improved reporting and of Barclays leading the way has been drowned out by the continuing public and shareholder anger at banker’s bonuses; the 2010 bonus pool at Barclays was £2.6 billion compared to dividends to shareholders of just £645 million.
So, whilst Sir Michael deserves a knighthood if he didn’t already have one, important improvements such as this one will be overlooked if more pressing business issues aren’t addressed by management teams, and if shareholders continue to feel that they aren’t being served by the people their company employs. In the case of Barclays, if Mr Lucas is free he might want to consider whether the cost of bonuses at this level makes business sense or whether a rebalancing with the dividend might prove to create more shareholder value.
(1) http://www.frc.org.uk/images/uploaded/documents/Effective%20Company%20Stewardship%20Final2.pdf
This article first appeared in Aimzine, www.aimzine.co.uk
I’m not sure why but I look back on the 1970’s with a degree of nostalgia. It could be the three day week resulting from the miners’ strike, or the country declining to the brink of bankruptcy or the ever present threat of nuclear annihilation. I suspect though that, as a child at the time, part of the nostalgia is down to having shared experiences such as most of the country simultaneously watching programmes like “Are You Being Served?”. So it was with some momentary sadness that I read of the death last month of Trevor Bannister who played Mr Lucas in the series. Another 70’s great passes away even though most of us probably never realised he was still alive.
Roll forward to the late 1980’s and the miners had been defeated in the return leg of the strike fixture, the economy had been brutally beaten into shape and as the USSR disintegrated, nuclear annihilation suddenly became further into the future than just four minutes. It was around that time that I was approaching graduation and wondering what I could do with my life to avoid practising my degree subject of pharmacy. I started to consider accountancy amongst other things, and one of the ladies I worked with in Boots during my pre-registration training suggested I have a chat with her son, Chris Lucas, who had joined Price Waterhouse a few years earlier. I met with Chris and his enthusiasm for accountancy was a key factor in my subsequently joining the profession, albeit with the slightly cuddlier firm of KPMG.
I haven’t seen Chris Lucas since but to be fair to him he hasn’t really been free. He’s been busy firstly rising to partner at what is now PricewaterhouseCoopers, then to Head of PwC’s Banking Practice, being the lead partner on the Barclays Bank audit, and then more recently becoming Group Finance Director of Barclays.
Close monitoring
With an audit partner becoming the Finance Director of a client, there is always, quite rightly, a closer monitoring of the individual’s role and whether the gamekeeper turned poacher has any implications for corporate governance and financial reporting. In this case, to their credit, Barclay’s dealt with the potential issue by appointing Sir Michael Rake as a non-executive director not long after. Sir Michael was previously Chairman of KPMG International and is one of the biggest hitters in accountancy circles.
We don’t know what impact Sir Michael has had on the governance of Barclays. In fact, shareholders seldom know what is happening behind the scenes in a company. Annual Reports and trading updates often refer to business activities in a rather perfunctory way. Although, regulators have tried to change this by requiring companies to discuss business operations and risks in more detail there has seldom been any discussion about why the numbers reported are as they are.
That box-ticking landscape began to change recently because Sir Michael as head of the Audit Committee of Barclays wrote a few paragraphs in his Audit Committee report about certain judgements the Committee discussed with the auditors. Whilst not very long this section highlights five issues which could have been accounted for differently and, if so, would have had a material impact on the numbers that Barclays subsequently reported for 2010.
Although shareholders cannot work out what financial impact there would have been if the issues had been accounted for differently they do provide an invaluable insight into the prudence applied or otherwise in preparing the accounts. This is the type of information which hitherto never went beyond the audit committee, board and auditors.
Methods and judgements
No doubt Sir Michael’s decision to introduce this improved reporting may be connected to a document issued by the Financial Reporting Council on Effective Company Stewardship (1) which is well worth a read and, amongst other things, highlights the reliability of financial statements being increasingly dependent on matters such as “the methods and the judgements made in valuing assets and liabilities”. In Barclays case for example, whether the fall in value of its investment in the fund manager Blackrock (to which it sold Barclays Global Investors) should be charged against reserves or go through the profit and loss account and hit earnings per share. Not surprisingly, Barclays chose to take it through reserves and not through the P&L, but at least it was highlighted and there was a rationale given for that decision.
Unfortunately, the significance of this improved reporting and of Barclays leading the way has been drowned out by the continuing public and shareholder anger at banker’s bonuses; the 2010 bonus pool at Barclays was £2.6 billion compared to dividends to shareholders of just £645 million.
So, whilst Sir Michael deserves a knighthood if he didn’t already have one, important improvements such as this one will be overlooked if more pressing business issues aren’t addressed by management teams, and if shareholders continue to feel that they aren’t being served by the people their company employs. In the case of Barclays, if Mr Lucas is free he might want to consider whether the cost of bonuses at this level makes business sense or whether a rebalancing with the dividend might prove to create more shareholder value.
(1) http://www.frc.org.uk/images/uploaded/documents/Effective%20Company%20Stewardship%20Final2.pdf
Wednesday 16 March 2011
Porridge for business leaders
If prison is a good deterrent to business crime why don't we use it more?
This article first appeared in Aimzine, www.aimzine.co.uk
Although I regard myself as very tech-savvy I’m not an avid Facebook user. Therefore I rely on old-fashioned techniques such as email and the telephone to keep in touch with what friends are up to. Recently though, one of my best friends from school was the subject of an article in the Evening Standard, which at least saved me a phone call. I say school friend but it will become apparent why I now need to refer to him as an acquaintance or even just someone I vaguely knew. “Oh, him. Yes I think I spoke to him once or twice”, I’ll have to respond when people question me about our secondary school friendship.
The reason is that he, let’s calls him PS, was in a crown court recently facing charges of fraud. It seems that his persona of being a successful property developer turned out to be a house of cards. The stunning home he and his wife owned (albeit partly with a fraudulently obtained mortgage) in the Guildford countryside, along with the obligatory Porsche and Land Rover parked outside, were funded mostly by asking parents from his children’s exclusive independent school to invest in his property empire that never was. Many “investors” put in six figure sums and actually those amounts were invested in property but it’s just that they were invested into his Guildford home. So, fair enough that PS is now serving time at Her Majesty’s pleasure and I daresay he’s probably not enjoying it, unless of course he’s discussing plans for a new business with two ex-directors of a Torex Retail subsidiary.
Last month, Edwin Dayan and Christopher Ford previously directors of XN Checkout which supplied software for shop tills to the likes of McDonald’s, Argos and Homebase were sentenced to prison for falsifying invoices to create the impression that XN had made £1.65 million more profit than it really had. Sentencing the two, the judge said 'such sentences may seem harsh on a personal level, but a strong deterrent is needed'. Again, it’s difficult to argue with that conclusion.
These two stories received a fair bit of coverage in the daily press, but of equal interest is the story of someone not going to prison.
Not going to prison
During the month, The Insolvency Service announced that it had applied to the High Court to disqualify all of the former directors of Farepak and its parent company EHR. You may remember that in 2006, just weeks before Christmas, Farepak went into administration. The company collects monthly payments from its customers then distributes vouchers back to those customers for use over the Christmas period. During that time it builds up substantial cash balances and had loaned £35m of those balances to another EHR group company which also went into administration. Savers, many of whom are from the poorest parts of society, lost out entirely that Christmas and only much later did they recover around a third of what they had saved. The Insolvency Service said that the directors’ conduct made them “unfit to be concerned in the management of a company”.
Something that doesn’t seem to have been addressed clearly enough though is the directors’ obligations under the Companies Act 2006. The Act, CA2006, was the largest piece of legislation to ever go through Parliament and codified much of what had previously been case law; you’d think therefore that it would be effective. One obligation it places on directors is that they use reasonable care, skill and diligence in exercising their duties. The extent of their obligation is related to the experience and knowledge they possess. Therefore a director who has more experience, knowledge and skill will have a higher threshold in discharging this duty. You’d think then that Sir Clive Thomson, chairman of EHR at the time, who has served on the boards of six FTSE companies, and ran Rentokil for two decades might have had some expectation on him as to his thinking during the Farepak crisis and a high threshold as to how he discharged his duties.
Independent judgement
Another obligation on directors is to “exercise independent judgement”. It’s not clear whether the directors of Farepak fulfilled that responsibility when they agreed to loan £35m of their customers’ cash to another group company. A degree of independence might have led them to question whether the credit risk was good and whether they would have made a loan to a third party in a similar situation.
However, we will never know as apparently CA2006 doesn’t allow investigations such as the one into the circumstances around Farepak’s collapse to be made public. We therefore have to trust the government and its agencies that their priorities are correct and that there are no other factors for stronger action not to have been taken.
From my layman’s position I find it hard to differentiate between someone who took other people’s money to invest in his own house, and a group of directors who took other people’s money from a savings plan to prop up another company that they were directors of.
The judge in the Torex case had it spot on when he sought to give a sentence which would act as a deterrent but of course for judges to do that the government and its agencies have to ensure that people with a case to answer do actually appear in the dock in the first place. The history of business misdemeanours over the last thirty years seems to indicate that government agencies whether the Serious Fraud Office, or the City of London Police or others have been either too indifferent or too incompetent to address this failing.
© Ash Mehta
This article first appeared in Aimzine, www.aimzine.co.uk
Although I regard myself as very tech-savvy I’m not an avid Facebook user. Therefore I rely on old-fashioned techniques such as email and the telephone to keep in touch with what friends are up to. Recently though, one of my best friends from school was the subject of an article in the Evening Standard, which at least saved me a phone call. I say school friend but it will become apparent why I now need to refer to him as an acquaintance or even just someone I vaguely knew. “Oh, him. Yes I think I spoke to him once or twice”, I’ll have to respond when people question me about our secondary school friendship.
The reason is that he, let’s calls him PS, was in a crown court recently facing charges of fraud. It seems that his persona of being a successful property developer turned out to be a house of cards. The stunning home he and his wife owned (albeit partly with a fraudulently obtained mortgage) in the Guildford countryside, along with the obligatory Porsche and Land Rover parked outside, were funded mostly by asking parents from his children’s exclusive independent school to invest in his property empire that never was. Many “investors” put in six figure sums and actually those amounts were invested in property but it’s just that they were invested into his Guildford home. So, fair enough that PS is now serving time at Her Majesty’s pleasure and I daresay he’s probably not enjoying it, unless of course he’s discussing plans for a new business with two ex-directors of a Torex Retail subsidiary.
Last month, Edwin Dayan and Christopher Ford previously directors of XN Checkout which supplied software for shop tills to the likes of McDonald’s, Argos and Homebase were sentenced to prison for falsifying invoices to create the impression that XN had made £1.65 million more profit than it really had. Sentencing the two, the judge said 'such sentences may seem harsh on a personal level, but a strong deterrent is needed'. Again, it’s difficult to argue with that conclusion.
These two stories received a fair bit of coverage in the daily press, but of equal interest is the story of someone not going to prison.
Not going to prison
During the month, The Insolvency Service announced that it had applied to the High Court to disqualify all of the former directors of Farepak and its parent company EHR. You may remember that in 2006, just weeks before Christmas, Farepak went into administration. The company collects monthly payments from its customers then distributes vouchers back to those customers for use over the Christmas period. During that time it builds up substantial cash balances and had loaned £35m of those balances to another EHR group company which also went into administration. Savers, many of whom are from the poorest parts of society, lost out entirely that Christmas and only much later did they recover around a third of what they had saved. The Insolvency Service said that the directors’ conduct made them “unfit to be concerned in the management of a company”.
Something that doesn’t seem to have been addressed clearly enough though is the directors’ obligations under the Companies Act 2006. The Act, CA2006, was the largest piece of legislation to ever go through Parliament and codified much of what had previously been case law; you’d think therefore that it would be effective. One obligation it places on directors is that they use reasonable care, skill and diligence in exercising their duties. The extent of their obligation is related to the experience and knowledge they possess. Therefore a director who has more experience, knowledge and skill will have a higher threshold in discharging this duty. You’d think then that Sir Clive Thomson, chairman of EHR at the time, who has served on the boards of six FTSE companies, and ran Rentokil for two decades might have had some expectation on him as to his thinking during the Farepak crisis and a high threshold as to how he discharged his duties.
Independent judgement
Another obligation on directors is to “exercise independent judgement”. It’s not clear whether the directors of Farepak fulfilled that responsibility when they agreed to loan £35m of their customers’ cash to another group company. A degree of independence might have led them to question whether the credit risk was good and whether they would have made a loan to a third party in a similar situation.
However, we will never know as apparently CA2006 doesn’t allow investigations such as the one into the circumstances around Farepak’s collapse to be made public. We therefore have to trust the government and its agencies that their priorities are correct and that there are no other factors for stronger action not to have been taken.
From my layman’s position I find it hard to differentiate between someone who took other people’s money to invest in his own house, and a group of directors who took other people’s money from a savings plan to prop up another company that they were directors of.
The judge in the Torex case had it spot on when he sought to give a sentence which would act as a deterrent but of course for judges to do that the government and its agencies have to ensure that people with a case to answer do actually appear in the dock in the first place. The history of business misdemeanours over the last thirty years seems to indicate that government agencies whether the Serious Fraud Office, or the City of London Police or others have been either too indifferent or too incompetent to address this failing.
© Ash Mehta
Friday 11 February 2011
Death, taxes and fairness
Companies should view taxes as a cost like any other but also realise the risks to their reputation as a result
This article first appeared in Aimzine www.aimzine.co.uk
Benjamin Franklin famously said that in life there are only two certainties, death and taxes. Well for IKEA, the “love-it-and-hate-it-at-the-same-time” furnishings retailer, it seems the two are closely linked. Last month a Swedish team of investigative journalists uncovered that the IKEA group is a complex web of companies and foundations with more parts than an ASPELUND wardrobe. The ultimate holding company turns out to be in Liechtenstein, and this, the founder, Ingvar Kamprad, claims is intended to ensure “eternal life” for IKEA even after the 84 year old has passed away.
You have to give Mr Kamprad credit for blaming his company’s tax avoidance structure on his own mortality. It’s a disarming attempt to deflect criticism even if it is more transparent than a 19p TEKLA tea towel. But like a Scooby Doo villain, just as he thought he might be in the clear he said too much, adding “We have always viewed taxes as a cost, equal to any other cost of doing business”. Well, Mr Kamprad, that rather gives the game away, but of course, he’s absolutely right. Taxes are just another cost of doing business and like any other cost if a company can reduce that cost then it should.
But like most costs, whether suppliers or employees, if it is reduced too far by whatever means then it gives rise to potential issues. You only have to look at the negative publicity surrounding certain clothing companies which a few years ago were exposed as buying from overseas suppliers who use child labour or require their staff to work in appalling or dangerous conditions.
Message to Vodafone
Last September, the Vodafone store in Oxford Street was blockaded by around 50 people. That’s not a huge topple-the-corrupt-dictator turnout but the message was nevertheless a potentially powerful one. Since then there have been further blockades in other stores across the country. The protest was over the fact that Vodafone had reached a settlement with HMRC and agreed to pay £1.25 billion in taxes dating back to 2000. This related to a subsidiary in the tax haven of Luxembourg. For those of you with a tough disposition the dispute centred around whether the Luxembourg company was a Controlled Foreign Corporation (“CFC”) or not ie. was it a company merely based there for tax avoidance but actually controlled and run out of the UK, in which case it should pay UK taxes.
Protestors claimed that the true tax bill should have been in the region of £6 billion and that the difference, had it been collected, could have allowed cuts to the welfare state to be less severe, or that the budget deficit could have been reduced.
What made the level of the settlement more remarkable was that Vodafone itself had set aside in its accounts a provision of £2.2 billion. At the time HMRC said that the settlement amount had been reached after a rigorous examination of the facts. However, this action seems to mark a new trend in HMRC which favours reaching settlements rather than pursuing claims through the courts, and the Revenue found itself in an awkward position supporting Vodafone’s assertion that the £6 billion claimed by protestors was an urban myth.
HMRC under scrutiny
Last month, HMRC officials were grilled by the Public Accounts Committee which expressed concern that there is little transparency for the ordinary taxpayer in the Revenue’s dealings with multinational corporations. Consequently, the National Audit Office announced during the month that it is going to launch an inquiry into how HMRC settles disputes with large companies. Meanwhile, there are £15 billion of disputes at the moment, only a third of which are expected to go to court, with the remainder subject to a settlement with the companies concerned.
Despite the apparent lack of vigour on the part of HMRC, ultimately the issue is one for companies to manage by reducing their tax charge but not taking undue risks to their reputation and always appearing to be paying their fair share of tax.
Heightened sensitivity
The sensitivity of this issue is heightened amongst the public at the moment by the fact that HMRC is actually becoming more aggressive in pursuing individuals who are potentially avoiding tax, by for example holding secret off-shore accounts. At the same time increases in indirect taxes such as VAT mean that the ordinary member of the public expects to see fairness in how taxes are charged and paid by companies.
It looks to me that the Vodafone protestors haven’t yet established a strong connection between over-aggressive tax avoidance and the losers of such actions. Unlike those companies turning a blind eye to child labour being used in their suppliers’ factories there is no emotive figure such as a malnourished child that they can draw upon.
However, once a connection is established then companies will have to be more vigilant and ensure there is trust amongst an increasingly sceptical public that they are paying their taxes fairly. The alternative is that they could face the risk of their brands being tarnished. That may not worry IKEA’s family shareholders but for shareholders of public companies the short term gain on tax avoidance could quickly turn into the long term loss of losing the trust of their customers.
Ash Mehta is an independent Finance Director consultant working with a portfolio of growing companies, having recently sold Orchard Growth Partners where he was Founder and CEO. He is also part-time Finance Director of Northbridge Industrial Services plc, an AIM-quoted hire company, and he sits on the Executive Committee of the Quoted Companies Alliance, the representative body for smaller quoted companies. The views expressed are his own and do not necessarily represent the views of those organisations. You can read his blog at www.ashmehta.co.uk and comment on this article by emailing ash@ashmehta.co.uk .
This article first appeared in Aimzine www.aimzine.co.uk
Benjamin Franklin famously said that in life there are only two certainties, death and taxes. Well for IKEA, the “love-it-and-hate-it-at-the-same-time” furnishings retailer, it seems the two are closely linked. Last month a Swedish team of investigative journalists uncovered that the IKEA group is a complex web of companies and foundations with more parts than an ASPELUND wardrobe. The ultimate holding company turns out to be in Liechtenstein, and this, the founder, Ingvar Kamprad, claims is intended to ensure “eternal life” for IKEA even after the 84 year old has passed away.
You have to give Mr Kamprad credit for blaming his company’s tax avoidance structure on his own mortality. It’s a disarming attempt to deflect criticism even if it is more transparent than a 19p TEKLA tea towel. But like a Scooby Doo villain, just as he thought he might be in the clear he said too much, adding “We have always viewed taxes as a cost, equal to any other cost of doing business”. Well, Mr Kamprad, that rather gives the game away, but of course, he’s absolutely right. Taxes are just another cost of doing business and like any other cost if a company can reduce that cost then it should.
But like most costs, whether suppliers or employees, if it is reduced too far by whatever means then it gives rise to potential issues. You only have to look at the negative publicity surrounding certain clothing companies which a few years ago were exposed as buying from overseas suppliers who use child labour or require their staff to work in appalling or dangerous conditions.
Message to Vodafone
Last September, the Vodafone store in Oxford Street was blockaded by around 50 people. That’s not a huge topple-the-corrupt-dictator turnout but the message was nevertheless a potentially powerful one. Since then there have been further blockades in other stores across the country. The protest was over the fact that Vodafone had reached a settlement with HMRC and agreed to pay £1.25 billion in taxes dating back to 2000. This related to a subsidiary in the tax haven of Luxembourg. For those of you with a tough disposition the dispute centred around whether the Luxembourg company was a Controlled Foreign Corporation (“CFC”) or not ie. was it a company merely based there for tax avoidance but actually controlled and run out of the UK, in which case it should pay UK taxes.
Protestors claimed that the true tax bill should have been in the region of £6 billion and that the difference, had it been collected, could have allowed cuts to the welfare state to be less severe, or that the budget deficit could have been reduced.
What made the level of the settlement more remarkable was that Vodafone itself had set aside in its accounts a provision of £2.2 billion. At the time HMRC said that the settlement amount had been reached after a rigorous examination of the facts. However, this action seems to mark a new trend in HMRC which favours reaching settlements rather than pursuing claims through the courts, and the Revenue found itself in an awkward position supporting Vodafone’s assertion that the £6 billion claimed by protestors was an urban myth.
HMRC under scrutiny
Last month, HMRC officials were grilled by the Public Accounts Committee which expressed concern that there is little transparency for the ordinary taxpayer in the Revenue’s dealings with multinational corporations. Consequently, the National Audit Office announced during the month that it is going to launch an inquiry into how HMRC settles disputes with large companies. Meanwhile, there are £15 billion of disputes at the moment, only a third of which are expected to go to court, with the remainder subject to a settlement with the companies concerned.
Despite the apparent lack of vigour on the part of HMRC, ultimately the issue is one for companies to manage by reducing their tax charge but not taking undue risks to their reputation and always appearing to be paying their fair share of tax.
Heightened sensitivity
The sensitivity of this issue is heightened amongst the public at the moment by the fact that HMRC is actually becoming more aggressive in pursuing individuals who are potentially avoiding tax, by for example holding secret off-shore accounts. At the same time increases in indirect taxes such as VAT mean that the ordinary member of the public expects to see fairness in how taxes are charged and paid by companies.
It looks to me that the Vodafone protestors haven’t yet established a strong connection between over-aggressive tax avoidance and the losers of such actions. Unlike those companies turning a blind eye to child labour being used in their suppliers’ factories there is no emotive figure such as a malnourished child that they can draw upon.
However, once a connection is established then companies will have to be more vigilant and ensure there is trust amongst an increasingly sceptical public that they are paying their taxes fairly. The alternative is that they could face the risk of their brands being tarnished. That may not worry IKEA’s family shareholders but for shareholders of public companies the short term gain on tax avoidance could quickly turn into the long term loss of losing the trust of their customers.
Ash Mehta is an independent Finance Director consultant working with a portfolio of growing companies, having recently sold Orchard Growth Partners where he was Founder and CEO. He is also part-time Finance Director of Northbridge Industrial Services plc, an AIM-quoted hire company, and he sits on the Executive Committee of the Quoted Companies Alliance, the representative body for smaller quoted companies. The views expressed are his own and do not necessarily represent the views of those organisations. You can read his blog at www.ashmehta.co.uk and comment on this article by emailing ash@ashmehta.co.uk .
Sunday 16 January 2011
A place in the sun?
Many AIM companies should be considering international expansion but what should you as an investor be asking those companies heading for the sun?
This article first appeared in Aimzine, www.aimzine.co.uk .
Last month, England’s bid to host the 2018 World Cup was comprehensively rejected by the FIFA selection committee which decided to choose Russia and Qatar to host the 2018 and 2022 competitions respectively. I would love to see the World Cup in England but I don’t think I could have tolerated nearly eight years of build up and hype over what the press will call “52 years of hurt” since the victory in 1966. Just as a pedantic aside, in 2018 it won’t of course be 52 years of hurt because that would imply that we were hurting in 1967 and 1968 and 1969 which of course we weren’t because England were the world champions during those years. The hurt really only started in 1970 but I think that makes the maths too difficult for the mainstream press.
Should we be surprised that England wasn’t chosen? Despite the involvement of the alpha male but cuddly triumvirate of David Cameron, Prince William and David Beckham the overriding factor in FIFA’s decision seems to have been reaching out to markets with growth potential as indeed they did with the first World Cup in Asia in 2002 and the first in Africa in 2010.
So, who can blame them for awarding the competition to Russia, whose increasing strength in the global economy will result in a growing middle-class eager to spend more on leisure activities or Qatar which today at least looks like one of the more stable Middle East economies even if its defence alliance with Iran ought to have raised a few eyebrows at FIFA headquarters in Zurich. As democracy and good governance do not come high on FIFA’s agenda either internally or in its selection process they did not have to resort to selecting duller locations, like England, Belgium or Spain, to host the competition.
As a business decision this looks like one burdened with risk but if FIFA have considered the risks and rewards properly it could turn out to be a lucrative master stroke.
For many companies, it also seems an opportune time to consider overseas markets and the return on capital from investing overseas compared to investing capital in the UK. The slower growth expected in the UK for 2011 due to lower government spending and increased taxes along with historically favourable exchange rates means that there is currently a stick and a carrot for UK companies to consider their capital allocation between the UK and overseas and for those companies which don’t have a strong overseas presence to seriously consider it, assuming of course that they can access capital at all under the ongoing banking constraints and hesitant equity markets.
So during this period it’s worth asking companies you invest in what their plans are for overseas markets.
Having worked in numerous companies with international operations and which expanded overseas either by acquisition or organically, there are a number of questions I ask of companies I invest in or consider investing in. They include;
1. How is the core business performing?
If the core business is not performing well, then any company should deal with those existing issues rather than potentially creating more issues by setting up new operations. You should beware of companies which mention international expansion to potentially mask issues in their core business. Last month, Betfair which only came to the stock exchange in October 2010 at 1,300p has rapidly fallen out of favour to a low of 964p and clearly felt compelled to mention the lure of international expansion in its first results announcement in December.
2. How have various international markets been ranked for targeting?
It’s important for you as a shareholder to know why the company has chosen a particular country over another. Perhaps it is perceived to have lower risk as the company already sells there or has local contacts. There ought to be some clear reason for the choice.
3. How similar are the market dynamics in the new markets compared to existing markets?
Having a successful domestic business is all very well but the factors in other countries may be different so it’s useful to hear from the management team how different those new markets are and what new challenges the company will face and how it will address those.
4. Is it preferable to make an acquisition or set up from scratch, or to go through a local partner and how has this been assessed?
With overseas expansion, a critical factor is to minimise investment and risk, at least in the early stages, until a pilot stage has been successfully negotiated. Seeking a local partner can reduce risk but can also increase complexity and of course will reduce the profits attributable to the company as the local partner will take (at least) their fair share.
5. What are the political, economic and social risks involved in the key markets?
Having the right formula for a successful business is all very well but if the political, economic and social risk turns against the company that success can change very rapidly especially if the overseas expansion has been into a country which doesn’t have an established legal system for business law or if there is extensive corruption and authorities can override normal legal processes.
6. How much capital is being allocated to the overseas expansion and how is it being funded?
For any initiative, the amount of capital required both for investment into assets and also to fund initial losses and working capital is important to know because without this the company cannot quantify its maximum downside. Also as overseas expansion can take some time to become established, the company’s profits may well suffer whilst capital is being invested but producing little return in the early stages. How that capital is funded obviously has an impact on earnings per share and if funded by the issue of equity it can quickly become a drag on the company’s EPS.
7. How long will it take for the business to break even and for cash generation to become positive?
This is applicable for any initiative requiring capital investment but more so for an overseas investment which may take longer and be more difficult to control and therefore have a higher degree of variability from the norm.
8. How will currency exposure be managed?
Although for a company just dipping its toes into international expansion the currency exposure ought to be quite small compared to the company overall, the favourable exchange rates that might give rise to overseas expansion initiatives might well be temporary and soon revert back to the mean. If that happens then the company can soon find that its investment has lost value thereby pushing the breakeven point further out into the future.
9. Who will be responsible for the performance of the overseas expansion?
As an investor you should get comfort that the overseas initiative is being entrusted to someone who has a track record of such activity. In my experience people who have those skills are few and far between as it requires a delicate balance of versatility, pragmatism, stubbornness and diplomacy on top of the usual business skills you’d expect of someone in such a role.
10. Who is the board member responsible for overseeing the initiative and what experience do they and the rest of the board have in international operations?
As mentioned above there is absolutely no substitute for having been there and done it before. An absence of international experience on the board should make you consider the exit as the number of companies who have been brought down by disastrous overseas forays is huge.
It’s highly unlikely you’ll get full answers to all of these questions but it may be that just asking them of the management will make the management team consider issues they hadn’t covered off. And it is my style with companies I invest in, if I don’t get reasonable answers I just keep asking the questions.
Ash Mehta is an independent Finance Director consultant working with a portfolio of growing companies, having recently sold Orchard Growth Partners where he was Founder and CEO. He is also part-time Finance Director of Northbridge Industrial Services plc, an AIM-quoted hire company, and he sits on the Executive Committee of the Quoted Companies Alliance, the representative body for smaller quoted companies. The views expressed are his own and do not necessarily represent the views of those organisations. You can read his blog at www.ashmehta.co.uk and comment on this article by emailing ash@ashmehta.co.uk .
© Ash Mehta
This article first appeared in Aimzine, www.aimzine.co.uk .
Last month, England’s bid to host the 2018 World Cup was comprehensively rejected by the FIFA selection committee which decided to choose Russia and Qatar to host the 2018 and 2022 competitions respectively. I would love to see the World Cup in England but I don’t think I could have tolerated nearly eight years of build up and hype over what the press will call “52 years of hurt” since the victory in 1966. Just as a pedantic aside, in 2018 it won’t of course be 52 years of hurt because that would imply that we were hurting in 1967 and 1968 and 1969 which of course we weren’t because England were the world champions during those years. The hurt really only started in 1970 but I think that makes the maths too difficult for the mainstream press.
Should we be surprised that England wasn’t chosen? Despite the involvement of the alpha male but cuddly triumvirate of David Cameron, Prince William and David Beckham the overriding factor in FIFA’s decision seems to have been reaching out to markets with growth potential as indeed they did with the first World Cup in Asia in 2002 and the first in Africa in 2010.
So, who can blame them for awarding the competition to Russia, whose increasing strength in the global economy will result in a growing middle-class eager to spend more on leisure activities or Qatar which today at least looks like one of the more stable Middle East economies even if its defence alliance with Iran ought to have raised a few eyebrows at FIFA headquarters in Zurich. As democracy and good governance do not come high on FIFA’s agenda either internally or in its selection process they did not have to resort to selecting duller locations, like England, Belgium or Spain, to host the competition.
As a business decision this looks like one burdened with risk but if FIFA have considered the risks and rewards properly it could turn out to be a lucrative master stroke.
For many companies, it also seems an opportune time to consider overseas markets and the return on capital from investing overseas compared to investing capital in the UK. The slower growth expected in the UK for 2011 due to lower government spending and increased taxes along with historically favourable exchange rates means that there is currently a stick and a carrot for UK companies to consider their capital allocation between the UK and overseas and for those companies which don’t have a strong overseas presence to seriously consider it, assuming of course that they can access capital at all under the ongoing banking constraints and hesitant equity markets.
So during this period it’s worth asking companies you invest in what their plans are for overseas markets.
Having worked in numerous companies with international operations and which expanded overseas either by acquisition or organically, there are a number of questions I ask of companies I invest in or consider investing in. They include;
1. How is the core business performing?
If the core business is not performing well, then any company should deal with those existing issues rather than potentially creating more issues by setting up new operations. You should beware of companies which mention international expansion to potentially mask issues in their core business. Last month, Betfair which only came to the stock exchange in October 2010 at 1,300p has rapidly fallen out of favour to a low of 964p and clearly felt compelled to mention the lure of international expansion in its first results announcement in December.
2. How have various international markets been ranked for targeting?
It’s important for you as a shareholder to know why the company has chosen a particular country over another. Perhaps it is perceived to have lower risk as the company already sells there or has local contacts. There ought to be some clear reason for the choice.
3. How similar are the market dynamics in the new markets compared to existing markets?
Having a successful domestic business is all very well but the factors in other countries may be different so it’s useful to hear from the management team how different those new markets are and what new challenges the company will face and how it will address those.
4. Is it preferable to make an acquisition or set up from scratch, or to go through a local partner and how has this been assessed?
With overseas expansion, a critical factor is to minimise investment and risk, at least in the early stages, until a pilot stage has been successfully negotiated. Seeking a local partner can reduce risk but can also increase complexity and of course will reduce the profits attributable to the company as the local partner will take (at least) their fair share.
5. What are the political, economic and social risks involved in the key markets?
Having the right formula for a successful business is all very well but if the political, economic and social risk turns against the company that success can change very rapidly especially if the overseas expansion has been into a country which doesn’t have an established legal system for business law or if there is extensive corruption and authorities can override normal legal processes.
6. How much capital is being allocated to the overseas expansion and how is it being funded?
For any initiative, the amount of capital required both for investment into assets and also to fund initial losses and working capital is important to know because without this the company cannot quantify its maximum downside. Also as overseas expansion can take some time to become established, the company’s profits may well suffer whilst capital is being invested but producing little return in the early stages. How that capital is funded obviously has an impact on earnings per share and if funded by the issue of equity it can quickly become a drag on the company’s EPS.
7. How long will it take for the business to break even and for cash generation to become positive?
This is applicable for any initiative requiring capital investment but more so for an overseas investment which may take longer and be more difficult to control and therefore have a higher degree of variability from the norm.
8. How will currency exposure be managed?
Although for a company just dipping its toes into international expansion the currency exposure ought to be quite small compared to the company overall, the favourable exchange rates that might give rise to overseas expansion initiatives might well be temporary and soon revert back to the mean. If that happens then the company can soon find that its investment has lost value thereby pushing the breakeven point further out into the future.
9. Who will be responsible for the performance of the overseas expansion?
As an investor you should get comfort that the overseas initiative is being entrusted to someone who has a track record of such activity. In my experience people who have those skills are few and far between as it requires a delicate balance of versatility, pragmatism, stubbornness and diplomacy on top of the usual business skills you’d expect of someone in such a role.
10. Who is the board member responsible for overseeing the initiative and what experience do they and the rest of the board have in international operations?
As mentioned above there is absolutely no substitute for having been there and done it before. An absence of international experience on the board should make you consider the exit as the number of companies who have been brought down by disastrous overseas forays is huge.
It’s highly unlikely you’ll get full answers to all of these questions but it may be that just asking them of the management will make the management team consider issues they hadn’t covered off. And it is my style with companies I invest in, if I don’t get reasonable answers I just keep asking the questions.
Ash Mehta is an independent Finance Director consultant working with a portfolio of growing companies, having recently sold Orchard Growth Partners where he was Founder and CEO. He is also part-time Finance Director of Northbridge Industrial Services plc, an AIM-quoted hire company, and he sits on the Executive Committee of the Quoted Companies Alliance, the representative body for smaller quoted companies. The views expressed are his own and do not necessarily represent the views of those organisations. You can read his blog at www.ashmehta.co.uk and comment on this article by emailing ash@ashmehta.co.uk .
© Ash Mehta
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