Small Cap Value Report (Mon 2 Dec 2019) - TED, BMY, SIXH, PTRO, LSL, SDI

2nd Dec '19 by Graham Neary

33 comments 8360 reads

Good morning! Today we have:

Ted Baker (LON:TED) - inventory was overstated
Bloomsbury Publishing (LON:BMY) - enters domestic Chinese market
600 (LON:SIXH) - half year report
LSL Property Services (LON:LSL) - trading update
Pelatro (LON:PTRO)
SDI (LON:SDI) - acquisition

Today's report is now finished.

Ted Baker (LON:TED)

Share price: 397.6p (pre-open).
No. of shares: 44.6 million
Market cap: £177 million

Independent review of inventory

I'm surprised the shares are down by less than 10% in early trading.

Ted Baker has identified that the value of inventory held on its balance sheet has been overstated. Based on preliminary analysis, the Board estimates an impact on value of £20m to £25m.

To give the estimated impact some context: TED's inventory was previously valued at £210 million (August 2019), which was also the company's net asset value.

With inventory and net assets both being written off by around 10%, I'm surprised that the market cap is down by less than 10%.

We've had our fair share of accounting problems over the last few years, and I think investors need to be wary of:

Early estimates being too optimistic.
Other accounting problems being discovered, after a more thorough investigation ("there's never just one cockroach in the kitchen").
Accounting problems being indicative of wider ethical problems in a company.
The company being unable to generate the expected level of profitability, when it starts telling the truth about its finances.

For all of these reasons, I think investors should be extremely cautious when a company makes an announcement like this.

On the third of the above four points, it should be pointed out that ethical problems at TED aren't a big surprise. Its founder Ray Kelvin left the company about a year ago, in the midst of a "forced hugging" scandal. Company culture was evidently not what it should be. Bad corporate culture has a funny habit of creeping into the financials.

And on the fourth point: overstated inventory means that historic profits were overstated by that amount, too.

While this doesn't automatically rule out a recovery, it means we need to bring extra scepticism when it comes to…

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andrea34

2nd Dec '19

Wow, Ab Dynamics (LON:ABDP) down another 9-10% today. I don't hold any more, I think the price is getting hit by the following:

'fears' of over-payment for acquisitions which are giving less of a payback than the acquisition price might indicate,
A very high valuation which leaves little room for disappointment,
Fears of slowdown in the automotive industry which would eventually have a knock-on effect to this company, even if they are very evolutionary and all about future auto technology.

Mark Carter

It's a strange feeling to watch a share that I coveted for so long, get cheaper and cheaper. And yet, the cheaper it gets, the less that I want to own it!

Investing is a funny ol' game. Shares can be high-fliers one moment, only to reveal a series of problems, perceived or real, that smack the share price. Sometimes the problems are so severe that they end in bankruptcy. It goes to show that it's rarely worthwhile investing in shares with high PE ratios. They'll usually be something that will humble them down the line.

I think that's why it's difficult, and dengerous, to be a LTBH investor. No-one ever really knows the future, things change, one's assessment can be wrong, and so on.

Ted Baker (LON:TED): From about 1500p to 363p in a year. Ouch. It has a Stockopedia Momentum score of 3, which may well go even lower after their computers do their updates to reflect the price change. We can, of course, argue all day whether momentum means anything to a value investor. I tend to take such a low M score as a serious warning. Something has to go drastically wrong for a score to get that low.

I also note that the debt ov the company is high in relation to its market cap and operating profits. There's clearly risk here.

It might be a good recovery play, though. They've been counted out in the past, if memory serves, only to stage a recovery. In summary: beats me, but I'll sit this one out.

Roger Lawson

Ted Baker (LON:TED) looks like yet another audit failure - auditors are supposed to count the stock, at least on a sample basis, but it's not always easy to do so.

FREng

Thanks. I saw the fall in SP, looked for what had caused it and didn't notice the disparity in dates!

jwebster

Ted Baker (LON:TED)

Update due soon 11-Dec

But over the weekend heavy discounting 30% off everything

https://www.tedbaker.com/row/Black-Friday

Also there is a 40% off Cyber Monday link on their site but if I click on it the web site throws an error message

Not really a good look all round

dealtn

"It might be prudent to imagine that the market cap was already inflated by another 44 million shares (i.e. by 38%), in exchange for the loan note conversion. If the company still looked too cheap after making this adjustment, that could be a reasonable basis for making a purchase of these shares."

You would presumably also adjust the p/l account of 600 (LON:SIXH) by the £0.68m saved in interest costs post conversion of the outstanding warrants too, to make a meaningful comparison? That would be a sizeable % increase in profits (and cash flow) available to the increased number of shareholders should such dilution occur.

Traderdiary

Im in kidda 2234p. Fly together, die together.

batt

I hold SIXH, decent results but I was not aware of the warrants, thanks for that info.

Esimba04

insightful! thank you!

Graham Neary

Excellent additional point, thanks dealtn.

bobsandy12

Great report and across a mixed bag. many thanks

Aislabie

While the auditors should be able to support a reasonable stock count (albeit on a statistical basis that can be fooled), ascribing value to individual stock items is fraught with possible error. The only basis seems to be to write down value on a time basis without regard to to individual valuation.
Underlying his extreme dislike of inventory Steve Jobs used to say that computers depreciated at 2% per week - not a bad guideline

Gromley

I'm surprised more has not been made of the fact that Ted Baker (LON:TED) have engaged some lawyers to lead on their "INDEPENDENT REVIEW OF INVENTORY" in advance of getting around to finding some accountants.

That cannot be a good sign surely?

Surely with regards the 600 (LON:SIXH) warrants - the issue of the potential dilution only comes into play if the share-price gets substantially above 20p? The note holders would want a significant premium in order to be able to cash in the equity.

A more worrying option for the company, surely would be that the notes are not converted by 2022 and instead the company needs to pay off or refinance £9m.

The company has been leaking cash for many years and have sold off pretty much all of the family silver to stay afloat.

Tangible book value is about £14m which is almost entirely working capital (excluding the IFRS16 "rights of use assets" on their lease commitments.)

I would love to be proven wrong, but I do worry that unless there is some dramatic payoff from their revised strategy in the next couple of years, they may struggle to repay or extend the loan notes.

Perhaps though an equity raise would not be too damaging to shareholders given the low earnings multiple.

Boon

Looks like a small cap "tech" company "headquartered" overseas (Bangalore, India).

I know the company has main registered addresses in the UK, New York, and Singapore. But if you look at LinkedIn, those look like token offices / glorified PO boxes.

I think I might pass on Pelatro (LON:PTRO) based on the many examples of past foreign-based, "hot tech" companies listed on AIM. The majority of them don't end well...

Paul Scott

3rd Dec '19

Good Evening,

Re Ted Baker (LON:TED) - we're pretty good at spotting dodgy accounts here, at the SCVR.

May I just point out that a reader & I rang the alarm bells over the specific problem (excess inventories) at TED balance sheet, very recently, here on 3 Oct 2019.

Just shows, that the warning signs are usually there, and we've got a fantastic track record here at SCVR of spotting them, and warning people;

Balance sheet - as always with profit warnings, my next port of call is to look at the balance sheet, to ascertain if the company is likely to go bust or not.

Remember that we saw with Bon Marche (opposite end of the fashion market, but still relevant) how an apparently strong balance sheet very quickly unravelled, after a couple of seasons poor performance.

Overall, I think the balance sheet looks a concern. As a reader {insert name} pointed out, the inventories figure looks wildly excessive, at £209.6m - remember that inventories are on the balance sheet at cost, not retail value. I cannot fathom why the business has such large stock-holdings? The bought in margin is high, so TED may still be able to sell this stock for more than cost, hence no write-down required by the auditors, but it might still need to be heavily discounted to shift it. I think this could be a precursor to a further decline in the gross margin, and hence increased future operating losses.

Not only did we (reader concerned, please come forward for a gong!) but also me, spot that the figures looked dodgy, but we spotted specifically which line on the balance sheet looked dodgy.

Make no mistake, as a former fashion FD, I know how closely the FD looks at the inventories. Ted Baker's former mgt must have been fiddling the figures. There is no doubt over that. Just like Patisserie Valerie, they're crooks. Don't make excuses for them, just dump the shares as quickly as you can.

The rules on inventories, are that you have to value everything on a line by line basis, at the lower of cost or realisable value. For a high-ish end fashion brand, that means realisable value should be well above cost, even at 50% discount.

I reckon the new CFO has come into TED, and probably discovered widespread fiddling of the figures.

Overall - the big freehold may save this business, but the creep who ran it, and the dodgy figures (believe me, when you're CFO, you know exactly what the inventories figures really are) make it a stock to avoid at all costs.

How many other companies are also fiddling their figures? Who knows. Probably a lot more than we think!

Hi Roger,

I've been both a (junior) auditor, and a CFO.

The audits only work if the client is fundamentally honest. For example, I did a year-end stock count, one of many, on 31 Dec 19xx, when I wanted to be with my mates boogying in Southampton. Instead I had to travel to the Isle of Wight, and count all these booms, which were components of oil-spillage projects. Am sure I've told this story before (probably many times!)

It was a nightmare. I didn't have a clue what I was doing, and it was around midnight. I had to count large items, which could have been anything to me. I asked the foreman what they were, and he told me. After a while, I picked up on something that made me feel uneasy. He just looked really nervous. Something felt wrong. So I decided that he was lying to me, in some way. This was in the 1990s, so long before you could take pictures, or evidence. But I demanded to take a photocopy of the sales day book, or despatch book.

3 months later, we went back there. I vomited on the hydrofoil to the Isle of Wight, but soon began to pick up on the feeling that something was wrong. The inexperienced, and highly-strung female CFO seemed on the point of a mental breakdown. She exploded at me, saying that one of my team (a rather brusque junior, from an obviously quite posh background) was winding her up too much, and she wanted him out of the place right now. I was horrified, and took a few moments to think about how to handle it. In the end, I decided to take him for a walk on a sunny day, and explained the problem, and invited him to moderate his style, which was too aggressive and military in style. I persuaded him to speak to her calmly & apologise. Thankfully, it resolved that difficulty. (years later he thanked me, and said it had been a good & calm intervention, that had worked very well, but that nobody at PW in seniority had even known about)

Anyway, bottom line, it turned out that the CFO was unhappy that her CEO had been fiddling the figures in advance of a MBO. She admitted it to me, once I gently probed a bit closer. She said, if you were to go to payroll, and ask to look at some payslips, you might find that they might be quite revealing. I quietly thanked here, then made a beeline to payroll. There I found timesheet after timesheet, around the year end, saying "moving gear down the road!" they had an over-spill warehouse, around the corner, where they shipped WIP just before 31 Dec, to pretend it had been sold to customers, in order to book the sales & hence profits. I found it by accident - by reading people's signals. People don't like lying. they want to be found out. If you just probe a little, it soon becomes obvious. Decent people have it written all over their faces. You don't have to say anything.

From that moment onwards, my reputation within PW went upwards a little, from being useless "buster budget" to someone who had just uncovered a fraud, by ignoring the budgeted hours & following my nose.

Overall then, my career at Price Waterhouse was pretty shite. There were 2 highlights though. They gave me one job to be a senior, which was the RNLI - I had previously been very passionate about this, and raised some money as a small child, in a garage sale, after visiting their HQ in Poole. Therefore, when I (coincidentally) ended up there as an audit senior in 1992, I loved it, and had a team of 4-5 juniors under my direction. It was a 5-week job, and I did it really well, within budget. When my (jumped up prick) manager appraised me, do you know what he said? We thought you would collapse & fail, but much to our surprise, you did OK!"

OK?! That's when I could see what a bunch of utter pricks Price Waterhouse people were. At my interview, the staff partner said, "We're going to change you, and make you a different person". I smiled, and thought to myself, you smug prick! You're not going to change me!

And they didn't!

Wait for Part 2, when I fell into a CFO job, and put our audit job out for tender, and invited my old boss at Price Waterhouse to tender for it. It was great to give him a warm welcome into our business, where I led a team of 25 people, and him say, "You've done so well Paul", as I invited him to meet my CEO - who thought he was awful, and gave the job to KPMG lol!

I'm giving a few things away from my autobiography.

My worst relationship with an auditor, was some idiot from a local firm, called BKL in Winchester. When I joined Pilot, this pompous fool from BKL came in, to check me out. He's previously been the boss of the previous FD called Simon.

My new boss had obviously called the BKL partner in to check me in. The reason? I was there initially as a sales ledger clerk, and it quickly became clear that Pilot was almost bust. The cashflow was on a knife-edge.

I was taken on, on a sales ledger clerk hourly rate, just before Xmas. Within a week, I was running the whole company's finances. One day, I took the formidable CEO to one side, and said, do you realise that your business is right on the edge of collapse?

Your CFO is about to leave, and join a larger competitor, New Look.

Yeah, and what? He replied?

You're going to go bust within a week or two.

Why?

You've got no money! You've got 16 shops, and overheads for 25+ shops!

The central overhead is far too high.

"The whole business is run on PD cheques" - I was told by a Director's father, Tony.

What's a PD cheque, I asked? Post dated!

From that moment onwards, I knew none of the cheques I issued every bounced, and they didn't. I created £3-10m of credit from PD chqs. None of my PD cheques EVER bounced. It was a source of credit that kept the business alive for many years.

Asagi

You would presumably also adjust the p/l account of 600 (LON:SIXH) by the £0.68m saved in interest costs post conversion of the outstanding warrants too, to make a meaningful comparison?

600 (LON:SIXH) says

if warrants are exercised the Group would save loan note interest of £680k pa and with no tax effect (due to substantial carry forward losses in the UK) the net effect on EPS is a little over 12% dilution

according to Stockopedia, the shares trade on a P/E for the full year of 5.6. According to the accounts, another $900k is expected post balance sheet date. $0.45m came in October from the sale of the UK bearing's business, with the balance to come from the sale of the site, which is under offer.

The CMS acquisition looks a beauty but only contributed 4 months to these results. Also worth noting that the tax position will change in coming years. 600 (LON:SIXH) is currently not paying any tax.

Asagi (long £SIXH)

Small Cap Value Report (Mon 2 Dec 2019) - TED, BMY, SIXH, PTRO, LSL, SDI

Ted Baker (LON:TED)

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Graham Neary

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