Small Cap Value Report (Thur 17 Jan 2019) - CAKE, GMD, DPEU, TAP, JDG, XLM, PMP, BWNG

17th May '19 by Graham Neary

71 comments 18256 reads

Good morning!

Patisserie Holdings (LON:CAKE)

We had a reminder last night that frauds are usually worse than they first appear.

Patisserie Holdings (LON:CAKE) provided investors with the following update:

"the misstatement of its accounts was extensive, involving very significant manipulation of the balance sheet and profit and loss accounts. Among other manipulations, this involved thousands of false entries into the Company's ledgers."
"the cash flow and profitability of the business has been overstated in the past and is materially below that announced in the trading update on 12 October 2018"

Shocking stuff and a cautionary tale about frauds: after initial discovery, there is usually a lot more deception that is yet to be discovered.

Commiserations to shareholders, as the equity must be worth less than the 12 October 2018 update suggested.

That update said revenue and EBITDA for FY 2019 could be c. £120 million and £12 million, respectively.

If EBITDA is running materially below £12 million for the year, I suppose we have to wonder whether the company is profitable at all - perhaps it has not been profitable for years.

It is impossible to say, but what we can say with certainty is that the shares would be worth very little if they were admitted to trading today.

Those who took part in the £15 million October placing will have been warned that the profitability estimates released at that time were based on very limited information, so I can't imagine that they have any recourse after this latest update. But one or two of them are likely to be feeling disappointed and angry after those initial estimates turned out to be optimistic.

Plenty of updates this morning. My list is:

GAME Digital (LON:GMD)
DP Eurasia NV (LON:DPEU)
Taptica International (LON:TAP)
Judges Scientific (LON:JDG)
XLMedia (LON:XLM)
Portmeirion (LON:PMP)
N Brown (LON:BWNG)

GAME Digital (LON:GMD)

Share price: 25.5p (+10%)
No. of shares: 173 million
Market cap: £44 million

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Trident

18th Jan '19

Oh, I see it was from the full report and accounts. Interestingly, and not unreasonably quite a bit of focus is on cash handling in stores, and revenues tracing. No particular statement for Group cash balances etc, which may be part of the high level disclosures by management.

Housemartin2

Bonita, thanks for your response though I am not sure that the points you make were actually visible before the HMRC petition was reported in the press. I take your word for that as I have never followed Patisserie Holdings (LON:CAKE) and have never held a position in it.

Directors selling all their award shares on vesting is not in itself a red flag; it does depend upon their individual circumstances at the time. However subsequent joining up the lines to show lack of proper disclosure certainly is.

Bonitabeach

Housemartin2,

I have probably been less than clear about the points I was trying to make.

It was not visible to investors about delayed payments to suppliers, landlords or HMRC. The directors and auditors had that visibility, unless visually impaired or too lazy or complacent to look. Auditors at the very least need an enquiring and analytical mindset.

There would be gossip amongst the staff and within the trade when a supplier the size of Brake Brothers apparently chooses no longer to give credit. What information were the credit agencies and invoice discounters holding?

This is looking like a nil sum end game and the directors knew enough to sell their share awards and not to participate in the rescue placing - or maybe they just got lucky? The directors sold £13,029,000 of shares in the past 12 monthe alone: purchases £Nil.

I didn't get caught by this fraud but I have suffered in others; I don't like it; and I don't like the perpetrators walking away with their fradulently obtained gains.

Take care out there.

doublelutz

I thought that it was not the case that there was cash missing but that there was another overdraft of which the other directors were not aware and which did not appear in the accounts. This could have been with another bank than that to which the auditors were enquiring.

shipoffrogs

"Interestingly the 2017 auditor's report considered revenue recognition as a significant risk and one which could result in a material misstatement".

Reacher - it is a requirement that auditors consider revenue recognition as a significant risk in their audits. So, there's nothing to read into this statement.

I think revenue recognition is an important consideration both from an audit and investor viewpoint, but in some companies it shouldn't be complex nor an issue. One would have thought recognising revenue from selling cakes and coffees was at the very low risk end of the spectrum.

When there is a lot of cash involved from hundreds of shops there is going to be a lot more scope for fraud than if a company is, say, manufacturing large items for sale to substantial companies with no cash receipts. The fraud would have built up gradually over the life of the company and that is why they are now referring to thousands of fraudulent entries in the books.

Gromley

Patisserie Holdings (LON:CAKE)

It is all speculation at the moment of course but I do not see that "revenue recognition" or cash going missing from the tills can be the issue.

Sales here are essentially cash on delivery so there should be very little lag between revenue reported and cash received at bank. This is borne out by the accounts 2017 revenues of £114m, accounts receivable £0.4m.

It does not seem credible to me that those numbers could be fudged or hidden,

What seems far more likely is that certain costs were being understated or not reported at all and if paid were done so out of this hidden bank account (overdraft) of which the directors and auditors appeared unaware.

Not sure that this really helps us understand at this stage, but surely the issue has to be unreported costs rather than over reported revenues?

JohnEustace

There was some discussion on this back in November. I estimated that the Patisserie Holdings (LON:CAKE) reported earnings equated to £142.50 for every hour of trading in every store.
Does that seem a likely number? I'm not sure.

If you were going to understate costs then you would have to leave the purchase invoice out of the accounts in the first instance otherwise it would be posted to the expense account. So you would have to choose certain invoices to ignore (an awful lot to make up the level of fraud) and then pay the creditor out of the unreported bank account. This sounds like a potential lot of effort for the CFO and could lead to problems if the purchase ledger department were checking suppliers statements.

You may, of course, be correct but unconventional though it may sound it could be easier simply to bring in the cash from the overdraft as additional income if the objective is simply to show better trading figures. As you say this is just speculation.

I don't know either, but it doesn't seem an incredible number.

If the average customer spends £10 per hour (coffee and cake = 30 mins £5, something more substantial 60 mins and £10) then that's an average occupancy of 14 throughout the trading week. My local Pat Val probably seats c. 50+ and is generally full at peak times. The motorway service concessions probably bring in significantly more?

But I was looking at it from the other end, which is that it would be difficult to invent turnover in a business like this.

doublelutz - just hit on the only way I could think of - withdraw cash from the secret bank account (overdraft and put it through the tills). That couldn't happen in the branches without every branch manager and assistant being complicit, so I think that's a no.

Or the recycled turnover could go through some special business unit, but surely that would be too obviously visible to be considered as concealable fraud?

cig

You're calculating a credible revenue number, the OP was talking about earnings...

Well the branch staff wouldn't have to be complicit if the CFO were paying money in from the overdraft and then doctoring the sales figures. Of course, you can say that someone should have been aware of this but the CFO could have set up his head office staff so that no one person had access to all of the information. The auditors would no doubt be more attuned to looking for money disappearing from the business rather than going in!

Nick Ray

Don't forget that Patisserie Holdings (LON:CAKE) is not just Pat Val. It includes Philpotts (always very busy) and a bunch of others too.

Ah - my mistake - thanks for the correction.

But then I would question the number.

For 2017

Turnover 110,000 (excluding online)
Average no. of stores 179 (199 at YE 20 openings in year - not sure if this includes SBRY
Turnover per store ~ £615,000
Opening hours per year c. 3,000 (c. 60/ week) probably more for the service stations
Revenue / hour / store c. £204

So that's slightly higher than noted above but a "similar" ball park

Net profit was c. 14% so per store per hour ~ £30 (obvs a higher number if you take out some of the overheads.

It still looks feasible to me.

Reacher

Hi Trident - sorry for the delay, a surprisingly hectic Friday. It's available on the investor relations section of their website:

http://investors.patisserieholdings.co.uk/results-and-presentations/2017.aspx

You may have to go through some disclaimer confirmations.

Tanglands

CAKE- bank fraud and bank letters. I have this evening just signed a QUALIFIED audit opinion as we were unable to get ,directly from the bank, a bank letter, confirming balances and security. I would be amazed ,considering that not having a bank letter is in my firm an absolute reason for a qualified report, if GT didn’t have bank letters. Therefore I feel the fraud, of which I know little detail, must have been somewhere else?

Albertos

20th Jan '19

Patisserie Holdings (LON:CAKE)

Further revelations/speculation over the weekend in the Times/Sunday Times. They are suggesting million pounds cheques bouncing after the year end and HSBC and Barclays being questioned about this.

I totally agree with what you are saying on bank letters - I was threatened with qualification when I was struggling to arrange a bank letter in a minor subsidiary (bank signatories left the organisation) - but also I remember from my auditing days checking on window dressing of the bank around the year end was standard audit procedure.

I do feel what has gone on in Patisserie Holdings (LON:CAKE) has to be put in the public domain ASAP but fear we'll only actually find out in a few years time (after all affected parties have had the time to comment in private). In the meantime, if the Times is correct, Patisserie Holdings (LON:CAKE) is toast - which means good money followed bad and this is really not acceptable

Sympathies to all holders.

Phil

Tanglands - I guess you didn't write to all banks in the UK and overseas! I was under the impression that the overdraft account of which the other directors supposedly had no knowledge would have been with a different bank to that to which the auditors were writing.

phoenixnight

Tanglands (#68)

It's been a good number of years since I was an auditor, but I recall the bank confirmation for audit purposes being a standard audit test. My memory is a little foggy though, so perhaps you could bring it up to date? From what I recall, we would send a letter to the banks with which the company had a relationship. For the sake of argument, let's say it was Midland Bank. Now then if (as has been reported here) a bank account with (say) RBS had been opened by the FD, other than the FD declaring it to the auditors, how would your tests pick up the existence of that RBS bank account?

I also read the headline in the business section of the Telegraph today. They were speculating that if it all goes wrong (as, unfortunately, appears likely), then Luke Johnson's £10m loan will rank as a secured creditor, whereas the additional £15m raised from new shares will not. Hmmm - they must be happy.

I concur with Edward (#68) - this needs to be out in the public domain ASAP. It won't count for much but as a former shareholder I have the greatest sympathy for those still holding the stock.

abtan

5th Feb '19

For any GAME Digital (LON:GMD) holders out there (like me) I saw this on twitter last week and thought some might be interested to see:

https://twitter.com/BelongArenas/status/1091396113779830785/video/1

Small Cap Value Report (Thur 17 Jan 2019) - CAKE, GMD, DPEU, TAP, JDG, XLM, PMP, BWNG

Patisserie Holdings (LON:CAKE)

GAME Digital (LON:GMD)

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Graham Neary

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