10foot Scuttlebutt: February 2018 edition

Back with another version of scuttlebutt, some stuff I’ve seen or thought recently. I am particularly keen to get thoughts and opinions on alternative investments & the UK fin services sector.

Buffett buys Teva

Has Warren lost the plot? He’s bought a stake in Teva Pharmaceuticals which has an at EV/EBITDA of 12ish and something like $32bn in debt. I first thought he was a) insane, and then b) that this might be validation of my Mayne Pharma purchase (buying pharma when there is blood in the streets, etc) but I realised he’s got something different in mind – job cuts. My guess is he’ll try and gut Teva, which is not nearly so expensive if you can fire half the staff.

There has been some interesting media coverage on the pharma industry recently, including one piece about pharmacy benefit management. It’s made me think Mayne might still be an opportunity, but equally, the media coverage only indicates how complex the situation is – I’m better off on the sidelines.

Bailed up by Bailador? 

Bailador Technology Investments (ASX:BTI) looks similar to Blue Sky Asset Management (ASX: BLA), except it’s wholly a venture-cap/technology style fund.  I was originally interested in it for its ~15% discount to NTA, as well as the underlying tech companies that were reportedly carried at modest valuations or cost.

However there were a couple of things I didn’t like. First it seems very difficult to get any sort of grip on its investment company performance or valuations as that part appears all quite opaque.

Second, Bailador appears to be externally managed, paying 1.75% & 17.5% to an entity controlled by Bailador management – talk about a conflict of interest! To be sure, I’ve seen them mark down at least one investment that wasn’t performing, but if you take a skeptical view (remember the incentives!) that could just be virtue signalling.

Third, related, Bailador has an illiquid portfolio that will probably go without generating cash for several years, as early stage growth companies don’t throw off cash, and sales of holdings should be very infrequent. To me this is problematic as shareholders will be paying annual (hefty) management fees – directly to management! – on an investment portfolio of opaque companies on basically a mark-to-model basis.

Bailador is currently paying a shade over $2m a year to management in management fees alone, and it has only $6m in cash. Portfolio companies seem to require additional investment semi regularly so I suspect Bailador will have to raise capital soon. It will be interesting to see if they are able to raise at NTA.

Sharpening the criticism a little, it appears Bailador will be raising capital at least in part to pay its ongoing management fees. On a positive note, upwards revaluations of some of its investments won’t trigger performance fees on unrealised gains (that is, performance is only payable on cash gains, such as from a sale).

Bailador management also receives director fees directly from subsidiary companies. That is, in addition to receiving management and performance fees, management receives ongoing director fees from portfolio companies. Money is being taken out of shareholder pockets via both the fund manager, and directly out of portfolio companies. Significant shareholdings notwithstanding, management is doing extraordinarily well out of this arrangement.

From the BTI 2017 annual report

This kind of company might be right for some, but it’s not my cup of tea.

Do alternative investments have a future? 

One of my many side projects aims to determine if Blue Sky Alternative Investments (ASX:BLA) is aggressively marking its portfolio (I have NFI*; disclosure is obtuse).

Still, judging by the AFR I’m pretty sure that their investment in Vinomofo is valued optimistically. Vino missed its revenue forecasts by $10m last year, but Blue Sky’s valuation for the Blue Sky Private Equity Vinomofo Fund increased by 3.6% from $4.342 million to $4.5 million while percentage interest remained constant. It was marked up a similar amount in the first half again today.

If I step back and ask myself where all the money looking for a home in a low yield environment is going, it’s not hard to envision some of it going into alternative assets. Plus if you look at BLA’s assets, it owns a decent amount of property and aged care investments (around 17% of net assets – and a lot more if you include student accommodation). I would guess that these investments almost definitely have their valuations inflated by lower interest rates.

Elsewhere BLA owns late stage venture-cap tech stocks, which are also pretty easy to mark to model, given that the underlying businesses are usually opaque and valuations can be pretty woolly e.g. multiples of revenue. I’m on the fence on BLA, but I do wonder how all of these investments would fare in a world where investors have a lot more choice (via higher interest rates). I suspect they would not be nearly so much in demand.

(*NFI = no fucking idea)

Big trouble in little Big Un

AFR has been belting it out of the park these past few months and there has been some really sterling coverage of Big Un (ASX: BIG) by Jonathon Shapiro recently.

Big Un shares dive 30% after financing admission

Big Un revelations as company goes into trading halt

I haven’t done the legwork on BIG but there are some concerning allegations in there. Customers are being filmed for free, one unhappy customer (if I understand correctly) was filmed for free, billed anyway, was unhappy with the service and had the video published by BIG anyway. The company financing BIG’s customers has a claim over Big TV’s assets, which makes the arrangement look a lot like a loan. I’m not familiar with the specifics of debtor finance but I thought it was normally secured solely against the customer receivables.

Reading between the lines I suspect that there’s a lot more to this story.

Given the point we’re at in the market and some of the shenanigans we’re seeing, I have been spending a fair bit of time looking at dodgy stocks with a view to finding one to short. I don’t short stocks (yet), and there’s no BIG shares available to borrow (I checked on the weekend) but if I found some I would have shorted BIG solely on the strength of the AFR’s articles and BIG’s Tipsly transaction. Buyer beware.

UK Fin Services

I’m keen on the UK wealth management space (and have been for a while – since I bought Just Group plc). I am still in the early stage of sieving a lot of companies, but I have a seemingly compelling thematic. UK pension contribution rates are currently around 3% and are rising to 9% in 2019. I also expect there will be additional inflows to the sector coming from the ongoing switch over from defined benefit to defined contribution pensions. I rate it at least a 50% chance that contribution rates go above 9% in the next ~5 years. In that context, prima facie, valuations of ~16x earnings at a bunch of asset manager + financial advisor firms look to be discounting the significant growth that could be coming.

I have not looked closely at any one co yet, as I am casting through a long list of firms trying to find something that is a) small enough to see significant growth, b) scalable, c) well run, and d) relatively future-proof.

Several firms appear kinda backwards here, including one called Brooks Macdonald (LON: BRK). I was interested in Brooks Macdonald and had it on my short list until I saw its fee structure. It charges 1.45% per annum (plus advisor fees, say 0.5%?) for a “Low Risk Portfolio Defensive Income” strategy that is up to 70% in bonds. Performance has been staunch – 13% per annum over the last 5 years (!!) and has more than covered the fees, although I do wonder how defensive it really is to get that type of return. Performance of other strategies has not been quite that good.

There are a few other things I didn’t like. Brooks MacDonald reports its returns gross of fees, and it charges 0.8% per annum (plus advisor fees) to customers in a passive defensive strategy that is 100% ETFs and around 50% Vanguard & similar index funds. Also, “Underlying charges may apply which will vary according to the specific assets within the portfolio.” Not only do you pay 0.8% to Brooks, plus 0.X% to your advisor, you also have to pay the fee for the funds that Brooks invests you in. So you pay a fee to your advisor for putting you in a Brooks strategy, then you pay a fee to Brooks for putting you in a basket of funds, then you pay the management fee for the funds themselves! I am not sure if I understand that correctly (it seems too wicked) but it really reeks.

This LSE-listed BRK gets a ‘no’ from me.

I own shares in Just Group plc. I formerly owned shares in Mayne Pharma but have sold them all. This is a disclosure and not a recommendation.

The Greatest Business On Earth

I have discovered what I believe to be literally the best business on Earth.

FacebookGoogleAlibabaFraud manufacturing?

Nup.

It’s the Australian Securities and Investment Commission (ASIC) corporate database, ASIC Connect.  This thing is a moneymaking machine. Let me put this to you.

  • Zero customer acquisition and marketing costs – if you need a corporate report, ASIC Connect is the only place to go.
  • An absolute moat – where else can you get these documents?
  • Zero manufacturing costs – every company above a certain size has to file their reports, change of shareholder forms, etc as a matter of course.
  • Zero regulatory concerns (obviously)
  • Minimal technology/operating costs – database is clunky but functional, and doesn’t look like it’s had a lot of $$ spent on it.
  • Close to zero admin costs – filing reports and selling them is all automated (or should be), and there are no refunds. There are a few analysts that are employed to handle regulatory complaints. If you spun it off, you’d leave the analysts in ASIC employ and just take the database.
  • Unlimited pricing power – files cost $20+ a pop and take it from me, you’ll need more than $600 to understand a business of anything more than basic complexity.
  • Wild guess I’d say it is capable of earning something north of 50% NPAT margins.

Course, putting prices up would make it harder for journalists and investors to catch fraud, but who cares about that?

According to ASIC’s FY17 annual report it raised $920 million in fees for the government in that year. There were 90.6 million searches of various corporate databases (flat YoY), of which approximately 95% were free of charge. There were 54.6 million searches of the companies registry (the one I refer to below, up 4% YoY) and 32.2 million searches of the business names register, down 4% YoY. There were 3.8 million searches of ASIC’s professional registers, down 22% YoY. I couldn’t find specific data on the fees raised by the companies register, but if 5% were paid searches at $20+ apiece it suggests at least $54.6 million in fees.

Lemme walk you through it:

  • Application for Registration as a Public Company – $20
  • Company Constitution – $40
  • Any addendums that might exist – $20 apiece
  • Change of Company appointments/officeholders (every time directors change) – $20
  • Change to share structure (every time the company issues shares) – $20
  • Resolution of change of share structure (share cancellation/consolidating etc) – $20
  • Annual financial report – $40

Straight up you’re looking at ~$200+ for the first year and easily another $100+ for every year after that that a company’s been listed – and that’s if you’re lucky and it only has a small number of shareholders.  And that is just one company.  Does your business have a subsidiary?  Rinse and repeat.  What if it has like 20 subsidiaries and they’re shuffling directors and shareholders around as a means of transferring money to China or the Caymans?  Tough shit.

If you’re looking at these documents, you are probably looking for fraud. You want to track the investors and the shareholdings over time. You want to know what the company constitution says. You definitely want to read all of their financial reports and appointments of officeholders. You pretty much have to buy every document that’s ever been issued within the last 3-5 years to get any idea of what you’re looking at (unless you’re lucky enough to catch the problems soon after inception).

Find mis-statements and report them to the regulator?  They’ll order the company to file updates. Then you gotta purchase the requests for correction for $20 a pop. I mean:

Greatest business on earth.

I have no interest in any company mentioned. This is disclosure and not recommendation, blah blah.

Getswift: Data Talks, Bullshit Walks

The title of this piece comes from an interview with Getswift (ASX:GSW) executive chairman Bane Hunter.  He’s spot on:

Hunter has a clear message for all startup founders seeking US investment:

Data talks, bullshit walks,” he says. 

He advises founders to “be conservative and over deliver when speaking to investors, because “everything you say is going to be recorded and measured”.

“When you come back 6-12 months later everything can and will be used against you when you raise,” Hunter says.  

I’m looking at Getswift’s latest quarterly. At first glance there’s a fair bit of ‘walking’ going on. Or to quote another prominent elder statesman figure, Marshall Mathers:

It’s quicker to count the things that ain’t wrong with you, than to count the things that are.

  • Cash flows lag revenue and the difference has blown out this quarter
  • Cash flows fell despite ‘geometric’ revenue growth
  • Interest payments don’t correlate with cash balance. (Getswift paid $15k in interest expense despite having no debt and $26m in the bank.)

 

I can think of 4 possible explanations, and I’m going to throw around a few ideas:

  • Getswift could be booking revenue on free trials that goes unpaid when clients discontinue. This could explain revenues running ahead of cash flow but does not explain interest expense.
  • Getswift could be recording revenue at its ‘headline’ delivery fee (26-29 cents per delivery) but only getting paid cash at the fee rate it’s negotiated with clients (much lower than the headline rate – ~13 cents or so). This matches the below table, and could explain revenue and cash flow but not the interest expense.
  • Getswift could be running free trials, recording revenue and financing the subsequent receivables (via debtor finance) to show cash flow. This could explain the revenue/cash flow difference (lenders won’t finance 100% of receivables) as well as the unusual interest expense.
  • Getswift could be counting the interest on its cash balance as ‘receipts from customers’. That would be pretty unconventional but the numbers roughly fit. That could explain cash receipts but not the interest expense.

 

Sure, that’s just speculation on my part, but there are some meaningful discrepancies here – and how would you know otherwise? Company disclosure is less than zero.

Quarterly revenue vs cash flow:

Quarter Revenue Cash receipts from customers Delivery #s Fee per delivery (revenue basis) Fee per delivery (cash basis) Net cash difference (compared to prior quarter revenue)* Cumulative cash difference LTM
Q218 $321,000 $160,000 ~1.2m $0.27 $0.13 -$95k -$70K (8% of Getswift’s LTM revenue hasn’t turned into cash)
Q118 $255,000 $175,000 ~0.996m $0.26 $0.18 +$23k
Q417 $152,000 $128,000 ~0.73m $0.21 $0.18 +$11k
Q317 $117,000 $54,000 ~0.5m $0.23 $0.11 -$8k
Q217

(IPO 9 Dec)

$62,850 not stated ~0.34m $0.18 not stated

(note that figures above have been rounded off and are not precisely correct)

*To see if there was a payment lag I subtracted cash flow from revenue in the prior quarter. For example Q218 cash receipts are $160k, vs Q118 revenues of $255k. Even if actual cash payment falls through into the following quarter, there is still a huge hole not being filled.

A more concerning implication is that, if you assume that 100% of the revenues booked lead to cash flow, up to ~$80k of this quarter’s receipts from customers could be due to last quarter’s revenue. Last quarter, Getswift had $255k revenue but only $175k receipts, i.e., $80k was unpaid. If that $80k got paid through in this quarter instead, then Getswift only earned $80k in receipts from customers in Q218. Overall cash flow also declined vs last quarter. I can only guess that Getswift is accruing revenue that it does not earn.

Getswift is reporting ‘geometric’ revenue growth but cash flows persistently fall short. This is surprising because Getswift’s revenue recognition policy from the 2017 annual report states:

“For contracted customers, the revenue is recognised on a monthly basis, when the group is able to reliably estimate the underlying value of service provided for the period. This is determined based on the number of task deliveries and SMS values tracked.”

However “For pay as you go customers, the revenue is recognised at the point when the cash payment is received from the customer.”

Under the PAYG model, there should be virtually zero mismatch between cash flow and revenue. Ergo most or all customers must be ‘contracted’. However, Getswift confused the issue in its ASX announcement last week.  The company said:

“Regardless of any POC (proof of concept) period, because the contracts are pay as you go, clients that wish to no longer use the platform simply cease using it and this is then reflected in our periodic reporting of delivery transactions and revenue.”

This does. not. make. sense. If the contracts are pay as you go, Getswift should record the revenue when the cash comes in and there should be zero mismatch with revenue. Is it contracted or not? I cannot be sure what to conclude from this, but to me it looks like a yellow flag from a company that is rapidly becoming a byword for poor disclosure and overly optimistic statements.

Getswift turns Chinese

$26.5 million cash at bank at the start of the quarter (the big capital raise came right at the end of December and so likely did not contribute anything). Zero debt. $0 interest income. A net interest expense of $15,000.  Getswift is Chinese, apparently.

Where’s the cash? Where’s the interest income going?  2.5% interest on $26.5m = $663k per year. Divide by 4 to get a quarterly figure = $166k.  Getswift’s receipts from customers for this quarter was $160k.  Coincidence that those numbers are so similar?  You tell me. Surely they wouldn’t record interest income as receipts from customers? Surely they wouldn’t keep all their cash in a business account earning 0% when the interest income is so significant relative to receipts? Surely..

Last quarter Getswift recorded $64k in interest which is about a 1% interest rate, but roughly makes sense in context of its cash balance and the timing post- capital raise. I cannot reconcile this quarter’s figure at all.

Where it at?

Also worthy of scorn is Getswift’s raising of $75 million to “advance new product development initiatives and general working capital purposes.” Forecast R&D cash outflow next month is $1m. Forecast staff expense is $1.3m. This company has $96 million in the bank.

And working capital? At a software company? Wot?

Ohhhhh wait, yeah if you know your revenues are gonna run well ahead of cash flow, and you’re gonna spend money and not make any, then you need a lot of working capital. Perhaps that explains it.

This company does not make sense. When revenue runs ahead of cash receipts, cash receipts are declining, and the interest income on $26m in cash ($96m, now) suddenly goes AWOL, those are some pretty glaring warning signs. With zero transparency and numerous unexplained issues – not to mention those undisclosed material facts I keep mentioning – in my opinion Getswift is worth no more than its cash backing per share, 50 cents or so. Not only that, I think it’s totally uninvestable.

One thing I would dearly like to ask management and Getswift’s corporate advisors is “at what point does this transition from poor disclosure and optimistic forecasts into a legal and regulatory issue? Cos I’m pretty sure you’re about to find out where the line is.”

With a totally non-independent board, I think that’s a question that needs to get some serious internal airtime.

I have no investment position in Getswift, and will not be taking any investment position. I have no relationship with Getswift, its management, staff, or corporate advisors whatsoever. This is a disclosure and not a recommendation.