Monday 21st July 2014
A common misconception used by longs against short sellers is that a short argument can be negated by the fact that a shorted company's management may have bought stock (typically subsequent to a short attack). This is not always so and can be a dangerous (and lazy) assumption. One of many instances where it proved a mistake is in the case of Connaught.
In March 2010, I was four years in to my six year stint in sell side equity research. I'd issued a bearish Sell note on Connaught Plc (CNT). At that time CNT was capitalised at £400 million, having fallen by c. 35% over the prior few months from its all time high market cap of c. £615 million. During the decade leading up to this CNT's share price had risen from 30p in 1999 to north of 400p per share in 2009. CNT was a decent sized, well covered (not to be confused with well researched) company. The group provided repair and maintenance services to the UK's Social Housing market, as well as compliance services, such as health and safety.
The analysis in my sell note principally focused on CNT's woeful record of cash generation in relation to its reported profits, its increasing capitalisation of software related costs, the frequency of 'one-off' restructuring charges, and its rising use of debt for acquisitions. I reckoned CNT was overstating profits by at least 20%, so I set my financial forecasts at around that level below market consensus. In the event, this was far too optimistic. CNT went into administration six months later in September 2010, seemingly on the back of some form of fraud.
Several things surprised me during those six months between March and September 2010.
Firstly I was amazed at the vitriolic response by CNT's management to what I thought was a fairly straight forward note. All I had really highlighted were facts that had led CNT's business and financials to where it was at the time. CNT's CEO, Mark Tincknell, issued a particularly pernicious email to his employees, institutional investors and some press concerning my research note. Further, CNT was so popular amongst institutions, and the sell side, I think there was a general perception that I'd gone mad to have issued a bearish note.
I was also surprised by the market reaction.
CNT's share price fell by 15% in the days following publication of my note. But then the shares staged a strong c. 33% rally in the months to end of June 2010. The rally was seemingly prompted by the arrival of a new Chairman, Sir Roy Gardner, a number of brokers coming to CNT's defence issuing 'strong buy' recommendations, an upbeat set of interims in April 2010 where the CEO commented "there are no big surprises out there", and director purchases.
In the weeks following April 2010's interims, CNT's directors purchased stock. Robert Alcock bought 10,000 shares at 304p, the CEO, Mark Tincknell purchased 335,399 shares at 309p (on the face of it an impressive £1 million worth), and Sir Roy Gardner picked up 158,808 shares at 315p. Poor Sir Roy. No really, poor Sir Roy. Half a million down the plug hole. Within six weeks of their purchases CNT issued a whopper of a profit warning and the shares fell by 67%. Poorer Sir Roy stepped in again. He bought a further 50,000 shares at 112p.
As fore-mentioned, within another few months or so of the whopping profit warning in late June 2010, CNT was a bust seemingly on the basis of some form of fraud. There is no doubt in my mind that the rally in April and early May was partly attributable to the perception of director purchases.
Given Sir Roy's late arrival to the fiasco, he was unlikely to have been involved in any improprieties. All he seems to have been is a pretty poor judge of character and financials. But why would the CEO have sent a further £1 million down the Swanee? One answer may be that in the year prior, Mark Tincknell (who at that time was the Chairman), dumped 650,000 shares on the market at 355p per share. So in context he bought less than half his holding back when things began to go sour. I also recall that in October 2009, almost at the peak of the share price, the former CEO, Mark Davies, sold close to £7 million in stock, while the former FD, Stephen Hill, sold £3.8 million worth of shares. Talk about timing!
Since then I've been wary of director purchases in situations where a cloud hangs over the underlying business, especially when purchases are in repeated flurries and small beer compared to prior director sales.
|Connaught Plc's share price|
|Connaught Plc director purchase and sale of stock|
Green = purchase
Red = sale
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.