RJH writes...

Context & Company:
Sanctuary has seen bid talks broken off recently; it has renegotiated finance terms with lenders; and has issued disappointing trading updates. If it is to be bought, and that is surely what lenders are craving, the plc has a serious negotiation to undertake from a weak position.

The Sanctuary Group plc described themselves in their last annual report thus:

Sanctuary is one of a kind. We are a diversified international music group with a unique approach: we call it the 360 degree business model.

The shares have declined from 42p in mid-June to 9.5p today - a 77% drop in less than 3 months.

Yet Sanctuary manages an impressive array of popular artists (amongst other related activities). Can the equity behind such popular products really stay depressed? Or is a share snapback due, even if only on a contrarian basis?

[Background track, Guns N Roses, Ain't it fun]: Red carpet interview quote - colourful and glossy reports, man. Dude - possibly the best posed board photos in town (check out Merck "Bad Boy" Mercuriadis' shot). And - mate - hip, fly, cool, wicked "passion for music" company products. Yeeeeaaah!

[Background track, Jadakiss, Kiss of Death]: Shareholder view - who has been (not) running the company? Read the interims - did the £88m of debt appear as unexpectedly as the prose suggests? Now management says it is at "a higher level than the Board is comfortable with going forward."

[Fade to Elton John, I guess that's why they call it the blues]: Part of this debt increase financed the acquisition of Twenty-First Artists from Sir Elton John. Yet turnover is still declining at the half (-4.5% and a frightening -12% pre-acquisition). The interim report talks about slippage but that's a veritable slip, collapse and hospital job.

[Fade to Robert Plant, Trouble your Money]: And what does this sentence from the interims mean?

"In line with its strategy, the Group has stepped up its infrastructure to support its longer term expectations in growth of sales and profits."

If it quacks, it's a duck - and that is unidentified, unquantified additional cost already en route. Swiftly on the heels of that declaration comes:

"The Board intends to cut costs, but not at the expense of damaging the Group's prospects".
Hardly meaningful contributions to managerial science or transparancy by the Sanctuary board; and less helpful than unambiguous commitment and plans of What They Will Do.

Financial Condition
Of course, much of what was in the interim report has been overtaken by events. Nonetheless, potential investors ought to consider more than the possibility of a bid from Warner (or whomever).

[Fade to Groove Armada, But I feel Good]: When goodwill is 60% of fixed assets, balance sheet liquidity is often worth looking at. Net current assets are £26.6m shy of long term liabilities at the half. Ignore goodwill and intangibles (yes, arguable since it's the Sanctuary record product catalogue) from the fixed asset total and saleable gear sits at £31.7m. And they'd never get close to that in a fire sale. Now, while this may be an original view of liquidity, some investors like their comfort. Especially when management are in an uninspiring phase.

[Fade to Slayer, Hell Awaits]: Liquidity is threatened by cash bleed, hence (so it seems) the urgent need for a bidder. Cash lost at the half totaled £7.3m, and you may want to read note 8 of the accounts. When (and during a poor top line period) finance managers and/or the board reduce creditors and increase debtors, shareholders are entitled to wonder what is going on. This combined action hemorrhaged £22.3m of cash and deserves more explaining and remedial plans than are evident in the report. Does anyone actually manage working capital month in and month out?

[Fade to The Who, The Real Me]: The scribe would feel more forgiving if Sanctuary did not have episodes resembling previous (Editor: note for non-UK readers - as in "previous convictions"). The 2004 annual report speaks touchingly of the "360 degree" model and its subsets, one of which is entitled "Financial Discipline". This scribe reads the blurb, looks at the numbers and concludes this is a plc run by the marketing and sales functions. What kind of financial discipline is it, for example, to issue loan notes of £28.3m in Feb 2004 (in itself an interesting story) followed by a £11.4m provision against these a bare 7 months later (see note 13 of the 2004 annuals for the detail)? This was classed an exceptional; but similar risk assessment methods will cause more such platinum non-musical hits going forward.

Redeeming features?
[Fade to Destiny's Child, Show me the Way] If the divi is maintained (ah, recall that cash bleed in urgent need of attention) yield is 5%+. The Capital Chronicle screening model (warning: eps & divi based, not holistic) likes it up to 12.8p. So at the current 9.75p it looks good - bombed out, even, at current PE levels (3.1 now, 4.2 next year - but based on eps estimates made prior to the latest trading updates).

Large trade bidders with proven, long-term financial management skills (and stronger balance sheets) must surely be eyeing-up Sanctuary as a tasty morsel ripe for integration into their businesses. Four times '06 earnings? And the buyer gets the 150,000 tracks in the Sanctuary music catalouges?

For their part, shareholders should hope existing Sanctuary management can pull a cat out of the bid-bag at a lot more than the current share price. But don't bet (much) on it, negotiations have failed once already.

Finally, as a go-it-alone proposition potential shareholders should factor in the company's recent financial management position / record / ability; and condition of the prevailing retailing environment, at least in the UK. On that basis the shares are a contrarian bet too far for this correspondent.

[Fade out with James Blunt, Tears and Rain]

NB: All background music the work of artists - sorry, arteests - currently associated with The Sanctuary Group plc. Value that.

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Between moules-frites and sancerre, MD writes...

The scribe went to the Made in Belgium exhibition last week (10/08/05) at the Dexia Art centre in Brussels. For those who don't know (and, let's be fair, that'll be most of you) it celebrates 175 years of Belgium as a stand alone country. Interestingly, the English commentary at the expo missed out some parts of the exhibition which focused on recent history, but I'll leave the detail for you to find out for yourselves (Editor: surely not the Eddy Merckx vs Lance Armstrong debate?).

The exhibition provided a potted history of all things Belgian and events in the territory from pre-history to the present. It was in comparison a marked contrast to the absolute crap dished up by HMG at the millennium dome.

However, and as ever in Belgium, there are some notable omissions: nothing on Hergé the creator of Tintin (some nonsense about his estate not being invited to participate in time); ditto, nothing about Johnny Halliday (Editor: still collecting his albums?); and and no doubt others.

In the industry sector contemporary achievements were presented and a number of companies in the engineering field caught the eye (notably in transmissions and aerospace). GKN might usefully investigate some of these for its cash pile (see previous post). But I also noted some potentially interesting companies as investments (some of which are quoted in New York and/or London). Readers seeking international diversification might want to research:

* Dexia (according to some the best bank here)
* Group Delhaize (int'l supermarket group; equity is up 400% since early 2003)
* UCB (biopharma group)
* Solvay (chemicals & pharmaceuticals)

NB: 5 famous Belgians - Eddy Merckx (The Cannibal is the greatest cyclist of all time), Jacques Brel (the late great ne me quitte pas musician), Jackie Ickx (motor racing, 6 time winner of Le Mans 24 hours), George Remi (aka Hergé of Tintin fame), Peter Paul Rubens (just google him if you don't know).

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MD writes...

Whilst seasoned City types know the truth (apparently), the average punter regards the financial pages as a generally unbiased view on all things in the world of business and commerce. Subject, of course, to the paper's editorial slant.

However, this writer's ire was raised somewhat last week when the Daily Telegraph did a particularly sloppy piece (05/08/05) on GKN plc's recent results. Unfortunately, the article is evidence (if proof were needed) that the financial pages are frequently simple mouthpieces for the investment banks. Real news analysis struggles to get a look in.

I quote from the "Questor" column edited, if that's the right word, by Philip Aldrick.

"GKN is the market leader in...The management has proved highly

and then he completely lets himself down with:
"...but its operations would sit more comfortably with a major US parts supplier like Delphi or Visteon."
My gast was flabbered, my gob was smacked! Who writes this nonsense? (Editor: you do).

Has it not escaped his notice that Visteon is to all intents and purposes bust and Delphi close behind, not to say many other US parts suppliers? Why would this be better for the company? Would it increase revenues? No - arguably they would decline as manufacturers demanded bigger discounts as part of a bigger group. Would innovation increase? I doubt it, not much left cash you see after a purchase.

And, oh, by the way UK Plc would lose out as R&D shifted, dividends flowed the other way, the balance sheet became more highly geared and the tax take dropped. Still, you know this makes sense...it would provide fat fees for the deal driven "advisors" in the City.

We, and the Telegraph, deserve better than this nonsense.

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How to invest. Step 2 - avoid risks with no obvious counterparty, aka don't arrive early. MD emails his reply to RJH...


My comments for what they are worth.

A bit like Matalan they've grown very fast; there has at some point to be a slow down. Now seems to be the time when that will happen. Whether they are lucky with the cycle and the fyr September 2005 results are good and it's in the first half of the new financial year that things turn down big time - I can't say. But I think the point is we're 18 months too late. Too risky for me so now so I'll avoid.

But I'd buy on signs of economic recovery. And yes, I know we're not, apparently, in a recession.

I've had a look at the spreadsheet and the assumptions (for a growing business) seem reasonable - if you think growth will continue. I've also just this minute found the interims (via Google) which, perhaps curiously, aren't on the investors page nor are the 2003 results - a poor year. Their absence is, I'm sure, an oversight! I also note these are draft audited not the pukka job.

* Management appear to act quickly - so probably a sound team;

* I note that they quote the order intake for 33 weeks (ie 8 month performance) is up 6%, so well shy of the growth they've reported of 19%;

* I also note that a (new) director (Editor: the Finance Director) bought in July;

* I see they have also closed another depot (Hitchin), there will be some costs for that (though may be they are already booked), there may be distribution problems as a results but probably not significant;

* Looking at the prior year to 2004 I noted:

(a) "progressive dividend policy" - euphemism for over distributing
(b) "major and specialist player" - erm, can you be both?
(c) [2003]"..disappointing result being well documented" (not to me)
(d) only recognise sales when delivered (I assume already paid for) and thank goodness for that
(e) "unique mezzanine floor layout" - well knock me over...
(f) "...20-25 suppliers...approx. 75% UK based...& regional exclusivity"
(g) admin expenses up sharply 18%...can't all be staff costs can it?
(h) Web site - "Cor Blimey guv - just like the Sun & it has an 'enders chap flogging the stuff!"

* Cautionary note - retail is very tough at present, particularly furnishing;

* health of housing market has a major impact on their volumes;

* they are (I think) heavily biased to the north where spending power may be squeezed more;

* I'm guessing like-for-like will show a decline in the second half; they are expanding very (too?) aggressively; and they will be (are) caught in the upwards only rent reviews;

* how secure are their cash flows - is it all via a fin co?

Usual disclaimers.


NB: RJH Verdict - still attracted by that cash pile. But share price at 327p does not cover the risks, even assuming enhanced divi payment. Mid-2006 (pre-green shoots if in a recession) may well be the moment for what, at that time, looks a contrarian move into cash and cash-flow rich retailers like SCS.

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How to invest. Step 1 - seek views from a cynic. RJH emails MD...


Am I mad?
I frankly hesitate to admit serious intent on this - a sofa maker. Had assumed housing market would have been screwing the bejesus out of it but, if so, effect well hidden (SCS Upholstery; EPIC=SUY, 329p. Buy-model likes it up to 310p).

I believe, and I realize this strays somewhat into the realm of the Unknowable, that even with a second half pbt affected by 7 new shop openings (no rev, only costs, for a quarter post-open) that the final dividend will be raised at least 20% for a full year payout of circa 17p (yield over 5%). On past form (function of pbt it would seem), that may be conservative - turnover going great guns and cash piling up. And therein lies the trap - an awful sales performance is curtains (or is that cushions?) for awhile.

Scene setting:
Having grown dramatically 1999-2004, usually at the expense of b/s liquidity, SCS now are in a position where it is clear they cannot (sensibly) open stores quickly enough to have turnover match previous trend. It is/has been a company where growth comes from expansion, not like-for-like (although that has been remarkably good over the last 18 months). Five years ago the annual report said they aimed to have 70 stores by now. They will have 73 by year-end. There's still growth opps but it'll be low double digits (turnover) for the medium term unless they go mental.

But here's the thing:
Their cash pile, on this slower capex-growth outlook, is large and set to increase: £19.2m on total assets of £61.6m at '05 half. That's 58p/share (shares at 327p) and 31% of total assets. Net current assets are £4.8m. I estimate (see attached) fyr '05 cash will increase to £25m or circa 76p/share (perhaps another 5-8 % points of total assets) on turnover of £158.3 and pbt of £16.4m.

Thinking of writing to the Finance Director - what's going to happen to that underperforming cash going forward?


5 year SCS Upholstery results/FYR '05 estimates spreadsheet

NB: MD replies tomorrow

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Friday, August 05, 2005 | 0 comments »

MD writes...

France Telecom has waded in and is taking over Amena the number 3 mobile telecom provider in Spain thus consolidating their position in Europe. Why O2 plc didn't have a go puzzles me what with their existing relationship, the high proportion of Brits in the Spanish market and so on. Still, UK plc doesn't grow businesses does it? (Editor: but like the Murphy's, I'm not bitter)

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MD writes...

Continuing speculation in the market about the imminent sale of their European drinks business. The European business is, in fact, an object lesson in How Not To Do It. However, Schweppes still has a good European franchise and appears particularly strong in Spain (amongst other places). Yet where is the advertising? Certainly there is none that I am able to recall in the UK.

A few years ago they purchased Orangina - yet can you get in the UK? No, or at least not through the regular distribution channels. It's a great product but they've no doubt been stitched up by Coca-Cola and are not permitted to distribute in the UK. It looks as though the only place it is seriously pushed is France. It is a similar tale for the other Schweppes fizzy drinks.

The mooted sale price of circa £1bn sounds low. Well done chaps - really earning your bonuses.

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Red Letter Days

Friday, August 05, 2005 | 0 comments »

MD writes...

Some schadenfreude about the demise of Red Letter Days and it's venomous chief exec Rachel Elnaugh notorious for her comments on the BBC TV Programme "Dragon's Den" (where inventors /entrepreneurs tout their ideas to a panel of "successful" entrepreneurs).

Clearly the Red Letter Days business model is badly broken - last year they managed to lose £4.7m. This year they've lost £700k on a turnover of £17m. Total debt is £12m so things appear to have been wrong for while. How they got into this position is unclear assuming they were getting the punters money well before they pay for the punters jolly.

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What price an identity card?

Friday, August 05, 2005 | 0 comments »

MD writes...

Whatever the rights and wrongs of ID cards - and most clearly they will do nothing to significantly enhance security in these troubled times - the UK Government bureaucrats are nothing if not persistent and continue to push the slim case for the cards.

What particularly surprises is the lack of a clamour about the proposed costs (together with completely untried technology). Suggestions have been made that the UK card will cost anything from £100 to £300 (€150 to €450)! You can buy a working car for the latter amount (Editor: OK, we'll review your fee). Having done some research I can't believe the brass neck about this amount. In Belgium the cost is €10 to €15 depending upon where you live - and people still object. In Spain the cost is similar to Belgium (and, incidentally, passports are a fraction of the cost in the UK). So why so much in the UK? Another stealth tax?

On a cautionary note regarding the untried technology, in Belgium new cards have a chip which holds the address of the holder. Unfortunately, there are no data readers around so people with the new card have to have a piece of paper with their address written on it.

And that, we are told, is progress.

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US Protectionism, a model?

Friday, August 05, 2005 | 0 comments »

MD writes...

When the US isn't telling the rest of the world how they should open their markets and embrace US companies (ie let them buy everything not nailed down) it is also on the quiet one of the most protectionist countries in the world. Witness the recent Unocal CNOC takeover soap opera.

HMG, please take note and do your best to stop yet another major UK company going overseas: BPB is about to go the way of Allied Domecq. Other likely candidates in the firing line include Pilkington, BAe Systems, British Gas, GKN, Cadbury’s, LTSB and Smiths.

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MD writes...

To no one's great surprise the banks, whilst delivering solid numbers (HSBC on Monday, HBOS on Wednesday, RBS yesterday (04/08/05), are raising provisions significantly - and this in a still benign environment. Alliance and Leicester delivered flat profits; and Northern Rock is I suspect anything but - particularly as it has chased market share.

Elsewhere, Lloyds TSB delivered it's usual uninspiring fare. Philip Hampton, former Lloyds Finance Director, could not resist a dig in a 31 July interview in the Sunday Telegraph:

"When I joined, Lloyds TSB was the biggest bank in the world. It's now the fifth biggest in the UK. I didn't enjoy it, and I don't think they enjoyed it either...I think the company needs radical change. It's still got the largest UK current account share at 22 percent or so. But they sold all the international businesses...It's got no growth prospects and no plan to address the lack of growth prospects."
My thoughts exactly - I could never understand why they sold the NZ bank. It had a great franchise, great ROE etc. As far as I can see they've shrunk the bank so that some rich US or European Bank can waltz in and take over a strong UK franchise...allowing Chief Executive Eric Daniels et al to go off with fat payoffs.

Still, HMG might always intervene in such an event and prevent any takeover à la Bank of Italy.

On second thoughts, fat chance of that.

NB: Author owns / beneficially owns shares in HSBC

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MD writes...

In my last blog fired in anger, I wrote that the proposed sale of PacifiCorp was a bad deal for the seller, Scottish Power. Following a comment from one of our readers I felt the need to review my initial statements. Here are my observations (from last accounts plus spreadsheet attached below):

* PacifiCorp grew revenues by 8% YOY in $ terms in 2004/05. Not
shabby for a utility;

* Predicting growth in expanding markets;

* The commentary suggests that regulatory price increases have been generally favourable;

* PacifiCorp delivered 25% of group revenues in 2004/05 (despite being adversely affected by the $ weakness);

* Despite this PacifiCorp ROS is 24% vs the UK business' 15% (Op Inc pre goodwill);

* Post goodwill the situation deteriorates. But despite this goodwill effect (related to the original acquisition) the ROS is still consistently better than the UK business;

* PacifiCorp delivers 45% of group Op Income (pre goodwill) - slightly less than the UK business, in prior years it delivered significantly more;

* Thus the headline numbers suggest that this is a sound business - quick to turn very significantly should the £ weaken vs the $ and, failing a $ recovery, deliver sound performance.

So no downsides? Well, not quite. Much of the asset-base is very elderly. Recent investment has centred on wind/renewables, no bad thing in itself; future committed investment includes new gas-powered stations (NB there is also a, perhaps belated, recognition by the authorities that the lights must stay on). There is clearly a need for significantly increased investment to upgrade / replace old coal and HEP assets (although this is not required overnight, and will generate a return).

* Still a bad, value destroying deal, particularly as it results in a significant write off;
* The justifications for the deal are specious;

* The deal ignores the future upside;

* Sets the company up for a takeover;

*Always a concern when the company chairman is Charles Miller-Smith, the man who brought ICI to its knees through a botched acquisition and a ludicrous "progressive" dividend policy. Mr Miller-Smith shrinks rather than grows businesses.

Well-done guys.

Download the Scottish Power/PacifiCorp numbers to Spreadsheet

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MD, fresh from swimming with dolphins in the Med, writes...

After a brief summer break the jot is back, crosser than ever. Well, nearly.

Your scribe has recently enjoyed two weeks in southern Spain on the Costa del Sol. Or the Costa del Golf, as it likes to style itself. Personally, I like to think of it as the Costa del Bling. For those who've never been, Marbella apparently has more Rolls-Royces than anywhere bar London. I can certainly vouch for this: Bentleys, Porsches and the like are two a' penny. Where else did you last see a top of the range Mercedes with Russian plates tooling around? Ditto as the place to see and been seen you can hardly beat Puerto Banus where scantly dressed (even if apparently fully clothed) women of all ages abound.

The region has a little bit of a reputation for hot money with stories aplenty of Russians turning up with suitcases stuffed with dollars and euros; I know of an individual who only a couple of weeks ago was due to start work on a building project and was rung the weekend before the start of the job - "Don't bother turning up on Monday - your employer is in gaol!"

However, like the weather some things never change. England, sad to say, have just been whipped in the 1st Test by the Aussies (Editor: but they have started the 2nd well this am) and the Windies are down and out in Sri Lanka.

Latest opinions to follow shortly.

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US headline economic data through July is good. So good it tests credulity. The choice for the incredulous remains being right too soon, or making money whilst the sun shines.

Still, one wonders why, of the indicators below, only the yield curve looks worrying. Flattening in itself does not herald a recession. But it does, usually, mean that money supply is becoming tighter and pessimism for growth and inflation is rising. Yet with real US rates remarkably low it is difficult to escape the conclusion that, whatever the yield curve says at the moment, the US economy is in stimulus mode - not the opposite.

Notes: "Triggers" consistent with indicator levels for previous recessions in the last 40 years; S&P500 M-6 column shows 6 month % change; ISM M-6 column shows 6 month indicator points change.

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