RJH writes...

Update: iSoft's June 8 announcement qualifies as an accounting funny - the scribe's position reverts to Mr Whiston must go.

Sanctuary plc is a mess; two previous posts cover this here and here.

As of today, the board sacked - belatedly - the CEO, Andy Taylor, who presided over this descent to near extinction (where the group unhappily still resides). They said this morning:

"The board's decision to remove Mr Taylor followed their conclusion that certain of the prior year adjustments made in the 2005 accounts should have been presented as a correction of fundamental errors and not as changes in accounting policy."
An ironic termination for an accountant and one which calls to mind another CEO accountant - Mr Whiston, of iSoft plc. He too sits on an accounting mess which this scribe has written ought to end his term with the company.

In fairness, that opinion must be contrasted to Sanctuary's predicament:

* iSoft has added value, not the opposite, for most of its quoted life; and Mr Whiston has been either finance chief or CEO during that time;

* iSoft's financial situation is best characterised as illiquid, not near insolvent, and at least partly due to forces beyond the company's reach; and

* iSoft, in this investor's view, is quite significantly mispriced / undervalued and will negotiate a solution with lenders that returns it to cash flow happiness

On the assumption - hitherto rejected - that Mr Whiston is capable of rebuilding investor trust, well, everyone deserves a chance to put right their ship.

Provided there are no more accounting funnies to appear.

The writer owns iSoft plc equity.

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RJH writes...

Goldman Sachs and Merill Lynch have the same forecast for the Baltic Dry Index (BDI): softer prices in 2006 lead to increased scrap rates followed by a steady upturn into 2007 and 2008. This is likely too sanguine.

Three interlinked factors mitigate against stronger freight rates:

* Iron ore represents circa 30% (650 million tonnes in 2005) of total global dry bulk trade

* Of this, China imported 275 million tonnes, or about 13% of total global dry bulk trade

* Although a year-over-year increase, the rise in China's iron ore usage was not incremental - it came at the expense of other major steel producers.

Accepting the argument that China's central planners are not capable of slowing down the steel industry implies either other major producers will have to shrink at Chinese expense as in 2005; or that steel prices and margins are headed for falls.

Other things being equal, the first outcome suggests flat dry bulk rates; and the second an initial rise followed by a steel glut and sharply lower freight rates. Until either denouement, shippers and the BDI at best will enjoy a stable environment whilst miners (contrary to current market sentiment) will laugh all the way to the bank.


Sources: Goldman Sachs Global Investment report, March 22 2006

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RJH writes...

As bullet-proof is the film, so it seems are iron price hikes.

A year ago the Priory of Sion - sorry, the Big 3 iron ore producers - secured a 71.5% increase in prices largely by exploiting non-Chinese steel mills' fears of insufficient supply in the face of huge Chinese demand.

This year's rise with non-Chinese producers is +19% (same Big 3 strategy - it ain't broke) and it is likely that China's steel mills will have to swallow the same. It does not take a Harvard symbologist to decipher the miners' argument: China's demand compels expansion of supply (read capex) and it's normal that price increases fund this. And, by the way, increased energy costs ramping up miners' operating costs don't help either.

With steel prices relatively soft non-Chinese steel mills must be rabid at the idea of being made to fund more Chinese production. Overcapacity risks include China becoming a net exporter, an outcome that would surely come about concurrent with the deflation - orderly or otherwise - of the Chinese construction bubble. Global knock effects considerable.

But why doesn't Chinese capacity simply calm down via market triggers like iron ore price increases? Da Vinci Code aficionados will know their villain as Silas, the handgun carrying Opus Dei monk. In this production the equivalent is Chinese Central Planning. Having long incentivised the steel sector the government is finding it a bit difficult to break the overcapacity code before time runs out.

(Click for larger image) Exhibit 1: Chinese central planning and steel production, 2003-2006






Sources: Consulate General of People’s Republic of China in NY; China Steel & Iron Association; and MEPS International

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RJH writes...

Before global equity markets lifted off circa 1984, it was the US monetary base, with a near two thirds share of total liquidity, that counted. Today the difference is startling: global liquidity has increased almost ten times; and since 1994 foreign official assets have usually dominated - their share today stands at 58%.

(Click for larger image) Exhibit 1: % shares of US and foreign official liquidity & total liquidity $bn, 1970 - 2006




Compared to the US monetary base, foreign official assets punch above their weight in terms of volatility (see Exhibit 2 below). And now, at over half the total, changes to foreign assets overpower those to the less volatile US monetary base component that much more.

(Click for larger image) Exhibit 2: Volatility impact of foreign official liquidity on global total, 1970-2006



Twice since 1994 foreign official assets have been taken off the liquidity board - in 1998 and 2000 - and shortly afterwards the S&P500 made corrections (as in 10% or more). Today's context remains such that the weight and volatility of foreign official assets continues to demand investor attention: any contraction is a significant indicator of possible equity trouble ahead.

The last available data point for foreign official assets shows a 4.1% year-over-year expansion.

Sources: Federal Reserve Archival System (FRASER); Federal Reserve Economic Data (FRED); and Yahoo Finance

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RJH writes...another graph to complement yesterday's conclusion

Two years hence, give or take, often has been the answer.

(Click for larger image) Exhibit 1:YoY% change in liquidity & SPX500 (RH scale), 1975-2006 (NB Crises and equity corrections are lined up with the liquidity oscillator





On the face of it, the immediate outlook is poor for the S&P500. But offsetting data, as in this graph, is not science. Depending on which period the best fit is sought for, offsets may range between 18 and 36 months. And, if one believes the Big One has already begun, equities are currently anticipating the impact of evaporating liquidity.

Previous declines in the rate of liquidity expansion – or even when it has contracted – have not automatically led to year over year declines in equity returns, or negative returns. The bottom line is that the two data sets are correlated by about 35%.

In the context of US economic imbalances, what would seem to matter now is reducing equity risk until it is clear how orderly the unwinding is turning out.

Sources: Federal Reserve Archival System (FRASER); Federal Reserve Economic Data (FRED);and Yahoo Finance

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RJH writes...

As much of the financial press gnashes its teeth - or reports gnashing of teeth - over recent equity action, market liquidity finds itself the centre of attention. The argument is not new: rising rates sucking excess cash out of stocks, coupled with energy inflation and dollar devaluation, spells disaster.

One UK daily, The Telegraph, yesterday quoted Lombard Street Research as saying the US is heading into recession, China a hard landing and that "an impending financial crisis" has become more probable (than last week, it seems).

Based on the historical data, it is unclear that evaporating global liquidity will significantly deflate equity prices; and it would wrong to characterise major stock market corrections, or US recessions, as usually provoked in part or whole by declining liquidity. Sometimes it has played a role but not always. Context is vital as Exhibit 1 illustrates:

(Click for larger image) Exhibit 1: Global liquidity, US recessions, notable crises & stock market corrections, 1971 to 2006



As a related aside, backing out the "global" element of liquidity as in Exhibit 2, reveals a loose proxy for what the Fed has done to interest rates in response to economic events. Contrasting the graphs reveals the difficulty the Fed sometimes faces weighing domestic economic needs against the demands of an economically inter-linked global system. The prescription for one will not always suit the other - as in the actual dollar situation.

(Click for larger image) Exhibit 2: US liquidity, recessions, stock market corrections and notable crises, 1961 to 2006



What is clear is that asset prices, in absolute historic terms, remain expensive even as the Fed raises rates. This is driven, perhaps, by investors who insist on using relative valuation methods whilst drawing comfort from a still, despite its imbalances, robust US economy. That continues to keep the equity market deroulement in the wings for now - and its public waiting.


Sources: Federal Reserve Archival System (FRASER); Federal Reserve Economic Data (FRED);and Yahoo Finance

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Capital Chronicle now uses Feedblitz to alert email subscribers to new postings. The previous system, Bloglet, suffered reliabilty problems and failed to send out several alerts for recent entries. As a result, subscribers will have to visit us to view at least the last 5 articles.

Apologies for the break in service.

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RJH writes...

As iSoft plc flounders under the formidable financial and technical challenges of its NHS contract obligations the question arises who might profit from their blotted copybook.

After its merger with Torex, iSoft parted company with Chris Moore, one time Oldham Athletic owner and the CEO of Torex Retail. It also "released" former Torex finance director Mark Woodbridge for undisclosed reasons (another story craving the light of day). After a polite pause both appeared on the payroll of Ascribe plc (LSE, ASP), software specialist to the UK health sector. Small world, eh?

Ascribe plc's financial profile bears comparison with that of the 1999 version of iSoft. Then iSoft turned over £11m - as Ascribe is likely to by end June 2007 - and from a similar balance sheet position; both seek to complement organic growth by acquisition; and both generate prodigious cash from existing maintenance contracts.

Capitalised on the AIM at £35m, the firm is a small fish in the lively medical software market ocean where the relative whales General Electric Medical Systems, EDS, Misys and iSoft all swim. But Ascribe occupies pole-position in its niche competing most directly in the UK with the similarly sized JAC, a subsidiary of Mediware, Inc (Nasdaq, MEDW). Slightly larger potential rival Cortex plays in continental Europe and has no UK presence.

As with its closest peers Ascribe plans market gains and a broader clinical IT offering by acquisition. This spur, coupled with Ascribe's strong niche base, makes the firm worth consideration as a potential Mark II version of iSoft plc. Without, hopefully, the adoption of risky off balance sheet financing and opaque communiqués (Ascribe have kept public relations in-house thus far).

In its latest interims, and with one eye on iSoft's travails, Ascribe sent out a little message to anyone who cared to listen:

"There has been much publicity about the delays in the National Programme for IT (NPfIT) now called Connecting for Health (CfH)...We are now seeing many more customers engage with us about their future plans to deliver the functionality they require."
Stand duly alerted.

The accounts do not distress but the shares (at 34p) are priced for growth and closely held.

The writer owns iSoft plc and Ascribe plc equity

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RJH, influenced by a recent sojourn in Latin America, writes...

In the Marquez novel, Angela's twin brothers Pedro and Pablo repeatedly announce their intention to kill Santiago for bedding and thus dishonouring their sister before her wedding to Bayardo. And, indeed, they carry out their intention.

If hardened number crunchers wonder where this is going, point them towards the last iSoft communiqué. It is another masterpiece of obfuscation by the firm and its public relations advisors Financial Dynamics: instead of any reference to the critical issue of what the auditors have been telling CEO Mr Whiston about his accounting, owners are given one new meaningful item of news - an additional profit warning.

This ommission is unsurprising given that iSoft threatened legal action against the last people who wanted to reveal what the Deloitte Touche view of the group's accounting was. Then, in 2004, it was the Guardian newspaper that was compelled to back down from publishing details of the due diligence opinions (as part of the Torex merger).

This time, though, it falls to Deloitte Touche to assume, albeit unannounced, the Pablo/Pedro assassin role; and there now remains no legal or other figleaf with which iSoft might conceal its modesty. The auditors have yet to sign off the accounts (if reports are true) casting Mr Whiston firmly in the role of Santiago (whose penultimate outing with the twins was to the local bordello).

It is not a particular pleasure to see a man deprived of his employ. But without Mr Whiston's departure the group's ability to win business will continue to labour under the strain of financial rumour for which he is currently and rightly carrying the can.

Following the Marquez script, Mr Whiston goes which would make the published accounts, due in June, represent rock bottom. On the other hand, keeping the CEO would mean iSoft resume digging, such is the loss of confidence in the company's accounting and communication.

Angela (iSoft) eventually fell for Bayardo (Misys?) but it took 17 years for him to come back for her. With good sense, the iSoft board will do the right thing for owners long before then and set the company on recovery road.

The writer owns iSoft plc equity

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