Begbies Traynor (BEG) - 'adjusted' profits

Hi Maynard,

I was pondering investing in this company until I saw the below chart. The two lines show co adj eps and reported eps. There are very large differences over the past 15 years, resulting in a nominal CAGR of Book Value Per Share. The red bars are acquisition spend per share, measured on the right hand axis.

The 2021 fy accounts reconcile a reported profit of £153k, which is inflated by £3,058k of amortisation of intangible assets and £6,546k (!)of ‘transaction costs’ to get to ‘adjusted earnings’.

Would this put you off investing in BEG???

Looking at SDI or JDG (other roll-up cos) there are similar differences, but maybe not as extreme as this example.

Do you happen to know if intangibles now have to be amortised according to ‘mark to market’/dcf calculation, or amortised over a set period of years under current accounting rules? Or, is it at the discretion of the company, provided they follow their own consistent policy?

Regards,
Ben

Hi Ben,

The accounting here is not straightforward.

The transaction costs include something called ‘deemed remuneration’…

…which represent sums paid to the vendors of acquisitions for post-acquisition services:

BEG AR 2021 transaction costs notes

I am not sure whether these post-acquisition services generate revenue; BEG could arguably be flattering its performance by highlighting ‘adjusted’ costs but not highlighting the value of the associated revenue these costs produce.

If ‘deemed remuneration’ does not generate revenue, the costs should be viewed as part of the acquisition expense and therefore added on to balance sheet for ROE/ROCE calculation purposes instead of being written through the P&L. This ‘deemed remuneration’ is a true economic cost to shareholders, but the accounting makes it very difficult to judge the effective value of the associated acquisitions.

The notes in the annual report say the ‘deemed remuneration’ for the latest purchases will be payable over five years. So this issue is ongoing.

Thankfully the adjusting for the amortisation of acquired intangibles is pretty standard.

Intangibles are amortised over a period determined by the company. BEG says its acquired intangibles have useful lives of between one and nine years:

The useful life applied to intangibles is generally academic, although a really long useful life (10+ years) may suggest the directors are a tad optimistic – and may therefore be optimistic about other matters as well.

Acquired intangibles (and goodwill) should be tested for impairment at least every year, which is when DCFs are constructed by management to prove the intangibles have a ‘recoverable’ value at least equal to their book value.

The accounting, while legit, is not clear and I don’t like the regular large acquisitions of late.

Insolvency practitioners are very much dependent on the productivity of professional employees, and so their operations can be difficult to scale and leave suitable rewards for outside shareholders. The annual report says the company employs 71 partners – a term best suited I think for private, partner-controlled ventures.

Maynard

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Thanks Maynard - that’s very helpful!
,
(There must be a better way to present these figures for the users of the accounts?).

In a similar way to the legal settlement companies, I’m struggling to get to the real picture, so I am passing on this one!

Regards,

Ben

Where the intangibles are this big, the profit and loss account becomes, in my view, relatively meaningless. It become much better to look at cash-flows: are they generating operating cash, is this sufficient to cover new investments, are they raising funding or paying it down.

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Hello Diogenes,

Yes you are correct of course - and management appear to be using all of the cash generated to gain scale and pay themselves.

There is also a 5% share dilution p.a., a real cost to the investor, which management are using for part-payment of acquired companies and share option awards (sold to directors for between 5p and 63p with the current market price at 135p)).

The 3 board execs received emoluments of £1.6m, in total, for the year to April 2021. This is in addition to the vesting of any share options (currently totalling 2.25m shares).

To put is into context, reported profit after tax was only £1.9m (adjusted up to over £11m).

Diluted normalised eps are increasing.
Diluted reported eps have basically declined to zilch.

I don’t understand this business model, how they are ever going to corner the insolvency market and gain abnormal returns (and if not then for the investor, what is the point of incurring the enormous professional fees related to acquisitions?), or how the investor gets to the bottom of these accounts (of which I hasten to add, I have no doubt are 100% technically correct and proper in their preparation and presentation).

Probably my failing rather than theirs! Good luck to them!!

Regards,

Ben

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