EMIS Group plc

Friday, 13th April 2018 12:23 - by Eric Chalker

 This is a company in which, as I write, I hold some shares.  They were bought on a professional recommendation and that source (plus one other) is currently saying ‘hold’, but I’m not sure I will.  The share price suffered a sharp fall in January, from which it has yet to recover and the question is, have the reasons for this been adequately addressed and all appropriate action taken?

  The share price fell because the company reported “a failure to meet certain service levels and reporting obligations with NHS Digital” relating to a software product it provides for English GPs.  When something like this happens, my particular interest is in finding out how the failure arose and what has been done to prevent it happening again.  The annual report, published at the end of March, should provide this information and to a limited extent it does, but to my mind there ought to be more.  What actually happened is rather opaque and difficult to understand, but it seemingly covers three years, for which an £8.2m retrospective provision has been made.

  But this is not the full cost.  To get the full picture, we must surely add the £5.8m special item for consequential reorganisation during the past year (which I find an astonishing figure) and the increased cost for software amortisation and impairment (a chunk was evidently found to be defective) and the forward provision for additional costs in 2018/2019 of £5.0m.  The total reported cost of what the company is calling “legacy issues” (note the plural) is £20.7m.  This is almost one third of the previous three years’ profits – ie virtually the whole of one year’s profit has been lost.

Management issues

  Whatever the cause, it took the new CEO six months to discover it.  He has now sacked four executives so we can assume those most responsible have gone, but how it happened – and for so long – is not revealed.   A new “principal risk” has been identified which probably provides a partial explanation, namely “The failure to monitor and rectify software defects on a timely basis……”, which will presumably be a key requirement of the new ‘group chief technology officer’.  The statement of principal risks and uncertainties reveals another welcome innovation, which is that, “Each risk has a named owner who is responsible for ensuring that adequate mitigating actions and controls are in place and operating effectively.”  But such a long term failure suggests attitudinal problems throughout the company, which may not be so easily remedied.

  There may also be structural problems.  This is a group with seven separately distinguishable markets and, in the annual report, no indication of the management structure.  I asked to see the senior management organisation chart, but it hasn’t been forthcoming.  This doesn’t instil confidence.

Company value

  The share price today stands close to what it was at the end of 2014.  Total equity (net assets) is actually less than it was then, £108.0m versus £114.9m, which makes the CEO’s belief that EMIS Group “has delivered consistent growth” look strange.  Dividends have certainly grown and in the last three years’ they have totalled 70.40p per share, but basic earnings per share have totalled only 50.40p, a 28 per cent shortfall.   Despite this, the chairman and CEO (although not the CFO) repeatedly insist that the company’s finances are “strong”, a conclusion they presumably draw from the size of the balance sheet, but that looks highly questionable to me.

  As much as 93 per cent of net assets are intangible – ie notional.  They comprise 47 per cent goodwill, 31 per cent software and 16 per cent customer relationships.  How real is this?  One might have thought that some impairment of goodwill was called for, after an event which Investors Chronicle calls reputationally damaging had taken place, or some reduction in the value of customer relationships, but apparently not.  This is despite the annual report revealing that some contracts need renegotation and one contract, albeit small, has been lost since the year end.

  Auditors have to assess risk in relation to ‘materiality’.  For Carillion, now bust, this was set at £8m, which turned out (not long after the audit) to be one per cent of what had to be written off, thus bringing the company down.  Materiality for EMIS has been set at £1.4m, which is 1.4 per cent of the intangible assets showing in the balance sheet.  Shareholders in EMIS must hope that KPMG have it right this time.

    A key test of balance sheets is the ratio of current assets (deemed to be available as cash within the following 12 months) to current liabilities.  EMIS consistently fails this test.  At the end of 2017, the ratio was 0.87 – ie less than satisfactory.  Despite this, the company repeatedly claims a “net cash”  position, which it apparently achieves by invoicing well in advance of its commitments: cash and cash equivalents come to £14.0m, but deferred income is £33.7m, 2.4 times as much.  Pre-invoicing is financing the business it seems, year after year.

  The new CEO has proclaimed his commitment to a better run company and to growth, which investors must hope will be achieved, but it is clear from the annual report that there is some way to go.  A company’s culture matters and my heart always sinks when I see directors posing tie-less, as do the CEO, the CFO and two of the non-executives who have supposedly been watching over investors’ interests during three years of failure.  In my book, lack of a tie is not only disrespectful to shareholders, but indicates a wholly inappropriate casualness to the running of a public corporation: perhaps that has something to do with the mess this company is in.

  The present share price is 50 times the average basic annual profit for the past three years.  This is for a company which has yet to show that it can start growing profitably again and may have actually lost its way.  With additional running costs for support and development already signalled in the 2017 annual report, such a hopeful expectation seems excessive.

Eric Chalker, UK Shareholders’ Association Policy Co-ordinator & Director, 2012-2016

 The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.