I’m sorry for anyone expecting to get an update on our gold trade today, but something’s cropped up – a company announcement that’s just way too tantalising to pass up.
On the face of it, there was nothing absolutely devastating about HMV’s announcement yesterday. They issued a profits warning. And said things remain “challenging”.
But that’s not the half of it. In fact, this announcement strikes me as a great example of why you must always maintain a healthy scepticism when investing. It is an abject lesson in why you must read between the lines when dealing with company announcements.
What we’re looking for here is something I call the ‘lay-up’. Because it can really help you profit as others get hoodwinked.
Looking for the Lay-up
In golf, a lay-up shot is where, instead of going for broke and trying to make the green, you think it safer to lay-up a little short and pitch it up on the next shot. In the same way a company can ‘lay-up’ bad news. They reckon that two short deliveries are safer than one big ugly announcement.
At the beginning of January HMV’s announced they’d had a lousy Christmas and would be shutting 60 stores. They also threw in a line saying that meeting bank covenants (terms set out by a lender) would be tight.
At the time I said that investors would hate that line – and indeed it paved the way for yesterday’s announcement that confirmed that ‘it (HMV) does not expect to meet certain of its covenant tests when they are next tested.’
So that’s the first lay-up. These guys will have to renegotiate terms with the group of eight lending banks. The shares are now down some 34% since I recommended dumping them.
The thing is that the company is now playing for another ‘lay-up’!
Yesterday they told us that net debt will be worse than £130m by April next year. Now, bearing in mind most analysts have pencilled in net debt of around £45m to £70m, this is serious, serious stuff.
And it begs the question, what is the second shot of the lay-up?
The banks are now in control
For me, this is all laying the groundwork for an announcement axing the dividend. Yesterday they didn’t have the guts to tell shareholders the bad news. But if you read in between the lines you can see what’s coming – analyst Nick Bubb of Arden Partners points out, this “firmly removes any lingering hopes of a final dividend.”
Many investors still haven’t cottoned on to what the announcement in January really told us… that the banks are now in control.
HMV have loans of £240m with eight banks. They have told us that they won’t be able to meet the terms of these loans. Do you really think that a company whose financial position is deteriorating rapidly will be allowed to pay out a dividend to shareholders? I don’t.
It’s much more likely that the banks start to secure their interests and minimise the risk of their loans going bad – and that won’t be good for shareholders…
The banks will want management to raise some equity – and get the covenants back to some sort of equilibrium. That’s likely to happen in one of two ways.
First, management can sell the jewel in the crown – and in this case that’s Waterstones the book retailing operation.
Amazon and the supermarkets have long-since been on Waterstones’ case. But now, with the advent of digital books sold through ‘tablets’ and the Kindle, this side of the business is under cyber-attack in exactly the same way as HMV.
And with competition hotting up in all sorts of new areas, Waterstones may not be as easy to sell as many in the City expect. A buyer would do well to sit on his hands for a while – this might not be the easy fund-raiser that many think.
The second option is to raise money from shareholders through a rights issue (where HMV issues new shares). HMV is now only worth about £70m – and they will need to raise tens of millions to make any real difference – any fund raising is bound to be highly dilutive for shareholders.
News of an equity issue is likely to send the shares plummeting.
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Do you share management’s confidence?
Let me just leave you with the closing lines from the company announcement. It’s from Simon Fox, CEO of HMV:
“Trading conditions remain tough, reflecting a difficult consumer environment as well the changing markets in which we operate. However, our business is adapting quickly to respond to these external factors, and we are confident that our plans will ensure its long-term and sustainable future.”
The thing is that this company has been ‘adapting quickly’ for years – and all the time it sinks deeper into the mire. They’ve squandered money on acquisitions and changed the ‘product mix’ – all at great expense. Yet the core business continues to wither.
Like a commander in battle, the CEO must look confident and so he trots out some trite line about un-erring confidence in the future. Don’t listen to a word of it.
Never take any company announcement at face value. Look for chinks in the phrases. Look for the lay-up and stay one step ahead of the pack.
How can you profit?
One way you could aim to profit from HMV’s misery is to short the company. In January, I told you about a very interesting way to do that using a “pairs trade”. Click here to have a read of that.
Another way to short HMV is to use a spread betting account. As I said in January, you shouldn’t be daunted by spread betting. It can be dangerous game if you are going into it blind.
But when you have a guide like John Burford, you are putting yourself at a serious advantage to most spread betters. John is a spread betting veteran. He spent years working as a trading advisor with the US Commodity Futures Trading Commission. And he now writes a very useful spread betting email called MoneyWeek Trader.
I go straight to this email when I see opportunities like HMV. John always has something useful to say about this kind of situation. If you haven’t signed up (it is free!), then click here to find out more.
MoneyWeek Trader is an unregulated product published by MoneyWeek Ltd.
• This article was first published in the free investment email The Right side. Sign up to The Right Side here.
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