During my frequent browses of the RNS feeds from the London Stock Exchange, I came across a possible tender offer on CPP Group (LSE:CPP) at 1p per share. I remembered having looked at this company months ago and thought it would be worth digging out my old notes. What I found was quite interesting. At the time I analysed it the share price was 138p. Today it stands at 3p. This really was a case of a falling knife rather than a value investment.
Thankfully, I hadn’t bought this company, my brief notes at the time put this down to the fact ‘I don’t see how the company will reinvest money in the future’. As it turns out I was a complete fool for even giving this a second thought given the headwinds the company was facing. Knowing what I do now, how could I have foreseen this was a falling knife, and not a value investment? Let’s take a look at what happened.
CPP provides insurance products through business partners such as banks and mobile phone companies. Their products are things such as card payment insurance, identity theft insurance and mobile phone insurance. The exact details of the business are not vitally important for this case study. Trouble started with an investigation by the Financial Services Authority (FSA) into potential mis-selling of their products. Anyone in the UK will know that PPI mis-selling is big news for banks, but companies like CPP were working in partnership with banks to offer these kind of products.
The FSA investigation has cost CPP money in legal and operating costs. It has also imposed restrictions on the selling of their products. Despite this the group remained profitable and developed new products without insurance components. For a couple of years the group didn’t seem in any imminent danger of bankruptcy.
Things started to get worse when RBS and then Santander announced they would not be renewing contracts to sell CPP products. Revenues and profits are expected to be significantly affected this year when the contracts end.
However things really got bad when the FSA imposed borrowing and asset sale restrictions on the company. With a revolving credit facility due for expiry in March 2013 and declining revenues, they are finding it increasingly difficult to refinance this debt. The shares now trade at 3p, the expectation is that they will soon enter administration.
How could you have avoided catching this falling knife?
The FSA investigation was well known at the time I initially analysed this company. After all, that was the reason the share price was under-performing and it may have been a value investment. What I should have given more consideration to though, was not the financial sanctions the FSA would levy (which don’t do long term damage), but rather the reputational damage that this would have on the business.
That is the reason RBS and Santander both cancelled their contracts. Their own reputation was already in ruin over the PPI fiasco, is it such a stretch to think they would cease selling other insurance products, especially with a company that has an FSA investigation into it?
You may have been fooled into thinking that if they had stayed with them up until that point, even with an FSA investigation then they would continue to do so. However what is important is that RBS and Santander were under contract. As soon as expiry came up for those contracts they were not renewed i.e. they dropped CPP at the earliest possible opportunity.
Another red flag was the announcement of the FSA borrowing restrictions. The management clearly stated
“A number of alternative financing and strategic options are under consideration with a view to putting funding in place in advance of the maturity of the Group’s current debt facilities due on 31 March 2013. Alternative financing or strategic options are necessary to secure the future viability of the Group.”
Note the word alternative, very easy to miss the relevance of this at first glance. When you have a company under so much pressure, with revenues in decline with no end in sight, it doesn’t matter if it’s making money or breaking even currently, if it has a debt facility that is maturing and it can’t refinance it, then bankruptcy is a very real risk.
It’s really easy looking back with hindsight and seeing the warning signs. What isn’t easy is learning lessons from this and applying it to future investments. That’s the purpose of these case studies and why I’ll be thinking far more carefully about the impact of regulatory investigations and their impact on reputation and customer retention in the future.