Interactive Investor

Stockwatch: fraud probe and share suspension is a lesson for every investor

10th March 2023 11:30

by Edmond Jackson from interactive investor

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This share surged over 500% in under a year, but shareholders are sweating amid ‘material uncertainty regarding its overall financial position’. Analyst Edmond Jackson explains why this rite of passage is something all successful investors go through.

High earner grimacing 600

Capital growth is a key investment objective, yet whether you are a novice or experienced, a challenge is identifying growth stocks that carry satisfactory risk. If you fail to spot key warning signs, any major hits will set back your long-term financial compounding. 

This week has confirmed a prime example of how not to get sucked into a silly valuation on a flaky business. Participants in a so-called efficient stock market somehow managed to chase Wandisco (LSE:WAND) shares up 1,429p on Monday for a valuation of over £900 million – a company with substantial losses and yet to prove annual revenue equivalent to £10 million.  

Feted as a “Silicon Valley company” since founding there in 2005 by a now 50-year-old Englishman who remains its CEO, WANdisco reports in US dollars and has had a roller-coaster chart since floating at 180p in 2012. 

Yesterday, its stock was suspended at 1,310p – effectively, pending clarification of its financial position. A “trading revision” announcement cited potentially fraudulent irregularities in revenue that will significantly impact the company’s financial position, and significant going concern issues.  

Anticipated 2022 revenue could be as low as $9 million (£7.5 million) instead of $24 million as guided, and the company has no confidence in its announced bookings. 

It pours a tank of cold water over announcements that WANdisco has teased the market with – especially in recent months – which cited no reference as to exactly who the customers are.  

Apparently, the fault is solely “representation by one senior sales employee”. 

Does the business meet key tests?     

Besides a goofy name, WANdisco describes itself as a “data activation company...that makes petabyte and Exabyte-scale data trapped in edge computing and on-premises data lakes actionable by delivering seamless cloud data migrations”. 

In plain English, that means helping clients run complex data via cloud computing and manage devices via the internet-of-things. Its website cites top-name partners such as Amazon and Microsoft, although it’s puzzling how it can act profitably as if an intermediary. Cloud computing is becoming increasingly competitive, and the big boys have their own margins to protect.  

Essentially, it is “software”. The sector has had successes including plodders such as Sanderson Group that led to solid long-term gains (and was ultimately acquired). But accounting issues – especially revenue recognition and capitalising costs - have often led to controversy. When a swashbuckling boss embarks on aggressive growth, software has been a serial minefield. 

Over the years, investors have lost big, for example at Versailles, Torex, Globo and Quindell.  

It is not hindsight to say that WANdisco’s soaring chart should have aroused wariness than greed – if you are properly steeled in the first objective of investing, to try not to lose money. 

Its CEO has made a big noise about 5G driving orders, but on a layperson’s level it has been possible to sense a lot of hype behind 5G, which is not rolling out as fast as some proclaim. Indeed, a latest 6G telecoms conference was lampooned for its unreality given the industry has not even got its act together for 5G devices.   

Avoid companies with a combined chairman/CEO 

A key finding of the 1992 Cadbury report on corporate governance – launched in response to a series of collapses by outwardly successful firms – highlighted an over-concentration of power in the boardroom, particularly when combining the roles of CEO and chairman.

WANdisco does have a vice-chairman who is the senior non-executive director alongside two others. But in 2016 there was turmoil when the previous chairman and non-executive directors sacked the same CEO, out of no-confidence. This chairman was himself ousted when the CEO then got support from 58% of shareholders.  

Perhaps they have themselves to blame if deciding to brush aside those independent directors who considered the CEO founder was not the right person to lead the company. 

A rogue salesperson now is being blamed for irregularities, but the CEO has a lot of explaining to do – as to the stream of “contract wins” he fronted – given the company now has no confidence in its sales outlook. 

After the Cadbury report docked auditors to improve their standards, at least it may be that WANdisco’s 2022 audit has unearthed such a colossal mis-match. If it eventually proves terminal, however, BDO (the auditor for three years) will face questions as to exactly when any fraud originated. 

Why you should seek proven earning power 

A difficulty is that WANdisco is a financially unproven business, hence very exposed to any big credibility hit.  

It has essentially been supported by investors’ goodwill, for example a circa £36 million equity-raising at 446p two years ago. 

If shocked investors no longer wish to rescue the business, companies like this can quickly fold. It happens when the best action to conserve stakeholder interests – customers, employees and creditors – is to appoint an administrator to identify a viable rump, potentially to sell on. Shareholders, however, must be steeled to lose all. 

The financial record shows a whopping amount of red: 

WANdisco - financial summary
Year end 31 Dec

201620172018201920202021
Turnover - $ million11.419.617.016.210.57.3
Operating margin - %-158-49.4-120-181-339-545
Operating profit - $m-17.9-9.7-20.4-29.2-35.7-39.8
Net profit - $m-9.3-13.5-19.7-28.3-34.3-37.6
Reported EPS - cents-27.9-36.5-47.2-62.6-68.0-65.0
Normalised EPS - c-27.8-36.5-53.9-58.1-64.4-62.6
Operating cash flow/share - c-7.34.7-27.2-30.5-37.0-48.8
Capital expenditure/share - c17.819.013.413.110.910.0
Free cash flow/share - c-25.1-14.3-40.6-43.647.958.8
Dividend/share - c0.00.00.00.00.00.0
Cash - $m7.627.410.823.421.027.8
Net debt - $m-7.2-23.1-6.7-18.3-18.1-25.9
Net assets/share - c10.242.732.562.655.557.7

Source: historic company REFS and company accounts

You might retort: why ever then did I re-iterate a long-term speculative “buy” stance on Aston Martin Lagonda Global Holdings (LSE:AML) in my last column? 

The difference being: proven top management from Ferrari are now in charge, there’s a global super-luxury brand to leverage, and deep pockets by way of Mercedes-Benz and Saudi Arabia in financial support. 

Balance sheet receivables may also be a red flag 

Last June’s balance sheet showed trade receivables soaring from $6.0 million to $16.2 million relative to interim revenue up from $3.4 million to $5.8 million.  

The company said: “The significant increase in trade receivables reflects favourable business terms on contracts signed in the period, and the acceleration of sales bookings compared to the prior year.” 

These do not appear to be translating into revenue, hence it will be interesting – according to what is this company’s outcome – to consider the extent that a mis-match between trade receivables and revenues is a warning sign. 

The last time I recall something like this happening was five years ago involving Air Partner, an aviation services group, which jolted the market by admitting a £3.3 million accounting error dating back to 2011. This arose during the year-end review, relating chiefly to accounting for receivables and deferred income.  

Likewise, its shares were suspended but did re-list – with a big hit – given the scale of the problem was not catastrophic and the business had a long (if volatile) earnings record since founding in 1961. Eventually, Air Partner was acquired for around £91 million.

Maximum investment in one stock 

Some may say that WANdisco affirms the rule that it’s wise not to invest more than 5% of your portfolio in one stock, or better to eschew stock-picking and rely on well-diversified investment funds

Yet to any seasoned observer, such examples unfold with comic consistency over decades. You can spot an accumulation of warning signs where hyped situations are liable to become duds. 

If you are suffering anguish as a WANdisco holder, do not blame yourself. It is a rite of passage that all successful investors go through, and one which helps hone our wits for identifying appropriate risk-reward in growth stocks.  

You will be better-skilled to judge situations that might deserve greater portfolio focus. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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