24th October 2013
The scramble for Royal Mail shares has felt like the modern day equivalent of a gold rush. But what does the frenzy say about the way people invest? After all, there are plenty of UK equity income funds that pay a similar income and without the associated risk of single company investing. Is it simply that they have got a canny eye for a bargain? Or, more worryingly, does it suggest that they still haven’t got a good handle on risk? Cherry Reynard reports.
In many ways the rush for Royal Mail shares was reminiscent of the giddy days of the 1980s and 1990s, when single stock investing was all the rage, first with the privatised utilities and then with the technology bubble. For a while it seemed that people had learned their lesson, understood diversification and would not be lured back into share dealing. Equity income funds were the big money spinners for fund companies rather than a ‘tech dynamo’ fund or similar.
In the popularity of the Royal Mail launch, there was the sneaking suspicion that many investors bought without properly understanding what they were buying. While a number of fund managers did invest at launch, a number questioned the Royal Mail’s prospects as the Telegraph reported.
George Godbar, co-manager of the Miton UK Value Opportunities fund, said: “What I really need to understand is two things. What claim does the pension fund, which is in the hands of the Government, have on the business and the assets – they are paying £400m a year into the fund, could this suddenly double; if they sell some land they don’t need, who gets the cash, shareholders or the pension fund? The second is execution. There must be scope for improvements in profit margins, for efficiencies – how much do you trust the management’s ability to implement them?”
Certainly, many investors may have been approaching it as a relatively short-term trade. Tim Cockerill, head of research at Ashcourt Rowan’s says: “Everyone knew it was selling off cheaply. The Government cannot afford for investors not to make money on this. People knew pretty well that the share price would go to a premium and quite a chunky one at that.” He says that the dividend was undoubtedly attractive: “A lot of our clients are still after income, but they didn’t get a meaningful allocation. The froth will settle and we will have a better idea of how it sits. Only then will we be able to make a proper assessment of its worth as an investment.”
There has been plenty of speculation that the shares were undervalued. Canaccord Genuity said it believed that Royal Mail should have been valued at nearer £6 billion (599p a share) compared with the 330p a share that ministers were asking for, and that appears to have played out in subsequent dealing.
Danny Cox, head of advice at Hargreaves Lansdown says that demand on its site was made up of a mixture of investors, some looking to capitalise on a quick profit and others attracting by the dividend yield and potential for capital growth. He adds: “The Royal Mail flotation has shown there is a real appetite for private share ownership and investing. The UK public will engage heartily when there is an attractive and simple offer to own shares in something they have heard of. Giving ordinary investors and taxpayers an opportunity to reap the personal rewards for the collective risks they took in bailing out the UK’s private banks during the crisis would be only fair. The conclusion is simple: if for no other reason than to not pass up a great opportunity to excite the population about investing in our great economy again, when returning the banks we bailed out to private ownership the Government must offer the UK public the opportunity to subscribe for shares.”
Equally, while some fund managers have rejected the Royal Mail launch as a bad deal, it is certainly not universally thought to be a poor investment. For example Artemis Income manager Adrian Gosden said at the time the pricing was launched: “We have some understanding of postal businesses and their economics due to our holding in Deutsche Post. The investment case in Royal Mail was predicated on an understanding of the decline in traditional mail (c. -5%) and the growth in parcels due to increasing volumes of home shopping. At a market cap of £3.3bn, the valuation looked attractive and the yield of over 5% particularly interesting for an income fund. The cash generation of the business and the limited debt on the balance sheet (less than 1x ebitda) gave us the margin of safety we look for in an investment.” Alistair Mundy, manager of the Investec UK Special Situations fund was also a buyer.
Ultimately, the allocations for private investors were too small to allow for too much speculation in the shares. Yes, a few investors undoubtedly wanted simply to turn a profit and probably didn’t understand nor need to understand the long-term nuances of the company’s pension fund liabilities. However, others have been attracted by the yield and the potential to own an apparently undervalued asset. They are in good company, with a number of fund managers participating in the launch. When the government comes to sell off the banks, it will be easier to judge whether investors are returning to the popular share owning habit of the 1980s or not.