THE NAKED FUND MANAGER - What changes are needed post Fusionex fiasco

Afternoon all,

Apologies ahead of time but as a holder of a small piece of Fusionex I’ve decided to go on a bit of a rant below about the parlous situation in which we find ourselves.

Fusionex

As I’ve mentioned above, I picked up a small piece of FXI a couple of months ago and was just starting to do some more involved work when the storm broke the Friday before last. Luckily my investment was really quite small so far, so the damage to the fund has been minimal.

However, it serves to highlight that there is much work to be done on the corporate governance side if we are going to reduce the frequency of these events.

What happened?

The shares had spiked up back in 2014 after an IPO around end 2012, but had since come off to the point where they were down around 28% from their IPO level by the time Fusionex announced a disappointing set of FY 2016 Results in March 2017.

Top line growth had continued, rising over 22% in 2016, but admin expenses rose dramatically over the period, more than doubling from 35m to over 72m Malaysian Ringgit (MYR), as the company repositioned from a licence model to be subscription-based. This turned a healthy 26% growth in Gross Profit to a minus 84% slump in PBT, from MYR 28m in 2015 down to just MYR 4.5m in 2016.

As you would expect, the shares slid off the back of these results, falling a further 10%. At this point, they were starting to look attractive as tangible progress was being made in the business and the transition pains in re-focussing on its GIANT product appeared behind them. However, to my mind, the level of discounting applied by the market was broadly fair because Fusionex had yet to properly deliver on its new strategic direction.

As an investor, there was a decent opportunity for high returns as GIANT started to deliver and this return looked attractive, yet fair, when balanced with the risks involved.

CEO decides to delist (and probably screw minorities)

Late in the afternoon on Friday 26th May, the company announced it was planning to delist from the exchange because it was disappointed with the amount of value the market was ascribing to the business, despite all the progress that was being made.

It’s difficult for that kind of statement to pass the red face test when held up against an 84% slump in profits recently reported.

The announcement precipitated a 70% fall in share price as the investors contemplated the prospect of holding shares in a private company that will be tricky to sell at anything like a reasonable price.

Furthermore, most funds that have a stake won’t have a remit to hold unlisted shares and therefore become forced sellers.

Unfortunately, Fusionex holds all the cards

Under the AIM Rules, a company can pass a delisting resolution with 75% of the vote that turn up on the day (in person or by proxy). Between the CEO (41% equity), another significant employee (13%) and a founding investor (5%), the resolution already has the backing of 59% of shareholders. On that basis, minority investors would need the turnout to exceed 78% and all other votes to go against the resolution for it to be stopped.

The unfortunate reality is that a turnout that high is unlikely in a company that has a relatively high level of retail ownership.

Caveat emptor

This is an incredibly disappointing outcome and is another example of minority investors being poorly served by a company and by the AIM Rules.

Investors should have known the risks as there is always a chance minorities can be squeezed out when there is a concentration of ownership as high as there was in this case. I would go so far as to say that investors did know the risks, and this was one of the reasons the market was discounting Fusionex higher than the CEO would have liked.

On a personal level, I should have considered the risks to my stake as a minority in more detail before making my initial investment, but again, the lack of sufficient due diligence is a reason the size of my initial investment was small.

Changes required to the AIM Rules

It seems clear to me that changes should be made to the AIM Rules in order to reduce the chances of this happening again. Fusionex looks like it can shortly be added to a long list of companies that have squeezed minority investors out unfairly.

The Quoted Companies Alliance (QCA) published a piece on this very subject back in 2009. It laid out a few potential solutions to better protect minority investors: 

• One option that was proposed as a solution was to make the resolution only passable if 75% of total shareholders voted in favour, rather than just those that turned up. It does seem bizarre that minorities can be punished and a company delisted, not because 75% of shareholders vote for a resolution but because other less engaged minority investors fail to show up.

• Another option would be to raise the threshold to 90% from 75%, although this option is not desirable in my opinion as there is more scope for unintended consequences.

If these black marks continue to amass against the track record of AIM markets, fewer investors (both retail and institutional) will want to invest, liquidity will deteriorate, and quality companies will choose other sources for capital when looking at the next stage of their growth.

The quality of companies on AIM has improved in recent years, but there are still many easy to implement changes that would significantly improve the market for all stakeholders.

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To read a brief outline of how I think about stocks, and what I aim to achieve in this blog, please check out my first blog where I set out my stall.

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Please Note: To be clear, I do not and will not ever give any advice. I will rarely mention individual stocks but when I do these will not be recommendations, instead just my thoughts at that point in time.