19
May
2017

Thoughts from the back office

In most investment banks “the back office” is where the lawyers, accountants, settlements, programmers, legal and compliance sit. It’s the least glamourous place to be in the bank.  The tendency is to see “the back office” as overhead. Not a productive place to be, because it doesn’t generate any money for the bank. At Seymour Pierce, where I used to work, we used to joke that the local bar, literally at the back of the office, was “the back office”. As in “I’ll meet you in the back office after markets close”.  You meet interesting people in the most unusual places. And I met the management of a “bagger” in the Seymour Pierce “back office.”

I came across a 28 bagger in the back office

On the 24th March 2009 the shares were worth 8p…they are now 220p. That’s an increase of over 28 times. When I met management in 2011 I wrote down the name of the company on a post it note and stuck it in a book I was reading (something by Bertrand Russell).  The management seemed straightforward, relaxing after a schedule of meeting investors in The City. And modest. Annoyingly though I didn’t invest, because the share price had gone from 8p low to 40p a couple of years later. So I thought that I’d missed the opportunity. More fool I.

Not normal

Now that everyone has read Nassim N Taleb, it’s quite common to say returns are random but not normally distributed. Everyone nods. Someone might even say “non Gaussian”. But what this means in practice is that what goes up doesn’t always come back down. This is a flaw in traditional value investing approach. The greatest returns come from assuming that mean reversion is NOT a fundamental law like gravity. A company that has increased in value 5x can keep going AND increase in value another 5x. Now we are really talking…a 25 bagger. 25 baggers are unusual, but Rightmove, ASOS and Trifast are not nearly as rare as the rather tame view of randomness that assumes “normal” distribution would predict.  Someone has even published a book about 100 baggers.

While most people have heard of Rightmove and ASOS, no one I know has heard of Trifast. So I thought the story is worth telling. Though I shared a bottle of wine with Trifast management in “the back office” I don’t know them, and haven’t seen them for more than half a decade. But I think their achievement has been fantastic, and it’s a shame that more people don’t know the story.

The Trifast story

American companies all seem to start in garages. Trifast began life in a Listed historic building, in a single rented room in 1973. Jim Barker joined in 1974, Malcolm Diamond and Geoff Budd joined in 1976. These three went on to become executive management.
The founders stayed with the business for 20 years, and still own shares even now but resigned as Directors when it became a public company in 1994. By then it had sales of £23m and was valued at £32m market capitalisation. The Diamond, Barker and Budd team ran the business ran for the next decade. Trifast growth was driven by the expertise in component logistics management – that is they helped multinational electronics and car manufacturers run their assembly lines. Making sure they never ran out of screws, self locking nuts, bolts or metal sheet fasteners. Perhaps not the most glamourous business, but nonetheless successful. The second half of the Nineties was a great time, Oasis, Blur, Christina Aguilera, Britney Spears, Shania Twain, The Big Breakfast and TFI Fridays.  It’s hard to think about just how much of an optimistic time the late 1990s were. For Trifast the second half of the 90’s were great too, sales quadrupled from £23m in 1994 to over £100m by year 2000, not to mention a share price that bagged 6x times from 50p and £3 (after adjusting for a later stock split).

But nothing goes up in straight line. Not even 28 baggers.

Trifast share price (log scale)

Things went wrong very quickly when the first internet bubble collapsed, they were hit hard. Demand for telecoms hardware hurt Trifast badly, causing a sharp fall in profit in a three months in 2001. To be fair to management, they knew their business was heavily reliant on the electronics sector, they wanted to raise money in 1998 to acquire a competitor that would reduce their dependence on these customers. But institutional shareholders in The City didn’t want to back the board. This is unusual, normally the institutional shareholders back the acquisitions (Royal Bank of Scotland / ABN Amro comes to mind). Institutional investors seem to vote through generous pay and crazy acquisitions at big companies. But the rules are different for smaller companies, often institutional investors struggle to appreciate entrepreneurs and founders.

Fitter

Management took some hard decisions, making people redundant and closing a struggling factory in Telford. A few years later, as profit and sales recovered to pre DotCom crash levels management stepped down.  When they left the business looked in good shape.  An ex Rothschilds corporate financier was appointed as Non Exec Chairman.
But then the financial crisis hit.
The company nearly failed in early 2009. Sales fell 27% in the H2 to March 2009. Profit fell from £4m the previous year to reporting a £15m loss. The company warned it was in danger of breaching its bank covenants. The share price fell 90% from 80p to 8p.
To be fair to the new management who came in they had ramped up their buying quantities from China in anticipation of new EU rules that prevented anti-dumping. But just at the wrong time demand declined and there was a huge overstocking problem in the sector…Maybe the previous management who had seen the dramatic slump after the DotCom crash would have been more cautious?

Happier

We will never know. But what happened next is the new management resigned and were replaced with the old team Jim Barker, Malcolm Diamond (Geoff Budd had never left and was still at the company). They were appointed with the backing of the key institutional shareholders. They turned it around. The share price is now up 28 times. The happy story of the turnaround probably deserves a separate post in itself.  But it was a success.  Compare the 28x share price increase to Lloyds, where Antonio Horta Osario is being lauded with flattering articles in the newspapers, and who earned himself £38m for rescuing Lloyds…. so that the Government have just about got taxpayers’ money back. Antonio did this by sacking tens of thousands of people making the business “more productive”. Many of these roles were in the Lloyds back office.  But if all these people were not needed, why were they hired in the first place?

More Productive

All this leads me to some confusing thoughts on “productivity”. Doubtless one reason that Trifast is still around is that in 2009 the Government and the Bank of England unleashed a huge liquidity bubble and schemes like “cash for clunkers” (paying people to trade in their old cars and buy new ones, in order to rescue the auto manufacturers). But there is also a good argument that this has harmed productivity, not enough creative destruction, zombie companies. Trifast most certainly is NOT a zombie company. This seems a paradox.
But there are many other productivity paradoxes. For instance, I am experimenting with using computers to read and learn from Annual Reports like Trifast’s. I want the computer to flag potential high return companies.  And also identify if there were any warning signs or “red flags” in the Annual Reports before things went wrong.  Reading the Trifast Annual Report, it’s not obvious what the warning signs were, even with hindsight.  Net debt was falling rapidly and profit margins increasing…which are not normally signs of a company that is facing difficulties in the near term.  Perhaps there were non-obvious signs that a computer could pick up?

Comfortable

Tariq Rashid, who is much cleverer than me, has taught a computer to read the public inquiry into the Hillsborough Tragedy and also the Iraq War inquiry. http://makeyourowntextminingtoolkit.blogspot.de/ But the technology is not really up to it…at the moment. Despite using techniques like Singular Value Decomposition (SVD) the truth is that if you want to learn about the Iraq War inquiry, the best thing to do is read about it yourself. Similarly the best way to learn about “baggers” like Trifast is by reading the past Annual Reports. I now have learnt how quickly things can go wrong, but have also seen how a company that was in danger of failing can be a great investment.  

Was this a waste of time? I talked about this with programmer friends, who thought that as long as you are learning something useful, then it’s productive. Does that mean Gauss’ mathematical ideas are productive? Only sometimes. But what about reading Bertrand Russell’s “In Praise of Idleness” is that productive?  Is studying a “useless” degree like History of Art productive?…it probably was for Michael Lewis and Eddie Redmayne.
Paradoxically too, the professions we view as the least productive are the ones that can’t be replace by a computer. For instance bar work and caring for the elderly is recorded in the statistics as low productivity. I have friends who work behind bars, and it is hard work, long unsociable hours, demanding and low paid. Bar workers and waitresses are some of the most creative people I know, it’s just they have a talent for music, art or acting which rarely pay the bills.  But when creative vocations pay off…they pay off in an extreme, non Gaussian way.  

http://allisonchaplin.blogspot.de/

On the other hand, a big bank financial analyst who builds a CDO with faulty assumptions, is viewed as highly productive by the economists who compile the statistics. No one at Seymour Pierce could have designed a CDO, and certainly not after a visit to the back office. I’d say that was a good thing. Our office was between Merrill Lynch and Goldman Sachs, but they never seemed to be in the bar at 5pm.

If highly skilled professions like accounting, financial analysis and law can be replaced by a computer, what is it that really makes them productive? They seem like “back office” professions to me. If one of the richest guys in the world spends all his time reading Annual Reports and thinking, and makes one correct decision a year, is he being productive?  Why is no one else interested in replacing Warren Buffett with some bits of software?

Not drinking too much

I’m not sure these questions have a correct answer. I don’t think that even a quantum computer could answer. But I know that my time spent in the back office meeting Trifast management might have been unproductive but it wasn’t wasted.

3 Responses

  1. Pingback : What I’m reading ~1/6/2017 – What I learned today!

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