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Tern – when is an investment company not an investment company?

By Cynical Bear | Thursday 4 February 2016


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.


Continuing my look at the world of investment companies, I look at one key aspect of the new rules, namely where an investment company has taken on a controlling stake in an investment, in the context of Tern plc (TERN). 

Thanks to Drunken Sailor for making reference to the notes on the new rules (HERE) in a comment to an article last week but I thought it worthy of a closer inspection and a potentially wider audience. 

Paragraph 3.1 includes the following section:

“Controlling stakes

Where an investing company takes a controlling stake in an investment, there should be sufficient separation between the company and the investment to ensure that the investing company does not become a trading company.”

My sense is that AIM Regulation is beginning to put pressure on investment companies in this regard and believe that this had a role to play in Afriag (AFRI) announcing its decision to leave AIM recently and also in the current suspension of Teathers Financial (TEA).

By looking at Tern’s recent RNS’s one would be forgiven for wondering about this issue as, in the last year, there has scarcely been a mention of its 3 other investments (Flexiant, Push Technology and Seal Software) but there have been 11 separate RNS updates in relation to its investment in Cryptosoft.

In addition, Tern owns 100% of the A shares in Cryptosoft (the B shares being owned by Cryptosoft’s management and staff and entitles the holders to 25% of the sale proceeds on exit). Perhaps someone with more technical accounting ability than me could explain why Tern does not have to consolidate Cryptosoft’s results as it is, but surely a 100% stake in a business would make one wonder whether there is such “sufficient separation” between the two entities.

In my opinion, Tern has an issue here as with investments in its accounts at £1.4 million, the only way it can justify its current market value of over £8 million is to encourage shareholders to get excited about its largest investment, Cryptosoft; however, the more that it bangs that particular drum, and the more that it continues to invest in it, the more blurred the line becomes between it being an investing business and a trading business that could incur the wrath of AIM Regulation at any time.

Accordingly, there are two issues preventing me from buying these shares at the moment.

First, there is limited visibility on the future earnings of Cryptosoft with the only contracts to date being relatively small, so the valuation looks punchy in any event and, secondly, how is one to know whether a suspension for breach of investment policy is just around the corner?

 


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