Stockwatch: Shareholder rebellion a bullish signal?

Is shareholder rebellion a bullish signal or a symptom of a troubled company? At Lakehouse, a £71 million builder and servicer mainly of council houses, the founder Steve Rawlings, who owns 15% of the equity, has joined forces with fund manager Slater Investments, with just over 6%, to try and replace the non-executive directors, including the chairman.

The stock initially rose on the 9 March announcement, but has since dropped from 54p to 45p. Remember, the shares had plunged from about 90p to 35p after a 1 February trading statement which cited changes in social housing legislation last July forcing adverse new rents.

In the latest defence, the board nit-picks about whether the rebels' proposals are strictly in line with a corporate governance code, while ignoring the plank in its own eye regarding just why all this came about; the directors' apparent failure to recognise a major change in its industry is blamed.

Lakehouse, which floated only a year ago, made no reference to this in its maiden prelims on 10 December, saying: "With a solid order book and pipeline for the forthcoming year, the board remains confident of its expectations for the current year and the future." Then on 1 February: "the group now expects the financial out-turn for the current year to fall short of its previous expectations and to see a reduction on last year's profit level."

Not only was it guaranteed to irritate investors who may have been assured in results' presentations, it most likely struck a fear the board doesn't have requisite controls and/or competence. The original 1992 Cadbury code on corporate governance clarified non-executive directors' special function to represent shareholder interests, so it is logical that the rebels focus on such appointments, rather than directly replacing executives.

Let's see the rebels' proposals

In its defence, the board uses smokescreen measures, for example: "the requisitionists' actions have caused unnecessary disruption to, and uncertainty within, the operations of the business at a time when the board wants to focus on the trading performance of the group." But Slater Investments is due to publish a letter to shareholders ahead of a shareholders' meeting on 19 April and it will be interesting to consider the rebels' plans.

It's possible for troubled smaller companies to get torn apart by feudingIn addition to proposing Rawlings joins the board, there is Ric Piper, the former finance director at engineering group WS Atkins, and Robert Legget, who runs a fund management group. They are not all seasoned plc professionals, but Slater is likely taking this action as a figurehead for institutions who took stock in the placing at 89p a year ago and who have lost confidence in the existing board.

Certainly it's possible for troubled smaller companies to get torn apart by feuding, so the matter needs resolving effectively and soon. Perhaps the executives feel they too will be ousted once the non-executive directors are changed (remember, it's the chairman who runs the board and has the power to fire the CEO). But this is how ownership rights are exercised.

Directors have been buying

On 2 February, I initially assessed Lakehouse as a risky recovery buy at 35p, which was then affirmed on 4 February by four executive directors each buying 71,430 shares likewise at 35p, even if this was perhaps a concerted effort to restore credibility. Three of them have shareholdings ranging from 5.5 million to 7.9 million, hence they have interests to protect.

But on 11 February one of the non-executive directors bought 50,000 shares at 38.57p, taking his stake to 83,307 shares. It's no guarantee, but worth noting.

'PE of 4 and yield over 8%' may be exaggerated

In online media and discussion, a consensus has taken hold that Lakehouse now trades on a forward price/earnings (PE) ratio of 4 and dividend yield over 8%. This is based on a heavily "normalised" view of the accounts which doesn't square with the company saying profits will be lower this financial year.

The table shows numbers on which such claims are based, deriving from a 12 February note by Peel Hunt, Lakehouse's broker. Mind also that Company REFS has its own way of normalising profit (as shown in the historic figures), which may be a fairer view, yet still derives a modest PE.

Looking at the 2015 accounts, I note four classes as exceptional: £2.5 million contract losses on businesses exited, £2.9 million "contract costs", £4.1 million flotation costs and £6.5 million amortisation of acquired intangibles.

So be aware of a gap between statutory and "normalised" accounting which will persist - e.g. the cost of advice currently to deal with the rebels.

The group had no debt at end-September, which mitigates the risk profileYet the 24 March announcement said: "the company remains on track to deliver its revised expectations for the current financial year," which properly means the Peel Hunt forecasts.

It's hard to know what to believe and this may help explain why Slater and others have had enough.

Regarding dividend capability, mind that this company has yet to establish a track record. The 2015 cash flow statement shows cash generated by operations up 24.5% to £19.1 million, albeit with £31.0 million applied for investment and a variance in the tax charge, such that dividends would not have been appropriate. A 3.5p per share payout as forecast would cost about £5.5 million, versus £6.9 million cash in the end-September 2015 balance sheet.

Lakehouse really needs to see how its year evolves after issuing a first profits warning, which also included delays in UK domestic smart meter installations that will impact profits in its energy services side. The key question for cash flows is how changes in rental formula will affect landlords' spending.

The group had no debt at end-September, which mitigates the risk profile, besides leaving scope for dividends.

Value is indistinct, but potentially exists

You won't find clear-cut measures here, but uncertainty after a shock profit warning raises the odds Lakehouse equity is under-priced. At 45p, it remains a speculative buy, assuming a capable board can get a grip and re-position as necessary to the changed market-place. Mind - that would also mean exceptional costs continue.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.