On the face of it, today’s trading update from Quindell PLC (LON:QPP) was positive, assuming you didn’t read it too carefully.
Revenues were double those of the same period last year, while the firm’s favourite flexible measure of profit, adjusted EBITDA, rose by 141% compared to the same period last year.
These morsels of apparent good news might have satisfied the market six months ago, but the mood seems different now, and as I write, shortly before markets close at 4.30pm, Quindell’s share price is down by 6% on the day.
Why? Today’s announcement suggests to me (and clearly to others) that the Quindell train could be coming off the rails.
The firm has cut its revenue forecasts for the full year to between £750m and £800m — down from £800m-£900m at the time of its interim results, three months ago (although many market commentators are citing last year’s forecasts of c.£1.1bn, I can’t find this number in print from QPP, although I do remember it).
As far as I can see, there are only two likely interpretations for this revenue guidance downgrade: either Quindell is turning away new work, because its cash flow is so dire it cannot fund the working capital situation, or the firm is writing down accrued income, which forms a substantial part of its annual revenue.
Rising profit margins
Quindell claims that it will meet full-year guidance for cash generation and adjusted EBITDA, thanks to rising EBITDA margins. The firm has now increased EBITDA margin guidance for 2014 to between 40% and 45% — the third increase this year, as I commented in a new article for the Motley Fool this morning:
This is the third time this year the firm has increased EBITDA margin guidance: in July it rose to “35 to 40%”, then in August it rose to “35% to 45%”. Now it’s risen again.
There’s also a puzzling situation regarding hearing loss, where the case numbers — in my view — seem very high compared to industry-wide claim figures.
I explain this aspect of today’s Quindell update more fully in my Motley Fool article, which you can read here.
In my view, today’s update was the tip of the iceberg. In addition to the factors I’ve mentioned above, the trading update ended with this paragraph:
The Board continues to consider and pursue, with advisors where relevant, all options available to it, including share buy backs, North American listing, disposal or demerger of assets or divisions and strategic and/or financial investments by third parties, in order to maximise shareholder value.
To me, this smacks of desperation and is somewhat bizaare: how can a company with such poor cash flow (the firm boasted of achieving adjusted operating cash flow of £9m in today’s update) possibly consider share buybacks?
Indeed, I suspect a shortage of cash flow may be at the root of the problem; the firm’s mention of asset sales and third-party investments sound to me like rescue funding, rather than ways of maximising shareholder value.
Incidentally, Gotham City Research agrees: the short sellers, whose original report wiped 50% off Quindell’s share price back in April, tweeted today:
Per Quindell’s trading statement & financial highlights released today, we believe #QPP is behaving as if it is at high risk of bankruptcy.
— Gotham City Research (@GothamResearch) October 13, 2014
We can only wait and see, but in the meantime I would remind bullish investors that while the market sometimes misprices assets, it rarely errs to the extent of assigning healthy, profitable companies a forecast P/E of 2.7…
Disclosure: This article is provided for information only and is not intended as investment advice. The author has a short position on Quindell PLC. Do your own research or seek qualified professional advice before making any trading decisions.