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The trio in ShadowFall's line of fire

ShadowFall’s managing partner Matthew Earl explains why the firm is short on Blue Prism, Future and Boohoo
December 1, 2020
  • Managing partner at short-seller ShadowFall, Matthew Earl, tells us why the firm maintains its short position against Blue Prism, Future and Boohoo
  • While most of these issues are not new, investors should be wary of persistent underlying concerns

Last month short-seller ShadowFall published a note on Blue Prism (PRSM), that raised similar concerns to those previously expressed by Investors Chronicle in a sell tip only a few weeks prior. Chief among them was the software company’s alarmingly low research and development spending in a highly competitive and technologically advanced market, alongside soaring sales and marketing expenditure.  ShadowFall’s note sent the shares down by 10 per cent on the day of the note publication, and they still have not recovered. 

That does not mean the company won’t eventually be able to shake off the short attack - it certainly would not be the first. ShadowFall has also published notes on media giant Future (FUTR) and online fashion retailer Boohoo (BOO) this year, although many of the issues raised were not new to the market and both shares have now mostly rebounded. But that does not mean that they have been resolved - and any bit of prose that can knock off more than a tenth of a stock’s market value is essential reading for a discerning investor.  

 

The mystery of Blue Prism

Concerns about Blue Prism’s weak research and development spending, especially compared to its mammoth marketing and sales costs, are not new. Indeed, Dan McCrum, the journalist who revealed fraud at Wirecard earlier this year, raised these questions at the Financial Times two years ago. But the market has routinely shaken off suggestions that this has affected the competitiveness of the group’s product - FactSet places a consensus forecast for sales growth at 41 per cent in 2020, albeit that is expected to slow to a still sizable 32 per cent in 2021. 

But, as the old saying goes, sales are vanity and profits sanity - and the latter remains elusive. “If they want to grow revenue in line with consensus forecast it seems unlikely that they will  be able to do that with their existing headcount. Despite the topline growing, the bottom line gets weaker and weaker,” says Mr Earl. 

The company’s effort to move to a profit has been held back by its huge travel and entertainment spending, which was more than three times the R&D spend last year. But while lockdown may have temporarily pushed down these costs, Mr Earl is not convinced that the company’s behaviour will change. “As and when the world opens up, one would imagine that will have to pick up again in order for them to compete  with their peers. UiPath aren’t going to sit back and not do any travelling, likewise with Automation Anywhere,” he adds.

Blue Prism’s shares were certainly not on a downward trend all of last month - indeed, they bounced 8 per cent the day before ShadowFall published its report, after the software company said that it was considering a listing in the US. But Mr Earl describes the announcement as a “spivvy move….often significantly loss making companies on AIM, they play this card that they’re going to do a US listing. Retail investors get all pumped up because they think that American investors are going to pay twice what they paid for their paper. But it doesn’t happen. One, the US listings hardly ever happen and two, when they do they discover that Americans are actually pretty discerning.” 

“They would fall under the purview of the Securities Exhange Commission, and so they better be damn sure that everything adds up if they’re going to list over in the US.” That is not to say that nothing escapes the eye of regulators stateside - evidenced by the growing number of allegedly fraudulent, listed Chinese companies, who frequently attract the attention of American short-sellers such as Muddy Waters and Wolfpack Research. 

 

More adds at Future 

ShadowFall’s key problem with Future lies with its acquisitive inorganic growth, which it claims rests on low-quality bolt-on dea;s. No doubt the short-seller would have felt some vindication last week, when the company alongside with its full-year results, announced its surprise takeover bid for GoCo (GOCO), the price comparison website. Future’s shares dropped by more than a tenth on the day of the news. “It feels very contrived...this has been developed by an investment bank, concocted by the deal desk.” suggests Mr Earl. “The growth prospects at Future are reliant on its ability to make bigger acquisitions and that we don’t think there’s particularly much more to it than that.” 

Indeed, Mr Earl was less than impressed with the group’s 1 per cent organic revenue growth in the second half. “What they’ve done in the past is that they’ve bought what I thought were pretty low quality businesses...and the market rewarded them thinking that they would be able to cobble them together into a significantly profitable and cohesive unit.” 

But GoCo is not a poor quality operation - indeed, its revenues grew by a respectable 13 per cent in the nine months ended in September, led by its new auto-switching service, AutoSave, which more than doubled its customer base. “GoCo is an okay company, it’s been rocking along for the past four years,” says Mr Earl. “As a GoCo shareholder, I’m not sure I would be entirely happy.”  

 

No tears for Boohoo

Meanwhile at another of ShadowFall’s shorts, Boohoo announced last month that it had hired Judge Brian Leveson, who oversaw the inquiry into the UK’s phone hacking scandal, to monitor their supply chain work. “Its margins have been conspicuously high for years,” says Mr Earl. The retailer’s gross margin sat at 55 per cent at its last interim results. “It seems as though it comes down to the exploitation of workers,” he adds. 

And Mr Earl rightly describes the labour concerns at Boohoo as “an open secret” - brought to light by an investigation led by Channel 4 in 2017. But he thinks that this year, the company will need to be seen as making a change.  “When this issue was raised again the Black Lives Matter movement was very much underway in the US, which had come over to the UK to some degree and obviously people were bringing up historical slavery issues...it turns out there’s a modern day slavery issue that’s happening in this country, in Leicester.” 

While Mr Earl is less convinced that management will want to part from its high margins, he is unsure that they will be able to recreate the same levels they have achieved so far. “They claim that they can source more overseas in places like Portugal, Turkey, Bangladesh...but my view is that they’re pretty hard-nosed, profit seeking individuals and if they thought that they could source more cheaply overseas then they would have done years ago.” 

For investors, it is not hard to feel some animosity towards short-sellers such as ShadowFall, who can wipe out a tenth of the value of a holding in just one morning. But it is smarter, and much more profitable in the long-run, not to take an opposing view on a stock to heart. Anything that flies in the face of an investor's initial logic should be welcomed - especially if, as with many of the concerns that ShadowFall has raised regarding all three companies, those issues have yet to be fully resolved. Indeed, if something is amiss at Blue Prism, Future or Boohoo, it may well take the attention of more short-sellers to pin down the source of the rot.