What Caused PSPI To Crash?

Published in Investing on 5 April 2012

This small cap shouldn't have been viewed as a value play in the first place.

I'm not easily surprised by anything in investment at my age, having seen it all over the years, but just occasionally something occurs that makes me wonder what is going on. And that's just what has happened over the last few days on the Value Board regarding a discussion thread about a company called Public Service Properties Investments Ltd (LSE: PSPI).

For those unaware, this is a small-cap property share specialising in care homes. It's not one that had appeared in my trawls or caught my attention in the past, and we'll see why shortly. On 2 April, the company issued a trading update with some bad news and the share price collapsed. Because it had been discussed on the boards as a value play a while back, with many investors apparently going in -- plus I understand that some writers here had reviewed it in articles as an attractive high yielder trading below tangible book -- naturally, the collapse attracted attention on the Value Board. And someone asked -- to my later surprise, it was a reader whose views I respect -- whether there were any lessons to be learned from the loss so as to maybe avoid such events in future.

Looking under the hood

So I gave it a proper once over, never having given it one before, to see if I could identify anything questionable in its past merits as a value play. Let me say first of all, though, that the most ostensibly attractive value plays can, and do, go wrong at times. This strategy is not a guarantee of winning every play because that is not possible in a risk game -- it is, though, one where on balance investors expect to come out comfortably ahead over all their trades.

So upon researching PSPI, I most definitely was not looking for some minor quibble with which to gloat and smugly berate those who went wrong in it. That's not me. I have gone wrong many times myself in both my personal trades and those I write up on Fool.co.uk, and that can happen to anyone, as I say above. But what I was looking for was anything big enough that might have caused me to avoid it, had I ever considered the share, which I hadn't.

So I looked up the last couple of accounts, exactly as if I was considering investing in it. I found that PSPI had traded well below net tangible asset value and had a high yield over the last year or two. So far, so good.

Finding fault

But then I looked at net debt. At 30/06/11 this totalled £137.7m, and at 31/12/10 £130.9m. Net assets, even before deducting goodwill, were £121.3m and £122.9m, making gearing of over 100% in each case. And that, for me, would have been the end of the story, and I would not have invested in it.

I don't care what business it's in -- as a small cap, in my view, it demands the tightest possible value criteria to minimise the downside. With net debt being so important to me, and especially crucial in a small-cap play like this, I would not have looked any further. I would have sought net cash, or maybe would have accepted a low level of gearing in view of the big asset discount, but over 100% is outrageous for a value share, even though that sort of level may be quite common in property companies. Of course, if a measure is quite common, by definition it can't be a value rating because value seeks the uncommonly cheap.

A couple of minor points caught my eye, too. Note the company name with the "Limited" tag. That's not the description of a UK-listed company, which are known as PLC, and it tells me immediately that it must be registered abroad somewhere. So I checked it out and, sure enough, the address is in the British Virgin Islands. I don't like that, but on its own this is a minor point.

Then I discovered that a significant proportion of their property portfolio, 31%, is based abroad in Bongo Bongo Land -- including places like Germany, Switzerland and the US, wherever they are. That is not good news for a very small cap like this. Again, though, like the above, it's a minor point on its own since most of their properties are in the UK.

Sharing the results

I posted my comments about the debt on the Value Board, but not the minor points, as a response to the query asking whether anything could be learned. To my surprise, back came some readers claiming more or less that this was not relevant and that the real reason the company was in difficulties was due to dodgy valuation methods. To me, it seemed odd for anyone on the Value Board to claim that the company's high gearing was not important when it would have caused me and many other value players to steer well clear.

Even if the valuation problem was the reason for the collapse, these readers miss the point. Which is that this share, in my view, was too risky in the first place because of its debt and should have been avoided. It doesn't then matter why it later went wrong; the lesson to be learned is that the debt should have put off value investors.

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rober00 05 Apr 2012 , 4:30pm

Thanks Stephen, the points are well made and noted.

Chinga1 05 Apr 2012 , 4:34pm


as an investor in this one and having been burnt badly on it, your advice will be writ large in my own personal commandments of "what to avoid in a value share". Let it serve as a lesson to all value investors.


cshfool 06 Apr 2012 , 12:08pm

Stephen has long advocated his P Y A D criteria on this board and that has proved very useful to many of us as is this article. - I wonder however if the order of the letters might be rearranged in order of importance - to for example D A Y P.

low levels of Debt most important, Assets - next most imporant, - (below Tang. Book), yield - less important, and PE ratio least important, followed by smell and some other things.

So is it good DAYP, or is it just a load of crepe?


Longtermyieldman 06 Apr 2012 , 8:25pm

The amount of debt is irrelevant as a standalone statistic; what matters is the proportion of the gross assets that the debt represents, and also the comfort with which the running yield covers interest payments.

While PSPI's gearing, at 106%, is relatively high, it is far from exceptional for a firm that has upward-only, mainly indexed, rents. It's problem is that in the UK (and not in 'bongo-bongo land' such as Germany, Switzerland or the US) all its property is let to one company, in the care home sector, which is experiencing lower levels of occupancy because cost-conscious local authorities are sending people into homes at a later stage than used to be the case. The management is trying to negotiate some kind of equ.ity (in the tenant company) for forgiveness on rents transaction to get round the refinancing hump this autumn.

pyad 07 Apr 2012 , 11:50am

Longtermyieldman: You miss the point I made in the article about debt when you say that it is "far from exceptional" in this case. If it is far from exceptional, which is a relative term, then it can't be a value rating.

Think about it, value seeks the cheap, which in the case of gearing means very low or ideally none, ie. net cash. Consequently debt levels that are far from exceptional cannot therefore offer value. It is in fact the exceptional in the form of net cash or very low gearing, which the value player should seek.

Quite apart from the value technicalities discussions, I am surprised by the affronted reaction of some readers to my comments. Naturally it's painful to lose money, I have been there many times, but I would remind people that a reader asked what could be learned and I merely responded to that.

I take no pleasure whatsoever from this sorry tale and my sole interest in contributing to the thread was to point out what I regard as the glaring error made by anyone investing in this share as a value player. It was simply a poor play and far too risky. That is the case even if it had worked out.

It's bad enough when you make the right play and it goes wrong, which happens sometimes, but there's nobody to blame, you did the right thing but some right things will not succeed. In those cases there is no lesson to be learned, you can't avoid them because of the risk inherent in any share. But when the play is based on questionable value criteria, then maybe you can revise your strategy in future.

mcturra2000 07 Apr 2012 , 1:24pm

Interest cover less than 2. That's asking for trouble.

Also, let's remember that the same thing happened to SCHE (Southern Cross Healthcare) last year.

Longtermyieldman 07 Apr 2012 , 4:23pm

Pyad, I think we are using different definitions of a value share. The PYAD approach you've pioneered on this site does indeed focus on businesses that are both undervalued and low-geared. But in general parlance, value shares are principally those that are trading at a low profit multiple and ideally also a discount to NAV.

Granted, from a risk viewpoint it is preferable to buy shares in a company that has assets of £1 per share for 50p per share than it is ones with assets of £2.50 and liabilities of £1.50 per share for the same price. But, everything being equal, the former will exhibit superior returns in any upturn. So you pays your money and you takes your chance.

For me the problem with PSPI is not the original risk profile of the investment but the conduct of the directors. They issued an initial statement to the effect that the share price of 51.5p did not fairly reflect the underlying NAV and they were exploring strategic options, which led reasonable investors to expect positive steps to be taken to enhance shareholder returns, and yet we now discover that the firm has concerns about rolling over its bank facility and about the solvency of its UK tenant.

BIACS 09 Apr 2012 , 3:36am

A few points in here I disagree with.

Of course, if a measure is quite common, by definition it can't be a value rating because value seeks the uncommonly cheap
- that would suggest the market never gets it wrong on a whole sector which, in my experience it often does, and 'value sector' opportunities can reap some of the best rewards. Just because a whole sector is in value territory does not mean you shouldn't buy any of it.

... back came some readers claiming claiming more or less that this was not relevant ...
- Nobody ever claimed debt was irrelevant. I think it's fair to say we all understand the critical role it can play. What was said is that in some cases certain value investors are willing to take a view on debt - especially where cashflows are strong and stable, the company operates in a conservative 'boring' sector with consitent revenue and an element of government subsidy support and the debt service appears to be affordable.

Even if the valuation problem was the reason for the collapse, these readers miss the point. Which is that this share, in my view, was too risky in the first place because of its debt
- Key words here are " in my view " - this is not cut and dried and many people would not agree. I think the better point to make is "if, after careful consideration, you are willing to accept debt then always ensure that the cashflows and debt service coverage are absolutely rock solid and asset valuation measures are as watertight as possible." Unfortunately not sure even this would have saved many people on PSPI though unless they somehow forecast the public sector spending cuts (though perhaps reliance on one primary tenant was a risk factor too far...).

renew1 10 Apr 2012 , 1:06pm

Surely the real red flag was when they had to capitalise rent owed from their primary tenant 12/18 months ago.That was good enough for me I was out like a rat up a drainpipe!

renew1 10 Apr 2012 , 1:06pm

Surely the real red flag was when they had to capitalise rent owed from their primary tenant 12/18 months ago.That was good enough for me I was out like a rat up a drainpipe!

Daytona2 14 Apr 2012 , 10:13pm

upward-only, mainly indexed, rents


Which are great until the point at which your tenants go bust, as is occurring ad nauseum at the moment.

Chinanigel 03 May 2012 , 5:32am

What about 15p per share and falling!?
Might be worth another look?

Longtermyieldman 02 Jun 2012 , 8:51pm

@ Chinanigel, I agree. Even after an aggressive writing down of the value of the UK care homes (to smooth the way for some kind of merger with European Care I wonder...?) the NTAV per share in the year-end accounts published last week ago is 108.7p. The share price is currently 12p. That's a PE ratio of around 3, based on the adjusted earnings figure (ie excluding the write-down).

The debt may not make it a PYAD share, but it's an extreme case of a value share, by any normal definition of value investing.

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