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QUALIPORT
Great Growth, Bad Business

By Maynard Paton (TMFMayn)
March 5, 2001

Rochester, Kent It may seem obvious, but few companies survive without willing customers and suppliers. If either party are inherently reluctant to do business with your firm, then trouble looms.

Fortunately, there are very few businesses that make it to the stock market without having happy customers and suppliers in place. But a handful can. Two companies in particular have recently succumbed to their deeply unenthusiastic "clients". What's more, both outfits exhibited impressive growth rates before falling from grace, a fact that may have enticed the odd long-term investor into the shares.

The companies involved are Helphire (LSE: HHR) and Claims Direct (LSE: CLA), two members of the "Speciality & Other Finance" sector. Here are the financial records of Helphire and Claims Direct:

Helphire

Year to 31st March        1998     1999     2000
  
Turnover (m)             25.5     47.6     69.7
Pre-tax Profit (m)        2.5      4.6      6.2
Earnings per Share (p)     2.7      4.8      5.6

Claims Direct

Year to 31st March        1998     1999     2000

Turnover (m)              2.4      7.0     40.0
Pre-tax Profit (m) (0.4) (0.6) 11.4 Earnings per Share (p) (0.2) (0.3) 4.3

It's not too surprising that both companies had recorded substantial sales growth. Both companies offer "free" services to their customers!

Helphire's main business is that of providing cars to drivers involved in accidents, but who were not at fault. It's a great deal for the "innocent" driver. Helphire supplies you one of its own cars, free of charge, while your car gets repaired. Helphire then recoups the cost of supplying you the car, and a bit more for profit, by claiming compensation against the insurer of the negligent driver.

Claims Direct is in a similar line of business. Following the recent introduction of government legislation, the company operates a "no win, no fee" service for people claiming damages on personal injury grounds. If you've got a good case, Claims Direct then fights for damages on your behalf, and takes a share of the proceeds should you win.

Both firms incur upfront expenses (in the form of solicitors and so on), while income (from the defendant's insurer) is only received some months after. So, cash flow, it has to be said, isn't the strongest point of Helphire or Claims Direct. The following tables, taken before their respective troubles and highlighting the large outflows in working capital, should put most investors on red alert:

Reconciliation of operating profit to operating cash flow 

                         Helphire       Claims Direct
                 

Operating profit (k)      7,940          10,404
Working Capital
  Change (k)            (40,119)         (6,918)
Other change (k)          2,294           1,327
Operating Cash Flow (k) (29,885)          4,813

Reluctant insurers

Insurers, being insurers, and not willing to pay a penny more than necessary, have persistently argued against the claims generated via Helphire and Claims Direct.

In Helphire's case, a long-standing wrangle over some of its claims was finally ended in Parliament, after the House of Lords ruled that insurers were exempt from paying the costs associated with certain Helphire contracts. Also, non-binding remarks made by the Lords concerning the rates charged by Helphire cast doubt over the long-term viability of its overall business plan. Of course, while Helphire's arguments went through various legal processes, the insurers did their best to delay all payments until the final ruling... 

Legal wrangling has also beset Claims Direct. Insurers were extremely keen to point out that, according to the Access to Justice legislation, certain costs could only be recovered from them if the cover was "appropriate and proportionate to the case being assessed". Unfortunately, Claims Direct had been rather overoptimistic in their assessment of certain costs. The insurers paid out only what was "appropriate", which meant Claims Direct had to make up somewhat large shortfalls from accompanying compensation payments. That didn't go down too well with the claimants, who went straight to The Sun newspaper and BBC Television's Watchdog to complain...

All the arguments over payments to Helphire and Claims Direct have severely dented shareholder confidence, as this chart and this chart show. Both companies will suffer large charges against profits in the near future as bad debts are written off. Management upheavals at Claims Direct and a rights issue at Helphire have also helped send their respective share prices into a nosedive. Both companies are now in a state of limbo as they develop different contracts and services to increase the likelihood of recovering their expenses.

Summary

While customers and suppliers may not like a company's terms, most have a choice whether to enter some sort of trade arrangement or not. That's unlike the large insurance firms who "do business" with Helphire and Claims Direct. As perhaps most people will know from their own experience, insurers aren't the easiest of people to extract money from. And when you're a small firm trying to profit from the insurance industry, you can be assured that it'll do everything it can to make life difficult. Taking legal battles to the House of Lords isn't done just for fun.

Overall, what's the lesson? In short, it pays to consider the trade relationships a company has. Historic growth record may be great, but having to rely on unwilling third parties to generate a profit won't show up in a company's financial history. For the long-term buy and hold investor, the ideal company will have its customers and suppliers beating a path to its door, not doing the uppermost to avoid any payment whatsoever.

More: Beware the highly prized customer!
Visit the Helphire discussion board | website
Visit the Claims Direct discussion board | website