Last week, insurance claims outsourcing business Quindell PLC (LSE:QPP) (NASDAQOTH:QUPPF.US) came under attack from short-sellers, following the publication of a research report by Gotham City Research.
Gotham’s report claims that Quindell’s business is “built on sand” and that the company’s shares are worth no more than 3 pence. However, soon afterwards Quindell issued a 12,500 word rebuttal to Gotham’s report, although this response was undermined to some degree by the news that Deutsche Bank had pulled out of a planned roadshow, which had been designed to pitch Quindell to US investors.
The question is, does Gotham’s argument have any substance and are Quindell’s shares likely to fall further?
Cash is King
One of Gotham’s main arguments against Quindell is the company’s negative of cash flow. In business, cash is king and if a firm is not generating cash, the company is unlikely to survive.
Gotham points out that Quindell’s cash flow is negative and has been for several years, despite the fact that Quindell has reported over £100m of profit for the past three years.
Still, Quindell’s management has stated that cash flow has remained negative as the company’s directors have decided to reinvest profits expanding the business. Further, Quindell has disputed Gotham’s method of accounting, stating that the research firm’s calculations used to arrive at results were “not meaningful”.
Broken promises
Another focal point of Gotham’s attack on Quindell is the company’s rising level of debtors. Gotham claims that Quindell is using aggressive accounting techniques to book revenue and income before it’s realized, which would explain the high level of debtors.
Unfortunately, this argument is supported by Quindell’s negative cash flow and implies that although Quindell is reporting rising profits, most of these are on paper.
Quindell’s management has previously promised to reduce debtor levels, but they have continued to rise, hitting £328m at the end of 2013. Quindell’s reported revenue was £380m for the same period.
Web of intrigue
What’s more, Gotham has called into question Quindell’s seemingly endless stream of complicated acquisitions and related-party-transactions.
The most publicized of these transactions is the £12m invested in Quindell by the company’s founder. Around the time of this investment, Quindell spent £12m building a country club.
Gotham gives another example, the acquisition of Quindell’s subsidiary, ClickUs4.com.
ClickUs4.com was acquired by Quindell, but then sold to the Quindell’s founder, who sold it back to a third party, which used ClickUs4.com to acquire telecoms assets before Quindell reacquired the company.
And it seems as if professional auditors can’t make sense of these transactions either, as the company has got through three auditors in the past three years — although I should say that none of these auditors has ever had anything bad to say about Quindell.
A degree of truth
However, one accusation made by Gotham against Quindell does appear to have some truth behind it.
Gotham claimed within its report that Quindell’s New York office does not exist, so to investigate this claim, the Financial Times sent one of its New York based reporters to investigate.
According to the paper, at Quindell’s New York address there was no sign of the company and the building’s receptionist had never heard of Quindell. Quindell has since removed details of a New York office from its website.
In conclusion
Overall, it would seem as if Gotham’s report has some substance and Quindell’s aggressive accounting techniques are a cause for concern.
That said, Quindell has built up a reputation with some of the UK’s most prominent insurance companies, none of which has had a bad word to say against Quindell and its management.
Still, Gotham’s report has sent shivers down the backs of many investors and Quindell’s future is uncertain. There is nothing the market dislikes more than uncertainty.
On that basis, I feel that Quindell’s shares could fall further unless concrete evidence is produced showing that the company is not misleading investors.
