Qualiport

The PizzaExpress share sale

There's no doubt about it -- a share portfolio has lots of ups and downs. In fact, each individual company has its ups and downs, and the longer you hold the shares, the more highs and lows you will experience.

Warren Buffett encourages investors to turn the stock market off. Don't look at the daily price movements of individual companies, because that can cloud your decision making process. A sharply rising share price may lull you into a false sense of security. You don't want to have too many favourite companies, because sure enough, something will happen to them that you don't approve of.

A case in point is my holding in Business Post (BPG). They won the 1998 Financial Times company of the year designation and had a great past growth record, above average margins, high return on equity and a sharply rising share price. I practically fell in love with them, but for the wrong reasons. I should have fallen in love with them because they were a great company, with great management, a competitive advantage and great cash generation. Instead, I fell for them because the share price kept heading up and up. In fact, having begun the year at 565p, they hit a high of 958p in May. It's not often you own a share that appreciates by 70% in just over 4 months. And that's why I mistakenly fell in love with Business Post.

Although the share price was moving down anyway, in line with the rest of the market, the Business Post profit warning on September 16th was like a bombshell. It also hit the shares, as they lost 47% of their value in one foul day, falling from 687p to 365p. The carnage didn't stop there, either. The shares later hit a low point of 220p as shareholders bailed out and there was not a buyer to be found. Suddenly, my love affair was over.

It was that experience that taught me never to fall in love with a company just because its share price is going up. A rising share price should be as a consequence of a company successfully executing its business plan. Although there was no indication of Business Post's troubles in the months leading up to the profit warning, instead of watching with delight as the share price hit the heights, perhaps I should have been concentrating on its valuation. At 958p, Business Post traded at trailing price to earnings ratio (P/E) of almost 38. Hindsight is a wonderful rear view mirror, but it now seems obvious that this was high for a parcel delivery company in a very competitive sector.

Enough of the woes of my personal portfolio. The Qualiport has also had its fair share of ups and downs, highs and lows. Take the two most recent purchases, Independent Insurance (IIG) and PizzaExpress (PIZ). Having done our homework and learnt a lot about the companies, we've seen the share prices oscillate up and down in the relatively short period we've owned them. Firstly, IIG jumped to as high as 290p in the weeks directly after our purchase, up a nice 12% from the 258p purchase price. We were feeling pleased with ourselves -- but weren't falling in love with the company. Then, lo and behold, the market interprets a trading statement as a profit warning and the shares are thwacked down to 204p, extinguishing the vague possibility of any sort of intimate relationship.

But, since that low point, the IIG share price has been gradually inching its way higher. I entertained the thought of topping up on the holding if the shares fell much below 204p, but that thought has moved further back in my mind with them now standing at a mid price of 247p. That's a nice little 20% present in the space of just 2 weeks.

With the EMAP (EMA) share price gradually recovering, Rentokil Initial (RTO) continuing its death defying rise (up 23p to 402p today) and Unilever (ULVR) being a solid performer, all was looking fine. Then, from out of left field comes yesterday's fall in the share price of PizzaExpress. It was nothing to panic about, and certainly didn't come because of a shock profit warning. The drop was probably justified, given the mass sale of shares by the directors of the company.

This sort of selling is hardly a good sign. We've covered the issue of director sales a few times previously at the Fool, but it is worth stating the obvious again. Directors usually sell shares for many reasons, but only buy for one reason. Regardless, when directors sell en masse it is definitely worth looking at closely.

I haven't yet received the 1998 PizzaExpress annual report but have the 1997 report. As at 30th June 1997, the company had 6,000,000 authorised deferred convertible shares. Of these, 3,230,000 had been issued between July and November 1996. These shares are convertible to ordinary shares on a one to one basis two years after the date of issue, up to June 2001. They are convertible if the company's earnings per share (EPS) increase by at least the retail price index (RPI) plus 5% per annum over the period between issue and conversion. The conversion price is set by a set formula, but basically it's about 16% above the price at the date of issue.

All that mumbo jumbo effectively means that these shares form part of the director's salary package. It's an incentive to grow the company's earnings, which in turn should see the share price rise. Although the hurdle for conversion looks relatively low, it probably only does so because PizzaExpress is growing so quickly. As far as shareholders are concerned, there should be nothing wrong with that happening.

Anyway, the conversion price worked out at 450p. Between 4th and 7th December, 6 directors converted a total of 1,150,000 of these shares, and immediately sold them at 848p and 820p, pocketing a total profit of £4,451,000. A nice little earner in anyone's books. When looking at the significance of this share sale, it is worth looking at a few facts.

One director, P. Gilligan, converted 130,000 shares at 450p and sold them all at 650p on 15th October. This transaction didn't stop the share price rising from 650p to 850p in less than two months. PizzaExpress directors and employees still have options over a further 1,950,000 deferred convertible shares. These are eligible to be sold anytime now. The directors' base salaries are relatively low. In fiscal 1997, most directors were paid a total of around £120,000, which included a £50,000 bonus. As corporate salaries go, these are quite low, especially when you consider that total packages (excluding share options) for some top executives exceed £1,000,000 per annum.

So, what shall we make of this mass conversion and sale? It's very difficult to come to any conclusions. We'll never know why they sold when they did. In fiscal 1997, PizzaExpress directors exercised all their 2,282,500 share options, at prices between 500p and 671p. Again, that didn't stop the share price from moving upwards, and more importantly, the growth of the company hasn't slowed.

Based on their past record of share sales, and the fact that the directors still hold almost two million further deferred convertible shares, this gives shareholders some degree of comfort. Share options and share sales are an inevitable part of a company's compensation scheme, and shareholders have to be aware of that. If PizzaExpress issues a shock profit warning in the next 6 months, we'll want questions answered. In the absence of that, it should be business as usual for PizzaExpress the company.

As you can see from the numbers on this page, we're in the black again. The princely sum of £9.32 won't even buy us a copy of The Motley Fool UK Investment Guide, but it gets close.

See you Friday, where we'll update our Qualiwatch progress. Today was all go for one of our chosen growth sectors -- the pharmaceuticals. Could AstraZeneca be a world force? Post your comments to the message boards.

Have you registered as a Fool? You'll never know what you're missing out on until you do it.

Bruce Jackson (TMF Googly)

                    9/12/98 Close

               Company  Change    Bid
                 EMA     +0.30    11.75
                 IIG     +0.05     2.42 
                 MKS     +0.03     4.03
                 PIZ     -0.05     8.00 
                 RTO     +0.23     4.02
                 ULVR    +0.12     6.09

Qualiport Stocks

Last Rec'd  Total # Company  In At  Current Change
 19/12/97    783      RTO     2.55    4.02   57.6%
 04/11/98    245      PIZ     7.93    8.00    0.9%
 17/04/98    169      EMA    11.85   11.75   (0.8%)
 17/07/98    298      ULVR    6.72    6.09   (9.4%)
 27/10/98    755      IIG     2.58    2.42   (6.2%)
 11/05/98    368      MKS     5.54    4.03  (27.2%)

Last Rec'd  Total # Company  In At    Value    Change
 19/12/97    783      RTO   2046.53  3147.66  1101.13
 04/11/98    245      PIZ   1966.34  1960.00    (6.34)
 17/04/98    169      EMA   2052.57  1985.75   (66.82)
 27/10/98    755      IIG   1972.64  1827.10  (145.54)
 17/07/98    298      ULVR  2052.54  1814.82  (237.72)
 11/05/98    368      MKS   2054.11  1483.04  (571.07)


Cash:                              £3,975.57
Current Total :                   £16,193.94

Total Invested:                   £16,184.62
Profit/(Loss) :                        £9.32

Value Per Share

                 Day     Month    Year    History
Qualiport       2.53%    1.57%   34.59%   37.62% 
FTSE 100        0.95%   -1.30%   10.39%   12.93%
FTSE All Share  0.81%   -1.54%    7.28%    9.53%

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