Sell Quindell as cash falls short of expectations

Quindell
54¼p-1½p
Questor says SELL

Quindell’s [LON:QPP] problem was never revenue and profits, which have been growing at breakneck speed, it was that its cash collection figure bore little resemblance to the reported results.

The company warned yesterday that the amount of money it collects has fallen short of expectations, and Questor is concerned what the implications are for investors.

The gap between reported profits and cash collection raised legitimate questions about the accounting estimates the company was using to recognise profits. Accountancy firm PwC has been brought in to review the recognition of those profits, while Quindell auditor KPMG, which signed off on last year’s accounts, will remain in place.

The company has bizarrely called this a “natural point” to conduct an “independent review”. Questor thinks reviewing the main accounting methodology just three weeks before the end of the year and after recognising millions in revenue and profit is about as natural as Frankenstein’s monster.

The Aim-listed company was growing rapidly by providing lawyers, car hire, repairs and medical checks when people claim on their insurance.

The business model was always reliant on a large number of retail investors funding the ongoing expansion. But with those funds now cut off as investors head for the exit, cracks are starting to appear as the company tries to survive on its own cash generation.

In order to accelerate growth, it raised £200m net of expenses from investors in November last year. The company aimed to take on more personal injury claims from car accidents and industrial hearing loss (IHL) cases from workers.

Quindell has to pay insurance companies upfront for each injury claim. It then takes about six months to resolve crash cases and up to 18 months for IHL before they receive payment. Quindell makes an estimate of how many cases will be successful and then recognises the profit in advance – this estimate is now under the microsope. Once the case is settled, the cash should flow back in.

That method of spending cash early, raising revenue figures and then taking in cash later helps to explain the current numbers. Revenue more than doubled to £357.3m in the six months ended June 30, while pre-tax profit more than tripled to £123m. In the three months after that period, the company recognised revenue of £198m and adjusted earnings of £83m.

Because Quindell is paying for the cases upfront, cash levels have fallen from about £200m at the start of the year to £78.9m at the end of September. The difference between the growth in revenue and profits, and the lack of cash is made up by the rapid growth in debtors. Given the third quarter revenue growth, debtors are likely to be even higher than the £561m at the end of June, with accrued income – or revenue taken in advance – more than tripling in the first six months.

Analysts from Exane BNP Paribas estimate that about £135m of the debtors relates to IHL claims at the end of June. The analysts estimate Quindell has already recognised more than half of the £9,000 settlement on each case, or about £60m of the £156m in first-half earnings before interest, tax, depreciation and amortisation (Ebitda). However, up to 80pc of IHL cases are typically rejected, according to BNP Paribas.

Quindell reported net funds – cash less total debts – of about £25m at the end of September. That now looks almost certain to be lower.

While Quindell is recognising profits in advance before the cash is received, it is being charged tax. Investors may be willing to wait for returns, but the taxman is less patient. Corporation tax is running at about £40m a year, or £10m a quarter, according to broker Cenkos.

Given tight cash and about £50m of borrowing facilities, this company is increasingly in the hands of the banks. Investors have to face the possibility of a very unpalatable agreement with the banks in the near future.

We said sell at 551p on April 1, and repeated that advice at 242p in June and at 184.25p in August, as I outlined the cashflow problems looming in the fourth quarter. There is still too much risk here. Sell.