For all its undoubted achievements in recent years, and those of its combative chairman Sir Christopher Lewinton, TI has a reputation in the City for dressing up its figures. There is no question of breaking the rules, or even bending them, but they've certainly been stretched to the limits.
Financial engineering of the type used by TI is common enough in entrepreneurially-led companies. What makes it a little more surprising in this case is that TI's finance director, Michael Garner, is a leading light on the Accounting Standards Board, which has been issuing new rules aimed at cleaning up company accounts and making them less susceptible to manipulative techniques. He's a classic poacher turned gamekeeper.
But that hasn't stopped TI from finding new wheezes to boost profits. If TI adopted the sort of practices advocated in some quarters of the accountancy profession, its profits would be a pale shadow of the sparkling performance it has been able to report. A careful reading of the small print of accounts issued last week shows that reported pre-tax profits of pounds 87.4m have been inflated by pounds 7.7m by capitalising certain development costs in aerospace and defence - treating them as a balance-sheet asset rather than writing them off as a cost. But this is just the tip of the iceberg.
Arguably, TI should also have written off pounds 35m against profits on the sale of Dowty's information technology business. TI has used an old profit- inflating trick to avoid it. There's a new ASB rule to stop this kind of abuse, which TI followed in the case of another disposal, that of Thermal Equipment. Good will previously written off against reserves was reinstated, with the result that TI was obliged to take a thumping great loss against profits on the sale.
So why didn't it follow the same procedure with the Dowty information technology business? Dowty originally purchased it for pounds 85m. Last year, the business was sold for pounds 50m which TI said was equivalent to book value, Dowty having already written off the pounds 35m balance against reserves. No doubt there is some perfectly reasonable technical explanation for this inconsistency, but it's hard to see.
TI also makes extensive use of so- called 'fair value provisioning'. It works like this. Every time there is an acquisition, a provision is made in the balance sheet to cover the costs of rationalisation and reorganisation. The profit and loss account is, as a consequence, shielded from these costs when they are incurred. This technique was worth pounds 28m to TI's reported profits last year.
If you add all these things together, TI's reported profit of pounds 87.4m is reduced to a surplus of just pounds 16.7m - not too hot for an FT-SE 100 stock. TI would no doubt argue that there is nothing wrong with what it does; it is disclosed in the accounts and if you don't like it, you can strip it all out and make your own calculations. Fine, except that most shareholders tend to concentrate on the headline figure; it takes a sophisticated investor even to read through the blinding mass of figures and detail in the breakdown of accounts, let alone make sense of it.
The headline figure also tends to be the public relations front of a company, enabling managements to say how well they've been doing, despite the recession and occasionally pay themselves big performance-related bonuses to boot.
TI is not a lone offender. Virtually every acquisitive company from BTR and Hanson down has used similar techniques. But as the new accounting rules begin to bite, and the scales progressively fall from the investment community's eyes, TI may find it hard to maintain its glamour stock status. Trafalgar House was once a well respected company in the City and look what happened. In little more than a year, it became an investment pariah. The figures showed the company to be financially healthy; the reality was that it was virtually bust.
I am not suggesting that TI is a comparable case but there are ominous signs. Already it is plain as a pikestaff that TI paid too much, too soon for Dowty. It is equally clear Mr Lewinton is unlikely to be able to deliver on the two promises he made at the time of the takeover - that the group would be debt-free by the end of 1993 and that the acquisition would not dilute earnings. With the benefit of hindsight, both pledges were little more than wishful thinking. Let's hope the group's profits performance doesn't come to be seen in the same light.
ODE TO BANKS
Ogden Nash - the man who wrote: 'I think I shall never see/A billboard lovely as a tree' - died in 1971, but he surely had Jacques Attali, the European Bank for Reconstruction and Development and its Carrara marble fittings in mind when he wrote the poem Bankers Are Just Like Anybody Else, Except Richer.
It goes: 'Most bankers dwell in marble halls/Which they get to dwell in because they encourage deposits and discourage withdralls (sic)/And particularly because they all observe one rule which woe betides the banker who fails to heed it/Which is you never lend any money to anyone unless they don't need it.'
Time to buy the pharmaceuticals sector. During the past 18 months, pharmaceutical companies have on average underperformed the rest of the stock market by some 40 per cent. High-flying glamour stocks like Glaxo have been reduced to little more than an average stock market rating.
Once upon a time, it might have been possible to float Zeneca, ICI's soon-to-be-demerged pharmaceuticals company, on some astronomic multiple of earnings with a star-rated token dividend yield to match. Not today. Once the darling of the stock market, the sector is reduced to a bombed- out wreck, wracked by every kind of rumour and counter-rumour, the victim of an astonishing turnround in investment sentiment.
Unless Zeneca can show unique characteristics, it will have to come to the market on something close to an average stock market yield of 4 per cent - the same sort of rating as you would find in a brewer or retailer.
As with most swings in investment sentiment, the process has gone too far. We don't yet know what President Clinton and his wife Hillary are going to do to address the issue of spiralling health care costs, but whatever it is, it cannot be as bad as the stock market seems to fear. Anyone would think we were witnessing an industry in its death throes to judge by the gloom that besets share prices.
In fact, nothing could be further from the truth. The world is undoubtedly a more hostile place for pharmaceutical companies. But this is still a sector for which all the projections, internal and independent, point to phenomenal growth, way above any other established industry. Glaxo, SmithKline Beecham, Wellcome - they've all had their problems but all are still good-quality, well-placed companies. Cut through the present malaise and it is hard to see anything other than upside for them.Reuse content