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Cobham – 2017 Cannot Come Soon Enough For Investors! By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

cobhamI am saddened although hardly surprised that Cobham should have been forced to issue yet another profit warning this morning, this time blaming weak demand for its large suite of electronics based products for a wide range of defence and marine customers.

How much better, I wonder, might it have been to see Cobham Chairman, John Devaney better admit to the many self-inflicted problems that are currently impacting on Cobham performance and that include decisions relating to senior management appointments on his watch during 2012 and 2013, that he might have more broadly accepted responsibility for the damage that has been wreaked on this very important company, its workforce and its long term investors, by doing the honourable thing?

Cobham now says that the FY16 annual trading profit will be around 12% lower than the already reduced analyst consensus £291 million forecasts. Interpreted, that means ‘trading profits’ somewhere between £255 million and £275 million for the year. At least the company is still in profits!

There was no further comment this morning in relation to the planned dividend pay-out for 2016 which, although at the full year 2015 results the company stated that the dividend would be rebased for 2016, the Chairman had rather amazingly repeated when the previous profit warning was thrust on the scene during August 2016, that there was no intention of suspending the dividend.

For a company with relatively high levels of acquisition related debt such failure to recognise that the dividend really should be suspended can only be described as shabby if not downright dangerous. Not surprisingly, the shares fell again in early morning trading today, down by another 13%.

While Cobham mentions that it had been further affected by low demand from shipping customers for its communications based range of products and also from defence customers, due to lower demand for its range of specialist electronic products (interestingly it chooses to cite delays on the Boeing KC-46 on which Cobham is involved supplying the air to air refuelling system) investors are hardly likely to ignore the self-inflicted wounds of what can surely be best described as serious failings in the senior management team particularly in relation to acquisition strategy and operation of its  wireless unit.

In response to consistent failure, during August the company announced that CEO Bob Murphy would be ‘stepping down’ from the role by the end of the year and that his place would, from January 2017, be taken by the highly respected CEO of Laird plc, Mr. David Lockwood, remaining institutional investors had at least been prepared to sit on their hands and wait.

Good news that both the new CEO and the separate earlier announcement confirming the appointment of David Mellors, currently CFO of QinetiQ, as future Chief Financial Officer to replace Simon Nicholls whose ‘resignation’ had been announced last January, it seems that although much of the underlying business activity remains fine, a lot more patience will be required of investors.

During this year alone Cobham investors have seen the value of their shares fall by 33% and the pity is that, as I write this commentary this morning, there is still more than two months to wait before Mr. Lockwood and the new Chief Finance Officer, David Mellors arrive on the Cobham scene to begin sorting out the mess that has occurred on the Devaney watch as chairman. I guess that takeover speculation will appear soon and that might lift the shares ahead of the new appointment coming in to take their much need places in the company.

I note too that there has been a noticeable degree of increased scepticism since the August statement that the Chairman has, so far, chosen not to take direct responsibility for senior management failings by falling on his own sword.

Two years ago when more signs that Cobham was struggling appeared, I said that, looking back across the 28 years that I had spent as a professional equity analyst covering defence and aerospace, I could recall the days when Cobham used to arouse a very high degree of interest and sometimes amazement amongst investors due to the very high quality of its earnings, thus its consistent ability to provide excellent margins and growth and so on. I exampled the Full Year 2000 results announcement when my old friend Sir Michael Knight was chairman and Gordon Page was CEO. In that year, results showed a company bursting with growth, declaring at £252 million, revenue up 13%, underlying earnings per share up 15% and the dividend up 15.1% not to mention an order book that had risen to £1 billion from £73m million the previous year. And that, for Cobham scribblers of today, was despite the company having serious issues with its ‘Westwind’ subsidiary.

What a fantastic company Cobham was back then though and indeed, continued to be over the following ten years during the tenure of Allan Cooke, CEO of Cobham until 2009. It really is worth recalling that the executive team of initially, former CEO and later Chairman until 2009, Gordon Page; Allan Cook who is today chair of the Defence Growth Partnership and also non-executive chair of Atkins Group plc, together with Warren Tucker, for ten years CFO of Cobham until 2012 and who together ran Cobham during the excellent 2000 to 2010 period quadrupled revenue during that time whilst maintaining margins, improved cash flow to 90% cash returns and grew earnings per share (EPS) by 15% CAGR. Even better, they took the company into the FTSE 100 index.

Today poor old Cobham languishes deep down in the FTSE 250 index just! The point about bringing up history over the past twenty years being that these were the guys that built on Cobham’s previous success rather than, as might seemingly appeared to have occurred since 2010, done their best to destroy it!

In August this year I wrote “For the record Cobham recorded a pre-tax loss of £39.8 million for FY15. This was followed six months later by first half 2016 losses totalling £38.4 million. Just how much of the £78 million of losses racked up by Cobham over an eighteen month period, not to mention the need to call on shareholders for £500 million to bail the balance sheet out, is due primarily to businesses acquired by Mr. Murphy as he attempted to diversify the company toward commercial communications and microelectronics and away from defence may never be known. But one thing is very clear – the £900 million acquisition of Aeroflex in the US has played a very large part in the problems that Cobham has subsequently suffered and all this came on Mr. Devaney’s watch alongside that of his CEO, Murphy. Not only did the Aeroflex acquisition increase Cobham’s borrowings significantly, at a total cost of $1.5 billion, inclusive of debt, it would ultimately cause what little confidence remained in Cobham senior management to evaporate.

I said this too – Mr Devaney has confirmed that despite the appalling situation the company finds itself in, that there is no intention of suspending the dividend. I reminded that the dividend paid in 2015 cost the company £126 million, a figure that represented no less than one quarter of the £500 million rights issue money being raised from shareholders? What sense is there in that? I said that I would like to know what the chairman and non-executive directors were doing when the problems at Aeroflex had first surfaced? Had they [management] been given all the facts or were they just allowing the wool to be pulled over their eyes? And if they did have facts of what was clearly a worsening situation, why on earth did they continue to place so much faith in the two most important members of the Cobham board – the CEO and CFO – for so long? Finally I asked the question of why, albeit that Cobham was at least still profitable, the situation reminded me so much of the final demise of Marconi?

Like remaining long term investors and all those that have had a long relationship with Cobham, we are left to live in hope that 2017 will begin the start of the climb back.

CHW (London – 24th October 2016)

Howard Wheeldon FRAeS

hwheeldon@wheeldonstrategic.com

Tel: 07710-779785

 

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