Honey AMA: SPACs, ISAs vs GIAs, and Ocado
The Honey team takes on your latest round of questioning.
Published
September 4, 2024
Another week, another AMA for Honey referrers. Anyone that refers three or more people to our daily newsletter can send in a question and our team will answer it.
This time around we’ve got questions on SPACs, GIAs and ISAs, UK private equity acquisitions, and Ocado.
You can watch a video of the AMA below or read the transcript. And if you haven’t signed up for Honey yet, then do so over at Freetrade.io/honey.
David Kimberley: Hello everyone, and welcome to another Honey AMA. This is for people that have referred three or more people to the honey newsletter, which you can sign up to in the link below. A reminder that if you have referred three people then you can submit questions at any time and we will endeavour to answer them next time. So if you haven't done that yet, then please do so, as it's always fun to answer your questions. And with me today again is Dan Lane, our Senior Analyst. Dan, thanks for joining me.
Dan Lane: Thanks very much, David. Good to see you.
David Kimberley: Ok, I’m just going to pull up the first question, which is from Yann and Yann asks, Ocado —buy or sell? It seems like the company missed its chance to become a genuine alternative to brick and mortar supermarkets during the pandemic. But there remains hope that their B2B service — business-to-business service — could help raise profits ala Amazon Amazon Web Services. So, Dan, and Dan is our kind of in-house expert on supermarkets as readers of our report the first quarter of this year will note.
Dan Lane: You know, Q1 seems a long time ago now, doesn't it with our supermarkets report?
And I guess the first thing to say is that we can't give you any specific advice on buying or selling what our financial advisors, but we can certainly have a chat about it. And Yann does actually raise a good point on Ocado specifically, because if you think about before the pandemic and supermarkets were kind of viewed as this kind of backward sector, which hadn't really budged in a long time.
It was the price race to the bottom. If you were the cheapest, you were the best, you got the most customers. And it was all of this real race to the bottom. But Ocado offered something different. And specifically in their customer fulfillment centers, which I think investors know them for now. And they were kind of like this tech firm masquerading as a supermarket.
And I think that really showed over the pandemic. So it was interesting to see, it was actually during the pandemic, that they changed the sector that they appear in from supermarkets to tech. So they actually said, “you know, guys, we are a tech company.” And this actually changes how we might want to view them, because what they're saying is we're not a supermarket anymore. Such is the success and focus point of our business that what we want to be doing is selling our fulfillment center, with this tech and wizzy robots, to other supermarkets.
And pre-pandemic that was a very, very strong source of revenue growth for them. So it's shifting it to Canadian companies, France's casino group. But, you know, the pandemic, really stunted that growth. So I would say the B2B area of the business is a much bigger focus point than concentrating on them as a traditional bricks and mortar, you know, shelf stacker supermarket.
I would say that recently the share price has come off for a couple of reasons. Investors are now realizing that they, you know, the market share really hasn't shifted in the past few years. I think Kantar World panel is always good to look at this. And they said, you know, recently, Ocado has about 1.8% of the market, the whole UK supermarket market. A few years ago, that was 1.4%, 1.5% and 1.6%, But you know, it's really not shooting the lights out.
Everyone thought it was going to just steal market share from everyone. It didn't happen because the focus point was never to become a supermarket, it was these fulfillment centers. Now, the share price is off because people are starting to realize that they maybe got a little bit ahead of themselves in terms of the tech, robots crashing and setting one of the warehouses on fire probably didn't help that headline. That really took a few points off the share price. There are a few hurdles to selling your product, you know, especially if it goes on fire.
Offering those out and trying to sell those fulfillment centers gets a little bit more tricky to customers. But, you know, look at the long term. There might still be opportunity in that once they get that under control, they're by far and away the most technologically minded of anyone connected to the supermarket chain. So, you know, we're not going to say who to buy or sell because I can't see the future. But there's certainly an interesting player to watch in the supermarket space.
David Kimberley: OK, hopefully that answers your question Yann. We'll move on to the next question, which is from Aaron. Aaron asks, index funds have been my entry point into investing after reading personal finance books. How do I bridge the knowledge gap to be able to analyse individual companies to decide if they are right for me to invest in? Are there any books that you could recommend? Dan, do you wanna start that?
Dan Lane: Yeah. You know what? I'm going to swing this back to you, because I know you have some interesting thoughts on this, but just just beforehand, I think it's a great question, by the way, as it's a very standard way to enter investing. You might be going into index ETFs for example, or these broad diversified ETFs. Hopefully something, you know, that gives you diversified exposure, maybe global, maybe a whole market. And it's a cheap way into investing as well a lot of the time.
But the thing to say is that there's no innate need to kind of graduate, as it were, into stocks. I mean, some of the best investors out there will stay in ETFs their whole lives. Buffett says that if you don't want to get in stocks, index trackers will probably suffice over the long-term. And remember, a lot of active managers fail to beat the benchmark or fail to beat their embassy. So you're not more intelligent or you're not a better investor if you go straight into stocks and as opposed to ETFs. I don't know. What are your thoughts, David?
David Kimberley: Yeah, I would agree with that. I think there's another point to add, which is that a lot of the time people when looking to move to invest in individual companies, think that there's a sort of exact science to it. And so if you know how to analyze a company using X, Y, Z methods, then you'll always be able to figure it out and you'll therefore always be able to make money from it.
Whereas, you know, everyone has their own approach and things are always uncertain. So you can't basically figure out one method and then think, “OK, well, that's always, always going to work.”
And so that's one thing I would say and I would also add that because people, a lot of the time, feel as though they haven't figured out ‘that’ method, they then feel reticent about jumping in and investing in companies. And that's not to say you should just rush into things, but basically, if you think, “OK, I've read this, I've studied this, and I think that this is a reasonably good method for putting a value on a company,” then you shouldn't feel like there’s something which should stop you from doing it.
I suppose that's one thing to say, but in terms of books, you know, we give out two of the books I would recommend as part of the referral scheme. So one is Investing for Growth by Terry Smith, which is a collection of articles that he's written, but also annual reports and letters to people invested in his fun. And I think that's a really good book. It's quite an easy read. Not too long. And you get some really good insights into how he looks at companies, values them, chooses what to invest in, chooses what not to invest in.
The other book that we give away is The Intelligent Investor by Benjamin Graham, that's quite an old book. I mean, I think the first one, and I could be wrong here, was maybe written in the 30s. And he updated it a few times, i think the last one was in the 1970s. So it's quite an old one. But I think what's interesting about that is you realize that, as much as technology and so on has changed, people's behavior hasn't really and the actual methods of identifying good companies hasn't really.
And if you get that book now, it comes, if you get one particular edition, with quite good commentary by Jason Zweig, who is still around and still writing. And I think those two together, it's quite a long read, about 500 pages, but it's worth it because it's got some really good insights and then a couple of others I've mentioned. One is kind of a classic one, which is One Up On Wall Street by Peter Lynch. Again, that's not a very difficult read, a couple hundred, maybe 300 pages, but very, very easy to get through. And it has some good tips on valuations, how to find companies, what advantages you have as an individual investor over fund managers. So those are good.
And then maybe the last one, I wouldn't necessarily say this is good for investing in individual stocks, but I think a lot of time people feel uncomfortable about investing because they feel that it's somehow tied to economics and perhaps they aren't familiar with just sort of rudimentary stuff in economics. So there's a book called Basic Economics by Thomas Sowell.
And I think that's again, it's quite an easy read and a very good introduction to the markets, how markets work, and how bonds work and all that sort of stuff. So if you're feeling uncomfortable, it's not necessarily going to be good in helping you to say, “OK, I should buy company X,” but it's good at easing you into how the economy works.
And yeah, then another thing I would say is to look at fund managers, and it could be as obvious as Warren Buffett. So they write quite a lot in sort of individual articles or reports to shareholders. I mean, Warren Buffett's annual Q&A thing he does with investors, I don't know how much longer that will go on given he’s 90, but it's worth a watch. So those sorts of things that maybe aren't as obvious as just a book, they're also a lot of the time quite useful.
Dan Lane: I would say a couple of things. I think Investing for Growth, super book you mentioned there. But Terry Smith gives an AGM every year. All of them are filmed. All of them are on YouTube and he goes through, so clearly, the methods that he uses to pick stocks, why he chooses them, he couldn't make it clearer.
In my mind, he is one of the clearest orators of investment processes. So I'd definitely recommend watching those and reading a book. Obviously, you just need to refer people who will give you the book for free.
But a last point on that, I would say, is there's a good middle ground between active management and, you know, running some index funds as well. A core and satellite approach can be really useful. So if you think about a daisy and the center, the central yellow part might be the biggest element of your portfolio, and that might be a broad based market ETF. And then the petals on the outside might be some smaller high conviction stocks that you choose.
You can talk about Peter Lynch's methods of looking at the peg, the PE divided by the growth rate. Or you might go into, you know, Terry Smith, who is willing to pay up for growth. You might go into value investing where price to book and price to sales comes in. You know, there's so many areas we can get involved in. But why not begin by managing your risk, by having that broad based ETF in the middle with a few high conviction stocks on the outside? If they go well, they'll be great. If they don't, it's not going to destroy your portfolio.
David Kimberley: Yeah, I would agree with that. I can move on to the next question, which is from Chris. Chris says, I'm curious to hear the team's thoughts on SPACs and where we go from here. Are there any legit use cases? What happens to the wider market when all these SPACs don't find the target and need to de-SPAC? Or is there going to be some crazy buying, crazy buying frenzy as everyone looks to make a deal? Something I've also really struggled to wrap my head around is the valuation mechanics of a SPAC once a target is found. Things get even murkier when you start to factor in the PIPE. This is not a particularly straightforward transaction. How are sponsors incentivized to act in the best interests of their shareholders?
Dan Lane: I mean, listen, I think Chris is expressing what a lot of investors have been kind of scratching their heads over the past couple of years as SPACs have really taken off. And for anyone who doesn't know, we're talking about these kind of cash shells that spring up list themselves on the market, get money from investors and then go out and look for a takeover opportunity in the private markets, often to affect a kind of reverse takeover to bring that private company to become becoming a public company.
You know, there's a few things that I've been kind of wondering. A couple of things just about the way that it lists and then people are investing in it. It is strange to me, what are you actually buying because it's a cash shell. So you're putting your money in there and there's no asset yet.
So to me, that says that you're probably buying into that management capability and probably not much else. You're kind of hoping that they have something up their sleeve or that they have a deal in mind. But over the past couple of years. We've seen enough SPACs come to market and sit there motionless for a long, long time to realize that a lot of them don't have ideas in mind, and that's whenever they go out and start looking. So my money is sitting there in that shell and not really being put to work. But the values are getting pushed up and down by other people in the market. It's made me quite uneasy. I mean, listen, you you schooled up on SPACs recently. What's your take on what Chris has asked there, what can you clear up for him?
David Kimberley: Yes, I mean, I would actually kind of agree with what was implied in the question itself about the transactions being pretty murky and how they work.
So I think a couple of things that maybe people aren't aware of when they invest in them. There's a sort of perception that you're buying a share in a company that's a cash shell and there's just these shares. And once the transaction takes place, the cash shell and the company merge. But as I said, yeah, there's two things I think people probably need to be aware of.
One is that the people, the companies or institutional investors that buy into a SPAC at the beginning, they usually get a share worth ten dollars, but they also get a warrant. So a warrant is kind of like a call option in a company, essentially it gives you the right, but not the obligation, to buy another share in that company at a set price. And usually those are priced at $11.50.
So you imagine the price of the shares is $20. It would make sense for you to buy at $11.50. So these initial investors, they buy these two things together. So with every share they get, they get a warrant. But then also, they can separate them so they can keep the warrant and sell off the share. But what usually happens as part of the process is that, once a deal is identified, shareholders have to approve that, but they can also go and redeem the share they have and get the money they paid for it back. And that's the case even if they say that they want the deal to happen.
So even if you approve the deal, you can still redeem the share. But because the warrant is separate, it means that it's almost like free money for a lot of these companies. So what they'll do is they'll buy the share. They'll either sell it off perhaps in the market or, when the deal is announced, redeem it. So they get the money they put in back and then they have the warrant, which they can either exercise or just sell off as well.
So something called the ‘SPAC mafia’, which is a lot of hedge funds who've invested huge amounts of money in SPACs, nearly all do this process. So they tend to redeem something like 98%, 99% of the time. And it's been kind of like free money for them. I think that someone calculated that they were making 11% annual returns from doing it.
The thing is, that doesn't really work well If you think about long term investing, if someone told me about a group of people doing that and then said, would you want to buy shares in the company that they're doing this, too, I'd probably say no, personally, because it's kind of an odd thing to be doing.
It doesn't suggest they have faith in the project for the long-term. It's just sort of arbitraging the system that's in place. So that's one element. And then something else that Chris brought up is a PIPE, which stands for private investment in public equity. And so what that means is, as I just said, a lot of the time, the investors who bought the SPAC at the beginning will redeem all their shares.
So if you imagine, a SPAC has raised, let's say, $100m and then a huge proportion of the time those initial investors will redeem their shares once the deal is approved. So let's say, and this happens a lot, sometimes it's 50%, 60%, 70%. So $100m is raised, but $50m is redeemed if 50% is taken back by people redeeming. But obviously in order to complete a deal worth $100m, you need to have $100m.
So what the SPAC will then do is go to private equity companies and have to raise additional money from them to complete the deal. Again, it's hard to say a lot of the time how that will impact you as an investor. But again, it's sort of an odd process and one that I think people might not be aware of. And again, the fact that so many people are redeeming doesn't necessarily bode well for you as an individual investor.
Of course, another part of this is the fact that warrants if everyone exercises them, create new shares and if there's lots of new shares, it means that the value of the existing shares also goes down.
And so I think one of the questions Chris asked was about incentives. And I think the problem at the moment is that a lot of the incentives are not aligned with those of investors. So if you're a sponsor, a sponsor is effectively the person who goes about raising the money. And another part of the process is they get 20% of the shares, or the value of the shares as compensation for helping, you know, raise the money, complete the deal and so on.
And that's, again, almost like free money for them and they're almost free to do what they want with their shares afterwards. So none of those things are necessarily great for you as a regular investor. And if you look at the returns on SPACs, I mean, they've been quite bad in general, mainly because a lot of the companies that have raised the money this way are pretty speculative and so they're very early stage.
I mean we spoke a month or so ago to a company called Lilium, and their idea is amazing, fantastic. You know, you look at it and it just sounds really cool. But it is very early stages. They've got some competition. So it's very hard to say, “OK, this company is going to do really well.” So I think that's part of the reason there's been poor returns from SPACs. I think the median return from 2015 to 2020 was something like a 30% loss.
So there's a lot to be careful of there. I think if you look at Bill Ackman, he’s a big investor and has also started a SPAC. He tried to complete a deal recently and it seemed incredibly convoluted to the point that it was a struggle, even when we were looking at the slides, to figure out exactly what the hell the deal actually meant.
But I think some of the processes he put in place were actually quite positive because they, for instance, stopped this kind of arbitrage of buying stocks, redeeming them and then selling the warrants. He didn't take a 20 percent fee and he put a lot of his own money into it as well. So all of those things meant that his incentives were aligned, I think, more with the investors than would otherwise be the case. And the fact that he didn't really allow the warrants to be exercised in the same way or sold off in the same way, stopped a lot of that short sightedness or short-term trickery, that's just people trying, again, to game the legal framework in which SPACs exist to try and make some money quickly.
Unfortunately, it doesn't seem like there's a lot of other SPACs that are trying to do similar things and so basically, I think my message would be to Chris, you were correct in saying that a lot of a lot of the stuff that's going on is quite murky and opaque and it's quite hard to figure out what is going on all the time. So leaving aside the fact that most of the companies that are listing using them, a lot of them are very early stage sort of companies that would usually get private equity funding. So that makes them almost inherently quite speculative.
But then you combine that with the sort of different dynamics that the SPAC legal framework creates, all of which, as you say, are a bit murky and a bit strange. And so I think anyone looking to invest should be pretty careful about putting their money into them and just figuring out, what are the dynamics at play? Is someone just using this to make a quick buck or is it a good long term investment? I know that’s quite a long answer.
Dan Lane: It was a long question, it deserved the long answer.
David Kimberley: Yeah. So hopefully that was easy to follow Chris, I understand there was a bit of a technical language, but if there was anything that was unclear, next time you can ask again. So I think we've probably done enough there. I can move on to the next question, which is from Ian, who says UK takeovers, loads of UK companies are being bought out. Is it a good or a bad thing? I can't tell.
Dan Lane: Yeah. Yeah. Listen, it's a fair question at the moment. It is barely a week goes by that we don't hear about some sort of bid coming in for a UK company. And listen, it's not a new thing. It's been happening for a little while, but there seems to be a few more not happening now. Basically, if you look at the UK market, it's full of backward looking industries, mining, banking. You've got big firms there that dominate the UK market like Vodafone, not exactly a forward-looking firm.
And a lot of this, when you've got the past year in which the tech high flyers have been everybody's flavour of the month, the UK market has looked a little bit musty and old. And all of that means that, you know, the buying frenzy in the US has meant that the US market on the whole is trading at around a 22x forward price to earnings ratio. So 22x, I mean, value investors would struggle to pay anything over 10x and 22x will be expensive to some people. The UK is selling at about 12x, so there is a big difference there. And, you know, less than 12x, it might sound cheap, but cheap doesn't necessarily guarantee the value of anything in there. It just says that the valuations are low, but the fact that valuations are lower, is attracting a lot of buyers.
So we're seeing UK pubs getting a lot of attention from foreign people looking to buy into the pub sector. UK gaming, especially the small caps, a lot of small gaming companies have been and have looked attractive on valuation levels. UK supermarkets, you know, Morrisons has got a big takeover battle going on. Sainsbury's has had some interest, I think it's a famous Czech investor that’s been hanging around for a little while. I wouldn't be surprised if a bid came in there.
Defense firms as well. We've seen a few things, like Ultra Electronics received a bid from Cobham, for example, just recently. But basically what you find is that competitors are thinking, can we buy at the competition cheaply? And private equity funds are thinking, can we buy out these things and basically clean them up, make them a little bit more efficient and make a lot more money out of them. So there are people who will say that it's not nice to have British companies bought out by foreign companies. And, you know, this is Blighty and we need to keep the British, British and stuff.
The reality is that the UK market is a very, very international market anyway. 75% of top UK 100 earnings come from abroad. In the mid cap index, 50% or nearly even 60% of the earnings from the whole index come from abroad. It’s a very international market. What a lot of these foreign investors are thinking that, well, if I can snap up the competition cheaply, integrate them into my business very cheaply, find synergies and still have a UK base with, you know, with a path into Europe or a path internationally, it's quite an attractive prospect, so I wouldn't say this is the end of it.
You know, as long as the UK market stays cheap, there will always be vultures hanging over them, which isn't necessarily a bad thing a lot of the time. Private equity sometimes gives itself a bad name by buying a company, loading it up with debt and putting it back on the market. That's not a great use of shareholder value there. But I would say it's probably going to continue as long as the UK market looks so cheap.
David Kimberley: Yeah, I think you're right. I mean, I maybe differ a bit. I think that in some cases, perhaps the government should do more to intervene. I mean, if you look at the Cobham acquisition, Cobham was itself acquired by a private equity firm before, which made all these promises about not asset stripping or breaking up or losing UK jobs and then did all of that stuff anyway.
So there's kind of a pattern of behavior. And I think that in some cases, you know, it's not such a big deal if if you have a foreign foreign owner. But then in other cases, if you look at stuff like defence, the UK should, I think, aspire to have some areas where it's a world leader and not be beholden completely to either China or the US. But it doesn't really seem like anyone in the government shares my views.
Anyway, maybe we can move on to the last question, which is I have an ISA with Freetrade, but can't work out whether I should cancel it and switch to a General Investment Account (GIA). What's the difference between them and which account is right for me? Sabrina asked that question. Thank you, Sabrina.
Dan Lane: Yeah, listen, really good question. It's nice to get these questions away from the markets on specific investment accounts as well. What I would say is, I mean, listen, start with what are your investing goals? What we would say is it's good practice to always have at least five years of a time horizon before you start thinking about what assets to invest in.
So if you're thinking about five, 10, 15 years, maybe think about, OK, well, what if those assets grow, especially if you're adding to them? You know, what happens if they grow and your assets are in a GIA and they could be liable for capital gains tax if you make over £12,500 in investment gains. In an ISA, it's a tax efficient account. So whatever gains you make, you get to keep.
So a lot of people think about, OK, well, I'll just invest in a GIA and cream off every year, the amount that would keep me up under the capital gains allowance. That really puzzles me, because why would you not just expose your money to an account that is telling you that it's tax efficient, that you'd be able to keep any games that you make over the long term, and you just don't really have to worry about it.
You know, there's a reason that the government offers us the £20,000 current allowance and and that's to encourage good savings habits and letting us keep our gains is one way of incentivizing us to take care of our own financial futures. You know, what I would say is the last thing that you'd want to be doing is 20 years down the line looking at your account and realizing that you could have saved an absolute heap in capital gains tax if you had just used a different account. Because realistically, you don't know what the investment performance of your assets is going to look like. So you may as well prep for it. So there's lots of information on the website. I mean, I'm not going to say that everyone should do the same thing. Obviously, we can suggest certain things and give it a little bit of guidance, but it's up to everyone in particular. I don't know. David, what do you think?
🤔 Deep dive: What is a stocks and shares ISA
David Kimberley: Yeah, I mean, I would agree with what you said. I mean, for some really basic answers to your questions, as in what's the difference between them? I think Dan has touched on that here. Essentially, if you invest money in an ISA, you aren't liable to capital gains tax, meaning the difference between the amount you bought a stock or ETF, whatever it might be, and the amount you sold it for.
Similarly, you don't have to pay tax on dividends from UK stocks. You often do for the US or other countries. But so those are the two benefits. But GIAs obviously don't have those. You just have government allowances. So as Dan said, for the current year, you have a capital gains allowance of I think it's £12,500. And so as long as you're kind of below that, you sell below that amount in a given tax year, you're not not going to be liable for capital gains tax.
I think that the problem is what happens then is people think, oh, well, I'm not going to make lots of money. So it doesn't matter. I don't need it. And then over time, they suddenly go, oh, you know, I've had this for X number of years and suddenly they realize that actually they are going to be liable for it and then try and rush to switch their money between their accounts and realize they can't really do it.
So,you know, this actually happened very recently with someone I know. A friend of mine who had done exactly this, they were basically trying to game their GIA. And then went, “oh it’s fine, you know, once I have loads of money I’ll just switch over to an ISA.” To which I said, you realize you can't really do that. So if you imagine, you have let's say £30,000-worth of assets in a GIA, you can't move the money. There's one way in which you can transfer, but even then you wouldn't be able to move the full amount over because of the limitations on how much you can put into an ISA in a given year.
So what I would say, and this is genuinely something that genuinely crops up all the time, is that, for anyone investing for a long period of time, so that's like a minimum of five, 10 years, which I think is probably most people using Freetrade or watching this. It's just much less of a headache to use an ISA. That’s not to say you shouldn’t use a GIA, but it's just much less stress to to use an ISA than it is to use a GIA. So hopefully that answer to your questions. Thank you for asking. And Dan, is there anything else you want to add to that one?
Dan Lane: No, I think you're absolutely right for me, genuinely, it's just about that headache. And I never really want to get to the end of the tax year and think about chopping off my gains and penalizing myself just to, you know, not have to fill in a tax bill. It's just not really what I've been doing and you know, £20,000 is a decent allowance, and then, as I said, obviously, if you filled up your ISA and you don't want to invest in your SIPP, a GIA can be really useful. But until you get there an ISA can be just as useful in the beginning.
David Kimberley: Great. Well, that's actually our last question. So thanks to everyone who submitted them. Again, if you have reached three referrals on Honey, please do send over any questions you have. We'll be happy to answer them. And there are quite a lot of you, so some of you haven't submitted any. So please do submit them and we'll be happy to do this again very soon. And a reminder, if you're watching this or listening to this and you haven't subscribed to Honey, you can do that at freetrade.io/honey. We'll put the link in the description to this video. And thanks again, everyone, for asking questions. And thanks for helping me Dan. Bye everyone and have a nice day.
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