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Was it a good bet or not? 10 years and £1.4 billion later and the answer seems to be…

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Although people have been gambling for a long time, the profile of the betting industry has changed dramatically over recent years.

The bookmakers that were seen on many a high street seem to be gradually disappearing.

People are still gambling though but the delivery method of the industry is switching to internet based gambling rather than placing bets at a physical bookmakers.

Ten years ago former professional gambler Andrew Black and former JP Morgan trader Edward Wray started up a betting business that addressed matters in a new novel way.

For years the typical approach to gambling had been where a bookmaker set the odds and it was up to the individual gambler whether or not he or she accepted these odds and placed the bet.

Betfair pioneered the concept of person to person betting whereby individuals bet against each other rather than the bookmaker. Betfair provide the platform for the betting and take a commission on each transaction.

A gambler will say that they want to bet on a certain event happening (or not happening) and if another gambler wants to accept the bet then the transaction goes ahead. Betfair provide the mechanism for this to happen.

This is known as a betting exchange and is a great example of where first mover advantage really counts.

In order for the business model to work there has to be a critical mass of gamblers that are willing to offer and accept bets. Without this critical mass the business simply would not work.

Another example of where first mover advantage has been critical to business success is in online auctions. After all, who are the main competitors to eBay?

Back to Betfair though and it certainly is a good business model. Risk for example, is nicely reduced as the company is not standing to lose on the bet but instead takes a nice commission on each transaction.

So how well has it done over the last 10 years?

The answer to this can be found last Friday when 15% of the company was floated on the London stock market and the company was valued at £1.4bn.

Betfair’s advisors were some of the biggest names in the business and included Goldman Sachs, Morgan Stanley and Barclays Capital to name a few.

Amongst other things their job was to identify the price range of the proposed offer. Initial indications were that it would be between £11 to £14. The final initial public offering (IPO) price was set at £13.

With some of the top investment bankers involved and Betfair being in the gambling industry (which is not necessarily renowned for being generous to gamblers) it was something of a surprise to some people to see the share price rise by nearly 20% in the first day of initial trading after the IPO. After all, this could imply that the IPO was undervalued if there was such an initial jump in price.

I wonder what odds you would have got from Betfair that the IPO share price would rise by 20% on the first day of trading?

Forget who’s in charge of the TV remote control, who’s in control of the TV channels?

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BSkyB is the largest broadcaster in the UK, reporting a profit of £11.7 million on revenues of £5.9 billion in its most recent financial statements.

Its ownership structure is dominated by News Corporation, the transnational media conglomerate owned by Rupert Murdoch, whose other ventures include numerous newspapers and Fox studios in the USA.

It’s fair to say that Rupert Murdoch is a controversial figure.

A review of the most recent financial statements shows that News Corporation presently owns approximately 39.1% of the shares of BSkyB.  The next two largest shareholders own 5.02% and 3.01% of the votes in the company.

In other words, resisting the might of News Corporation to impose its will on BSkyB would require something more akin to a peasants’ revolt than a more standard company vote in the AGM.

IFRS 3 defines a subsidiary as an entity that is controlled by another entity.

Looking at the evidence, it would appear that the 39.1% ownership would be enough to give control of BSkyB to News Corporation, on grounds that it would be almost impossible to resist decisions favoured by such a dominant investor.

One such decision was appointing James Murdoch, son of Rupert Murdoch as chairman of BSkyB.  Lots of investors didn’t like this, but Murdoch took the helm of the company.

News Corporation produces its financial statements under US GAAP and has always consolidated BSkyB using the equity method, as an associate.

Under IFRS, it would have been arguable that full consolidation as a subsidiary would have presented a more true and fair view, as IFRS uses more principles based recognition of control than US GAAP.

However, a shock recently came to News Corporation, when it tried to increase its holding from 39.1% to a clearly controlling 61%.

The board of BSkyB refused to agree with the chairman that an offer of 700p per share should be accepted.  The board defied its biggest investor and said that they would recommend refusal of any offer less than 800p.  This appears to have come rather as a surprise to the dominant Murdoch family, who show signs of thinking of BSkyB as their fiefdom.

It’s just a nice example of when apparent control is not control and thus how to be cautious in deciding when to consolidate a company as a subsidiary, even if it generally does everything you tell it to.  If there appears to be a chance of the other investors saying “enough” and refusing to give into your will, it’s not a subsidiary.

That’s some obligation – it will take 180,000 years to repay it…

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Yesterday, the so called “Rogue Trader”, Jerome Kerviel, whose unauthorised trades cost his former employer Societe Generale vast losses was sentenced.

Whilst this has got a serious element to it (he was jailed for 5 years) it also has a certain element of farce. As well as the jail sentence he was ordered to pay compensation to his former employer.

Now, this wasn’t any “normal” compensation we’re talking about here. It was the princely sum of €4.9 billion. Yes, Mr Kerviel was told that he has to pay nearly €5,000,000,000 to his former employer.

Based on his annual earnings before going to jail it would take him nearly 180,000 years to pay that amount! Societe Generale have sensibly announced that they will not be pursuing the money.

Control environments don’t generally strike students as the most scintillating area of their studies.  A number of ACCA and CIMA Papers however place considerable emphasis on controls, using Sarbanes-Oxley and the COSO frameworks.

Respecting controls might slow down an employee’s daily work routine and may feel sometimes like a constraint on innovation and enterprise.  Sometimes, it may be tempting to circumvent controls, especially if it generally appears to result in making quicker profits.

Anybody tempted to do this might be interested to note the Paris court’s decision to sentence Mr Kervie.  Although the hapless gentleman alleged that the bank had been complicit in allowing him to trade beyond his authority limits, this seemed to be little defence in either showing innocence or getting a more lenient sentence.

The lesson seems to be fairly clear.  Even if the tone appears to be one of disregarding controls because management don’t take them seriously, if anything then goes wrong, management will most probably not agree that controls were considered to be unimportant!

The safest thing to do is to assume that any controls are meant to be respected, even if it doesn’t feel that way.

It could literally be your “get out of jail” card.

How much does it cost to buy your loyalty?

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Last week one of the top policemen in the UK admitted to getting discounted flights for his family by using air miles obtained on tax payer funded flights.

John Yates, who is the Assistant Commissioner of the Metropolitan Police (i.e. the  Greater London Police), is entitled to fly business class on official trips abroad. This enables him to amass significant amounts of air miles which can then be used for free flights in the future.

With a nice corporate governance angle the rules of the Metropolitan Police say that these air miles must be used for future work related flights and not personal ones. In what he claimed was an oversight, Mr Yates however used these air miles for a number of personal flights.

I’m sure it was the last thing on Mr Yates mind but from the Airline’s point of view, the provision of air miles can involve big figures.

The IFRS Interpretation Committee (formerly known as IFRIC) didn’t make many friends when they wrote IFRIC 13: Loyalty Programmes.

Broadly, IFRIC 13 says that when you are given loyalty programme points by a business, they have to recognise a proportion of the total sale to you as a sale of loyalty points.  In other words, they are buying your loyalty, rather than rewarding it.

This means that each sale has to be unbundled into two components – a sale of loyalty points at the value to the customer (which is likely to be very much higher than the cost of delivering the promised service) and the underlying sale itself.

As the loyalty points are used up or expire, the deferred revenue from loyalty points sold is recognised as revenue.

Previously, the accounting policy of most companies had been to recognise loyalty costs as a provision at the expected marginal cost of delivering the service.

This can be a fairly significant figure.  By “fairly significant”, we naturally mean “completely massive”.  Have a guess what the effect was on shareholders’ equity in the restated 2008 accounts of British Airways for implementation of IFRIC 13.

The answer is £206 million.  Nope, that’s not a typo; getting towards a quarter of a billion British Pounds.  Ouch.

We at ExP travel fairly a lot for work and we’ve noticed that airline loyalty programmes have become a little less generous of late.  Maybe the new accounting rules are something to do with this?

Do you own a iPhone or is it a Hiphone, an Ephone or a Ciphone?

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On Saturday Apple officially launched the iPhone 4 in China. They also opened up two new flagship stores in Shanghai and Beijing.

China is the world’s largest mobile market with more than 800 million subscribers so it would seem to make sense that Apple sell their products there.

Why has is taken them so long to launch the iPhone 4 in China though? After all, the iPhone 4 was originally launched in the US back in June and in countries such as Australia, Netherlands and Singapore in July.

The handsets themselves are manufactured in China so it’s not as though they haven’t had any experience of doing business in the country.

There are various reasons why companies have phased product roll outs in different countries. The sheer scale of a “global launch” for a company like Apple would be extremely challenging. Having sufficient inventory in stock on global launch day would not only be a logistical nightmare but would probably be physically impossible.

An additional challenge for Apple is that they need to agree matters with their strategic communication service providers in each territory (in other words, the mobile phone operator they will be partnering with in each particular country). This also takes time.

Anyway, from now onwards we’ll be seeing the iPhone 4 in China but anyone that has been to China recently though could be forgiven for thinking that the iPhone 4 has already been in the country for a while.

A significant issue for Apple is the increase in the number of iPhone clone companies.

As well as clone companies that produce illegal fake copies of the phone there are also businesses that produce reasonable quality phones which are very similar to the iPhone. They are designed so that they try not to break any patent protection that Apple has set up. I’m sure though that Apple’s patent lawyers are monitoring these products very closely!

A quick search on the internet for example shows websites selling products such as the HiPhone, the Ephone and the Ciphone. With prices starting at less than $100 there will be a significant number of people opting for these items.

Oh, and in case you were wondering the photo above is of the Hiphone.

Auditing the auditors – in a rather public way!

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In the UK, the Professional Oversight Board is one of the bodies that works towards improving the quality of audit work and audit firms.

They have just published their 2010 inspection reports into the Big Four audit firms.  If you feel so inspired, you can read these reports free here.

Obviously, not only the Big Four know how to audit.  However, it’s probably fair to assume that if there is a pattern in perceived weakness in audit within the biggest firms, it’s probably a pattern within the profession as a whole.

The good news is that in almost all cases, the POB found that audit work was done well or acceptably, though with room for improvement.  There’s something very healthy about a profession that scrutinises its own commanding heights and then publishes its findings in a wholly public way.

The general public are all stakeholders in our profession and they deserve to see the results of our own introspection.  Partners in big audit firms whose work has just been the subject of constructive criticism may feel somewhat differently about this of course!

A pattern within the reports is that nobody seems to be especially strong at conducting goodwill impairments.  Three of the Big Four were specifically criticised by the POB for failing to obtain sufficient, appropriate evidence to support the clients’ assertions that goodwill had not been impaired.

In the frank but diplomatic language of these reports, it sounds like the audit teams in certain particular audits didn’t really know how to approach deciding whether purchased goodwill had actually been impaired.

Is this the fault of the auditor, or is it the fault of accounting standards that require goodwill impairments to be recorded but aren’t entirely specific about how to do it?  We think it might well be a bit of both.

Criticisms such as audit reports being issued on a date before the audit working papers had been signed are somewhat harder to justify, however.

We imagine that the partner responsible for that one might have a table to himself or herself at the office Christmas party.

If you go to the bank today be careful in case you Kop some abuse for being a toxic asset.

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On Saturday Wayne Rooney the England and Manchester United footballer was dropped for the game against Everton.

According to the Manchester United manager Alex Ferguson, he was dropped so that he wouldn’t have to endure excessive abuse from the Everton fans (whilst the married Mr Rooney has recently gone through a barren patch of scoring on the pitch he was reported in the press last week as having scored off the pitch with a number of prostitutes).

So, the Everton supporters didn’t have the opportunity to direct their witty chants towards Mr Rooney.

The Accountants amongst the Everton supporters though must now be looking forward to when they play their neighbours and fierce rivals, Liverpool.

Last week it was reported that Liverpool FC’s loan with the Royal Bank of Scotland (RBS) had been reclassified and moved to RBS’s toxic debt division. In other words the £260 million loan is now within the “bad bank” part of RBS which was created to put all their toxic assets from the recent worldwide financial crisis.

Even though RBS were reportedly getting £1million interest per week on the loan it is now considered clear that they have severe doubts over whether they will get their money back.

We blogged a couple of months ago about the going concern risk with Liverpool FC and this latest news can only add to the excitement.

One thing’s for sure though and the toxic debt division of RBS won’t be very sympathetic with Liverpool and will be looking to recover their money as soon as possible. A quick sale of the football club at a knock down price is expected.

Now, all you accountants in the Everton crowd get your singing voice ready and altogether “You’re toxic and you know you are, you’re toxic and you know you are….”

Look out for two prostitutes, £3.7 million of stolen cash and a 58 year old accountant at your local Toys R Us store.

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Toys R Us is one of the largest toy store chains in the world.

It’s very successful and has nearly 1,300 stores around the world. What it didn’t have though was a strong internal control system in their UK purchase ledger department.

Between 2006 and 2008, married father of two and accounts payable manager Paul Hopes made over 20 illegal payments ranging from £100,000 to £300,000 to bank accounts of fictitious toy suppliers in the Far East which he had set up himself.

The £3.7 million of illicit money was then spent on various items. One of Mr Hopes favourite methods of spending the money was on Wednesday nights when he would regularly entertain 2 prostitutes at luxury hotel suites.

As well as paying for their time and energy he also bought them a string of luxury cars including a Bentley, Toyota Land Cruiser and a BMW M3 (incidentally, his wife was at the time driving the family Ford Mondeo).

In total he spent nearly £2.5 million on the two prostitutes.

It all came to a sticky ending for Mr Hopes though as he was sentenced to 7 years in jail.

What is interesting about the sentencing is that under the Proceeds of Crime Act the Judge ordered Mr Hopes to repay £3.4 million of the £3.7 million stolen. If he fails to repay the £3.4 million then an additional 10 years will be added to his 7 year sentence. At the end of the 17 year sentence he will still be obliged to repay the £3.4 million.

Now, remember that Mr Hopes is an Accountant so I’m sure he’s an expert in double entry but even the best bookkeeping skills won’t be able to make “income” of £3.7 million minus “expenses” of £2.5 million equal a balance of £3.4 million.

I guess he’s hoping that these two particular ladies are now desperately trying to find him every Wednesday evening to give him the money back.

I take my hat off to Bethany Hare, Charlie Chaplin and Mendelow’s Matrix but should I be smiling?

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Bethany Hare is a remarkable young lady. She’s only 10 years old and wanted to raise money for a local children’s hospice.

She came up with the idea of dressing up as Charlie Chaplin, singing the song “Smile” (the theme from Chaplin’s 1936 film “Modern Times”) and then posting it on a charity website.

She was aiming to raise £5,500 and it all started well with people appreciating the effort she had put in and making donations.

She was then contacted by New York based Bourne Music Publishers, who own the rights to the song. Several discussions between Bethany’s mum and the Publishers later and the end result was that Bethany was told that she must either remove the song or pay a license fee of $2,000 to keep it online for one year plus a further $250 every time she performs it in public.

This is a lot of money for a little girl of 10 years old to pay to a big music publisher especially when she’s trying to raise £5,500 for terminally ill children. Bethany removed the song from her video and in true Chaplin style ran it as a “silent movie”.

A lot of people will question the approach taken by Bourne Music.

Mendelow’s Matrix is a method of analysing stakeholders in a business. According to this model the stakeholders that management should really look after are the “key players” (high interest / high power). Bethany falls within the low interest / low power quadrant of Bourne Music’s matrix and hence the theory goes that they can employ “minimal effort” to this category.

Some would argue that they had a duty to protect the song and obtain all the royalties they could from it but it seemed obvious that Bethany was never going to pay that sort of money.

This story has however got a happy ending. Ben Model from Silent Clowns in New York wrote a piano score especially for Bethany to use and she has now reached her money raising target. Bethany’s performance can be seen here.

I’ll leave it up to you to decide who you think are the good guys and the bad guys in this story. My view is that the title of the song in debate was “Smile” and I’m pretty certain that not a lot of people were smiling when they heard the approach taken by the Publishers.

Things are getting more expensive in China but is this good news for McDonalds?

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A report issued by Credit Suisse this week highlighted the fact that costs of manufacturing in China are on the increase.

Average salaries for example have increased from $1,000 per annum in 2000 to nearly $4,000 in 2010. This increase, together with the cost of transporting goods to Europe and America, means that the cost base has increased significantly and importantly is likely to continue to increase.

A number of companies have invested in China principally on the basis of their low cost base.  The rising cost base though is causing concern for a number of companies.

Will they be able to switch production to other low cost locations such as Bangladesh or Vietnam? They probably will be able to but it could be costly.

Will they be able to pass on these cost increases to the end consumer by way of price increases? Given that we are only just starting to come out of recession my guess is that this will be challenging to say the least.

But does all of this really come as a surprise? With the explosion of globalisation over the last couple of decades and companies manufacturing in cheaper location or “off shoring” services then surely it’s simply a case of supply and demand.

If companies set up offshore operations in a certain territory which is renowned for having, for example, good quality cheap IT skills then when other companies join them there will be a surge in demand for these individuals and wages will increase.

It will take a number of years or even generations but some people’s view is that eventually there will be very similar wage levels wherever you are in the world.

Back to the increase in wages in China though and whilst this will be bad news for a number of companies there will also be companies that will benefit from the increase in local spending power. McDonalds for example are no doubt licking their lips in anticipation at all the Big Macs that could well be sold in China in the near future.