This looks like a total calamity!

I have a question for you: what value would you place on a business that has just reported semi-annual revenue of $2.6m, a net loss of $7.3m and has net tangible assets of less than zero?

Not much, I hope.

Why would you want to stump up for these losses? What chance is there that the business could possibly grow its revenue to a level that turned those losses into profits?

Well, City advisers have turned their highly trained professional minds to this conundrum and decided that, all things considered, this business is actually worth $142m.

Did you read that correctly? Is it a misprint? Did I mean $1.42m or $14.2m? No! This tiddly, loss-making business has really been valued at $142m. I reckon that makes the proposed deal in which Gemfields (GEM) is to acquire this business – which  goes by the name of Fabergé – an absolute stinker.

An ambitious plan to infiltrate the luxury market

This is not the news I want to hear and it gives me no pleasure. I am a shareholder in Gemfields. I like its chief executive, Ian Harebottle, a lot. He is a real enthusiast for the gemstones business and he has done a great job of running Gemfields’ Kagem mine in Zambia and marketing its emeralds. But judging by his carefully choreographed comments, I doubt that he is very happy about this deal. Because, for reasons that will become clear, I doubt he has had much say in its terms.

So let’s get down to the nitty-gritty. You will have heard of Fabergé. It was created by Gustav Fabergé in 1842 in St Petersburg and made the fabulous jewelled eggs commissioned by the Imperial Russian family from 1885 through to 1916. Since then it has not been plain sailing.

The Bolshevik revolution saw a violent end to production, and in 1951 the Fabergé family were forced to cede their rights to use the family name to an American corporation in return for just $25,000. After various further changes of ownership the family was reunited with the brand and the business ended up in the control of the South African conglomerate Pallinghurst Resources – remember this name.

In 2009 Fabergé was re-launched as a luxury goods brand and now has five retail outlets in Geneva, Hong Kong, New York and London, where you can find them in Mayfair and in Harrods. It has ambitious plans. It wants to open 20 stores over the next ten years and have a total of 71 by 2033. It reckons that each store is capable of selling $6.5m of luxury goods at a high margin which, if achieved, would make it a quite large and certainly profitable concern.

Fabergé’s only value is its name

But that is all supposition. What we have today is a small, loss-making business whose main attraction is the Fabergé name. In marketing-speak this name has ‘resonance’, it is clearly worth something and Gemfields cannot expect to acquire this for a song.

But this is where it gets really murky. You see, in its latest balance sheet, at the end of September, Fabergé recorded intangible assets of $36.2m. I do not see how Fabergé can have any significant intangible assets beyond its famous name. This was valued by

Fabergé’s directors at $36.2m just two months ago – and yet, (given that the tangible assets are a negative number) Gemfields is now proposing to pay over $142m for these same intangibles.

If you are wondering how this could possibly happen, then wait for the punchline. But first let me tell you about the other supposed attractions of the deal. Gemfields will acquire a ready-made retail outlet through which to promote its emeralds and the rubies that it hopes to mine in Mozambique. Fair enough – but Fabergé gets a supply of stones for its jewellery, so the advantages are not all in one direction.

A ridiculous price tag

Gemfields claims that building a luxury goods brand of its own would cost much more. That is a debatable point which should have been captured in Fabergé’s intangible value and fails to explain why Gemfields is paying almost four times their balance sheet value.

Lastly, Gemfields claims that the combined group will be bestowed with the high rating given to luxury goods companies, but this makes no sense. Gemfields will be half miner and half luxury goods retailer, and to suggest that this will be rated as if it were a pure luxury goods concern implies that investors are stupid.

As a Gemfields shareholder I would vote against the deal on the proposed terms. While the principle of the merger is OK, the price tag for Fabergé is just ridiculous. But here is the punch line. Fabergé is controlled by Pallinghurst Corporation – and so is Gemfields! Pallinghurst can do what it wants, regardless of the interest of minority shareholders – and it just has!

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

  • stephenlindbrook

    With such a colossal disparity, doesn’t this amount to a textbook case of false accounting – the sort which (theoretically at least) LSE and AIM disapprove of, and (again theoretically, as it never seems to occur in reality) which carries a spell at Her Majesty’s pleasure, plus disqualification?
    Even on Planet Bling, ten years from now, 20 units @ 25% gross margin is not that great a yield.
    Also, suggest asking the auditors how they will live with themselves?
    [Comments based on what the article says, not my own research, NB]

  • D Lunnun

    The Moneyweek ad that the link in this article takes you to is a complete waste of time. The crux of their issue is that the market is going to fail. When? It says some time in the next ten years. Well it’s going to go up or down and if you wait long enough your prediction will come true. I subscribed to Moneyweek for some time and I have recently been looking back at several years of their recommendations and the vast majority are now worth a fraction of what they were when recommended. Unfortunately that includes several that I invested in.

  • Ian

    . Karl Faberge would be spinning in his grave at the quality of current productions- a man who personally inspected every piece made in his St Petersburg workshop, and smashed it if it was not up to the highest standards of workmanship. The company is trying to confuse the public into thinking that the modern pieces are somehow equivalent to the old ones, which now fetch mega-money. By this standard, the new pieces may seem good value to the uninformed punter; but taken as inferior modern copies in the Faberge taste, they are not. I don’t have shares, but I would be worried too! $142 million for a brand name!

  • Ko-lin

    There’s no doubt that if Pallinghurst were listed on LSE, this deal would at very least cause suspicion and/or investigation, but the’re not, so they can do pretty much as they like.
    No wonder the precious metals/stones market has always been surrounded by intrigue/dodgy deals/celebrity hype and bloodshed. Might be time to bale Tom!

  • Nacho

    That is an interesting story.
    Could it be that Pallinghurst own a greater percentage of Faberge than they do of Gemfileds? So they end up increasing their net worth at the expense of the minority holders of Gemfields?
    Just one possible conspiracy theory. I haven’t done any research, just putting it out there.

  • Greg

    Thanks Tom. As a holder of about 10k shares in GEM I was bemused by the recent SP drop and a bit suspicious of this transaction when it was announced. A reading of the announcements etc didnt truly enlighten me on who and what Pallinghurst was – I dare say I could have tried harder. But on the face of it big brand like F seemed a good business to buy and I assumed GEM would pay a fair price and they were taking GEM stock for it. OK then. ON seeing your email the scales were lifted from my eyes today and my shares were flogged within 60 seconds of reading your article. I’ve made a very nice profit on GEM in the last 2 years, but this stinks.

  • marf

    Also received email this morning from Alliance Trust Savings with their weekly share tips proclaiming- ‘Grab Gemfields ahead of Faberge Deal’
    Its getting more difficult to sift through all this advice.

  • Justin

    Tom, you got me in to Gemfields via RHPS a few years ago, and I thought you were mad when you sold them from your portfolio.

    I considered this my safest small cap investment until the Faberge t/o was announced. Now it feels just too risky and your excellent email has persuded me to sell the vast proportion of my stock.

    I have to agree Harebottle does look a little nervous and sweaty in the Youtube video of the Faberge announcement. He’s usually cool, calm and collected.

    Such as shame as this company has so much potential with the rubies coming on stream next year!

    I hope I haven’t made a bad call – will watch it closely… but at least have made a handsome profit on it so far!

  • Phil

    Thanks for your insight on this deal. Gemfields has been on my watch list for some considerable time but the mechanics of the deal would make me wary of taking my interest any further.

  • Rufford

    If the listing had been this morning, I would have lost £13.60 from each 1000 shares I own. That is because of dilution, My holding would be 60% of the value at close of business yesterday 33.25p.
    That would have gone from my portfolio to the Pallinghust Pals who can sell after 12 months.
    So far their management has saddled Fab with stock that will take 12 years to sell.
    They loaned $50m to Fab – there was no chance of getting it back so they decided to weld Gemfields and Fab together.

    So there we are.