Northern Rock: a lesson in how shares go down as well as up

published 27 February 2008

Roger Lawson, director of the UK Shareholders Association and chairman of the Northern Rock Shareholder Action Group, was on BBC's MoneyBox programme on Saturday morning to argue that the private shareholders whom he represents were entitled to compensation.

Citing his many years of experience at valuing companies, he said that he could easily make a case that the shares that have been appropriated by the Government were worth £4 each. If that is the case those same small shareholders may like to ask him why he did not dispense this useful piece of advice when the share price was flying high at £12 and presumably a screaming sell.

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We can dismiss the big shareholders straight away. The hedge funds are no better that the scavengers who descended upon Branscombe Bay after the wreck of the MSC Napoli. They took a massive contrarian gamble, made a nuisance of themselves, and have deservedly lost their money. The big institutional shareholders know in their hearts that they backed an aggressive and risky business model that came unstuck. They will no doubt sign up to any claims for compensation as a PR exercise on behalf of their insurance and pension policy customers. But they will only be going through the motions.

But what really annoys me is the stance of private investor groups. Their arguments are fatuous. Robin Ashby defines fair compensation as either the value of the bank on the day after it floated on the stock exchange in the late 1990s (452p) or the value on the day after the run on the bank in September last year (438p). He must be in cloud cuckoo land. How nice it would be if we could turn back the clock and sell all our shares at some previous date when circumstances were different and the price was higher!

Roger Lawson made reference to Northern Rock's net asset value which, according to the bank's balance sheet at June 30th of last year, was 563p per share, or 538p if one excludes intangibles. However this net asset value is the difference between two very large figures, the 27,232p per share of Northern Rock's balance sheet assets, largely mortgage loans, and its 26,421p per share of liabilities. The latter figure is 97% of the former, meaning that it only takes a 3% decline in the value of the assets to wipe out Northern Rock's net asset value. It beggars belief to argue that Northern Rock's assets are worth what they were last June. Stop behaving like children.

Nobody is more concerned about the interests of private investors than I am. This type of thing annoys me because it does the reputation of private investors no good at all when they behave like children who have dropped their ice-cream on the pavement. Anyone who buys - or as in the case of many Northern Rock shareholders is gifted a share should understand two things. The price of shares is determined by the market. In other words they are only worth whatever somebody else is prepared to pay for them. And companies, and the environment for their business, change from day to day and not always to the benefit of the value of the shares.

Shareholders in Northern Rock have received a stream of rising dividends and have had every chance to sell out for handsome profits in the past. Indeed many no doubt did so. Perhaps tax-payers should now be claiming back these profits on the grounds that they were made in the exceptional circumstances of a reckless house-price boom? But most private shareholders did not sell out. So what were they thinking when Northern Rock shares were going from strength to strength? That a bank operating in one of the most competitive of all arenas had found some elixir for limitless growth? Were they congratulating themselves on their profits or were they asking themselves whether the forces that were driving Northern Rock's apparent success just might be too good to last?

The Government is now to appoint an independent valuer' to decide the level of compensation that should be paid to shareholders. I should think that independent' in this case means leaned all over by the Chancellor and the Prime Minister' and some sort of token payment may be made. But the only basis for making any such payment would be if there was an alternative offer on the table. Northern Rock shareholders need to establish if, as has been reported, Richard Branson was prepared to offer 50p per share. If the Government has denied shareholders this or any other price then they have a case.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.