Quindell has more explaining to do to aid its shares

There appears little doubt Quindell Plc. needs to redouble efforts to explain its accounts.

It’s the rationale behind the Alternate Investment Market (AIM) -listed IT and business services firm that has come under fire of late, sending the stock about 50% lower from its June highs.

A spotlight of negative market attention was trained on the medium-sized firm after Gotham City Research, an independent analysis firm, published a view on its website titled, “Quindell PLC: A Country Club Built On Quicksand”.

Gotham City, which focuses on short selling the shares of companies it has produced negative reports about, concluded Quindell stock was worth “no more than 3p/share.”

Additionally, critics have queried the large portfolio of industrial insurance business Quindell is taking on, especially after influential insurance sector firms stated they will avoid the business area due to concerns of widespread fraud.

Quindell said it started legal proceedings against Gotham City Research and a blogger, who it said made defamatory statements, seeking unspecified damages.

“(We are seeking) compensation for the damage they tried to do to the business and, of course, that they have done to the share price in the short term,” Quindell’s executive chairman, Robert Terry, said on Thursday.

On the same day it reported a near-quadrupling in first-half pre-tax profit to £153.7m and revenue more than doubled to £357.3m.

It emerged in June the London Stock Exchange rejected Quindell’s application to list on the UK’s main market.

The company said the exchange deemed it ineligible as its business has undergone “a significant change in its scale or operations” during the last three years.

The central issue latched on to by the company’s critics appears to be revenue recognition and how these are represented in the firm’s accounts.

Critics noted some sales were recorded (or ‘recognised’, in accounting terms) months before payments were received.

Quindell said its recent accounts meet statutory performance targets, adding on Friday that progress in the Gotham case was due “within days”.

Quindell appears to have fallen foul of a type of problem that affects many firms whose businesses accrue cash long after initial contracts are confirmed – for instance, legal firms and insurance.

In such firms, costs may be incurred well in advance of settlements capable of producing incoming cash flows

Qindell appears to have dealt with the difficulty by—described very basically–accounting for expected revenues as intangible assets and ‘trade and other receivables’ even though the cash was not yet in Quindell’s possession.

No suggestion of legal wrong doing by Quindell

This does not appear to be illegal.

However, it has opened the firm up to criticism, including from institutional investors, which have expressed unease with Quindell’s methods and corporate governance.

They have also noted the executive chairman’s involvement in a failed insurance firm, The Innovation Group.

If Quindell manages to gain the upper hand in the debate with its critics, its share price would have a fighting chance to recover from losses, including today’s 10.5% drop to 165p.

To do that, its accounts would need to be laid out in a way which is far less ambiguous and with more explanatory notes.

There’s of course certainly scope for Quindell to be more conservative in its accounting practices.

Doing so would place it on a firmer footing and provide it with the time required to translate the cash flows in its complicated business model into profits that the market can understand.

Afterwards, the stock will return to its biggest near-term test at 170p – a 61.8% retracement of the attempted recovery beginning in July.

Before then, 160p looks to me like the only protection from a repeat of the collapse towards 130p and potentially lower.