Activist shareholders question Spacetalk’s “creative” audits
Price at posting: $0.052
Spacetalk Ltd (ASX:SPA)
The Oxford Dictionary defines ‘creative accountancy’ as “the exploitation of loopholes in financial regulation in order to gain advantage or present figures in a misleadingly favourable light.”
Given auditing is a branch of accounting, it may then seem inappropriate to name an audit firm ‘Creative Auditing’. But this is exactly what Spacetalk Ltd’s auditor, Ian G McDonald has done and unsurprisingly, a group of activist shareholders has raised its suspicions.
Spacetalk is an Australian technology company that develops smart watches for children. The products have a focus on child safety and allow selected family members to track the watches, and therefore the wearer, through a mobile app. The company has also released a similar product targeted at adults.
Spacetalk listed on the ASX in 2003, starting life as a school-to-home messaging service aimed at solving truancy. The clever pivot to wearables in 2018 caused an upswell in the company’s share price though much of these gains have now been undone as the company has so far failed to convert record revenue from watch sales and app subscriptions into profit. Spacetalk is helmed by Founder and Managing Director, Mark Fortunatow. Mr Fortunatow stepped down from his role as Chairman on 30 June 2022.
Since the launch of the first Spacetalk watch in FY18, Spacetalk’s revenues have grown from $2 million to over $20 million for the year ended June 2022. The inflection point for this huge increase in revenue coincides with a change in the company’s auditor.
Ian G McDonald was appointed Spacetalk’s auditor on 8 June 2018. While Creative Auditing appears to be a firm of two people, Ian G McDonald is listed as the auditor of Spacetalk in an individual capacity.
Mr McDonald’s appointment followed the resignation of former auditor Grant Thornton, the seventh largest accounting firm globally. The reasons for the resignation were not disclosed but the resignation was consented to by ASIC.
A change of auditor is often regarded as a red flag.
Ideally, auditors act as gatekeepers and perform a critical role in ensuring that investors are informed through high-quality financial reports. It is however possible to fall short of this ideal in situations where company management have interests that are not fully aligned with the conduct of quality audits.
A recent example is the failure of Big Un Limited which switched audit firms from PKF to a much smaller firm. In October 2017, Big Un released to the ASX its results for the financial year ending 30 June 2017, based on the audit provided by the new firm. The results showed Big Un’s cash revenue was up 429% with cash and cash equivalents of $9.2 million.
In July 2018, as a result of reporting from The Australian Financial Review and a direction from ASIC, Big Un issued corrections to its report, including that cash and cash equivalents were not $9.2 million but rather $918,000. Overall, Big Un’s financial position was restated from approximately $1 million in net assets to $9.5 million in net liabilities.
On 1 August 2022, the former auditor of the collapsed entity was convicted for failing to conduct the audit of Big Un in compliance with auditing standards.
To be clear, there is no suggestion of impropriety on the part of Mr McDonald or Spacetalk.
It is however highly unusual for an ASX listed company to be audited by a single individual, even for a company of Spacetalk’s size. Of the 38 companies listed on the ASX with a market capitalisation between $11 million and $12 million as of market close on 9 August 2022, Spacetalk was the only company with an individual listed as the auditor.
From the Creative Auditing website, it appears that Spacetalk is the only listed entity audited by Mr McDonald, whose other audit clients include rural local governments, aged care organisations, non-profits and self-managed super funds. Spacetalk is incongruous in this list with its ASX listing and international operations.
Shareholders raise concerns
In August 2021 the Spacetalk Shareholders Group (SSG) was formed by a group of concerned shareholders. The group has set up a website and also appears to be active on HotCopper, an ASX forum frequented by retail investors.
SSG members include Merewether Capital Management Pty Ltd as Manager of Merewether Capital Inception Fund, Harry Basle, Ian Cameron, Lindsay Cardno, Mitchell Cardno, Peter Cossetto & Annamaria Cossetto ATF Cossetto Family Superannuation Fund, Coz-E Pty Ltd ATF Cossetto Family Trust, Mark Gately, Savvas Ioannou & Maria Ioannou, Matthew Payne, Lasse Petersen and Lasse Petersen ATF the Icebear Trust and Neil Page.
The SSG’s website states “SSG members have a shared optimism but also common concerns about the impacts of adverse governance and management on Spacetalk’s operational, financial, market and investment performance.”
On 1 July 2022, the SSG sent a s249D notice to Spacetalk. A s249D notice is a common mechanism for shareholders to replace the board of a public company. The notice allows shareholders with at least 5% of a company’s share capital to compel the company to call a general meeting to vote on resolutions proposed in the notice.
The notice requested the convening of an extraordinary general meeting of the Company and proposed two resolutions. Firstly, the removal of Mark Fortunatow as Director of the company, and secondly, the removal of any director appointed from 27 June 2022 until the end of this general meeting. This would include both the current Chairman, Georg Chmiel and the former Premier of South Australia, Michael Rann.
On 10 August 2022, the company announced that the SSG had withdrawn resolution 2. This means that the SSG are now only seeking the removal of Mark Fortunatow as a Director. The resolution would not affect Mr Fortunatow’s position as CEO.
Allegations of non-compliant remuneration and financial reporting
The SSG reasoning for the removal of Mr Fortunatow is a perceived lack of alignment between the company and Mr Fortunatow which the group maintains is reflected in a history of poor governance practices under Mr Fortunatow’s chairmanship, including alleged instances of selective, unbalanced and promotional disclosure, non-compliant reporting and failed guidance.
The SSG has previously tried to address its members concerns. The SSG stated that during the two weeks prior to the 2021 AGM, an SSG member submitted to the Company and Mr McDonald, comments, concerns and questions in relation to the audits of Spacetalk’s 2021 remuneration and financial reports. The submission included 11 questions relating to concerns about apparent instances of non-compliance of Spacetalk’s 2021 remuneration report and 24 questions relating to concerns about apparent instances of misstatement (including non-disclosures and potentially misleading disclosures) in Spacetalk’s 2021 financial report.
The SSG stated that despite efforts to engage further with Mr McDonald, Mr McDonald has not provided any substantive response. SSG members have stated that they “are concerned that Mr McDonald appears not to have engaged to understand the nature of the concerns raised, investigated the concerns, or responded appropriately and in accordance with his legal, professional and ethical obligations.”
A statement from Spacetalk’s Non-Executive Directors, Mr Martin Pretty, Mr Saurabh Jain and Dr Brandon Gien has advised shareholders to vote against the resolution. The statement refutes all points that the SSG makes in its statement. It is not however forthcoming with any answers to the questions asked by the SSG in relation to audit of the remuneration and financial reports.
Regardless of whether the SSG achieves a vote in favour of its lone resolution, there is likely to be much greater scrutiny of Spacetalk’s governance and reporting going forward and maybe even a little less creativity.