The party's over before you get there

Be wary as private equity backed IPOs may be about to return


This article first appeared in Aimzine, www.aimzine.co.uk 
 
With some reluctance, I went on my first ever cruise this month. My reluctance wasn’t the fear of being on a large piece of floating steel in the calm waters of the Med for a week, but rather the thought of being captive in a mobile hotel with a very large number of Americans. I suspect that like most Brits, there are certain things about America that I love such as its energy, optimism and vibrancy but there are other things which cause me, at best, concern and at worst total dismay. Putting aside serious matters such as the possibility that a Soccer Mom might become the next President, the unquestioning support by successive American governments for brutal dictatorships and the huge amount of US government debt which will one day cripple the global economy, my greatest concern and dismay right now is over the import into the UK of the US concept of the Prom Party. This phenomenon is growing massively in the UK with more and more schools every year organising these over-glamorised school-disco celebrations of insignificance.

The Prom Party is good news for some people though; most notably retailers. Rob Templeman, soon-to-depart Chief Executive of Debenhams says that for his company it is now the second largest sales peak of the year, second only to Christmas. That’s probably little comfort for his shareholders who have seen the Debenhams share price fall from 195p at IPO in 2006 to around 70p currently.

Large dividends
The IPO price although at the bottom end of the range at the time still delivered a good return for the private equity firms which had originally taken Debenhams private in 2003. CVC, Texas Pacific and Merrill Lynch tripled their £600m investment during the three years the company was in private equity ownership, partly through selling properties, increasing the company’s debt and taking out large dividends.

Since the company listed on the stock exchange with shares being bought by reputable institutions there have been numerous questions raised about the growth prospects for Debenhams, even before gloom descended on the high street. Strong sales growth was essential to service the debt that had been foist on to it by the private equity firms, as well as to meet the largely fixed costs of a retail business. However, that sales growth hasn’t come through with the last reported figures showing like-for-like sales excluding VAT being down by 1.5%. Moreover, after repeated profits warnings and dividend cuts the Chairman admits that the current outlook is “no real change in consumer confidence”.

So for institutional shareholders who bought shares at the IPO it has been a fairly torrid time made worse by knowing that the previous shareholders managed a phenomenal return on their investment.**

I was reminded of the Debenhams saga during the month as another private equity backed clothing retailer New Look revealed that it wouldn’t be seeking an IPO in the near future. Looking through the results they announced for the year to March 2011 that was hardly surprising as like-for-like sales were down by 5.5%. This downturn in revenues contributed to a fall in Operating Profit from £162m last year to £98m; quite a problem when the company has net debt of over £1 billion on its balance sheet. No doubt though that the current owners of New Look, the private equity firms Apax and Permira, will do what they need to do to prepare the company for IPO at some point in the future, and pass the problems on to some nice-but-dim fund manager.

Successes and failures
Of course, over the years, there have been some cases of private equity successfully improving performance in acquired businesses, including Halfords, the Automobile Association, Homebase and RHM. There have of course been notable failures, the most spectacular being the imminent failure this month of the care homes business, Southern Cross, previously owned by another private equity group, Blackstone. Southern Cross provides a further example of property sales followed by increased debt and massive dividends for private equity groups, ending up with an IPO, although in this case of course its failure has more serious consequences for its customers than a high street retailer disappearing into receivership.

Most recently this month, Aviva announced that it was selling its RAC roadside rescue business to the private equity group Carlyle for £1 billion. The managing director of Carlyle, Andrew Burgess, said he saw a “strong longer-term potential to grow the business by investing in new and innovative financial services offerings, such as motor and household insurance”. No mention of course of selling properties, increased debt or huge dividends for Carlyle. However, bank debt is becoming more available for these types of deals and is likely to be used in the RAC deal; infact JP Morgan which ran the sale process for Aviva is also making finance available for the successful bidder which will put debt on to RAC’s balance sheet of up to seven times the company’s operating profit.

What is certain is that at some point RAC will come back to the public markets along with other PE-backed companies such as Merlin, the owner of tourist attractions including Madame Tussauds, Phones4U, and numerous other companies being lined up for IPO. Ernst & Young, a leading accountancy firm estimates that there are fifty private equity backed companies intending to IPO in the near future and looking to raise around £10 billion in aggregate.

The question for investors both institutional and private is if by the time they get on board the party will still be going on or whether it will be about to fizzle out leaving the new shareholders to do the clearing up.



** For anyone wanting to understand the fascinating case study of Debenhams from its purchase by private equity in 2003 through to its profit warnings and dividend cuts as a public company, contact me on the email address below for an excellent academic research report.

Keeping it in the family

Why investors always need to watch out for related party transactions


This first appeared in Aimzine, an online publication for the AIM community www.aimzine.co.uk 


This month I had the pleasure of speaking at an event run by Cityzone which is a network for entrepreneurs, SMEs, investors and advisers. The event was part of their IPO Club which seeks to assist companies in considering their options and preparing for IPO. Introduced by the silky-tongued, boy-band sound-a-like, founder of Cityzone, Ronan Bryan, I gave a presentation which I’ve often given before at PLUS Markets seminars and also to entrepreneurs looking to raise Angel and VC funding; it’s a fairly versatile presentation because the issues it raises are common for companies seeking funding from whatever type of investor.


It seemed a good time to raise these issues because with the credit crunch firmly behind us companies are again looking at their options for growth funding and need to be aware of common gripes that potential investors raise. It is also a good time because one of the key issues the presentation raises is the matter of related-party transactions (RPTs) which have been in the news again (more on that later).


RPTs and shareholders


In private owner-managed companies it is not unusual for there to be RPTs. Of course, if there are no other shareholders it really doesn’t matter to anyone if the owner is running the business out of a property that he himself owns and is paying rent out of the company to himself. If there are other shareholders, then quite rightly they would expect to be told of such an arrangement to ensure that it is a normal commercial transaction at normal commercial rates and also to ensure that the owner cannot hold the company hostage at any time.


IFRS defines a related party as one which is related to the company preparing financial statements by way of joint control, management, ownership or significant influence.


When giving examples in my presentation I always presage the RPT section by saying that obviously these are old examples and of course no one would dream of having any such transactions in their company these days. It’s interesting at that point to see the looks on the faces of entrepreneurs. My co-presenters from the accounting firm BDO and the lawyers, Fasken Martineau, gave me wry smiles reiterating that infact such transactions are still commonplace in companies coming to IPO and even in many companies post-IPO. The point, of course, is that shareholders will put up with RPTs whilst things are good and the founder or CEO or director is critical to the business but soon become unforgiving about them when the business falters.


Clarity example


Such was the case a few years ago when Clarity Commerce Solutions, an AIM-quoted software company, was headed up by its founder Graham York. Amongst the various dubious activities going on in the company at the time was an expense of over £270,000 which had been incurred for the hire of an executive jet. Now we all know the hubris of CEOs having corporate jets, but this seems all the more bizarre for the fact that Clarity at that time only had revenues of around £20m. In this incident though, the facts were even more bizarre because the company which was providing the jet had as a director and principal shareholder none other than Graham York.


This was clearly an extreme and rather gratuitous example but this month a more subtle example of related party transactions was in the news again.
   
Recent example


A company called Eco City Vehicles plc (“ECV”) gave an update at the beginning of November about some litigation involving Cabvision, an associate company in which ECV holds a 29% stake. ECV is not a party to the Cabvision litigation but it came to the attention of the non executive directors that KPM, a wholly-owned subsidiary of ECV had been making payments, totalling over £500,000, as loans to Cabvision in order to, amongst other things, fund Cabvision’s litigation. Whilst these payments were recorded correctly in ECV’s books they were not disclosed separately in the management accounts circulated to the board, and clearly hadn’t been approved by the board or any assessment undertaken as to whether they are reasonable.


The commercial logic of those loans would be questionable under normal circumstances but in this case, the picture was muddied by the fact that Cabvision is majority owned by relations of three directors of ECV. Fortunately, any loss to ECV’s shareholders would be covered by indemnities given by the directors of ECV when they undertook the reverse takeover that gave rise to ECV. However, that should not reduce the significance of these events and infact the lesson is that the facts behind related party transactions should never be overlooked. 


Following a period when corporate governance has generally been improving, we should not lose sight of the fact that companies both on AIM and coming to AIM may have related party transactions. Many of these will be in the normal course of business and of no concern but you should always turn to note 93 (or wherever they’re tucked away) in annual reports to see if there are any related party transactions, and if the description doesn’t tell you all you need to know then it’s worth calling the company to find out more. The chances are that there may well be more to the transaction than meets the eye.

Quote of the year - strong contender

Can a fund manager really be this ridiculous?

Well, the year is nearly over and there have been some good quotes bandied around this year but a latecomer has appeared courtesy of an anonymous fund manager.

Now, we know that fund managers are always being ridiculed by the press. Commentators accuse them of having a herd mentality by following each other into certain shares for fear of being left out of the “next big thing”. Others accuse them of actually destroying the value of investors by their poor selection of shares and making things worse by creaming off a few percent of the funds every year for themselves, whether the fund has a good year or bad year.

Perhaps, we should lay off the attacks because on the basis of this contender for quote of the year, some of them appear to be able to ridicule themselves without our support.

During the last 12 months there have been very few companies coming to IPO and the main reason for this has been that fund managers have been nervous about valuations of companies coming to market and haven’t wanted to invest their surplus cash. So, no fund manager support, no IPO for the company. “Simples” as a meerkat would say. Well, not if you’re this particular fund manager, who said;

“There are serious questions to be asked, [such as] why a company which was so reliant on just two people was allowed to list in the first place.”

The answer to this “serious question” is because fund managers (like the contributor of this quote who is a large shareholder) supported it, despite the fact that the risk factors section in the IPO document specifically mentioned the reliance on two employees.

The irony of all this, as the price has fallen from 220p at IPO last December to 115p today, is that the company he is referring to is Gartmore, a well known errr…. fund manager. Ouch!

Presenting at Cass Business School...

...and why an IPO is a bit like getting married.

Off to Cass Business School yesterday to present at the Cityzone IPO Club sponsored by law firm Fasken Martineau and accountancy firm BDO.

The presentation I gave was one I use frequently as it talks about what companies need to do from a finance perspective to prepare not just for IPO but for any fundraising, and what they need to do to make a success of their IPO.

This includes not having related party transactions. Crudely put this means not siphoning money out of the company. Many entrepreneurs run their businesses from property they own in their own right rather than it being owned by the business. That’s all very well if you don’t have external investors but if you do they will want to see that it’s at a market rent and not a ruse by which the entrepreneur can take shareholders cash out of the business. The property example is a common and simple one but there are many other more exotic arrangements (like company jets) which I’ll describe another time. Other areas companies usually have to clean up their act is in ownership of key assets. Again, many entrepreneurs will try to keep the key assets, eg patents, trademarks etc. out of the company so as not to jeopardise them but also because they feel the assets are personal to them. And finally, these days we have to have a few slides on corporate governance, and the importance of good control, reporting, non executive directors etc..
I went to a rather average university and never got round to going to business school. I would have liked to but could never fit it amongst work and life, in so I’m always a little overawed by any good academic institution like Cass Business school. A friend of mine recently became a professor and whilst I’m not one for titles, if I had a title other than Mr then it would have to be Prof. It sounds so like you didn’t really want it; that it was foist upon you for your greatness, unlike say Sir or Lord which most people who receive it were probably very desperate for it. Alas, to get the Prof title you need to need to follow the academic route, which frankly was never my cup of tea, or should I say as in academia, my glass of port.
The Cityzone IPO Club is run by the silky-tongued, boy-band sound-a-like, founder of Cityzone, Ronan Bryan, who manages the room deftly and with quiet confidence and the usual Celtic charm. He makes a group of professional advisers and entrepreneurs feel like it’s just a get together of friends, and the interaction amongst the group is quite stimulating.

I go on to talk about how to get the most out of going through the costly, and time-consuming process of an IPO. Many companies see it as an end point, in the same way as some men see marriage as an end point, but looking optimistically it’s actually the start of something potentially beautiful, and like marriage it doesn’t just create happiness by itself. Being a quoted company, like being in a successful marriage, requires hard work, and getting through the tough times. A lesson that many entreprenuers often forget.

AIM – Not enough liquidity, but plenty at Grocers Hall

Off to Grocers Hall in the City for the Growth Company Awards where we sip champagne in a beautiful red velvet room adorned by paintings of well known grocers of shopping days past, including er…. Lord Carrington. I’m not sure what his connection is; perhaps like me he worked at Sainsbury’s while he was a student (though somehow I doubt it).

The Awards are sponsored by Sharemark, promoting its leading alternative share-trading platform which allows small businesses to raise liquidity (even for businesses already quoted on another exchange). These events can become a bit indistinguishable from each other especially after plenty of liquidity of the bubbly kind and so it was good to see that Gavin Oldham, the founder and CEO of Share plc, Sharemark’s parent company, was the headline speaker to kick the evening off.

Mr Oldham always has something memorable to say, based on his many years in the City and having set up not only Share plc but also Barclays Stockbrokers. He is a fierce advocate of private shareholder rights and not afraid to point his finger at the City when he feels it appropriate, and that was what he did this evening. He had taken part in a breakfast seminar with a dozen CEOs of AIM companies and all were questioning the benefit of staying on the market; not surprising when you consider that 257 companies delisted from AIM last year.

The thrust of his talk was that too often companies are taken down the IPO route onto AIM or PLUS but that thereafter they get little support from advisers in making the most of their listing, and become “stranded”. The problem is often that too few companies focus on liquidity or get support from advisers on managing liquidity. This in turn is usually due to the IPO process almost invariably being satisfied by a placing to institutional shareholders and having too few retail shareholders on board. He suggested that City brokers should get retail brokers involved so the company has more private shareholders on its share register. These are the people who provide liquidity through frequent trading whereas institutional shareholders tend to hold their shares and not trade frequently and sometimes the shares stagnate due to minimal trading.
You can’t fault Mr Oldham’s logic but equally looking at this commercially from a City brokers point of view, it’s much easier to just talk to a few institutions and get the placing done rather than deal with tens or hundreds of private shareholders. Of course, Mr Oldham would point out that Share plc can handle this nightmare for City brokers, but this is too rational an argument; the City, despite its dynamic image, is actually quite slow at changing its ways whatever those ways are. Hence, Mr Oldham’s rallying call that this area requires a change of attitude from corporate advisers.

An excellent evening overall, and a good point made by Mr Oldham, but I was left wondering why something called the Growth Company Awards only has two of its nine awards for growth companies and the remainder for City advisers. Surely shome misthtake as they say after too much fizzy liquidity.