Dear Mr Boyd,
I take it from the tone of today’s Chanticleer article that we have upset you. We don’t have an agenda to push here and are not blaming anyone for Dick Smith’s collapse. We simply found it extraordinary that Anchorage took $20m of their own money and turned it into $520m (that fact doesn’t seem to be in dispute). You could say we were amazed, and simply wanted to explain how they had done it.
At the time, October last year, the share price had fallen significantly and we were looking at it as a potential buying opportunity. We didn’t buy it – a few too many hairs for us – but we also didn’t know that it was going bust.
Yet the story has taken on a life of its own and here we are today writing more and more about a stock that we have never had an interest in. So this is it for me, I’m done with Dick Smith.
I do want to clear up this depreciation issue before I move on though. The, “litany of factual errors” you cite seems fairly small in the scheme of a $520m float, but the depreciation issue is a meaningful one. You wrote:
Forager said that $55 million in plant and equipment write-downs in 2012 reduced the annual depreciation charge by $15 million.
“Throw in a few onerous lease provisions and the like, totalling roughly $10 million, and you can fairly easily turn a $7 million 2013 profit into a $40 million forecast 2014 profit,” Forager said.
But page 55 of the prospectus shows the 2012 deprecation [sic] and amortisation was $12.5 million. The 2014 depreciation was higher than 2013 at $12.8 million reflecting the 45 per cent increase in fixed assets in the year due to investment in new stores and the takeover of David Jones Electronics department.
Forager’s $15 million depreciation number is plainly wrong. It suggests an average life of assets of less than four years whereas page 61 of the annual accounts says the useful life is five to 10 years for leasehold improvements and plant and equipment.
Those numbers on page 55 of the prospectus are pro-forma. They have already been adjusted to reflect the new written down values of PP&E and don’t tell us anything about what the depreciation charge would have been in the absence of the write downs.
Our point is that, had the values not been written down, the depreciation charge would have been significantly higher. How much higher is, we agree, open to interpretation. All we did was assume that, because they had halved the value of the net PP&E, they halved the depreciation charge.
You go on to say we have used an ‘average live of assets of less than four years’, which proves our number is far too high. As I’m sure you are aware, average lives refer to the original cost of the PP&E, not the current written down value. If you buy a table for $1,000 and depreciate it over 10 years, you will report $100 of depreciation expense every year. After five years, half of the table’s useful life, you will have a written down value of $500 on the balance sheet and still be reporting $100 per annum of depreciation. The older the table gets, the more depreciation you report as a percentage of the current value.
So if you assume that, on average, Dick Smith’s PP&E was half way through its 5-10 year useful life, there is nothing strange about assuming depreciation of 25% of net PP&E. Indeed, that’s fairly close to what the company has reported historically.
To be clear, we have made some assumptions and could easily be out by a few million here or there. And we’re not for a second arguing that the writedowns were illegal or completely baseless. As your colleague Trevor Sykes has written on inventory, charges like this are notoriously rubbery and open to discretion. What we are saying is that the reported profit was substantially higher than it would have been had the adjustments not been made. If you compare capital expenditure since listing to depreciation, that certainly bears this out:
|Year ended 30 June||2013 (10 months)||2014||2015|
In any case, you are spot on about the performance of that International Fund of ours. It has done its job – 14.4% per annum since inception – but we won’t have the tailwind of a falling AUD forever, it needs to be much better, especially now that turbulent markets are giving us many more opportunities.
Don’t worry too much about those “anonymous supporters” of ours, though, most of them are invested in our Australian Fund too. You must have missed it when poking around our website, but the Australian Fund has been around much longer and the performance is excellent.
As far as I can tell they are a happy bunch. And I don’t think it has historically been the AFR logo on our website that has been the deciding factor in their decision making. It is there because of my monthly column for AFR Smart Investor and no, we don’t pay for it. But I am happy to remove it if you wish?
Again, apologies for any offence caused. We are just a small company trying to do our best for clients. Running around upsetting people is a relatively new pastime for us and one we don’t intend on maintaining.
Kind regards and have a nice weekend,
Want to know more about the style of investing we practice at Forager? Check out our page what is value investing
22 thoughts on “Closing the Book on Dick Smith”
Steve, well written. Tony Boyd’s agenda was always misguided.
A sensible way to bring what was fast becoming a very heated public discussion to a conclusion.
Hey Steve – they say that any publicity is good publicity. I was initially surprised to see you getting so much press but I thought what the heck, its probably a good thing to raise Forager’s profile a bit.
It looks like Tony’s just got an axe to grind now. Case closed…
PS. I’m a happily invested in both funds “anonymous” supporter 🙂
Shutting it down just when it was getting entertaining? I’m sure you had absolutely no idea what was going to unfold when you wrote the original article but you guys have done a top job on this one and clearly you’ve kicked the hornets nest. Now hopefully the Senate can work out whether it was Forager, Apple, the banks, Macquarie, Woolies, Oliver Cromwell, Rumpelstiltskin, the bogeyman or the man in the moon who was to blame for Dick Smith’s demise. The AFR has made it very clear it certainly wasn’t Anchorage Capital! 🙂
Great response Steve, very professional and to the point. I wish reporters were able to show such grace.
Well said Steve.
One of the biggest issues with this whole Dick Smith heist (perhaps it is a legal heist which in itself says something) is the conflicts of interest among the various parties involved, most of whom are professional firms (or who’s members are members of professional organisations), who made a lot of money out of this IPO being successful.
Macquarie $9m (both as Joint Lead Manager, and also as investor in Anchorage), Goldman Sachs $9m (Joint Lead Manager), Minter Ellison$1.45m (Legal Adviser), Deloittes (Investigating Accountant$784k and Auditor$324k+ $579k), Ernst & Young$470k (Tax Adviser), Aquasia P/L $1.4m(Adviser to the Board), and this doesn’t include the directors and senior management.
It’s worth noting that even the directors Wavish, Raines and Ishak each received consulting fees of $110k each for consulting fees on the IPO.
It wasn’t just Anchorage who made a lot of money out of this. Most of the others are the purported gatekeepers for the investing public. This is where the real ‘failure’ occurred. It’s all well and good for analysts etc., but really the investing public are the bunnies in this whole episode and where the gatekeepers fail (which is what I would contend has happened here) then the law needs to change to prevent this sort of outrageous corporate gamesmanship from occurring.
I’ve given up on ASIC – I think that organisation needs major shakeup.
Keep up the good work Steve!
I’ve been with your Aus fund since the start and love sending your blog posts around to friends and family – particularly the Dick Smith ones. Boyd’s carrying on like a shock jock/Abbott frontbencher, so I’m glad you’ve closed the book on it and can get back to dominating the Australian Equity scene.
And by ‘your’ I mean Forager of course, as the whole team writes great updates!
Good wrap-up Steve; time to move on.
Once journalists start “Shooting the Messenger” (think about that) the story has run it’s course.
finis coronat opus
Steve – one comment only needed – Gold
Things haven’t changed much, it’s just that more sophisticated ways and means are used to avoid the ethical implications of the law.
A comment from 1895 from the UK Davey Committee looking at the adequacy of corporate regulation.
“It is therefore of the highest importance that the prospectus upon which the public are invited to subscribe shall not only not contain any misrepresentation but shall satisfy a high standard of good faith. It may be a counsel of perfection and impossible of attainment to say that a prospectus shall disclose everything which could reasonably influence the mind of an investor of average prudence. But this in the opinion of your committee is the ideal to be aimed at, and……….the end to which new legislation on the formation of companies should be directed.”
It’s a sorry indictment of ASIC and quite frankly many of the fund managers and analysts that it required Forager Funds to expose this heist.
That’s why you should get full marks Steve (and Matt) for exposing this when it really is the job of others, and as Boyd from the AFR shows even the obvious isn’t readily accepted by some. Just makes me ask where is he coming from?
Anchorage Capital did not make over $500m from the float of DSH, they made a bit over $450m
Page 4 of the prospectus states there are 236.5m shares all up with 156.6m being sold to investors in the float at $2.20, 47.3m being retained by Anchorage and the remainder (32.6m) to be issued under the employee award offer.
Page 15 shows that Anchorage was paid $358.1m. This was sourced from the proceeds of selling the shares to investors plus a bit extra from the DSH balance sheet.
Anchorage sold their 47.3m shares in September 2014 for $105m (See ASX announcement on 19 September 2014).
This gave them a total return of $463m for their $10m investment.
Investors have paid over $450m to Anchorage for shares that are now worthless.
What are you getting at Lainie?
$500m, $463m, $450m.
Normally pretty significant differences but insofar as the size of the heist goes when the shares are now close to worthless, and that Anchorage only invested $10m, it seems a bit of a moot point to focus on the differences of what they made.
It was a heck of a lot and hopefully someone (hint hint ASIC) shall investigate this more closely than the likes of Tony Boyd from AFR. One question I would love someone to ask the Investigating Accountants to the IPO (Steven Shirtliff of Deloittes) would be what was the budgeted closing stock for the first year of operation? Was it anything like the low stock figure that resulted? If so, did they look at the most basic KPI in retail which is stockturn?
In other words did they think it worth reporting that the same sales could be achieved with half the stock (which would be almost double the stockturn) without the need to look a bit closer. Stock at acquisition date of Nov 2012 was $370m, then 7 months later at 30th June 2013 it was $168m. Matt from Forager clearly showed that this certainly enabled profitability to be maintained (with lower cost of stock as much was written down) but the question I have is did the Investigating Accountant ask questions on this as he must have seen the budget workings.
They achieved it but at what a cost to the business and where did those proceeds go? Well we now know the answer to that one (they paid off the balance of the purchase price total of $115m by Anchorage) but did the Investigating Accountant think this was worth mentioning in his Investigating Accountants Report?
I can’t imagine any retailer would budget on a doubling of their stockturn without a significant effect on the working capital base of the business. But no mention of this in the Prospectus or Investigating Accountants Report. Mmm.
Deloitte would have been responsible for only reviewing what appeared in the prospectus and whether the assumptions contained therein were reasonable – not necessarily whether or not such assumptions and forecasts were sustainable in the longer term (as such a view would be subjective in nature and dependent on management execution after the forecast period in the prospectus).
Arguably there is information Anchorage would have had access to which would have been useful to have in the prospectus but didn’t need to be disclose based on the requirements of ASIC Regulatory Guidance 228 (i.e. information a trade buyer of Dick Smith Holdings would have wanted to assess but did not appear in the prospectus). Hopefully the Senate inquiry identifies this issue and asks ASIC to update RG 228 accordingly.
I have yet to see any retailer, let alone a public company retailer, show a gross profit for the coming year (as was shown in the Prospectus) without knowing what the closing stock was going to be.
It is a key part of the accounting calculation of gross profit.
In other words the anticipated closing stock at 30th June must have been known by the Investigating Accountant when the Prospectus was issued. If he didn’t I would certainly think ASIC should be jumping in there boots first.
If it was shown to be at less than half the opening stock level one does not need to be Einstein to ask a few questions (with the most obvious one being how was this to be achieved? and the obvious point to this being why this answer was not disclosed in the Prospectus). After all that is the primary reason for the Investigating Accountants Report – to provide to potential investors some sort of purportedly expert and objective opinion on the veracity of the Prospectus’s financial claims. At the most basic level they could have checked the stockturn which must have been budgeted to jump dramatically.
I think Ben your attitude seems to be actively defensive of Deloittes and your constant referring to possible deficiencies in the ASIC RG 228 as if that is where the problem lay is misguided (I suggest).
I hardly think the approach should be that the Investigating Accountants Report should be a tick box mentality to the minimum standards detailed in RG228. It is a regulatory GUIDE that’s all.
As you said in your opening sentence they were to determine whether the assumptions contained in the Prospectus were reasonable.
It’s worth noting that in the Prospectus the Investigating Accountant was to be paid $470,000 which in itself is no small amount. Have a guess what they were eventually paid? $784,000. Thats an extra $314,000. You can check it by looking at Note 23 in the 2014 DSH A/Report page 81. Also note that there work specifically included ‘review of forecast for IPO’.
So here you have Deloittes as both the Auditor of DSH and the Investigating Accountant for the IPO receiving a significant $1,348,000 in the year ended 30th June 2014 (look at above note if you want to check). And this doesn’t include the $325,000 they received as auditors of the holding company of Dick Smith prior to the IPO being Dick Smith Sub-holdings Pty Ltd (refer note 22 page 39 of this company’s financial report for the 10 months to 30th June 2013. In total Deloittes generated fees of some $1.673 million in this critical two year period as the auditors and Investigating Accountant. Now they may come out smelling of roses but I think it is worth someone raising these questions given that in these roles they are the supposedly objective and independent third party who the general public, and in particular the investors, suppliers and staff of Dick Smith, can rely upon to just make sure everything is above board and shenanigans are not occurring. Thats their job, and they were rewarded handsomely to do that.
Mind you I haven’t mentioned that they also received another $460,418 as auditors for the 2015 financial year (note 21 of 2015 a/r of DSH). I am not accusing Deloittes of any wrongdoing but I sure would like someone to make sure they didn’t miss something given that this business was purchased by Anchorage for $115 million in Nov 2012, was floated for $520 million a year later in December 2013 and two years later it is worthless with almost 3000 staff laid off and who knows how much money banks and suppliers are owed. And of course Anchorage walk away with a ‘fistful of dollars’ and all the professional gatekeepers such as Deloittes (auditor $1.67million), Ernst and Young (tax advisers $470k), Minter Ellison (legal adviser $1.45 million), Aquasia P/L (adviser to Board $1.4 million), Goldman Sachs and Macquarie (Lead Mgrs of the IPO $18.2 million) etc all made a killing as well. Meanwhile the shareholders, staff and suppliers of DSH are left to count the cost.
Come on ASIC. Do your job.
It’s also worth noting the actual auditors and directors at Deloittes who were responsible for the various audits and the investigating accountants report into Dick Smith. It’s just two people.
Steven Shirtliff was the Investigating Accountant.
And David White was the auditor of both Dick Smith Sub-Holdings Pty Ltd (for period ended 30th June 2013), and then again for Dick Smith Holdings Limited for the years ended 30th June 2014, and 2015.
One would have thought a change of auditor between these two companies would have been prudent. Just as one would have thought having a different accounting firm do the Investigating Accountants Report would have been prudent.
Perhaps the two principal partners of Aquasia Pty Ltd (Angus James and Colin McKeith) which was paid a handsome $1.3m plus for being the independent advisor to the Board on this matter could shed some light on this. Did the matter of how the balance of the $115m purchase price for Dick Smith come up in discussions, and what was their advice? Its impact on Dick Smith Holdings Limited for the future? It’s worth noting that they were the INDEPENDENT Advisor to the Board (re-emphasised by them on their website) which again provides to the investing public an assumed level of objectivity and gatekeeping protection for them. You ally that with the Boards key role being to look after the actual company (a separate person in the law) itself then you have strong reasons why the investing public (and suppliers and staff) should be able to trust that all this advice is kosher and in the best interests of the company. As opposed, for example, to maximising the return for certain shareholders in the short term, or ‘dressing up’ the profit by lowering the working capital base of the company, or (heaven forbid) allowing their fee of .25% of the enterprise value (a nice little $1.3m plus) override the need for complete transparency in the Prospectus.
A great question Brett.
When firms over riding goal is to increase fee revenue to boost them up the accounting/audit ladder it is is an indictment on their professionalism.
In my opinion these things will continue to occur when audit firms select partners based on their ability to attract fees rather than the quality of their work and professional rigor.
Looks like the books are closed on Dick Smith in the literal sense Steve.
Lets hope ASIC open them up a bit to see what is revealed.
Looks like someone with access to the Ferrier Hodgson data room has passed on a summary of Dick Smith’s monthly financial P&Ls and balance sheets for 1H16 to the media.
A quick glance is revealing Ben.
The figures look kosher if comparison with the Annual Reports of 2014 and 2015 is any indicator.
Unfortunately no long term liabilities shown (and hence the net asset position). But worth noting that the interest expense had almost doubled in 18 months from June 2014 to Dec 2015. Full year for full 12 months to 30/6/14 it was $2.334 million whereas for just the 6 months to 31/12/15 it had climbed to $2.075m. So that would indicate a considerable expansion of debt which is perhaps not surprising if the working capital was reduced (primarily lower stock) to pay for the purchase by Anchorage while keeping profits high. They had to ‘refurbish’ the working capital somehow eh.
The revenue line looks okay in terms of maintaining sales but it would seem achieved at considerable cost to the Dick Smith infrastructure (the balance sheet) which is perhaps where more attention needs to be focussed on just what sort of condition the balance sheet items were of Dick Smith at the time of the IPO and in the year thereafter. I guess thats where ‘dressing something up for the kill’ perhaps points the finger at Anchorage.
Back to work for me so leave that to the Administrators to unravel while ASIC twiddles away in the bunkers.
I know you have closed the book on Dick Smith commentary from Forager Steve but surely you must be tempted to ask Matt (as no longer with Forager) to provide a neat little summary of the court proceedings and revelations to date.
The enormous chasm between the perception (or perhaps even myth is not too strong a word) about the governance and management of companies, and the reality is being openly displayed as we read about the court proceedings re Dick Smith.
Without being too much of a moralist/utopian I would like to think somewhere that the word ‘shame’ needs to come back into vogue when we look at directors and managers of companies. I would like to think value investing and company performance has a moral dimension beyond just the dollar.
In other words some people ‘in the know'(mainly the professional advisers – some of them are listed above- and the private equity firm Anchorage) made a lot of money out of Dick Smith while a hack of a lot of ordinary people ‘not in the know’ lost out big time. Is shame too strong a word to use?