Want to know how to turn $10m in to $520m in less than two years? Just ask Anchorage Capital. The private equity group has pulled off one of the great heists of all time, using all the tricks in the book, to turn Dick Smith from a $10m piece of mutton into a $520m lamb.
Having spent the morning poking through the accounts, we’re going to show you how it all happened.
Firstly, Anchorage set up a holding company called Dick Smith Sub-holdings that they used to acquire the Dick Smith business from Woolworths. They say they paid $115m, but the notes to the 2014 accounts show that only $20m in cash was initially paid by the holding company.
It doesn’t look like they even paid that much, because they acquired the Dick Smith business with $12.6m in cash already in it. Dick Smith Sub-holdings was formed with only $10m of issued capital and no debt, and that is most likely Anchorage’s actual cash commitment.
So if Woolworths got paid $115m and Anchorage only forked out $10m, where did the rest of the cash come from?
The answer is the Dick Smith balance sheet, and this is always the first chapter in the private equity playbook: pull out the maximum amount of cash as quickly as you can.
In this case, first they had to mark-down the assets of the business as much as possible as part of the acquisition. This was easy enough to do with a low purchase price. You can see in the table below, that $58m was written-off from inventory, $55m from plant and equipment, and $8m in provisions were taken.
The inventory writedown is the most important step in the short term. They are about to sell a huge chunk of inventory but they don’t want to do it at a loss, because these losses would show up in the financial statements and make it hard to float the business. The adjustments never touch the new Dick Smith’s profit and loss statement and, at the stroke of the pen, they have created (or avoided) $120m in future pre-tax profit (or avoided losses).
Now they can liquidate inventory without racking up losses. And boy did they liquidate.
At 26 November 2012, Dick Smith had inventory that cost $371m but which had been written down to $312m. Yet by 30 June 2013, inventory has dropped to just $171m.
That points to a very big clearance sale, and the prospectus confirms that sales in financial year 2013 were exaggerated by this. The reduction in inventory has produced a monstrous $140m benefit to operating cash flow, basically from selling lots of inventory and then not restocking.
The cash flow statement shows that Anchorage then used the $117m operating cash flow of the business to fund the outstanding payments to Woolworths, rather than funding it from their own pockets (note that the pro-forma profit was only $7m during this period).
And that, my friends, is a perfectly executed chapter 1: How to buy a business for $115m using only $10m of your own money.
Chapter 2 involves selling a $115m business for $520m, and it’s a little more nuanced. The good news is that, while private equity are focused on cashflow, equity market investors aren’t really focusing on how much cash has been ripped out of the business. All they seem to care about is profit.
So the focus now turns from the balance sheet to the profit and loss statement, and it’s time to make this business look as profitable as possible in the year following the float (allowing them to sell it on a seemingly attractive “forecast price earnings ratio”).
The big clearance sale in financial year 2013 leaves them with almost no old stock to start the 2014 year. That’s a huge (unsustainable) benefit in a business like consumer electronics which has rapid product obsolescence.
Remember that marked down inventory? Most of it was probably sold by 30 June 13 but there would still be some benefit flowing through to the 2014 financial year.
Remember the plant and equipment writedowns? That reduces the annual depreciation charge by $15m. Throw in a few onerous lease provisions and the like, totaling roughly $10m, and you can fairly easily turn a $7m 2013 profit into a $40m forecast 2014 profit. That allows Anchorage to confidently forecast a huge profit number and, on the back of this rosy forecast, the business is floated for a $520m market capitalisation, some 52 times the $10m they put in.
Anchorage were able to sell the last of their shares in September 2014 at prices slightly higher than the $2.20 float price and walk away with a quiet half a billion. Private equity are renowned for pulling off deals, but if there’s a better one than this I haven’t heard about it.
Chickens home to roost
Of course, all of the steps taken above have consequences. By the end of 2014, inventory had increased to $254m, with new shareholders footing the bill for repurchasing inventory. This should have resulted in poor operating cash flow, but most of this was funded by suppliers at year-end, with payables increasing by $95m.
Come the end of 2015 financial year, however, it really comes home to roost. Operating cash flow was negative $4m, as inventory increases further and suppliers demand payment, decreasing accounts payable. The business is required to take on $71m in debt to fund a more sustainable amount of working capital. As the benefit of prior accounting provisions taper-off, profit margins fall, and the company reports a toxic combination of falling same-store sales and shrinking gross margins in the recent trading update.
Following a profit downgrade yesterday, the shares are now valued by the market at $0.77, and investors in the float are sitting on a 65% loss of capital from the $2.20 float price.
This float, as we pointed out in Dick Smith Takes A Bath, Comes Out Nice and Clean, smelled funny from the very beginning. Sorry Dick Smith investors, you’ve been had.
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154 thoughts on “Dick Smith is the Greatest Private Equity Heist of All Time”
Awesome analysis….but hey it was legal right? Buyer beware I guess!
Great breakdown of the financials particularly the fact that the fair value of net assets (post acquisition adjustments) was c.$261m and a majority of the $115m acquisition is comprised of contingent/deferred consideration.
What is interesting is that the FY15 financials were lodged on 18 August 2015 with director providing a 12 month solvency declaration from lodgement date.
Furthermore, the auditors providing a clean audit opinion for FY15. No emphasis of matter with going concern pointing to debt repayment issues, liquidity issues, inventory issues.
It surprising that an Australian listed company can enter administration, potentially receivership, only 4 months after accounts signing with a clean audit opinion.
It will be interesting to read the administrator report.
Yeah the administrators report will be worth a read. The AFR suggested this morning that Dick Smith now owes $150m (presumably gross) compared to $70m of debt (and $30m cash) at 30-Jun-15.
As Steve said they should currently be at a seasonally low net debt position in January. Will be interesting to see just how bad trading went in the last few months.
Any ideas on why the debt of $70m was classified entirely as a current liability as at 30 June 15? The facility was effective from 22 June 15, 8 days only.
The debt note outlines the term of the facility was at least 18 months for tranche a and 3 years for tranche b.
Unless they had an irrevocably right of deferral of payment, the full amount has to be classified as current. Just the way current accounting principles require it to be.
Jo the slop,
You may wish to revisit your understanding of the accounting rules. I have never heard of a bank providing a borrower the right to deferral of payment. The banks provide waiver letters to borrowers when in a “workout situation”, but always reserve their rights under the facility agreement.
Every clause I have seen from a bank has a covenant, which if breached may have a cure period and condition, and if not cured the facility is in an event of default and accelerates to immediate repayment (classified 100% as a current liability)
Dick smiths current liability should have only reflected in current for the next 12 months the principal and interest obligations; which should be the facility drawn.
Correction to last line, “….,which should not be the value of the facility drawn unless full repayment is required within the next 12 months”.
The PE part was legal. What was not legal was the falsifying of cash flow reporting by insisting suppliers offer back to back rebates (outside of contractual obligations) to secure orders, which were then banked as profits (even though most suppliers simply inflated their prices by the required percentage). Usually 10% was demanded, however when this was a requirement of the Chinese factories responsible for making the Dick Smith “house brand” products, the factor was more like 3 or 4 times the real cost of the product. That’s why they have tonnes of that junk left over and were trying to sell $20 cases for $1 at the end…
Someone’s going to jail.
Hi. Nice sentiments, but “Adviser to Anchorage’s Investment Committee” Alan Moss has just been appointed to the Reserve Bank’s board. Good luck with your investing.
Probably WOW is next in the firing line!
Investors only had to visit some DSmith stores and look at their clearance prices, to know it was a dud offering.
Legal? Yes. But rmember the names of people responsible and avoid them if you come across them …..
Mote importantly let’s look at all fund managers and super funds that participated in the float and question their investing principals.
Who were the fund manager bunnies that fell for all this? Perpetual, AXA, Commonwealth Bank and AMP. Well done guys! Now who can name the investment managers responsible so as we can all give them a wide berth?
You ask who “fell” for it? I’d be more inclined to ask who was “In On It”
Your line of thinking is correct, however these guys must take the occasional strap-on so they can be allocated the IPO winners along the way. Fair to say these portfolio managers hardly look at the company and merely subscribe to keep the corporate chain greased, especially in the small and nepotistic Australian equity market. It’s just sadly ironic that investors in Australia have taken a hit investing in a business named after the 1986 Australian of the Year. I’m sure the Australian media will publicly lynch Anchorage Capital despite the partners not giving a toss sun baking on the back of their yachts.
Which fund managers do we know owned dick smith ?
I can help you with that Josh! Clime Asset Management.
See this link to the special report on 10 Sept 2015 by Clime Senior Analyst, David Walker, headed “Five stocks we like in the correction”.
And how does Clime come to light upon such undiscovered nuggets as Dick Smith? Allow Chief Investment Officer, John Abernethy, to reveal the secret.
“Our funds management team uses StocksInValue to derive clear, consistent and prudent valuation of stocks we invest in. This tool is the back-bone of our investment process; it uses an approach to value investing that I’ve adopted successfully for over 30 years.“
Clime is happy to share this steely ‘backbone’ with you for your our own portfolio. Mind you, at $1195 per year it doesn’t come cheap. Then again, you really can’t put a price on the kind of rigorous analysis that guides the Climes of this world to uncover such hidden gems as Dick Smith.
put them in jail.these r real white collar criminals.i feel sorry for the share holders…….looks 2 me that if u wear collar and tie u got 1 law.if u don’t wear collar and tie u got another law 2 face..
Great analysis Matt. Well done.
You’d think with full disclosure requirements this kind of analysis would have been part of the prospectus and in the Investigating Accountant’s report.
Great work. Were you short?
Should have been short.
Fascinating story about highway robbery. Very similar to Feltex in NZ – floated in 2004, bankrupt by 2006.
Same (or any of the same) people involved?
Also managed by McN+
We were talking about this yesterday. The problem is that they only have to provide you with a balance sheet at one point in time. We knew it was fishy at the time of the float but there was no way of working all of this out until you can see a time series (and, importantly, they had to give you the old balance sheet as part of the business combinations note). The $170m of inventory in the prospectus was roughly two months sales, about the same as JBH. Looks low but you wouldn’t think only half of what is usually required.
Hmm, this is the part I’m having trouble understanding. Looking at their annual report for 2013, you see the $170m, and as you say, you would not see the inventory write down. Does anyone know where they managed to find the financial report that is used above to show us their trickery?? Can’t find it for the life of me…
Note 18 (Business combinations) on page 37 of that 2013 report.
Question is whether Anchorage or another might get another shot… DSH net debt/EBITDA expected at 4.5-times come June 30. Covenant was 4.75x at the float
Great Article – love reading about this stuff and how the big guys can do over others! But do not like seeing “mum and dad” investors taken for a ride.
Hey Anonymous (…the one that posted at 9.20am) that worked for Minters and suggests it was always a piece of crap, and digitally laughed, I guess if you used an ethics filter to take on work, you’d most likely be out of a job.
good point, hopefully you guys can push the price down to PE of 2
Yeah righto – how about the value now? LOL at writing the article after the fact.
interesting to release this after the price fall
question, and i thought it was the law when analysts were writing opinion pieces, what is Forager’s disclosure in DSH? Are you long or short??
Not long or short, just bystanders on this one
And here’s the pre-float article Dick Smith Takes a Bath, Comes out Nice and Clean
Excellent insight into the strategy behind PE and how manipulation (within the rules) of accounting can extract short term distortion to create value, usually at the expense of long term investors. Keep up the great work.
Brilliant analysis Matt, and hopefully we can name some of the persons involved so we ‘can be wary in the future’.
Also the professional firms involved. Really does make you wonder about their ethics.
There is a big difference between what is legal and what is right when looking at a float like this one. Unfortunately, as one of the comments said, it is the little shareholder who pays.
Trust is a big part of the sharemarket, and it is cases like this that make one wary.
Just a reminder to very sceptical of floats or public offerings.
How Nick Abboud partnered with private equity to turn Dick Smith around Friday, 05 September 2014 2:14
Great article Steve. I think note 15(a) (reconciling NPAT to NOCF) better shows the run down of stock to generate the cash to pay Woolworths than the cash flow statement you have used in the article.
Just on your comment regarding not being able to see the business combination information in the prospectus so things looked fishy (and prove being made available in the FY14 accounts). Whilst you are correct on this it was possible to download from ASIC a copy of the FY13 financial accounts for Dick Smith Sub-Holdings P/L (the entity which acquired DSE from Woolworths) at the time the prospectus was released and get the information they finally ended up presenting in the FY14 accounts.
Makes a mockery of the IPO process if useful information in the FY13 accounts is not provided in the prospectus.
I just looked up the Prospectus and here are some of the key the advisers listed.
Joint Lead Managers – Goldman Sachs and Macquarie Capital (2.75% of total offer plus .75% incentive fee)
Legal Adviser – Minter Ellison ($1.3m)
Investigating Accountant – Deloitte Corporate Finance Pty Ltd ($430K)
Tax Adviser – Ernst and Young ($470K)
And the Board of Directors
Phillip Cave (Chairman), Nicholas Abboud (CEO), William Wavish, Lorna Raine, Robert Ishak
I wonder if they all knew about this? (Rhetorical question eh?)
If Minter Ellison were involved it had to be a shinny deal
The only floats you should consider are from Governments who are getting rid of state assets for ideological reasons, distressed sellers with too much debt or companies ridding themselves of legacy non-core assets which just don’t sit right with their business. We should give private equity sellers a wide berth.
Gee you just need to walk into a Dick Smith (full of stock and a couple guys trying to sell to no customers) versus a JB Hi Fi (full of stock and a team of “cool” kids selling to a store packed with customers).
I’m one of the stupid investors in Dick Smith after reading a glowing article in AFR. Why isn’t this fraud being exposed in mainstream media?
You committed your own money after a review in a financial tabloid?
You deserve to get fleeced.
Good analysis Steve but I went through this one Spotless, Myer and Healthscare in Under The Radar about a year ago to show how punters had been legally ripped off in each case. I can’t believe anyone doing two minutes of elementary accounting could have bought DSH, let alone visiting the stores or trying their crappy “Click and don’t Collect”. The biggest investor issue here is that ASIC don’t require these PC players to fully disclose what they paid and what they added on the way to selling it to you.
i don’t think Dick Smith dumped their inventories back then, do anyone here remembered they actually sold their items that cheap ?????
@ M Kool J – yes they did – Deals were done persistently and strongly promoted through their online marking campaign (their target audience anyway) throughout the year. Please visit their website and subscribe to their marketing e-newsletter and you will soon know what i mean.
Working as a salesperson for a year there you could tell it was a massive pump and dump/sinking ship. A close and reliable source of mine said a few large shareholders turned up at DS head office last week and were NOT happy.
Great analysis. The actual business is and for a long time has been terrible, with two major product lines (Apple and Panasonic) dominating sales which in my experience attract single digit margins.
The lessons are simple: if private equity is selling, don’t buy; and look at the core business to see if its good. I think DSE is worth a lot less than 75 cents.
Great article! Doesn’t this highlight the adage that you shouldn’t invest in something if you don’t understand it fully! Financial statements have been manipulated for as long as they have existed. You need to understand the different mechanisms before you invest. And don’t believe a thing you read in the mainstream business press. They are full of sheep.
And probably ask yourself the question in this case “why is the PE firm looking to float (now)?”. If Anchorage thought they stood to gain by holding the asset for another year to bump profit they would have. But they didn’t and that should be the first (of many) red flags.
Dick Smith was a bad performer many years ago when WOW bought it. The real issue is the gullibility and foolishness of analysts in allowing themselves to be captured by the sales pitch from management to believe that ‘things were different now’. And the gullibility of those who bought the stock following it’s relisting by the private equity fund. Point’s out to me that young gullible analysts are still being churned out.
Actually there was nothing wrong with DSE when WOW bought it. The company was successful in its target market, which it knew well, electronics. Working in the industry at the time and having close ties to both DSE and Jaycar I can tell you that DSE was doing very well in its core markets.
Where the rot began was when Woolworths decided to move out of the core markets the company was known for and move in to consumer electronics with the intention of competing against JB Hifi, BigW, K-Mart and other consumer electrical and whitegoods retailers. They never were able to integrate in to this market very well and constantly changed the range, store format and offerings to the point where no-one really understood what Dick Smith actually stood for any more.
Anchorage could have been the saviour, instead, they have used deceitful methods to destroy what was left of the company.
There is a ‘play-book’ for private equity acquisitions of retailers – look at Myers (TPG) and Debenhams in the UK (KKR and others). I fear that Rebel is underperforming for SuperCheap and sold out.
One thing I’m missing: to begin with, why did Woolworths sell a company with inventory worth $312m for $115m? Am I missing another benefit to Woolworths here, or did they not even think they could liquidate it for $115m?
Kickbacks all round at Woolworths. No company with that many pokies could ever have clean hands.
I agree with Largo, why would Woolworths sell for 115 million a business that has over 300 million in inventory?
Because it was never worth $300m. It was discounted by 97.5% in some cases. In hindsight, Woolies did well to get out at the price they did.
So shouldn’t Woolworths have also done what anchorage capital did and sell off inventory Prior to its sale?
Well Woollies was perhaps aware of what Anchorage would do and how they operated, and in fact had it in the contract to gain at least $70 mil as part of a future float. So that possibly makes them part of the [legal?] scam.
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This was a con from day one
Can’t turn a bad business into 520m in 2 years thieves
Surely this needs to be called for what it is… fraud. Maybe legal only because laws have not caught up with the new smart thieves.
Dick Smith was never comparable to JB-HIFI and that’s probably played a factor here with retail investors.
Its a pity that these private equity companies walk away with bags of cash without any legal come backs, you could say its like robbing a bank.
I love it when you hear a private equity company has walked away after looking at the books, obviously there wasn’t a quick buck to make!!
The next thing will be WOW selling Masters to some private equity company and repeating the same process again.
When wondering how financial press commentators can get it so wrong we should remind ourselves that their qualification is journalism, not finance. And Christopher Scase was originally a journalist come financial commentator………
Great work by Forager Funds Management.
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This is not fraud, it’s caveat emptor.
If people did their homework, they would have realised there’s no quick buck to be made – well, not by this company anyways.
They had been recently sold, nothing had changed with the business strategy (in an already saturated market), and they specialise in products that are obsolete as they come in the door?
It didn’t take a genius to work out these shares were massively overpriced.
Anchorage simply bought a tired old house full of white ants and asbestos, gave it a coat of paint and asked for 10 million dollars for it, and got it.
Unfortunately, mum and dads would make up a large part of the investor pool here – not that anyone deserves to lose their hard earned.
Kudos to Forager for sticking their necks out when it was all happening.
Did you guys receive any legal threats re: your “bath” article (12 Sep 2013)?
“This is not fraud, it’s caveat emptor.”
And what about people with Super in places like AMP who have taken a bath on this? Caveat emptor for them too? It stinks.
AMP is a BAD example as they have some of the worst fees in the super game. If anyone has their super with AMP, bad investment decisions is the least of their worries.
On what basis do you make such a broad statement on fees Glenn? Are you talking about AMPs current superannuation offerings all legacy product offerings which attracted high commissions to agents? These products have not been on sale for many years, but I suspect that you are referring to them.
Are you also inferring industry funds be being headline cheap are better? What do you think of MTAA and similar funds not revaluing unlisted assets in the GFC and advertising to unsuspecting investors in funds with daily unit pricing how good they are? Those poor suckers then switching to the better performing industry fund, only then to suffer the same losses again on the same investments. This is corporate governance incompetence at best, criminal most likely.
Getting back to the subject at hand, any fund manager that invested in the DS float has to explain to its investors why and how they got it so wrong. This is the real issue.
There is legal comeback against the PE promoter and the Prospectus experts; when they fail to disclose sufficient information in a Prospectus that an investor might reasonably require to make an informed investment decision, whether ASIC require it to be disclosed or not.
In this case this would focus on the two main points discussed above – the heavy sell off of inventory to pay for the acquisition, and the related inflating of profits as the basis for the float price.
a/ The sell down of inventory to strip out cash such that the new entity has insufficient inventory for the business it is conducting, requiring future inventory rebuild above and beyond the normal sales cycle, is one area to examine disclosures;
and b/ the inflating of profits by the inclusion of one-off, non-recurring items (like inventory sell down profits) following a purpose-made write down of carrying values such that it makes the sell down profitable, is another.
Also, the non-disclosure of the DS Sub Holdings P/L FY13 accounts in the Prospectus, whether they were released elsewhere or not at the time, seems like fertile legal ground.
The failure of the independent investigating Accountant Deloitte to adequately deal with any of these questions is of concern and could warrant further examination.
In addition, ASIC clearly have questions to answer on the Prospectus yet again.
I am in agreement with Tony above. They paid $20m upfront and listed it for $520m 9 months later, do you need to know anything more?
In any case, the (probably Bermudan) Anchorage entity that listed it won’t have any assets worth suing for – that I can assure you.
Agree anything that looks to good to be true is to good to be true no matter what it is .
DaveR, you have mentioned the important areas of this float which should be thoroughly examined, and I am in total agreement with your views. In my opinion, this is fraud by deception and omission of important information.
And how is it, with all the lessons learned from previous fraud and neligence cases brought against Australian investment companies and auditors, that in 2014, a float such as this is given a “clean bill of health” by so-called reputable and diligent organistions? Surely this case is ripe for litigation against multiple parties and points to further tightening of legal disclosure requirements! I foresee a movie; JAWS 5: Moby Dick-Smith…. the investor-eating shark that has a “whale” of a time!
I feel sorry for all the staff and good customers of Dick Smith. I will offer an opinion not as a financial expert but as a former staff member for 18 years with then sometimes rival Retravision.
The industry has changed with online shopping and the relative “temporary quality” nature of electronic goods. With Dick Smith, one may recall Tandy Electronics Australia too, which was merged into Dick Smith Electronics, during the last decade. The simple fact (and I acknowledge the excellent article above) is the entire electrical appliance market has been shredding since the late 1990’s. Retravision first fell over in 2006, wiping out Retravision NSW. Despite the glib and pompous promises of Retravision Victoria, Retravision fell over again in 2012. Followed the same year by Retravision Queensland, then Retravision Western Australia. (The Retravision brand in WA was then sold to Narta, the buying group for Bing Lee, David Jones etc).
Despite the lack of loyalty by the founder Mr Dick Smith himself, I have always found during the late ownership by Woolworths, then the parties involved above, that the Dick Smith stores were very interesting to shop at, had the right stock that I needed to purchase (not phone covers!) and the staff helpful.
Too much information, but I wanted to qualify some more information at grassroots level for you and others to read.
I hope the Dick Smith business restructures away from the types of accounting mentioned above and that it can be a viable and helpful business to it’s customers in Australia & New Zealand.
All the best to the article writers. Have never worked for Dick Smith or owned shares, so writing from the heart, this time round. Hoping the fallout and grief eases for all concerned.
Thanks David, those indeed are some major headwinds to be sailing against. Yep, you’ve gotta feel for the workers and suppliers involved, here’s hoping they quickly find employment elsewhere or within a restructured entity. Thanks for the insights. All the best.
Meanwhile at the Anchorage website news section….
But a couple of press releases still mention this clanger in the Anchorage profile –
“Anchorage has significant experience in the consumer products and retail sector, gained through successful investments including Dick Smith Holdings, Burger King New Zealand and Golden Circle. “
If one wanted to pursue these thieves the next thing to look at would be if any of the half billion Anchorage Capital profits from their shenanigans then went into shorting Dick Smith stock.
So you basically do the following:
1.) Acquire an underperforming corporate entity
2.) Set up a new shell entity
3.) Perform write downs and asset liquidations in old entity on effective date plus a millisecond
4.) Transfer written down assets to new entity
5.) Have a full trading period in the new entity commencing on a effective date plus a millisecond (with the written down and semi liquidated assets transferred)
6.) Link the trading results of the new and old entities either side of the effective date with the “bad news” hidden in the old entity in the millisecond prior to the asset transfer
7.) Only publish one balance sheet, long after the “bad news” has been laundered
How is this transparent? I have looked at the prospectus and “Dick Smith” is referred to, ie the “business” but no continuum of a corporate entity. This effectively allows Anchorage to both transfer cash to itself and flush bad news into a non reportable window – even if its only a millisecond – which is plenty for creative accountants.
So how is this transparent? It is laundering and misrepresentative – however legal it might be.
This is a very insightful article Matt. Well down. Food for thought for the regulators and investors.
Great article, but i have a few hopefully constructively critical comments. and a couple of questions.
*it is a bit misleading to talk about a “$10m company”. it was a $10m (or whatever exactly) cash payment to Woolies, but Anchorage still had to cough up the other $95m somehow. yes, i get that it came from the asset they had purchased, but they still paid $115m. where Anchorage got the $115m is inconsequential. if i give you $1 now to buy an asset worth $1bn, with a promise to pay you a further $500m later, i have still paid you $500m for it. youve just lent me $500m in the process, and i went to the trouble of actually selling the asset for you.
*question: why would Woolies have sold DSE for $115m when its net assets were $261m even after being written down? they must have had some reason for that. whatever the reason/s, noone can say a company like Woolies was fleeced. they are big boys, and dont require anyone’s sympathy. (i see an earlier comment asked the same question but with no response).
*the float sounds rather more shabby, but i note that the reasoning in this excellent article, is based on just a few (presumably) publicly available documents. so while a large numbers of fools were parted from their money, you can hardly say they were ‘had’. it reads more like a sad indictment on the quality of stock market analysts who, again presumably, could all have made the same observations as appear above?
*i realise that the article includes numbers from the end of FY 2014, which was after the float, but as i read the above, the critical flaws in the debacle were the write downs and the inventory selloff, which i think would have been visible to anyone who cared to look, right?
it is all pretty slick, for sure, but talking about fraud seems a bit overdone.
anyway, it is good to read something so direct and to the point for a change, so well done.
You are correct. Woolworths effectively received $115m and we’re not arguing they were fleeced. Hindsight suggests they got a pretty good deal.
But the way private equity raided the balance sheet is extremely relevant to the company’s current predicament. That inventory needed to be replaced after they float and someone needed to pay for it. Had it not been short working capital, there would be no bank debt today.
And it is actually not possible to tell this at the time of the float. You only get one balance sheet and in this case – because the listing entity was just a holding company, you didn’t get any insight into what the historical balance sheet looked like until the audited accounts came out well after listing,
Thank you for the reply, Steve.
As I understand it, the crux of the matter is this: Anchorage ran inventory down to an unsustainable level, and use the proceeds to pay Woolies for most of the purchase price. Consequently, significant inventory restocking was inevitable after the float, and that restocking has at least contributed to cash shortage and refinancing difficulties.
Assuming that is a fair description of the situation, my question is this: do you think it was legally (understood you may not be able to comment on that) or morally required to talk about the inventory change, or express an opinion about restocking issues, in the Prospectus? After all, the P. does state the actual inventory level at end of FY 2013, and I would have thought it the job of analysts and investors, to form a view on appopriate inventory to expected sales ratio. ie shouldnt a conspicuously low inventory/sales ratio have been a basic metric for comparison to competitors? I am not asking as a way of challenging the article; just that I dont have a particular opinion and dont know what is ‘normal’.
I note in passing that the rather large inventory increase shown in the 2014 accounts does not seem to have raised alot of alarm bells in the press! Even today, comment I have looked at about this debacle does not seem to be homing in on that. No doubt this is why fund managers with an eye for forensic accounting analysis exist 🙂
Steve – as I said in a post on this blog article on 30 October it WAS possible to see what Anchorage had done with the balance sheet prior to listing. To say the data wasn’t available, simply because it didn’t appear in the prospectus, is patently wrong.
As you say in your post DSH was simply a holding company which was to acquire Dick Smith Sub-holdings Pty Ltd (‘DSSH’) with the float proceeds. If you looked up DSSH on ASIC you would see Anchorage lodged DSSH’s FY13 accounts on 31 October 2013 (3 weeks before the DSH prospectus was lodged with ASIC and the last date they could lodge with a June balance date) – look through the notes to these accounts and it reveals everything in Matt Ryan’s analysis in this blog post. The only difference is the analysis could have been done at the time of listing – not in retrospect. The FY13 accounts were subsequently given to the ASX on the day of listing
I admit very few people would have been aware that such a document would be available on the ASIC database (I have little doubt Anchorage would have been aware of the investing public’s ignorance of this too) and buy the FY13 accounts.
To my mind this raises an argument that (among other deficiencies in the Australian IPO process):
• listing companies should lodge all audited financial reports referred to in their prospectus with the ASX at the same time the prospectus is lodged
• Prominent notice should be placed at the beginning of the financials section of a prospectus providing a direct link to the ASX website where the historical financials can be obtained by potential investors for free (and therefore not rely solely on scant pro-forma financials).
If such changes were in place at the time, making access to the FY13 accounts easier for potential investors, it is arguable Anchorage would have thought twice about listing DSH in December 2013. If this was the case Anchorage would have needed to execute on all the pro-forma uplifts in 2014 earnings themselves (rather than selling these potential benefits to incoming investors at a price that reflected no execution risks)
Retailers have huge off balance sheet liabilities in the form of store leases. That’s why bad ones can (and regularly do) sell for less than net assets.
Is there any chance you can do a similar analysis article on Spotless Holdings. Very much the same appears to have happened there and it’s burnt a lot of us – I’d like to know the bottom line but can’t get my head around exactly what the accounts mean with all the smoke and mirrors that appears to have gone on.
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Talking about floats, South32 investors have all been had as well. Big write downs only weeks after listing, and look now at the share price going sub $1!! . Most investors would be sitting on massive losses thanks to hyped up valuations and targets by a consensus of brokers. Looks like nobody is even running that company.
I am really looking forward to the story on the banks side of this. They were just as hoodwinked as the shareholders in this.
Knowing one of the banks involved well, that RM would have been ruthlessly walked by 9am yesterday. And will the credit risk people whom missed the B/Sheet shenanigans and signed off on the recent extension of facilities and W/C be held accountable? Typically, and most likely not, the RM is the fall guy.
His/Her story needs telling.
Great article Matt Ryan!
The issue relating to the involvement of major fund managers is interesting. They become hamstrung as a float such as DSE has portfolio index-balancing issues (ASX200 etc). If they all “refuse” to participate, then sectors of the market and media would call collusion. A single major objects, the float goes ahead, they are then “forced” to backfill via on-market orders (at a premium post-float). Stuck between the devil and the deep, blue sea. It is an open market. Does the ASX have responsibility in the process? Is better regulation of continuous and transparent disclosure required?
In any case, if you see a proposed equity buyout of Masters Hardware…
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Joint Lead Managers – Goldman Sachs and Macquarie Capital (2.75% of total offer plus .75% incentive fee)
Legal Adviser – Minter Ellison ($1.3m)
Investigating Accountant – Deloitte Corporate Finance Pty Ltd ($430K)
Tax Adviser – Ernst and Young ($470K)
Is Malcolm Turnbull to have a Royal Commission for Dick Smith as Abbott had into Trade Unions? Could be something about his old mates’ being found out!
Can you please write an analysis on what TPG did with Myers. Same result, Australian shareholders ripped off. Also the auditors of Dick Smith must answer some questions.
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Anchorage do indeed seem to be the masters of cashflow. Clearly none has gone on their website.
If you’re still on holidays and need a ‘beach novel’ check out their own casestudy of their DSE ‘Turnaround’. Never a greater work of fiction penned. Look out Booker Prize…
Amazing read – and I’m a non-financial person. Are there any recommended books that tell more stories of events like this?
Thanks for this analysis. Anchorage are still showing this as a case study on their site. http://www.anchoragecapital.com.au/case-study-dick-smith
In their own words from that case study it suggests they put in $20m of their own.
“Dick Smith was acquired from Woolworths in February 2011 & After a period of exclusivity, in November 2012 Anchorage acquired the business for $20 million. ”
They also got an award from AVCAL – for Winner
AVCAL Best Management Buyout under $75 Million – 2014
and 2 awards from TMA – https://www.turnaround.org.au/ for Dick Smith
At the very least – the manipulation of the inventories was ethically wrong but it does seem that two industry organisations (AVCAL & TMA) gave them awards which either devalues those awards or suggests there is financial industry support and rewards for unethical and probably illegal behaviour.
Can you please dig out how this happened? http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10430928
This is excellent analysis. Serious ethical questions obviously arise, and we are reminded of the importance of the balance sheet. An inquiry (maybe a review by ASIC) would appear appropriate. Who knew what and when … and what was planned even from the start …. presumably there were forecasts a year ago – how were they ever going to get out to the hole they dug once the cash had gone and were those assumptions ever reasonable? Outcomes such as this only advance the case for more govt regulation rather than letting the finance industry behave responsibly and ethically… all very sad and even more so for those loosing their jobs ….
Hi Matt, thanks for this analysis. Great insight.
Oh how wonderful the benefit of hindsight is! I very much doubt anyone would have seen this outcome at IPO. A “lean” inventory in a lot of cases is a good sign. It can mean the company is turning over old stock well. It would have been hard enough to spot this at IPO, made all the more difficult if you didn’t have the historical information.
Just another reason to avoid IPOs, but especially private equity. Wait for the company to trade for a few years and then take a look.
A smart man once said – “It’s almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors).” One guess as to who that wonderful quote came from.
It’s funny how they go under like Radio Shack (Tandy)… All in the same season
Surely some of the blame has to rest with the management of the company rather than solely resting at the feet of the private equity owners.
No argument from us on that point Sam, there’s plenty of blame to go around and management deserves a fair heaping. Cheers
Stu on 5th Jan posted a link to Anchorage website; Anchorage announce the following acquisition – if I was a parent that had my child in one of these 160 day care centres run by Affinity Education Group I’d be moving them to a new day care…REAL SOON !
ANCHORAGE CAPITAL PARTNERS ACQUIRES AFFINITY EDUCATION GROUP
December 15, 2015
Anchorage Capital Partners announced today that it has completed the acquisition of Affinity Education Group (Affinity).
Affinity is one of the largest child care operators in Australia, with a portfolio of more than 160 centres. Affinity’s key focus is providing exceptional child care and education services.
Brilliant synopsis … and yet another example in how public servant regulators are so far behind the market when it comes to inventive schemes involving financial wizardry. The GFC taught us nothing and Bankers/Fund Managers will continue to push the legal boundaries for greed and bonus payments whilst dickhead administrators can’t see the ‘tigers’ stalking in the tall grass …
AVCAL Best Management Buyout under $75 Million – 2014
1) It shows Woolworths management are knuckleheads. – They were so happy to get rid of non core assets that they didnt think to properly do themselves. If they had employed the same tricks (and writing down inventory not that tricky) and at that time wol share price was still looking OK they would have made a killing by selling one year later – now look at Wollworths they can’t tell their T from their A
2) Writing down inventory so close to y/e shows the value of auditing & audit firms – zero. What was the true value the y/e before sale $300+m ?? They fluff the B/S to sell a high amount of worthless inventory. IPO investment strategy either pays big or crashes thats just the way it is. But as soon as you here PE is involved alarm bells should ring. They are there either because they see value in LT or to make a quick buck and get out and if the management cant see that coming they deserve to be kicked out without the ubiquitous golden handshake.
3) Woolworths management copied UK supermarket strategy until this day and made the same mistakes the UK firms did in market saturation. My advise stay away from these knuckleheads and go buy some vitamins from Blackmores.
Can similar analysis be done to the Australia Government Use of Tax Payers money to Finance Global Weather Change, Education Revolution, Pink Batts, Queensland Floods….
Surely the Anger should Exceed this Dick Smith Collapse many more time …like to the Tune of $350 Billion…… Should we have senate enquiry on how Australia which had $20 Billion in the Bank Suddenly have a Deficit of $350 Billion and the Labor-Greens Wizards Leaders got their on going Retirements entitlement to the tune of $200,000 each yearly till Death…. I say CUT ALL Politician Benefits AFTER 5 years out of Office and I will see some hope for this Once Great nation Ruined by Mainly the Greens – Labor Gender Bias equality Agenda!!
Go bang your drum elsewhere. This is a discussion of business practice – stop trying to co-opt it to give your political hysteria some airtime. Take your anti-green/left scapegoating to somewhere where someone cares.
So, did Woolies know then, that the inventory wasn’t worth $300m when they sold it?
While your analysis is interesting, I doubt that Anchorage would have sold DS if they expected it to fail as quickly as it did.
I’m sure right now they’re rolling around in pain as well – while they had a very successful exit in DS, they still have five portfolio companies to worry about.
Given all of this press, you would expect that they won’t be able to exit out of any of those successfully.
While it’s pretty clear that they played with the balance sheet, my guess is that a big part of the downfall was driven by management and competitive dynamics as well. As other comments mentioned, they don’t compete well against JB and in your post you mention that they had a drop in same store sales and a decrease in margins – neither of which was driven by Anchorage. It appears that the inventory shenanigans were a catalyst to their eventual downfall, and that Anchorage was lucky to get out early enough.
As for investors being duped, ask yourself “would Warren Buffet have purchased DS IPO stock?” Always go back to competitive fundamentals, and this was a business that lacked them.
Goes to show that all your high powered investigating accountants and legal opinions are worth a pinch of the proverbial. And they still got lots of money for providing wrong conclusions. And the community still respects the big accounting firms over the smaller owner operator suburban public accountants who actually feel for their clients. Work that one out.
I haven’t read all the comments so excuse me if this has already been observed. A Working Capital Balance calculation would have shown the deficiency in inventory. Having the same brokers on both sides of the deal may have meant that the full extent of analytical techniques were left to be applied by others. Or am I just cynical?
I heard today that Coles were going to honour Dick Smith gift cards! Is this just a rumour ?
SCUM!!!, That’s how it works – load the company up with your own (or someone else’s) debt, put that money in your pocket and charge decent interest on top, and make sure company runs at a loss so you don’t pay tax. The PE game as practiced offshore is twofold – financial engineering and business turnaround, and the vast share of the gains are made by the engineering, often at the expense of taxpayers, other investors and banks.”
FYI in NZ gift certificates sold over Christmas are no longer honored, the b#$stards waited till after the seasonal spending madness to pull the pin knowing full well at the time of selling these gift cards the company would not be able to be redeemed
Thinking of Dick Smith, anybody recall the Sunbeam Victa MBO?. Back in 1987, Reil Corp bought Sunbeam Victa for $54M from Allegany (which was in Ch 11 bankruptcy). Their super fund surplus of around $15M was used to retrench a big chunk of the workforce. Land and buildings of $30M were sold on a sale lease back. Then a dividend of some $20M plus was paid to Reil. Reil then sold Sunbeam Victa to Byvest and the management team for $110M in Nov 1998. A record Australian MBO at the time. A massive profit in just 18 months. What followed at Sunbeam Victa was a complete disaster with many employees sacked and the company almost put into liquidation. Astute work by Reil Corp, but a disaster for those left behind.
I would appreciate some education for those who have read this article and have a good understanding of financial accounting. The article describes how the purchase price of Dick Smith was $115m but that the business holds $370m of stock. It goes on to state that it was a write down of this stock (followed by liquidation of stock) in large part that helped the funding of the purchase price by Anchorage Capital with a fraction of the purchase price being introduced by way of cash. Unless there was a huge amount of debt against this stock, how could Dick Smith trading as a going concern be worth far less than the stock value entered into the balance sheet at cost. I would have thought the stock value would be factored into the purchase price along with a multiplier of the net income of the business.
Further to my question:
written down stock value was $312m sale price $115m. Sale price was $197m less than the stock value entered at cost.
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Anchorage Capital did what PE firms are in business to do – buy cheap and sell expensive. Bravo to Phil Cave. Commiserations to the buyers and the bankers.
# Lou Richard your bouquets and commiserations omit two important groups – the thousands of employees (one report mentioned 3,300) who are facing unemployment, and the thousands of superannuants who just did their dough through no fault of their own.
If you applaud a handful of shonks who heisted some $500m by legally dubious means without giving a moment’s thought about these two groups, then mate you are part of the problem.
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Goldman Sachs had it dirty little fingers in the pie. It was always going to end bad for the little guy.
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Hey this is all interesting to read and thanks author for taking the time to explain things. I have a question though, if the idea of the write downs was to avoid losses on the books then how exactly does that work and allow Anchorage to get enough cash to pay for the remainder of the debt?
No matter which way I look at it all I can see if that it results in a loss. :/
Think of cash flow and reported profit separately, they’re two different issues.
First cash flow. The way they got the cash was to liquidate much of their inventory – they had sales, brought cash in the door and didn’t properly replace all that inventory. Those shelves were ultimately restocked with new inventory, but mostly after the company was floated and the cash for that inventory was provided by the new owners rather than Anchorage.
Now profit. If they didn’t massively mark down that inventory beforehand, that process where they discounted stock and shipped it out soon after Anchorage bought the company would have created accounting losses. By marking down the inventory before buying the company, the situation is created where those sales make profits, or at least appear to make profits.
Impressive analysis, I’ll be sure to share your site around.
Any similar stories from Anchorage or its puppetmasters? I’d like to see if they have a pattern of this.
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I have read the full thread and am impressed by the details of the analysis. It’s amazing how creative accounting can make a tin cup look look like the golden holy grail. I have one questions about how this all worked in reality.
Where did the profits from the IPO end up? Whilst I understand all the points of the debate as to how ethical/ legal the deal was, it would peeve me greatly if the profits were spirited away to a tax haven without Australia getting anything out of it.
That’s a question really for Anchorage Mike.
And I daresay some of their professional advisors on the IPO (in particular Minter Ellison, Ernst & Young, and Deloittes)
Ernst & Young (according to the Prospectus) received $470,000 for tax advice on the IPO. Although it could well have been much more if the growth in the amount paid to Deloittes as the Investigating Accountant (from $470k in the Prospectus to the reality of $784k) is any indication.
And usually the auditors provide tax advice as well (amazingly eh) so perhaps Deloittes also.
I would suggest the tax paid on the ‘capital gain’ from the $115m (purchase price) to the around $520m (‘sale price’) would have been minimal given the above professional assistance provided and the mindset of private equity companies like Anchorage.
And it’s worth noting that Alan Moss (ex Macquarie Bank CEO, and now involved with Anchorage – refer their website) has just been appointed as one of the new board members of the Reserve Bank of Australia!!
I’ve spent the last three days trying to source the data that is listed above. I cant find any thing pre 2013. Essentially, im looking for evidence of the inventory write off down immediately after anchorage purchased the company. Can some one PLEASE help me dig up this data? Im using this as a case study for Uni but its pretty much pointless unless I can reference it properly.
That table Matt has included above (with $58m of inventory writedowns) is in the acquisitions note in the 2013 annual report.
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Do we know whether the issue was fully subscribed and fully underwritten?
This is all very interesting. I am currently undertaking studies from an auditors point of view, in particular risks of material misstatements.
Is there anybody able to help me understand the material misstatements of Dick Smith, in particular for the period 1/7/14 to 31/12/15. Looking for a handful or so.
My initial thoughts so far are:
– the $60m non-cash impairment write – off in Oct/Nov 15 – poor inventory management
– expanding into new locations and alliances – the purchase of MAC1 – an authorised Apple service centre and reseller and the alliance with David Jones & Trade-me-alliance.
Any help would be appreciated.
Anchorage has made a submission outlining its position to how it managed Dick Smith as part of the Senate inquiry into the collapse of listed retailers.
With all the comment it seems astonishing that no one seems to have queried the quality of the ‘in depth analysis’ by the brokers who brought this offering to their retail clients. Macquarie and Goldman Sachs no less; and Macquarie was I think an unsecured creditor at the time.
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the article mentions increasing p&l through onerous lease provisions, however creation of such provisions results in a expense debit and liability credit in the balance sheet – this reduces profit.
Am I missing something?
At the time you create it (pre-listing), you incur an expense. But it reduces your future rental expense (but not your cashflow) so that the prospectus forecasts look good.
This is an anomaly of the IPO process. A lot of disclosure is required concerning the P&L but little is required about the B/S and cash flow.
There’s no way Anchorage would accept that when looking to buy a business – so why should retail investors have to in an IPO?
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If you’re stupid enough to go near an IPO after an American private equity firm has been near it, you don’t get any sympathy from me. Even your typical mum-and-dad investor should realise this. They almost never end up ahead, once these rapacious and greedy private equity firms have done their ‘financial engineering’. Given the same story is repeated so often, you wonder why stupid people still fall for it. The only consolation is the taxpayer was never on the hook for any of it. It’s just another example of cunning, smart people meeting fools who are easily parted of their money. The lesson won’t be learnt though – that’s why there’s a private equity industry in the first place!
I thought that Anchorage Capital was an Australian Private equity firm? (Unless the likes of Phil Cave and Alan Moss are US citizens in ‘disguise’)
But I agree with your comments about private equity firms irrespective of their national background.
Barbarians and the Gates captured it well, and they have continually plundered for the last 50 or so years.
My leaning is more along the lines of thinking that the ‘stupid people who fall for it’ are my neighbours and they need to be warned of these ‘cunning, smart people’ who have lots of money and are armed to the hilt with professional and financial advisers who can disguise porkies.
As Brandeis said way back in 1914 – “Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”
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A bit late to the conversation…Im a student and Im wondering the relationship between significantly reducing the fair value of inventory and PPE in relation to the guidelines mentioned in AASB 13?