The Value Fund underperformed the All Ordinaries Accumulation Index by 9.09% in the September quarter, declining by 0.41% in a period where the index rose 8.68%. Most of the underperformance occurred in September and was almost wholly attributable to one stock — Photon Group. The remainder of the portfolio has performed well thanks to takeover bids for Prime Infrastructure and Alinta Energy Group, and good profit results from some of the core holdings.
In physics, a photon particle has zero mass. The board and management of marketing services company Photon Group seem determined to give their company’s share price the same value. It had already fallen from an all-time high in excess of $6 to approximately $1 when the Fund first invested. As a result of deteriorating earnings and a $100m blowout in its liabilities, the share price has since fallen another 91% to end September at an all-time low of $0.085. This one stock detracted 12% from the Fund’s performance for the quarter (including a 15% loss on the new shares issued at $0.10 as part of the restructure).
The company’s problems are not to be underestimated. Despite the recent $102m capital raising, it remains highly leveraged and the recent dramas will have taken a toll on staff morale. This company does not have any tangible capital — if it loses its people it loses its business.
However, while the share price may not indicate it, the deal new CEO Jeremy Philips has done for shareholders is a good one. It was announced soon after his arrival that the company owed approximately $100m more in deferred consideration payments than had been previously disclosed. For a business with a $180m market capitalisation at the time, and not enough cash to make the payments, it was potentially fatal.
Somehow Philips managed to shepherd 15 former business owners into an arrangement whereby they agreed to make $85m of the deferred payments contingent on the overall business meeting certain targets. In effect, shareholders are not far from where they were before the balance sheet hole was discovered, but with more of the potential upside going to deferred consideration recipients (most of whom are now employees of the business). Yet the share price, on a weighted average basis, has fallen by more than half.
Photon owns some of Australia’s most successful marketing agencies including Belgiovane Williams Mackay and BMF, and the Bailey Group is the dominant field marketing business (in store advertising, product testing, outdoor promos and the like) in the country. Pulling together these and the 40-odd other disparate marketing businesses Photon owns won’t be easy but Philips has done an outstanding job so far and, as a former right hand man to Rupert Murdoch, he seems well equipped to deal with difficult personalities.
Following the capital raising, the Fund’s average purchase price is approximately 15 cents. The range of potential outcomes is wide but we still expect healthy returns on our investment.