On the Money W Beware of the zombies
Market analysis with Roger Willis
hen insolvency administrator Ernst & Young finally sounded a death knell
for the failed Frank Thomas group of companies at the end of January, aiming what was left into liquidation, it ended a zombie-like status for the business spanning two years. Throughout that period, Ernst &
Young rightly acted on the assumption that no operational element of what had once been the biggest motorcycle accessory and apparel distributor in Britain was viable. The administrator’s task was simply to gut the tattered shell of saleable assets and chase recoverable debts. But applying “living dead” nomenclature to this entity once it had collapsed into administration is actually inaccurate because, in the modern financial lexicon, Frank Thomas was already a zombie before it went bust.
That description refers to
struggling companies which are just about managing to generate sufficient funds to service accrued debt mountains but haven’t got a hope in hell of earning past that level to dig themselves out of the holes into which they’ve sunk. As long as interest rates stay low, they can blunder on for a while, keeping the banks at bay. But without the ability to invest in growth or restructure from their own resources – or borrow more money – they will be doomed to failure. One recent estimate claims that almost 150,000 UK businesses, some of them very big, now languish in this category. Broadly speaking, there are
two routes towards this degree of perdition. Most topical is that taken by the serried ranks of high street names going belly up – the likes of Comet, JJB Sports, Blacks Leisure, Jessops, Blockbuster, HMV and Republic. Typically, these retail chains imprudently expanded like there was no tomorrow prior to the credit crunch. And then there indeed wasn’t a tomorrow. Saddled with extensive property
portfolios worth far less than the borrowing required to finance them in better days, and in many cases suffering from dysfunctional business models that had missed the trick as regards consumer sentiment
moving away from the high street to shop online, their cashflow- strapped demise became depressingly predictable. The other avenue to misery
involves the churning of once-hunky businesses through serial take-overs backed by private equity investment. These investors borrow money to buy a company and then load that acquisition burden onto it, relying on operational cost-cutting, managerial streamlining and disposal of extraneous assets to improve financial performance, and therefore enterprise value, before engineering a profitable exit. Frequently, the next buyer in line
is yet another private equity hopeful. But the inevitable result is a steadily- mounting debt pile which might eventually be unsustainable. Although it was seen as a big bike industry player, Frank Thomas was in fact a fairly modest example of this phenomenon. Successive management buy-outs fuelled debt that finally amounted to £13.9m, owed to Barclays at the point when the rug was pulled. The bank retrieved only 28 per cent of that. As I recall, a previous MBO funder at a lower point of indebtedness had been the private equity arm of Dutch bank ABN Amro. There are vastly larger fish in this sea of debt. One new candidate for zombie condemnation is General Healthcare Group, Britain’s biggest private hospital chain. A parcel passed between several private equity firms over the years, it was most recently acquired by private equity group Apax Partners, fronting a consortium of investors, in 2006. The consequence of that deal is that GHG now has to service mind-boggling loans of £2bn in total, a task with which it is experiencing difficulty. Its senior
lenders, led by
Barclays, the Japanese bank Mizuho and the German Pfandbriefbank, have developed major jitters because a large portion of GHG borrowing is due for renewal. Significantly, yet another private equity fund – the supremely aggressive US outfit Kohlberg Kravis Roberts – is lurking in the undergrowth. KKR has reportedly bought some of GHG’s debt so it can swoop like a vulture onto tastier morsels of the business in the likely event of restructuring. Closer to the motorcycle industry’s home (and mine!) is the venerable Isle of Man Steam Packet. Besides being sole maritime provider to bikers wishing to visit the TT, this shipping line is also obviously a commercial life support system, transporting the bulk of freight and all vehicular traffic on and off the Island. It is also, sadly, a ripe zombie. The Steam Packet was sold by its last shipping industry parent, Sea Containers, to Montagu Private Equity for £142m in 2003. Montagu asset-stripped redundant waterfront development sites which had been Steam Packet terminals in various Irish Sea ports and then flogged the business on for £225m to Australian investment bank Macquarie in 2005. Macquarie cashed in part of its holding at a premium by forming an ownership consortium with a number of pension funds but was also obliged to increase borrowing attributed to the company in 2009 by purchasing a bigger and fancier fastcraft ferry.
In October 2010, the Steam Packet
was reportedly servicing a debt of £212m, soaking up about £14m in annual operating profit before passing go. Floating assets comprised a large
freight-friendly ferry called the Ben-my-Chree more than halfway through its sailing life, and the newer Manannan fastcraft, which is generally regarded as not fit for profitable purpose in arduous Irish Sea weather and can’t carry freight. But the key asset was a piece of paper signed by the Isle of Man Government, the user agreement giving exclusive access to the loading link-spans in Douglas harbour and thereby guaranteeing its monopoly. However, Macquarie was clearly not convinced of their ongoing combined value. Having decided that useful juice had been squeezed dry, the investor group it led essentially walked away in April 2011. The Steam Packet therefore fell into the hands of senior lenders headed up by Portugal’s Banco Espirito Santo, which had been holding the debt on their books ever since 2005. And so it remains, with that debt now in excess of £220m and little prospect for the future that doesn’t involve a voyage into insolvency. But don’t mistake this for an unbridled attack on private equity input. It’s a risk game like all potentially high-profit activity with winners and losers – the latter subsiding into zombiedom. No, the real problem is with the banks, which are loathe to write-down bad loans which they have no realistic chance of recovering in full. There is a powerful argument that these lenders need to make provision (albeit painful) for clearing such toxic borrowings from their balance sheets, burying the zombies and freeing up much-needed capital investment availability for vibrant businesses with a brighter horizon. Their mealy-mouthed reluctance to do so – “forbearance” in banker- speak – is effectively obstructing UK economic recovery. Success for the majority of enterprises is necessarily dependent on failure for the few in a truly competitive environment.
MARCH 2013 65
Financial column
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