Investment columnist for the NZ Herald

Brian Gaynor: Why did two companies fail?

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What went wrong? Can directors, management and investors learn any lessons from these corporate collapses?
What went wrong? Can directors, management and investors learn any lessons from these corporate collapses?

It has been a traumatic week for the NZX, with two companies - Pumpkin Patch and Wynyard Group - placed into voluntary administration. This is the first time since the early 1990s that two listed companies have gone bust in the same week.

The two companies have fallen a long, long way, as Pumpkin Patch had a sharemarket value of $830 million in 2007 and Wynyard was worth $340m in early 2014.

What went wrong? Can directors, management and investors learn any lessons from these corporate collapses?

Pumpkin Patch, which was established in 1990, listed on the sharemarket in June 2004 following the issue of shares to the public at $1.25 each. Existing shareholders, including executive chairman Greg Muir and managing director Maurice Prendergast, retained 51 per cent ownership of the company.

Investors fell in love with the kids clothing company and its share price finished the 2004 year at $2.76, an impressive 121 per cent above its IPO price just six months earlier.

The love affair continued throughout 2005 and 2006, with the company's share price reaching an all time high of $4.95 in January 2007.

Pumpkin Patch was on a tear, with the number of Australian stores leaping from 54 to 107 in the five years to July 2008.

New Zealand store numbers increased from 21 to 52 over the same period, while the company had 35 UK stores compared with only 9 in July 2003. Meanwhile, the number of US stores increased from zero to 34.

Muir's annual remuneration had increased to $551,000, Prendergast received $587,000 and a company associated with the latter was paid $22.5m for providing store fixtures and fittings to Pumpkin Patch in the four years following its 2004 NZX listing.

But one of the biggest issues was the huge increase in debt. The company raised $101.3m through its IPO but $61.3m of this was used to purchase shares from existing shareholders.

The post-IPO store expansion programme was funded mainly through borrowings, with the company's short and long term debt increasing from $4.7m in July 2004 to $81.3m four years later.

There are a large number of reasons for Pumpkin Patch's failure, including:

• The expansion into the US and the UK was too rapid and almost totally funded by debt. The company had stores spread throughout the United States in California (15), Texas (5), Arizona (4), Washington State (3), Colorado (2), Virginia (2), Maryland (2) and Oregon (1). This was extremely challenging from an operational point of view.

• The board and management didn't have sufficient international experience or expertise. Pumpkin Patch had no overseas director even though 85 per cent of group revenue was derived from offshore activities.

• The company neglected its New Zealand and Australian operations as it focused on its international expansion. One former insider observes that Pumpkin Patch had "crumbling foundations" because of its failure to invest in people and infrastructure in New Zealand.

• Store locations in Australia and New Zealand were poor.

• The company was slow to respond to increased competition, particularly the entry of offshore operators into the Australian market, while Pumpkin Patch's clothing designs failed to keep pace with changing fashion trends.

Two additional issues were its unshakable belief in "the brand" and poor capital management.

Directors and management believed the Pumpkin Patch brand was so strong that it would protect the company from mistakes, regardless of their magnitude. This proved to be an incredibly naive assumption in a competitive commercial environment.

Pumpkin Patch was also capital light. The original shareholders contributed only $10.9m of capital yet they extracted $61.3m through the IPO process. This left the company with minimal equity to fund its ambitious expansion plans.

In addition, the directors declared dividends of $88.2m in the seven years between 2005 and 2011, compared with reported profits of $90.6m.

Pumpkin Patch's Ponsonby store. Photo / Nick Reed
Pumpkin Patch's Ponsonby store. Photo / Nick Reed

There is a very strong argument that the financial demands of the original shareholders, in terms of the IPO proceeds and high annual dividends, forced the company to fund its aggressive and failed offshore expansion through debt. This high debt ultimately led to the failure of Pumpkin Patch and has created huge uncertainty for its remaining 1700 New Zealand and Australian employees.

The Wynyard story is shorter and easier to explain.

In December 2011 Wynyard was incorporated as a non-trading subsidiary of Christchurch based Jade Software. In early 2012 "Wynyard Group" was launched as a brand and discrete business unit of Jade. The Wynyard Risk Management and Wynyard Investigations products were relaunched and Wynyard also assumed management of several Jade financial services accounts, which were the foundations of the Wynyard Intelligence product.

In June 2013 the company issued a prospectus for the sale of shares to the public at an indicative price range between $1.10 and $1.65 a share. The final price was $1.10, which enabled it to raise $66.1m from the public. However, $23.6m of this was used to purchase intangible assets from Jade Software.

Wynyard listed on the NZX on July 19, 2013 and its share price rose steadily to reach an all-time high of $3.30 in January 2014. However, the company's result for the December 2013 year was disappointing as it reported a net loss of $11.2m compared with its prospectus net loss forecast of $10.1m.

The board and management of Wynyard Group have been totally naive in the way they ran the company.

In March 2014 the company raised a further $30.0m through the issue of new shares at $2.70 each and a further $5m a month later through the issue of shares at $2.36 each.

However, Wynyard's share price dropped steadily over the next 18 months as it failed to meet revenue expectations and its operating expenses continued to soar. On November 11, 2015 the company announced that it planned to raise $30m of new capital from investors at $2.00 a share compared with a closing price of $1.38 the day before the announcement.

This was a staggering announcement because no one had agreed to pay $2.00 a share and in my view demonstrated that Wynyard's board and management had limited financial market expertise.

The downhill slide after this was relatively rapid, as the company could not convince investors to pay $2.00 a share and a conditional $27m contract with a potential customer in the Middle East was never executed. However, Wynyard did manage to raise $32.1m of new equity through a one-for-four rights issue at 85c a share in March 2016.

Wynyard's result for the six months to June 30, 2016 showed that it had revenue of only $11.6m compared with total costs, including capitalised software development expenses, of $40.5m. A company cannot survive if it has no revenue growth and has a cash deficit of $28.9m for a six-month period.

The obvious lesson to be learned from the Wynyard debacle is that high-tech startups are extremely risky and investors should adopt a diversified portfolio approach in order to mitigate the potential of these companies going bust.

However, directors and management also need to concern themselves with shareholders' interests.

They originally raised a net $42.5m from investors through the 2013 IPO, yet the company's cash burn has been $3.3m per month since listing. Thus, Wynyard only raised sufficient money through the IPO to survive for twelve months at its long-term monthly cash burn rate.

The board and management of Wynyard Group have been totally naive in the way they ran the company. They allowed its cost structure to soar while revenue was well below expectations.

Wynyard has blown $176.3m of shareholders' equity in just over three years. This is comparable - and arguably worse - than the bad old days of the 1980s.

- NZ Herald

Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management, which holds Wynyard shares on behalf of clients.

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Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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