Float of Dick Smith a huge earner – for private equity

Investment analyst Matt Ryan doesn't beat about the bush when outlining his view on private equity-backed sharemarket floats.

"My general rule is to avoid them entirely," he says. "Just don't go there."

Back in October, Ryan, of Sydney's Forager Funds Management, penned a blog that analysed in deep detail how Australia's Anchorage Capital Partners pulled off "the greatest private equity heist of all time" when it floated Dick Smith on the ASX in December 2013.

Creditors to gather to hear Dick Smith news
Business Insider: Blame game begins over Dick Smith's receivership


The article was widely circulated this week after the electronics retailer was placed in receivership by its banks on Tuesday, owing roughly A$150 million.

Forager Funds' website even crashed at one point under the weight of traffic accessing the blog.

According to Ryan's analysis, Anchorage used only A$10 million of its own capital to fund its A$115 million acquisition of the retail chain from supermarket operator Woolworths in 2012.

Through writing down the value of assets and then liquidating stock through a monster clearance sale, the investment firm funded most of the purchase with cash from Dick Smith's own balance sheet, he wrote.

A bullish profit forecast, aided by the unsustainable financial benefits of the stock clearance, attracted investors and allowed Anchorage to float the retail chain with an eye-popping market value of A$520 million.

"Anchorage were able to sell the last of their shares in September 2014 at prices slightly higher than the A$2.20 float price and walk away with a quiet half a billion," Ryan wrote. "Private equity are renowned for pulling off deals, but if there's a better one than this I haven't heard about it."

In Ryan's opinion the ballooning debts and cashflow challenges Dick Smith struggled with post-listing are the consequences of the tactics of Anchorage in the lead-up to the float.

But while the private equity firm has been copping much of the blame for Dick Smith's demise, Ryan says investors who supported the listing need to take some responsibility too.


"In fact, I'd place 80 per cent of the blame with investors who bought into the float," he said. "It's private equity's job to buy a business and try and sell it at the maximum profit possible. It's really up to investors to be sceptical and ask hard questions when things are brought to them."

Anchorage declined to comment.

Feltex provides a cautionary tale for investors. Photo / Duncan Brown
Feltex provides a cautionary tale for investors. Photo / Duncan Brown

In the wake of Dick Smith's receivership, debate has resumed about the complex financial techniques - often utilising hefty doses of debt - private equity employs when preparing businesses for sale.

Across the Tasman, shares in other companies brought to market by private equity-backers have slumped below their offer prices.

These include department store chain Myer, cleaning and catering giant Spotless and television operator Nine Entertainment.

And many New Zealand investors will remember all too well Feltex Carpets, which collapsed in 2006 after being floated by a private equity fund run by Credit Suisse in 2004.

Ryan says he hopes the trouble at Dick Smith leads to more due diligence and harder questions being asked by investors.

"In the short-term you might see a response," he says. "I think Anchorage, particularly, might have a bit of difficulty in the short-term bringing anything back to the market - there's trust there that's been burned."

But Ryan isn't convinced the Dick Smith receivership will have a long-term impact on investors' approach.

"Investors, particularly the ones who participate in floats, tend to have very short memories," he says. "I think the lessons might disappear into the ether five years from now and we'll go through the same thing again, perhaps."

Milford Asset Management's Brian Gaynor, who questioned the Dick Smith IPO in a November 2013 Business Herald column, says "gold talk" about the float from investment bankers, quoted in press reports in the lead-up to the listing, fanned much of the public share offer hype.

"When you see these constant unnamed investment bankers saying there's a huge demand for shares, it leaves retail investors in a very vulnerable position," Gaynor says.

He says it becomes a dangerous combination for retail investors when private equity firms float companies with well-known brand names.

Private equity are renowned for pulling off deals, but if there's a better one than this I haven't heard about it.

"Obviously Feltex was a well-known name in New Zealand, Myer is a well-known name in Australia and Dick Smith is a well-known name in Australasia."

Kiwi chicken producer Tegel, owned by private equity investor Affinity Equity Partners, is expected to launch a transtasman IPO in the first quarter of this year.

The deal has been tipped to place a $1 billion price tag on the Auckland-based company, but Gaynor says the Dick Smith failure will weigh on the pricing of the poultry firm's float.

"If they try for too high a price I don't think it will go through."

The fact that a planned IPO was aborted by private equity-backed Hirepool in 2014, as well as Rank Group's Carter Holt Harvey last year, shows the New Zealand market is exercising caution, Gaynor says.

And he says investors can do well out of private equity-backed floats, if they pick the right ones.

A case in point is retirement village operator Summerset Holdings, brought to market by Quadrant Private Equity in 2011, whose shares had gained 183.6 per cent on their offer price as at the close of trading yesterday.

Another strong performer is Christchurch-based fruit exporter Scales Corporation, floated by Direct Capital in July 2014. The firm's shares closed at $2.33 yesterday - a 45.6 per cent increase on their $1.60 IPO price.

An IPO of Tegel is expected this year. Photo / Kenny Rodger
An IPO of Tegel is expected this year. Photo / Kenny Rodger

Colin McKinnon, executive director of the New Zealand Private Equity & Venture Capital Association, says investors should be wary of all IPOs.

"But I don't think you can draw the conclusion that you have to be more careful about PE-backed ones," McKinnon says. "Private equity has a positive impact on privately owned businesses, it generally makes them more efficient."

He points to recent research on ASX IPOs in 2013, 2014 and 2015, which found private equity-backed deals had an average return of 37.3 per cent, versus 21.6 per cent from non-PE backed floats.

The analysis, released last month, canvassed 65 IPOs (30 of which were private equity-backed) and was conducted by financial services firm Rothschild for the Australian Private Equity & Venture Capital Association.

"The fact of the matter is PE-backed IPOs in recent times have done better than non PE-backed ones," McKinnon says.

Shane Solly, a portfolio manager with Harbour Asset Management, says private equity plays an important role in the market, often providing capital that wouldn't be provided by other investors. "The key lesson out of [Dick Smith] for all investors is know what you're investing in."

Rickey Ward, New Zealand equity manager at investment firm JBWere, says the "buy low, sell high" strategy is not unique to private equity firms. "Where they do differ is they're not afraid to use leverage ... and they generally take a longer-term investment horizon."

Dick Smith provides a cautionary tale for investors. Photo / Nick Reed
Dick Smith provides a cautionary tale for investors. Photo / Nick Reed

What's hurting Dick Smith?

• A sales slump, which left the firm with excess stock in the lead-up to Christmas that had to be heavily discounted in a bid to bring in cash.

• Tough competition from online competitors, as well as bricks-and-mortar players such as JB Hi-Fi.

• Cashflow constraints and high debt levels - net debt sat at A$41 million ($43.8 million) on June 28.

• The end of support from its banking syndicate, which appointed receivers Ferrier Hodgson this week.

Slide into receivership


Dick Smith, a young entrepreneur and electronics technician, opened a car radio installation business beneath a car park in Sydney.

1970s: Interest in electronics and CB radio boom led to expansion.

1980: More than 20 stores in Australia and during the decade expanded to NZ.

1982: Smith completed sale to Woolworths, there was rapid expansion helped by PC boom and diversification. By late last year there were 393 stores in Australasia.

2012: Woolworths sold Dick Smith to Anchorage Capital Partners for less than A$100 million ($106 million) which the following year launched a A$534 million public listing.

2015: Sales growth slowed, huge inventory problems and shares slumped more than 80 per cent.

This week: Put into administration and receivers appointed.