AA (not) okay!

I wrote about Aa (LON:AA.) here speculating that there was considerable upside...

https://www.stockopedia.com/co...

Well, today I capitulated and sold at c.32.6p. I bought my first piece at c.85p in early 2018 after the change to new CEO and new 'strategic plan' and I bought my last piece at near 15p in covid panic. I averaged a 23% loss on a not insignificant position. In another situation I would have bought more at 15p and be positive today but I only half bought in March/April as the reflexivity around balance sheet and financial market situation was gigantic so assuming sound assessment of 'fundamentals' was more hubristic than normal. And if my view was right then the upside was a lot anyway.

I still believe that there is a lot of value on the table and this is a good, durable and high quality business but with a capital structure that needs fixed...but as its a good underlying franchise the capital structure is fixable.

At 85p I believed that combo of secular persistent low interest rates and slow deleveraging meant that AA was a combined macro and stock position with high embedded optionality. It was uncomfortable but had a valuable role in my portfolio due to idiosyncratic high upside potential.

Once the global yield blip came around late 2018 and early 2019 (a false dawn in growth/inflation expectations!) then AA went down as yield on debt went up so refinancing more costly. I bought some more in low 40s. It was now clear that without reversion to low yields an equity refinance would me needed. Still good upside IMO...with the super upside of slow deleveraging still there too.

Its a tough/galling/ironic that there's been a number of very speculative and questionable equity raises since covid kicked in. Things like companies raising cash so as they have a war chest for acquisitions even when the raiser has a less than certain business themselves (it can be small, rapidly growth etc...but a speculation rather than a durable franchise certainty). The AA is a much safer and value creating candidate for a raise. In my previous post linked above I compared it to Diageo (LON:DGE) and I really don't believe this to be a misappropriation of Diageo's quality.

However, I think the issue is that AA mgt don't want to be public and aren't up for the fight with shareholders. The CEOs increasingly worn down presentations at results were a clue I should have weighted more perhaps. Obvs shareholders can knock back the bid but it feels to me that comes with a new CEO as the current one wont want to play on...without someone providing a really quick solution in replacement. A replacement solution to the bid may appear but it will take time and probably share pain to muster as someone needs to go sell to some deep pocketed institutions how supporting an equity raise at a premium to current price and greater than the market cap of the current listing is a good idea....its a sure fire fast profit on committed capital (as explained in prior note). Why? The underlying business is high quality and not to be confused with it bad capital structure.

If shareholders find their collective balls and knock back the bid then that's vg, but....its probably going to make the share price very unhappy in the interim. I've got a decent chance of being able to see this unfold and buy back in at a price that is below my sell...I know the company well and can price info quickly. I'd buy above my sell price too as the transformation in outlook would be profound (assuming the right approach to new equity).

Today's update on the bid contained this statement: " In addition, the Proposal includes the option for eligible AA shareholders to elect to receive unlisted securities in lieu of cash consideration subject, inter alia, to elections being limited in the aggregate to 16 per cent. of the equity of the acquiring group¹." (Note 1: Electing shareholders are likely to have to make a further equity investment very shortly after closing of the offer to avoid a material dilution in their ownership.)

The above statement looks to me like they've peeled off some existing investors to support the bid. Two of the significant shareholders are hardball corporate finance sorts (Davidson Kempner and Gary Klesch). Together they own c.15% of equity directly and then DK have a further c.10% in swaps increasing their economic interest alone to near 16%. This pocket seems ready made for one or both of these guys and may leave only Albert Bridge with 20% (public market value investors) as significant stand outs. Really hard for me as small guy to see where this game is at but the 16% pocket probably boosts the power of the 35p bid significantly....

...and even if resistance is successful to the bid it will make the resistance messier and longer duration. This means I get to reassess again at lower price.

Additionally, a significant negative for me in 2020 has been my experience of the Smart Breakdown product and I believe the customer engagement model is suboptimal and demonstrates financial strains. Earlier this year I joined the AA with one of my cars as it came off 3 year warranty to check it out. I also took on their Smart Breakdown product as an additional option. It costs £49pa which gives you a plug in dongle manufactured by Trakm8 Holdings (LON:TRAK) . IMO smart breakdown and the move to be full on motoring data company by AA is a great thing...something that secures franchise durability, generates lots of future revenue and partnerships opps and will lead to superior customer service and loyalty...

BUT they need to fund that transition rather than get customer to pay £49 for it (maybe a lesser sum would work, say £15, but £49 on top of membership is a joke). In addition, the dongle isn't even mine to keep and if I cancel subscription I've got to send it back (not that its much use to me but its a but of a pfaff and annoying).

The problem with £49 is multifold. If the car works fine through the year then I neither use my membership nor my smart breakdown...yet I've paid for two services I don't use, although its hard for me appreciate that Smart Breakdown is an additional service (its one interaction with me thro year was to message me and tell me that my battery was going a bit flat during lockdown!).

A business in a healthier position would take more of the immediate cost of this 'innovation' itself so as to secure it future franchise. I believe AA aren't doing this due to capital structure. This piece of perspective made me realise that an equity raise was more necessary and that the most optimal route of slow deleveraging had more business negatives than I'd originally assessed.

Anyway, I don't know if my perspective above is correct. Such a fluid situation now and the reflexivity around resolution is massive. There's decent odds I regret my capitulation. The 16% pocket just makes me weight the information and expected path differently.

High risk, DYOR