AA: Who rescues the 4th emergency service?

1st Feb '18 by mojomogoz

98 comments 15187 reads

Hello

I wrote a response to an interesting discussion re general UK stock debt level kicked off by kalkanite (https://www.stockopedia.com/content/the-mass-misallocation-of-capital-303808/?submitted=15#15).

I'm interested in AA views so have copied and pasted here for anyone else interested in AA. Here goes....

AA has been on my radar since latter part of 2017. My work on it is really light so far so not very informed and interested in in feedback. I think an interesting opportunity may emerge out of short term pain.

My view is that AA is a great business with a bad capital structure. This is interesting and could lead to opportunity for me. Margins are very high. This is as it sells reassurance as much as actual real product. I see the move to electric vehicles over time as an opportunity to sell its very high margin reassurance brand and do even less than it does now!

My near term outlook on AA is that a financial event is very likely imminent (IMO inevitable) under the stewardship of new CEO Simon Breakwell (explained below).

The options:

1) meaningfully dilutive equity issuance
2) debt for equity swap
3) Take private / takeover
4) Dividend suspension

4 is an absolute certainty IMO. Its only worth £50m retained cash but Breakwell needs it to fund growth strategies for the business. Look at his past (founded and grew Expedia and then developed Uber Europe) and it is easy to see that this is a guy you have as CEO to grow and develop the business and not run it as sparsely as possible just to pay back bondholders. Paying back bondholders is a necessity and he will try and grow to do it rather than prune and shrink. He needs the £50m to invest...and I am not sure on the debt covenants (haven't done that level of work) but the firm is obviously fearful of breaching them and must be too close for comfort. so they need to make extra room in cash flow to make investments.

On to option 2. I don't think the PE firms that IPOed AA are bondholders so its all new money (nearly all the debt was issued in 2013). That means that debt for equity is not likely, at least not without…

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rhomboid1

28th Feb '18

There’s a conference call in an hour that is essential listening for anyone short or long ;

‘AA Bond Co Limited

(incorporated with limited liability in Jersey with registered number 112992)

Call regarding Announcement relating to strategy of the AA Group

Building the new AA

Following the announcement made on 23 February 2018 by AA Bond Co Limited that Simon Breakwell, CEO, and Martin Clarke, CFO, will hold a further call on Wednesday 28 February at 15:00. They intend to address additional investor questions relating to the AA Group's strategy as well as its capital structure. The Company notifies those wishing to have any questions answered to submit them by 9am on Wednesday 28 February to InvestorRelations@theAA.com.

Answers to the Frequently Asked Questions relating to the Group's strategy and capital structure will be dealt with in writing and posted after the call to the AA website: http://www.theaaplc.com

The Dial in for listening in to the call are:

Dial in: +44 203 936 2999

Password: 97 89 05

Replay: UK: 0203 936 3001

US: +1 845 709 8569

All other locations: +44 203 936 3001

Password: 13 19 56’

mojomogoz

Thanks. Looking forward to it :)

Hopefully it does not shatter my delusions too severely

Some quick thoughts on the debt:

1) Whilst everyone is clear that the debt is too much, particularly relative to the current valuation of the equity. This is somewhat circular...higher equity value makes debt look less disrespectable...nevertheless it is just bad. But with equity low the earn out looks much further away and that creates a self reinforcing vortex.

2) However, the debt holders are equally trapped. Undoubtedly they never believed that they were getting fully paid back over duration of current bonds. A significant proportion was always getting rolled over. AA is a strange sort of prisoners dilemma

3) Bondholders will want to protect cash flows to them....but they cannot be seen to be in the way of anything that stands in the way of the equity.

4) Did new CEO just play bully with the bond guys by outlining his plans for growth? Probably they would have preferred him to be on the old script of all okay and earns lots of money....but that doesn't suit him...nor really the future of AA.

My conclusion is that I think the idea of imminent bond harassment and covenant stress is overdone. Lets say that that the covenant get technically broken. What are the bondholders going to get as collateral? Much much less than they need. Pennies in the pound as its a brand with high cash flow potential. What they need is the company to be run in a way that pays them back with adequate long term forbearance from them...

The prisoners dilemma.

I am expecting a really rather dull call as everyone apart from the new CEO is currently snookered. Famous last words...boom...

ed_miller

21st Mar '18

Re AA (LON:AA.) "I cannot see how they can avoid a massive debt for equity swap."

- Maybe that will happen, though they don't have that much bank debt (just as well with you guys and your net debt/EBITDA covenants ;-) but they do have quite a bit (everything is relative!) of underlying operating cashflow (i.e. prior to movements in WC) interest cover and high recurring revenue. Plus they've refinanced last July, at reduced bond interest rates, and don't need to pay anything back until July 2020. They have revised their dividend payments so as to redirect it to additional opex & capex and avoid breaching their dividend payment 'covenant,' so I wouldn't expect them even to cut their dividend. Very few companies could manage as much debt as the AA (LON:AA.)

Re the AA (LON:AA.) the debt looks affordable to me following the refinancing (very high but manageable), and it doesn't look to me that debt covenants will be broken nor even that the dividend will be cut now they've dropped it to 2p per year, though I wish I hadn't bought it on the 8th Feb(!!) and I wish I hadn't bought just after a new CEO was appointed - him and his bloody kitchen sink.

Do you still hold (as I do)? Think I'm doomed?

Yes, I have bought some between 85 & 90, and will probably pick up some more. I have analysed the debt and think it is sustainable too unless there is significant and imminent deterioration in operations. I'll write a post when I get time.

Thanks. I've analysed the debt structure, cashflow, business model and been following the AA's efforts to rebuild itself after being hollowed out and debt-laden by vampire PE on and off for nearly three years. I was wrong in my timing but anyone can look at high debt ratios and suck through their teeth. The AA (LON:AA.) has debt that would sink nearly every company, but the AA is not like nearly every other company. I feel that with shorters & bears around we who hold AA shares are too pessimistic about its prospects. I'm happy to listen to a detailed bear case, people, that shows me I'm wrong in thinking the refinance, current debt structure, covenants and the business strategy will, slowly, do the trick (though it's a tough one), but quoting leverage ratios that are frightening and would sink most companies doesn't answer that and isn't adding anything.

PS And don't just bang on about its sh*tty balance sheet, people - I know it's sh*t! The AA (LON:AA.) depends on its strong cashflow, strong brand and high recurring revenue, not its sh*tty balance sheet.

nicobos

18th Apr '18

Very positive bounce on the annual results. Business is still very cash generative and profitable so debt service doesn't look an issue (for now). Could be a good time to take a small position!

nigelpm

Lots of shorts closing would be my immediate guess. They were a reasonable set of results all told but need to make progress on the debt for me. No interest currently.

I bought in after the strategy presentation in Feb in the 85-90p range. The move seems entirely sentiment driven at the moment so could easily go up or down 30p for not much reason. I got about 2/3rd position then waited...but it's taken off and I won't chase here...a bit annoying as I was being greedy seeing it had traded down as low as 70p and I thought I would get a chance to buy more at a lower settled price. I don't see what was terribly surprising to the positive side in the results and they were quite business as usual. That said, I listened in to the mgt call, but I haven't gone through report in detail as busy on other things. I will do ASAP.

I'm naturally a bit contrary and happiest to buy when I like something and others don't if I believe I can see a fundamental base with upside. It can be annoying but is what it is. In the last 4-5 months I've bought quite a lot of names on a contrarian kick and I think that held me back from loading fully into AA (LON:AA.) as it was giving me a confidence wobble to go into so many at once. I felt like I might be having some sort of analytical brainfart.

I like AA a lot. I have modelled debt profile assuming zero growth thro to the new CEOs targeted EBITDA growth at 5-8% and then looking at debt rescheduling at current rates and up to 3% above current (note that their current interest burden is above what they could strike today in the market so I'm effectively assuming >3% rise in cost of finance). Looked at a 7yr ish horizon and the dynamics. I felt the analysis showed me that AA is far too cheap assuming fairly poor growth outcomes and debt cost rises, and hysterically cheap if there is any pick up in performance and cost of debt doesn't rise much. I'll be sounding like a joker but from purchase I felt that my outcome was something like 2-10x what I paid without factoring in the potential for new CEO to build other revenue lines (IMO 2x was just ticking along). Big window I know but when margins are as high as they are at AA (>30%) a flip to positive perspective is massive. Of course, there is a more negative outcome which is AA's business being competed away by OEMs and 'EV revolution' - I think neither likely and that AA will benefit from both.

(Note: I think there is potential for more than 10x upside from purchase price...but I might sound mad if I say that...)

Since I kicked off this AA discussion I planned to post up the analysis and some other views re company but haven't had time. I will try to do it.

Shorts have come down. IMO looking at the list of significant shorters I felt they tended to be quanty and/or trend biased. High debt and negative price momentum gets them going and they short it down as far as it can go and then cover as it comes back up. In factor sense can work well however perhaps they did not weigh the extent of AA's margin and more joy in weaker margin companies likely for them

Well played - I nearly bought at 90p but couldn't bring myself to do it with the debt where it is.

They have but they are still c.10% if I recall correctly - will have had a fairly major impact on recent price moves - any hint of good news - as there was in that statement send them to the hills.

Thanks...however, I'm planning to hold so only well played if I sell out at a profit and don't get dragged down into a debt crisis vortex!

Gorsh

I'm fairly new to Stockopedia, so can someone please explain how the momentum rank is only 1? I bought AA. in early March and am up over 80% since then. Interesting thread, I bought using a biggest faller list and thought they surely couldn't go any lower.

Nick Ray

It's based on these factors:

https://www.stockopedia.com/aj...

AA MomentumRank™ Components
Ratio	Value	Rank
Price Momentum Factors
%-vs-52-week-high	-51.3
%50dma / 200dma	61.1
RS 6m	-13.6
RS 1y	-51.5
Earnings Estimate Upgrade Factors
% 1m EPS Upgrade FY2	-10
% 3m EPS Upgrade FY1	-34.4
Scaled Earnings Surprise	-2.76
EPS Surprise %, Last Interim	-8.13
Change in Cons. Rec. 1m	0.11

The calculation is explained here:

https://help.stockopedia.com/p...

But as you can clearly see most of the contributions are well in the negative because they are looking back over about six months to a year which is why the Momentum Rank is so low.

19th Apr '18

Thanks for that Nick - I realise now I could have looked all that up for myself. I was a little puzzled after the recent price jump, I suppose being able to adjust the momentum over shorter timescales would be useful - but on the other hand there are other ways such as biggest risers list to spot stocks rebounding after a low. Another thing to watch for! as for the AA I don't want to jump yet as there could be a lot more upside to come.

You could also look at % Price change over 1 month or 1 week in a screen (or RS 1m) for short term momentum. So for example you could screen for low Momentum Rank but high "RS 1m". (Comes with a lot of risk though obviously)

TheShareWhisperer

31st Dec '18

Where are we with the AA now. Dividend was cut, but the saving seemed to go to paying for Software rollouts rather than paying down debt.

Is it cheap at 70p, or is the debt issue going to drive it cheaper until it is clear how it can be reduced

I'm still holding after buying (85-90ish I think) following the plunge following the strategic review in early 2018. As of today I'm underwater. At time of purchase I expected a very wide and uncertain performance arc (probably said somewhere in this long thread). That has been the case as the period from 2018 to 2019 results can really only be coloured by sentiment rather than proof of progress.

Results coming at end of January 2019 will be the first concrete measuring point for new CEO. I don't expect any great tangible evidence through financial performance and, perversely, tangible progress may come with some modestly negative short term financial consequences.

I have a half position. Partly as not sure where the bottom is and partly as there is an inherent lack of visibility through this change process. However, with AA's strong position and brand I feel a positive outcome is near inevitable so why I don't I buy more at this price?...well, a badly received year end could see the price down at, say, 40p. Absolutely preposterous unless you believe its game over for AA. I'll buy more down there unless debt sustainability is tangible rather than market angst...

I don't believe there is a problem with debt sustainability. It was saddled with a silly amount (at least £1bn too much) and of course as equity falls the debt looks more ridiculous. If it got nervy the AA debt structure and the nature of AA's business (all intangible value really thro brand and service provided) there is no incentive for debt holders to spook the equity horses. So far the evidence has been that debt holders are happy and rollover on favourable terms.

My perspective is 5+ years but I believe I'll get multiples of purchase (10x) through earnings growth (top line and some debt reduction) and multiple re-rating. I just need to not worry about the near term stresses and strains.

HNY!

AA: Who rescues the 4th emergency service?

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Mojomogoz

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