Small Cap Value Report (Tue 4 Aug 2020) - AA., R4E, BKS, BRCK, NWF

4th Aug '20 by Paul Scott

38 comments 7580 reads

Good morning! It's Paul here with the SCVR for Tuesday.

Please see the header above for companies reporting today that I will be reviewing.

As usual, it's initially a blank article, which I put up about 7am, so that readers can add any comments you have about the 7am RNS releases. I then write up the main report throughout the morning, section by section. Assuming I can manage to avoid accidentally deleting any of them!

Estimated timings - I have to write today's report early today, due to needing to travel back to Bournemouth this afternoon, from London. It will be interesting to see how the city centre looks these days. It was like a ghost town last time I walked through the City, towards Waterloo. It's difficult to predict what is likely to happen to all those fancy offices, if companies decide to have staff permanently based from home. Or will companies & staff gradually return, once treatment/vaccines have resolved covid-19 (whenever that might be)? My feeling is that humans don't have terribly long memories, and it often surprises how quickly things do return to normal. after e.g. natural disasters, terrorist attacks, wars, etc..

Today's report is now finished.

AA.

Share price: 25p (pre-market open)
No. shares: 620.8m
Market cap: £155.2m

Possible Offer & Update on Refinancing Progress

Possible Offer for AA

The Board of Directors of AA plc (the "Company" or the "Group") notes the recent press speculation regarding a potential refinancing of the Group's indebtedness and the possibility of an offer being made for the Company in connection with such a refinancing.

The Company confirms that it is currently in discussions with a number of parties in relation to a wide range of potential refinancing options.

This is particularly interesting, because the AA's balance sheet was wrecked by financial engineers, who came up with the ridiculous idea to load it up with massive debt that would never be repaid. It was therefore only a matter of time before the company ran into a financial crisis. The scale of the problem is mind-boggling, given it's only now a £155m market cap company;

As stated in its preliminary results announcement on 7 May 2020, while the Group continues to remain well within its financial covenants, at the end of the last financial year the Group had approximately £2.65 billion of total…

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Chris Brown

4th Aug '20

I did my MSc dissertation on the Aa (LON:AA.) The way it has been treated does not reflect well on free-market capitalism.

The AA was founded in 1905. It was demutualised in 1999, at which point it had zero long-term debt. In 2004 Centrica sold the business to private equity firms CVC and Permira. By the time it listed in 2014, after 15 years of private ownership, AA’s debt pile was £3.3bn.

During CVC & Permira’s ownership, they attached subordinated preference certificates to the company, generating compound interest of 16% pa. The table below also shows a £2.57bn dividend paid to the holding company, Acromas, immediately prior to IPO.

Permira claim to have made a 4.6x return on investment, with the AA and Saga. Good for them. I consider it little more than corporate thievery. It is fairly disgusting and should be outlawed, in my opinion.

By my estimates, Permira & CVC extracted around £4.3bn from the business across 10 years.

They paid a purchase price of £1.75bn to Centrica in 2004, managed to recoup £1.39bn at IPO in 2014, and now the true devastation is apparent, with AA having a market cap of only £150m. Those who helped the IPO get away are also complicit, to an extent.

I sincerely hope some sort of deal is reached, so the debt may be paid off and one of the UK’s best known brands may continue as a viable business for decades to come.

If the AA goes bust and 7,500 jobs are lost, I’m sure the usual generalisms will be trotted out, about poor management, failure to adapt, too much debt. Yes, too much debt, but I doubt Permira and CVC will face any ramifications.

davidjhill

Mojo - good/interesting analysis. I have no position but the special situation intrigues me a little. What is to stop ABC, DK & Parvus doing the whole fundraise at 25p though. They wouldn't worry too much about their existing equity as the new money would more than make up the shortfall. Is that not a feasible scenario?

I did my MSc dissertation on the AA. The way it has been treated does not reflect well on free-market capitalism.

AA was founded in 1905. It was demutualised in 1999, at which point it had zero long-term debt. In 2004 Centrica sold the business to private equity firms CVC and Permira. By the time it listed in 2014, after 15 years of private ownership, AA’s debt pile was £3.3bn.

Permira claim to have made a 4.6x return on investment, with the AA and Saga. Good for them.

By my estimates, Permira & CVC extracted around £4.3bn from the business across 10 years. I consider it little more than corporate thievery. It is fairly disgusting and should be outlawed, in my opinion.

They paid a purchase price of £1.75bn to Centrica in 2004, managed to recoup £1.39bn at IPO in 2014, and now the true devastation is apparent, with AA having a market cap of only £150m.

I sincerely hope some sort of deal is reached, so the debt may be paid off and one of the UK’s best known brands may continue as a viable business for decades longer.

grumpy5

"Corporate thievery" - indeed! A good example of why the tax treatment of interest needs re-thinking.

barnetpeter

My wife and I went to our local cafe today. I am keen to support it anyway. It was rather busy albeit within the covid rules for a Tuesday; I ordered two breakfasts and two coffees to have in. That's £6 please in total. What? Of course.... its a Tuesday in August. So the Government is picking up half of the tab. I noticed that more of the usual staff were back working too. Thumbs up from the owner.

So maybe this innovative little scheme will help small businesses like this keep afloat. I hope to see this idea both extended in time and to other types of smaller retail too. Good one Rishi Sunak.

SlickMongoose

I agree with you, and it's worth looking out for these companies to avoid at all costs. Any time there's an IPO from private equity with huge debts, it's probably because they've extracted everything they could from it.

mojomogoz

I agree with what you say Chris Brown. I looked into all this too ahead of taking a position.

IMO blame attaches to more than private equity though...ie the rest of us idiots that thought this structure was okay. Some debt on balance sheet is fine for AA....a decent amount but half of what they did saddle if with.

Jobs will go at AA as old practices and systems have been updated since IPO and particularly under the current CEO (who hopefully has repointed some prior duff investment).

IMO the old CFO was part of the problem too and created a byzantine reporting and financial management approach that obfuscated (he came from the PE firm).

But even if the company goes into default on bonds the brand and most of the people will carry on

Bonitabeach

Chris,

Re: LON:AA

The real "villans" of this sorry saga (no pun intended) are:

Aviva Investors (AV.L), Blackrock (BLK.N), CRMC, GLG Partners, Henderson Global HGGH.L, Henderson Volantis, Invesco, Legal and General (LGEN.L) and Lansdowne Partners are among the deal’s backers, with 930 million pounds in commitments led by Bob Mackenzie, a former boss of car insurer Green Flag, who will be executive chairman.

These "professional" managers of other people's savings are the muppets who grossly overpaid the private equity groups for this - only weeks after the IPO of SAGA where the share price sat well below the 185p offer price and it's now 15p!

See: Speed to Exit

"Buy the fund managers not the funds"

Wol

Thank you for providing all that detail Chris. And yes, that seems to be the usual private equity formula. Nothing to do with improving the operational performance of the business. Just load it up with debt, take out lots of money, make an obscene level of profit and then float it again to unwitting investors. If it goes bust, so what. Definitely the worst face of capitalism. And a good reason for avoiding any IPOs coming out of private equity.

Operationally AA is a very good business. I have been rescued several time by the AA van. The staff are always, knowledgeable, capable and friendly. Let's hope someone can rescue this good business from what has been left by the vultures

Apologies for the duplicate post - the original seemed to vanish on the first attempt.

I agree with the comments - those involved with the IPO and indeed the bond financings are also complicit. The underlying business itself is fantastic as you say Julianh - very high margins and ROCE, a defensive revenue stream, lots of operating cash flow.

I did hold if for a brief period and would like to take the optimistic view: that if debt was repaid, then it would be valued on a high multiple and be able to pay a substantial dividend stream.

rmillaree

AA (LON:AA.)

Chris.Brown

excellent post Chris great example of ultimate capitalism at work !!

I think in defence of free market capitalism the AA. debt situation has not exactly been hidden - there has been enough time since floating where the shareprice didn't collapse that there was plenty of willing takers for the shares and it was not obviously a bad un (still isnt really looking at core business) - the fact that those bods may have lost part of the shirt 5 years later to me is the age old adage buyer beware. I would though guess unfortunately that many pension funds may be big holders of this share which is a shame. You pays you money and you take your chance though.

The stupidity here lies with the numpty millionaire directors who decided it was prudent to pay chomping dividends while the debt was going nowhere - presumably thinking that profits would never reduce we would never have a financial crisis or any other similar incident that would mean the profits would take a hit - orperhaps they ha d acunning plan all along.

Thankfully its very unlikely to be the case - the underlying business has sound profits that have excellent value as a going concern (way more than market cap which is presumably a good point being made by mojomogoz above) so other than a natural decision to close parts of the business which could happen anytime anyway i see aalmost nil chance that the core profit earning machine would be shut down anytime soon (thankfully).

kgb1953

Im not disagreeing but the enterprise value includes the debt. If it goes bust it will survive. The equity will be wiped and the business will emerge. It wont go away.

mevans6890

Very good post - while decent companies like this can be milked like this the system is clearly rotten. Such short term financial sleight of hand works firmly against the interests of the AA, it’s employees and the national interest while only benefiting those making the money. The AA provides an essential service that could have/still might be killed off by such unrestrained greed

Yes i think this is a very very good idea (social distancing sensibilities ignored) - money targetted exactly where it is needed at present with the scheme giving a fighting chance that marginal staff may be able to keep their jobs (ditto for the buisness staying afloat) . Unfortunately for me i had my mega mixed grill lined up for tonight at my local Trukish restaurant only to find out that they are not participating in the scheme so i will have to make do with sometjing not so drool worthy elsewhere - bizarre that some are choosing to turn down this free cash ogger- i guess fair play to this business if they feel they don't need to take the freebie on offer for whatever reason.

The Phoenix

Hi out of interest did you have to use apps and go on websites ?

I went out last night to a local eatery it was rammed but mass confusion on scanning codes on tables then downloading apps which only worked on i-phones, going on web sites to apply goverment discount.

The waiters/ress were generally all hunched over the tables sorting out the IT problems to get the orders through which defeated the idea of it all helping with social distancing. So much easier to just have someone stand a metre away note down the order then pay contactless.

Oversight by me to ignore the Cleveland Square 10%. This is a private vehicle of billionaire Gary Klesch https://en.wikipedia.org/wiki/A._Gary_Klesch (my rush to print made me forget about this guy...I did know)

Another interesting holder. So updating para in original to...

"Me, Albert Bridge Capital, Davidson Kempner, Cleveland Square and Parvus own 46% of the equity (0%, 16%, 15%, 10% and 5% respectively - obviously I've rounded my sizeable stake to the nearest whole number). Now we are some hard hitting mofos at the negotiation table."

This combo is interesting .

Approx average acquisition prices (done by v crude some eyeball averaging):

Albert Bridge 45p

Davidson Kempner 25p

Cleveland Square 100p

Parvus 220p

To some extent Parvus are so far out of the money and their stake at 5% is way reduced from 25% that perhaps they are just passengers.

The rest are pretty actively engaged on what the price can be. A lot depends on whether this cohort wants to seek informal price alliance....and it adds to the potential for public equity value creating recap rather than take private.

Fishcake

Ate out at the pub yesterday and no IT involved, just got half the usual bill. My main concern with the scheme is whether it's just moved the rush - will there be tumbleweed blowing through on Thursday? We're using it as an excuse to try lots of local eateries to see whether we'd be interested in using them at full price in the future. For the owners I see it as a no-brainer to sign up.

shipoffrogs

"By the time it listed in 2014, after 15 years of private ownership, AA’s debt pile was £3.3bn".

Looking at the AA's website - it boasts 2900 mobile mechanics.

So, it's managed to borrow over £1m for each mechanic. Wow!

SundayTrader

My own view on AA (LON:AA.) is that the core business - breakdown recovery - has been treated as a cash cow to spend on entry into other, highly competitive businesses. Has not gone well, and I think it would take drastic action for them to survive at all. Not investible. Don't think it is an indictment of private equity as such - some of them have been very successful as corporate stewards - I see it as management with their heads in the clouds.

smatthews1

This post definitely exceeded expectations. Nice work!

Small Cap Value Report (Tue 4 Aug 2020) - AA., R4E, BKS, BRCK, NWF

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Paul Scott

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