Here is my story that appears on the Fairfax sites. I have a go at private equity, but they can take it. I also look at a new stock I'm covering, Corporate Travel. It will be interesting to see how the Qantas lock out effects the travel agent business.
Collins Foods hard to swallow
November 4, 2011
Could the Collins Foods debacle be the nail in the coffin for private equity in this country?
Many small cap fund managers are saying as much, after the Queensland based KFC franchisee delivered a significant profit downgrade just three months after its initial public offering, having raised a touch over $200 million. At $1.26, its shares (ASX code CKF) are now down about 25 per cent this week and are roughly half their $2.50 listing price.
The vendor was the private equity firm Pacific Equity Partners, which sold its 52 per cent stake in the float managed by Deutsche Bank and UBS. After a mountain of debt was repaid, Pacific Equity netted $60 million from the sale.
Collins Foods said that the reason for the downgrade was the “fragile consumer confidence”, but this flies in the face of the reason investors invested in the first place.
The UBS broker report released prior to the float said that Collins provided “exposure to the defensive fast food segment”.
“Defensive against what?” investors must be asking.
The concern in the funds management industry is understandable. After all, some of its biggest names in the sector each hold stakes of more than 5 per cent - MLC, AMP, BT, Aviva, Pengana and Colonial.
The fundies spoken to have all said they would think very carefully before buying when private equity is involved in a sale. Mutterings of “juicing the profits up for sale” were the flavour of what Radar heard.
What is private equity?
For the uninitiated, private equity take moneys from institutions such as super funds, normally in $10 million lots. They then borrow as much as they can and use the money to buy companies, with a view to selling them within five years.
The idea is to strip the company down to the bones by cutting costs in order to make the interest payments, and produce a massive return for investors.
In return for doing this, the private equity fund manager normally takes a 2 per cent management fee on the funds committed by institutions and 20 per cent of the profit made on any transaction.
It is the selling bit that is the hard part in this process. The domestic funds are under pressure and we understand that superannuation funds are ditching domestic private equity in favour of offshore operators that typically don't have as much trouble exiting investments.
The Collins Foods disaster comes in the wake of other private equity flops, most notably the $2.4 billion float of Myer (ASX code MYR) 18 months ago by TPG for $4.10 a share. This stock now trades at $2.42 and is associated with a high profile tax chase by the ATO.
Other failures include the retailer Colorado, which was owned by Hong Kong based Affinity Equity, and the bookstore chain Borders, owned by Pacific Equity. That latter firm has also been unable to sell the Godfreys vacuum-cleaner business, so it must have needed the money from Collins Foods badly.
There have been successes, notably adventure wear retailer Kathmandu (ASX code KMD) and Archer Capital's sale of Rebel Sport to Super Retail (ASX code SUL) for $610 million. But overall, because of its microscopic size, Australian private equity will struggle - the sector has about $25 billion under management in contrast to the $3 trillion or so managed out of Europe and the US.
Which brings us back to Collins Foods. After the downgrades, the stock trades on a current price/earnings multiple of six times and a dividend yield of 7 per cent. As one invested fundie said: “The big money is made when people panic and KFC isn't going out the back door. Buy the fear, buy the fear…”
He didn't say whether he was topping up his holding though.
Travel agents bucking the trend
AGM season is throwing up a raft of upgrades and downgrades, but most observers agree that it is the latter which is predominating as tough spending conditions prevail.
One group of companies that has been bucking the trend is travel agents, with significant earnings upgrades from Flight Centre (ASX code FLT), Webjet (WEB) and this week, Corporate Travel Management (CTD).
Corporate Travel forecast operational earnings growth, or earnings before interest, tax, depreciation and amortisation (EBITDA) of between 30 to 40 per cent for this fiscal year. Its chief executive Jamie Pherous said that the FY2012 results so far “are at the top end of the guidance range”.
The main reasons for the success of the sector are the high Australian dollar, encouraging people to travel overseas, and cheap flight prices.
In the wake of the Qantas lock-out announced last week-end, it will be interesting to see whether flights remain at current levels.
One fund manager who is invested in Corporate Travel said that he liked the stock because of its Big Brother service:
“The real added value is that corporates can check on where their people are, which will win them market share. (Corporate Travel) has this iPhone app with GPS that really locks people into the service.”
At $1.90 the company has a market cap of $137 million. It's slightly expensive, trading on a P/E of 11.5 times, but it certainly seems to have tapped into the zeitgeist of the high-flying executive culture.