Let Watson walk on alone

By Shoeshine

Friday 28th May 2004

Eric Watson's appetite for finance companies is well known. There are so many things, he mused a while ago, that banks won't lend for.

Also a while ago (Shoeshine likes to be precise) a cartoon doing the rounds had the caption: "Sometimes the path less travelled is less travelled for a good reason." It was accompanied by a picture of a sun-bleached skeleton, or some such.

The remaining shareholders in Pacific Retail Group, all 721 of them at the last headcount, have now to decide whether they care to accompany Watson into the trackless wastes.

Watson's Logan Corporation owns 73% of Pacific Retail and the company's Logan-dominated board is proposing to flog off the crown jewels the Bond & Bond and Noel Leeming appliance retail chains in a public float late next month.

Shareholders will get a chance to vote on the proposal, but as Logan has, ostensibly, no more interest in the sale than any other holder, the outcome is a foregone conclusion.

According to brokers' back-of-the-fag-packet estimates, the float will raise somewhere between $150 million and $200 million and looks solid enough.

The question is, what will be left?

Shorn of its New Zealand retail operations, the group will have Pacific Retail Finance, lingerie maker Bendon, and British appliance retailer Powerhouse, the outfit bought from the receiver last September for $48 million.

Yesterday's results presentation showed a pretty solid result in New Zealand but investors will have to wait for the annual report next month to get some of the interesting detail.

The group will be selling 79% of its 2003 revenues, 64% of its net profit and 50% of its assets. Powerhouse, it should be noted, will add a lot of revenues and assets, but its earnings contribution for now at least remains firmly negative an earnings before interest, tax, and amortisation loss of $46.4 million.

The cash raised from the float will be devoted to "future investments," feeding Powerhouse with working capital, paying off Powerhouse's $14 million debt to Pacific Retail Finance and paying down bank debt.

Shoeshine suspects the last is by far the most significant.

The company says it is selling the New Zealand retail chains because they are mature assets no longer suited to an investment company.

But with capital notes debt in 2003 of $64 million and loans from ANZ of $98 million, Pacific Retail's equity ratio shareholders' funds as a percentage of total assets shrunk to 22.6%, from 47.4% in 2001.

In 2003, operating cashflow covered the interest bill 1.1 times, a ratio that leaves a company with tissue-thin room to manoeuvre and makes bankers very nervous.

These numbers will be the ones to look for in the annual report.

Still, you might think, the cashflow of the country's largest appliance retailer, backed by a good solid hire purchase finance company, must give the bankers a good night's rest.

Maybe not. Pacific Retail Finance recently took a flying leap into what Shoeshine, without any desire to be unduly rude, would call the loan-sharking business, where banks don't operate.

Still with the last annual report, the finance companies' assets tripled, from $70 million to $210 million, in a single year. Only some of the growth came from the secured, dependable appliance hire purchase business, which increased its loan book 2.7 times, to $41 million.

The explosive growth was in the new personal loans arm. From $11 million (net of "unearned income" and provisions) in 2002, the book rocketed to $105 million last year.

Personal loans made up 36% of Pacific Retail group assets, from 7% in 2002.

This stuff is risky, as evidenced by the effective interest rate on the hire purchase and personal loan book: 17.95%. And rewarding; the company issued its capital notes 18 months ago at 9.25%.

Pacific Retail "does not require collateral or security ... other than for hire purchase and personal loan receivables." That's fine for a fridge, a car, or a boat. But getting security on a holiday or a deck, for which the company's brochures cheerfully advertise loans, is a little tricky.

Again, the updated figures will be interesting. The company noted yesterday that Finance division assets under management, including securitised receivables, rose 54% to $517 million.

The riskiness of the charge into personal lending shouldn't be exaggerated.

Although such loans are vulnerable to an economic downturn, there are few signs at present that one is in sight.

And today's Budget with its largesse to high-borrowing, low income earners will boost consumer spending and help underwrite credit profiles.

Neither have doubtful debt provisions mushroomed: the 2003 figure was 3.3%, up from 3.2% a year earlier, although cynics would say companies have plenty of latitude to massage their exposures.

Even so the "rump" Pacific Retail will consist of a still-unquantified Black Hole in Britain; an aggressive, risked-up finance company; and Bendon, one of the group's bright spots. In the latest year revenue rose 21% to $110 million and ebita rose from $4 million to $10.7 million.

Impressive though that sounds, with a newly floated Pacific Brands tipped to compete aggressively for market share, Shoeshine wouldn't place much stock in Bendon's ability to boost its revenue or earnings by so much from here on.

In fact if he were a Pacific Retail shareholder he'd be taking advantage of the curiously strong share price to cash up, stick his money in the bank and see whether the pricing of the retail division float looks attractive.

Those who hold on can expect another stingy mop-up offer from Watson.

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Let Watson walk on ­ alone

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