Aussie doer-uppers fudge Vertex financials

Friday 14th June 2002

It's an old adage. Before you buy something, ask yourself why the owner is selling. This is particularly so when the vendors are professional investors like Australia's Pacific Equity Partners and Bain Capital.

So Shoeshine launched into his copy of the prospectus for plastics packaging maker Vertex Group with more than the usual interest.

At first glance the float looks enticing. Vertex's "core" businesses are solid performers and prospects for the "growth" units look fine.

Managing director Paddy Boyle has been at the helm since Carter Holt Harvey owned the company and he obviously knows the business minutely.

Chief operating officer Jim Bini is a former senior executive of Amcor's packaging operations. He came to Vertex from PEP but is on a one-year contract only.

Mum and dad investors will be attracted by the forecast gross dividend yield of 10.3%. At the offer price of $2.05 a share, the forecast 2003 price to earnings ratio of 10.4 times hardly looks ritzy.

Still, Shoeshine's antennae continued bristling as he ploughed on through the prospectus.

The memory that kept coming back was Frucor Beverages, the last leveraged buyout (LBO) job Bain and PEP flogged off to the New Zealand investing public.

The duo, it will be recalled, bought Frucor from the old Apple & Pear Marketing Board (now Enza) in April 1998 for $50.4 million, most of which was borrowed.

The May 2000 float prospectus offered 62.6 million shares, or 50.1% of the company, at an indicative price range of $1.95 to $2.25 a share.

Sadly for Bain and PEP investors didn't buy the profit forecasts. In a move that suggested desperation the partners got the float away at just $1.50 a share.

The market was right. The prospectus forecast was for a June 2001 earnings before interest, tax, depreciation and amortisation of $42.5 million.

But the actual figure came in 29% lower at $30.1 million, mainly because the company's projections for sales of the V drink in Britain had proved wildly optimistic.

The shares never went higher than $2.52 but many analysts, and the company itself, remained optimistic.

So eyebrows were raised when Bain accepted Danone's $2.35 offer this January.

This was a mere 10c above the high end of the range at which it tried to flog off Frucor 18 months previously.

Still, there were no complaints from investors who bought in the float and made a 57% capital gain. Bain and PEP made more than 10 times the amount of equity they ploughed in less than four years earlier.

Vertex is of course a very different beast to Frucor. And Bain/PEP's modus operandi is different this time around.

The duo is selling out altogether, keeping not even a 10% blocking stake lest some multinational swing by and try to pick Vertex up on the cheap.

Ask Boyle and Bini why this is and they'll tell you Bain/PEP couldn't be bothered with the maximum 20% stake allowed by the Takeovers Code.

But this seems at odds with their argument PEP had to move on quickly because it's only a $A500 million fund.

Their haste, after only 20 months of ownership, seems indecent. They have done only the basic LBO fix-up job: cut costs, minimised working capital, sold and leased back non-operating assets.

What effect has this had? Here's where you come to the interesting bit.

Turn to the statement of financial performance on page 36 of the prospectus and examine the March 2002 year.

To make sense of these figures you may have to take off your glasses as Shoeshine did. That's because the footnotes are in microscopic print.

Included in 2002 revenue, ebit and net profit is a $2.43 million gain on the sale and leaseback of land and buildings.

Included in ebit and net profit are also a $2.15 million gain on an "extension in the estimated economic lives of intangible assets, plant and equipment," and $2.08 million of restructuring costs.

Most companies would consider these to be one-offs. Vertex has treated them as though they are a normal, everyday part of its trading activities.

Shoeshine, a diehard traditionalist, prefers to take out the first two and add back the third to get to something vaguely approximating core, ongoing earnings.

This gives 2002 revenue of $86.74 million, ebit of $6.78 million, and a net profit of just $1.31 million.

Now take a look at the 2003 forecasts on page 58 (where, inconsistently, restructuring costs are taken above the ebit line).

From the adjusted 2002 position Vertex is forecasting a revenue gain of 4.5%. But ebit is forecast to rise by 65.3% and net profit by 342.1%.

Some turnaround.

What PEP and Bain paid for Vertex hasn't been revealed publicly but Shoeshine understands it was about $13.5 million.

Twenty months later they're asking $60 million.

Sure, they got a great deal on Frucor. But the old Apple & Pear Board wasn't renowned for its business expertise or financial acumen, to put it mildly.

Carter Holt, under former investment banker Chris Liddell, is.

Could the forester really have left $46.5 million on the table for Bain and PEP?

Another useful question to ask is why Vertex' advisors, JB Were and UBS Warburg, didn't manage to find a trade buyer. They were, reportedly, looking around for six months.

Shoeshine doesn't mean to suggest Vertex is a dog. It has, after all, been around in one form or another since 1941.

But investors mesmerised by that 10.3% forecast dividend yield need to ask themselves if the cheque is ever going to arrive.

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