Dick Smith was purchased by a Private Equity firm from Woolworths in 2012 for A$115m. It appears however that it only cost them $10m of their own cash. Private Equity then sold Dick Smith on the sharemarket for A$520m.
On the face of it, it should be a profitable business. What happened?
Well, the short and simple answer may be that it’s the difference between cashflow and profit. Private Equity is focused on cashflow, while the sharemarket is interested in profit. Private Equity took a bet on the cashflow, and the sharemarket on the profit. We know who won.
When Private Equity purchased Dick Smith, it appears they stumped up with A$10m of their own cash. The remaining A$105m of the purchase price came from Dick Smith itself.
A massive clearance sale of stock meant that there was plenty of cash floating around to pay the remainder of the purchase price.
However, selling the stock at less than original cost would (generally) create a loss on the Profit & Loss Report. Private Equity needed to avoid this to make the eventual sharemarket sale easier (remember, the sharemarket is interested in profit).
The trick is writing down the value of business on purchase. From the financial statements, it seems that Private Equity wrote down stock by A$58m, plant and equipment by A$55m and made other provisions of A$8m. This hit would only have been picked up on the old company’s financial statements with a lower profit reported but as we know the Private Equity firm is not so concerned about profit.
These write downs at the time of purchase meant that the subsequent fire sale of stock didn’t have an impact on the bottom line.
Now the sharemarket listing gets a little more complicated. Improving the bottom line and Balance Sheet isn’t quite so easy. Amongst other things, this involves a reduced depreciation expense from the plant write off, a benefit from low opening stock after the fire sale, and reversals of provisions. In short, they were able to confidently forecast high profits, and made the share market listing a success.
In Walk the Banks
Now the banks would have realised that they had an issue with their lending to Dick Smith. They will have identified that they were unlikely to get their lending back any time soon if they didn’t pull the pin.
If you were the bank, there’s no better time to pull the pin than just after Christmas. Dick Smith have just finished their busiest time of year, there’s not too much stock sitting on the shelf, and they may not have placed further orders for stock. Put another way, major retailers never have more cash in than what they have at Christmas time. What better time to pull the pin?
What’s more, Dick Smith have no doubt sold vouchers and got more cash in the door. The bank can use the cash from the vouchers to help recover their debt. Cynical maybe, but good practice from the bank.
My thoughts on vouchers
I completely understand why the banks did what they did. To be honest, I’d likely do the same thing if I were in their position. However, at the end of the day the holder of the voucher is left to fend for themselves.
Personally I’d love to see some sort of trust system, where the funds from the voucher is held in trust and can’t be accessed by the business until the voucher is redeemed or expired. This would protect the holder of the voucher from this happening in the future.
Now in reality it’ll never happen…all I can do is hope.