Australia IPOs: Crisis of confidence?

As far as LPs are concerned, Dick Smith Electronics is a success story. Anchorage Capital Partners acquired the underperforming Australian business from Woolworths in 2012 for A$20 million ($14 million), plus a share of any upside resulting from the PE firm's exit (this right was bought out by Dick Smith for A$74 million). Following an IPO in late 2013, Anchorage completed its exit in September 2014 with estimated total proceeds of around $450 million.

The turnaround from distressed asset to a valuation on listing of A$520.3 million is detailed on the PE firm's website. A new CEO was appointed; new key performance indicator (KPI) dashboards were linked to staff incentives; training and recruitment were improved; new relationships were developed with suppliers and existing agreements renegotiated; the marketing strategy and website were revised; and old and obsolete stock was cleared, and new stock management and ordering practices were phased in. The store network was also expanded under new brands and formats.

Net profit had slipped from A$13.2 million in 2012 to A$6.7 million in 2013, with EBITDA falling from A$32.6 million to A$23.4 million, and sales declining from A$1.37 billion to A$1.28 billion. In 2014, net profit rebounded to A$42.1 million, with EBITDA reaching A$74.4 million and sales coming to A$1.22 billion.

Just over a year after Anchorage sold its remaining shares, Dick Smith has entered receivership and the unofficial post mortem is underway. The company's founder - who sold the business to Woolworths in 1982 - has blamed Anchorage and politicians are calling for an independent inquiry into the GP's behavior.

A more detailed critique of the investment came in late October when Forager Funds Management concluded that the PE firm had done all it could to dress up the business for the IPO at the expense of long-term sustainability. It claimed that Anchorage marked down the assets as much as possible as part of the acquisition and substantially reduced inventory so that cash flow and earnings were artificially inflated. Two years later, new inventory had been purchased, cash flow turned negative, more debt was taken on, accounting provisions were tapering off, and financial performance suffered.

It remains to be seen to what extent Anchorage is responsible for Dick Smith's demise, but there are already worrying ramifications for private equity as a whole. No one has accused the GP of illegal activity so the retail investors who lost out did so at their own risk. However, the question is whether any PE-backed offering in Australia should be taken at face value.

The last authoritative study of the performance of PE-backed IPOs was carried out by Rothschild, with the Australian Private Equity & Venture Capital Association, and published in early 2015. It analyzed the share price returns for 49 IPOs - 23 PE-backed and 26 non-PE backed - on the Australian bourse in 2013 and 2014 with an offer size of A$100 million or more.

The PE-backed IPOs since 2013 had achieved an average return of 10.3% and a weighted-average return of 16.9%, outperforming non-PE backed IPOs by 3% and 4% respectively. In 2014, non-PE backed IPOs outperformed PE backed IPOs on an average basis by 7% and on a weighted-average basis by 5%. All the IPOs had also significantly outperformed the benchmark Small Industrials Index for 2013 and 2014.

In 75% of cases, PE firms retained a stake in the business post-IPO, with an average holding of over 20%, to ensure an alignment of interests between incoming and existing shareholders.

Clearly, not every PE-backed offering is a time bomb, and the minority of situations in which problems are encountered attract disproportionate attention. A couple of years ago at an AVCJ Forum, several industry participants said it was irresponsible for investors to make a full exit on IPO. It is, however, worth discussion as to whether the typical holding period - GPs often exit once the 12-month earnings forecast period in the prospectus expires - is long enough.

In several other Asian markets the lock-up periods are longer, with PE investors in China-listed companies unable to sell their last tranche of shares for three years. Admittedly, this is a bugbear for many China investors, but if there really is a crisis of confidence in PE-backed IPOs in Australia - and we don't yet know if this is the case - perhaps special action is required, voluntary or otherwise.

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• Topics
• IPO
• Australasia
• Regulation
• Australia
• regulation
• IPO
• Exit
• Anchorage Capital Partners