Why Dick Smith’s IPO was in trouble from the start
Tuesday, February 2, 2016/
Dick Smith’s ASX listing and its subsequent slide into receivership have taken on the appearance of a car crash but it’s a crash that’s been caused by reckless driving.
The listing was always set up for trouble. Stock reductions prior to listing left Dick Smith short of cash. Combined with prior stock write-downs, this was an act of restructuring that made earnings look attractive on a profit and loss statement and generated considerable cash for the previous owners, but difficult for potential investors to see the true value of the business.
If Dick Smith were being sold in a private transaction, potential trade buyers and their advisors would be savvy enough to identify gaps in balance sheets and look for evidence of long-term, sustainable cash flow.
But initial public offering financial document disclosures only require the most recent balance sheet – in comparison to three years’ worth of earnings and P&L details. The emphasis that listings place on earnings makes it difficult for mum and dad investors to get a true sense of the long-term viability and cash flows of a business.
Shareholders vs stakeholders
When we talk about the success or failure of IPOs, we talk in terms of how much money is made for owners. In an age of socially responsible investing, which considers social and community effects in addition to environmental ones, we need to question whether simply focusing on how much money a listing generates is too narrow and if it further encourages would-be investors to disregard balance sheet fundamentals when faced with attractive earnings figures.
It’s important to remember that stakeholders to the sale of a business are not just its shareholders.
Dick Smith’s administrators may be able to find a buyer who will take what’s left of the company but its reputation and the loyalty of its consumers are irrevocably compromised. This necessarily affects future sales and its ability to maintain a foothold in the market, further reducing competition and potentially forcing up prices on consumer electronics.
Dick Smith’s competitors may also feel the pinch. It’s not difficult to envisage a reality where customers who lost money on Dick Smith gift cards are less likely to buy gift cards from, say, JB Hi-Fi or Harvey Norman in the future, which would affect the cash flows and earnings of other consumer electronics retail firms.
And for Dick Smith employees who may stand to lose their jobs, if confidence in consumer electronics drops it will be harder for them to find jobs within the sector.
The implications for investors
The effects are broader than consumer electronics retailers as well. Confidence in the ASX is also lowered; when a 48-year-old iconic company with a long-term trading record lists on the ASX, it’s an act that is supposed to confer stability, trust, and the aura of a good investment.
Prime Minister Malcolm Turnbull has set his government a mandate to encourage innovation and to attract more foreign and domestic investment into the ASX, badging it as a safe and desirable investment destination. So when an icon of consumer retail goes under after listing because of reckless attempts to structure it in a way that makes it more attractive to investors and allows the vendors to pocket more cash, confidence in the ASX can’t help but be undermined.
Hits to confidence flow through to the sort of mum and dad investors who Turnbull hopes will become driving sources of crowdsourced equity funding. Any event like Dick Smith’s collapse is likely to make this class of investor a little more risk averse, and a little more likely to hold onto their money.
This strikes a blow to the greater risk-taking culture that Turnbull hopes to promote.
It’ll be tempting for regulators to respond with more red tape but all this will achieve is to make it harder for genuine businesses to get themselves to the point of listing.
What’s more, the interests of small business are represented in parliament – after all, there is a minister for small business – but middle market firms, which are most susceptible to such reckless behaviour, remain under-represented and under-considered by governments, despite their importance to the Australian economy.
Maybe it’s time for the government to consider a minister for middle markets. It’s certainly time for regulators to approach listings from the perspective of commerciality rather than simply making sure that technical compliance requirements are ticked off against the relevant legislation.
Whether it’s at a regulator level or an investor level, we need to take a broader view of whether these transactions are ‘genuine’ and represent long-term viability, or whether it’s an exercise in reckless driving designed solely to make the sellers as much money as possible.
Michael Sonego is a corporate finance partner and Simon Johnson is a corporate finance principal at Pitcher Partners.