Consumer

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

What a difference a couple of months can make. On Oct. 28, the chairman of Australian electronics chain Dick Smith was lauding the company's "strong and conservative balance sheet" at its annual shareholder meeting, and setting out plans to open more than 30 new stores.  This morning, he announced that the company had run out of funds and was being put into administration.

What happened? Nothing that caught the eye of auditors at Deloitte, who signed off on the accounts last August without red flags, and raised no fresh issues when they were questioned at the October meeting. Christmas can be a challenging time for retailers, who take on debt to fill their warehouses in the hope of selling the inventory through the peak season, but getting that right is garden-variety stuff. If single-outlet convenience stores can survive December in one piece, you'd think an electronics chain with 393 outlets and 3,300 employees could manage it.

The finger of blame will naturally point at private equity. Sydney-based Anchorage Capital Partners bought the business from the country's largest grocery chain, Woolworths, for A$20 million ($14 million) in November 2012. Six months later, Anchorage paid a further A$74 million to release it from performance payments to Woolworths, and by the end of the year 80 percent of the company was sold back to the market in a deal valuing all of Dick Smith at A$520 million. Anchorage cleared out of its remaining stake last September, when the shares were trading on average marginally above the offer price. That 453 percent return seems pretty decent for two years of work.

Australian investors have been burned by private equity exits before. Myer, the country's largest publicly-traded department-store chain, has never regained the A$4.10-a-share price that a TPG-led group won from new shareholders in selling the stock back to the market in 2009. It's currently trading at just A$1.21. While Australia's private equity-linked deals tend to outperform the broader group of initial public offerings in the first year of trading, when existing shareholders are often prevented from selling all their shares, those benefits tend to evaporate later, leaving little return for the risk that new investors are taking on. Indeed, fund managers would typically do better just making a passive investment in the index rather than trawling through share prospectuses, according to data compiled by Bloomberg:

Pain, Little Gain
Investors in Australian IPOs don't get much return for their risk
Source: Bloomberg data
Note: Chart shows one-year and offer-to-date returns for 107 IPOs above $100 million between Jan. 1, 2005 and Dec. 31 2014 and eight private-equity linked IPOs at same values and dates. S&P/ASX 200 figures are for the median annual performance over the period and for the 10-year performance.

It's too early to work out what caused the crisis at Dick Smith, according to the administrator, Ferrier Hodgson, so assigning blame at this stage will be even harder. Anchorage certainly can't be held responsible for the scant information given to shareholders, who received just a single warning since the Oct. 28 shareholder meeting that things could be looking bleaker than expected. In hindsight, the closest the management came to disclosing how short cash was getting was the decision to "keep our cost down" (in Chairman Rob Murray's words) by holding the October meeting not at some hotel conference center in Sydney's central business district, but at Dick Smith's own offices in an industrial estate in western Sydney.

Still, you have to wonder at the speed of Dick Smith's profit recovery under Anchorage's aegis. About A$23.6 million of the forecast improvement in Ebitda in the year ended June 2014 would come from the ill-defined area of "corporate/procurement efficiencies and marketing rebates," according to the IPO prospectus -- a sum greater than the A$23.4 million of Ebitda in all of the 2013 fiscal year. Increases in gross profit, a firmer foundation for a recovery, were forecast at just A$4.2 million. 

Incredible Performance
Dick Smith's profit recovery after its 2012 buyout was remarkable
Source: Company reports

There's no reason such a turnaround isn't achievable, but it should have given any new investor reason to pause before plunging in. And remember the old lesson of buyer beware: If something looks too good to last, it often is.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

((Corrects number of Dick Smith employees in second paragraph))

An earlier version of this story mis-stated the number of Dick Smith employees in the second paragraph

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Paul Sillitoe at psillitoe@bloomberg.net