Too many firms created an illusion of success with hidden debt
The era of cheap credit may be little more than a fond memory, but it’s only just now that the irresponsible behaviour of some of our corporate leaders is coming home to roost.
With debt unprecedentedly cheap and plentiful in the five years until last July, many chief executives ratcheted up their borrowings to boost profits growth — and their own bonus packages. However, a degree of subterfuge was involved and investors were not always informed.
Colin McLean, founder and chief executive of Edinburgh-based SVM Asset Management, believes that many ordinary investors are now paying the price, having remained blissfully unaware of corporate conjuring tricks. He says many boards were, at best, disingenuous in their use of debt.
The practice is one reason so many consumer-facing firms, such as housebuilders and food and drink businesses, previously resilient through economic downturns, have in recent days seen their share prices drop.
McLean believes investors should have spent more time poring over cashflow statements than earnings-per-share. He says investors need to be particularly wary of firms which, over the last five years, have returned capital to investors, bought back their own shares or made acquisitions with cash.
He says: “Debt seems a simple concept, yet it is widely misunderstood. In a bull market, few question debt, as gearing boosts growth. But now, as the economy slows, high borrowings punish companies. The share prices of many consumer and financial businesses have collapsed. Investors urgently need to learn how to assess debt risks and companies themselves must give much clearer disclosure.”
McLean points out that many boards have recently scrapped buyback programmes, having recognised that they had taken such things too far. Trinity Mirror, publisher of The Daily Record, spent more than £108m to buy back 35.5m of its own shares at an average price of more than £3 a share.
Following an 80% collapse in the publisher’s share price since January, investors are entitled to wonder if this was money well spent. With the shares at 70p, they are today worth less than a quarter of the average price at which Trinity Mirror bought them back.
Now the newspaper group’s buyback programme has been stopped, and not before time, believes McLean. He thinks investors need to be wary in today’s climate, even of companies that claim to have adequate banking facilities. “That cannot be taken as any reassurance, as they may be in breach of lending terms simply because of falling asset values or earnings. The actual terms of the banking covenants that must be met, such as income cover, will determine whether these borrowing facilities can actually be drawn down,” says McLean.
“Investors have lost out heavily in recent weeks, with shares of some indebted businesses in freefall. Apparent strong asset backing and attractive dividend yields have drawn unwary investors into businesses that were actually at the mercy of their bankers.”
Sir Fred: older and wiser
Sir Fred Goodwin has changed his views when it comes to older, more experienced bank managers.
When the Paisley-born accountant ran National Australia Bank’s Glasgow-based Clydesdale unit in the 1990s, his Melbourne-based masters egged him on to orchestrate a cull of older managers as part of a cost-saving drive.
Thanks to the ruthless precision with which Sir Fred — now at the Royal Bank of Scotland — carried out this task, he earned himself the nickname Fred the Shred.
It might have something to do with his age — Goodwin turns 50 this year — but the banker is now looking more favourably at experienced colleagues.
According to a report last week, RBS is now calling on so-called Captain Mainwarings — seasoned bank managers who have seen a recession or two — to help small business customers pick a path through the current economic doom and gloom.
RBS believes that having a few grey hairs around will be particularly valuable to SMEs whose own managers are wet behind the ears. Appropriately enough, the programme has been called Project Common Sense internally. It’s a shame there was no grey-haired RBS board member last year to stop Goodwin taking on debt to spectacularly overpay for ABN Amro.
On the road to ruin?
The inadequacies of Scotland’s transport infrastructure was thrown into sharper focus last week. One of Scotland’s arterial routes to England — the A7 — was blocked by a landslide south of Langholm. A representative of Bear Scotland, the company that is supposed to look after the road, admitted the highway has “no formal engineering drainage system”.
Whether or not that has exacerbated the damage to the road, I don’t know. But given that the A7 now looks likely to be closed for at least eight weeks, causing economic “disaster” for the borders town of Langholm, isn’t it about time our A-roads were given proper drainage systems?
This Scottish Agenda column was published in The Sunday Times Scotland on 13 July 2008.