One of the biggest shocks of the past month was the rapid unravelling of Conviviality, the owner of Bargain Booze and other brands. Owners of this particular share are most likely to see virtually all their investment wiped out, as even if the company is saved, the injection of equity required will dilute holdings by a massive factor.
Business failure is not that uncommon. But what made Conviviality more alarming was that it was largely unexpected by the markets. At least in the other large failure this year (Carillion), there was a continuous stream of bad news, declining share price and increasing shorts. There were plenty of points for someone to cut their losses and get out.
The price action for Conviviality shows a rather flat trend over the past year:
And to the investor there were some things to like. Profits were on the increase, the company was aggressively expanding and they also had started to pay dividends. Then the bombshell hit:
Further to the announcements made by Conviviality Plc on 8 March 2018 and 13 March 2018, the Company yesterday identified a payment due to HM Revenue & Customs of approximately 30.0 million which falls due for payment on 29 March 2018 and which has not been accrued for within its short term cash flow projections. This has created a short term funding requirement.
Their next comments basically said they were maxed on debt:
The Company is currently in compliance with its banking covenants. The next covenant test date is 29 April 2018. The Company is subject to two banking covenants (i) for covenant debt (which excludes any amount drawn down under the Company’s invoice discounting facility) to be less than 2.5 times the last 12 months adjusted EBITDA, and (ii) adjusted EBITDA to be at least 4 times the net financial charge. The Company is fully drawn under its term loans and revolving credit facility and covenant net debt at 29 April 2018 is expected to be approximately 113.0 million (which excludes any amount drawn down under the Company’s invoice discounting facility). Based on the expected adjusted EBITDA of between 55.3 million and 56.4 million, this would give rise to a covenant test result of 2.04x to 2.00x adjusted EBITDA. The Company continues to expect net debt to be approximately 150.0 million for the period ending 29 April 2018 including the invoice discounting facility.
And with a projected debt of £150m, EBITDA had to be at least 4 times less than that to satisfy the covenants. With an immediate need for cash, it would be difficult to see the business continue trading as normal – and that’s before the loss of any confidence from customers. And so came an equity fundraise for £125m, but there were no takers.
There are several lessons we can take on board from this debacle:
Bad things can (still) happen at this level: The kind of event that brought this about should not have happened, period. But that isn’t impossible for it to happen. Corporate culture and pressure can make people do things that are good for them, but not so good for the company. And it’s entirely possible that things can be concealed from the auditors, so that bad news never comes to light.
I find it unlikely that the senior managers were not aware of this but rather hoped this would go away, or that some other solution could be found. But it was not to be.
For investors, this means you have to be on your guard. It would have been difficult or perhaps impossible to deduce that there would be an unaccounted £30m payable from the information we get, but the risks of this can be mitigated by diversification. Arguably the bigger stake sizes should be reserved for bigger companies.
Cash flow is just as important as profits: It was not a loss that brought this on: the company were reporting consistent, increasing profits. Had the company had sufficient cash, it could have paid off the expense and also repaired relationships with suppliers. From the accounts we can see the cash balance was increasing, but nowhere near fast enough: the £10m reported in the last year does not offer much of a cushion relative to the size of the business.
Much more so than bigger companies, running out of cash puts smaller fry at the mercy of the banks should something bad happen.
Debt levels are also something to be wary of: Combined with the cash flow problem, this led to a perfect storm. Had no debt existed, an option to raise funds would be to offer bonds on the market, or to approach the banks. But the accounts show why this wasn’t possible:
It’s clear that the net debt level was rising quickly as this is how the acquisitions were funded. Whilst not all debt is bad, the trend was becoming worse and not better – the trailing 12 months showing an increase to £133m. It was clearly tricky to stretch this any further and from the point of view of lenders, the risk outweighed any return.
Low margins can be a bad sign: One of the reasons for this is that the margin on the products and services was incredibly low:
You would have hoped that margins would actually increase after acquisitions as synergies took effect, but the trend was actually downward. Many successful companies have large, increasing margins as competitive advantage gives the customer a compelling reason to return.
The same isn’t the case here, as there are plenty of places to pick up alcohol. Indeed, price is a major selling point for them.
Not all low margins are bad. Some companies have this enforced such as the utilities, others like Primark involved having prices which were much under that of the competition, and having the ability to scale that. It is difficult to say the same for Conviviality.
It’s fair to say that I think the company will survive. It generates profits and it may be able to reclaim lost goodwill. That is of no comfort to investors, who will end up sharing in virtually none of the future spoils, if there are any. Given the nature of what has happened, it may be that their best chance of recourse will come through the courts
Pure Passive Investor. Always looking for ways to make money (but not myself) work harder.