2e2 Group - a 'zombie' collapse...sad but inevitable

2e2’s faltering steps to administration

Alas it happened late on Monday 28^th January 2013, a month or two after main senior directors were released and replaced by others on the instructions of owners Hutton Collins.

It had recently re-stated a year’s accounts and was rumoured to have been in breach of banking covenants and finally, could not reach agreement on re-financing or find alternative buyers.

The timing of administration is crucial in that many employees expect their salary payments to be made at the end of this month and most suppliers would equally expect month end payment to be received. This increases the level of debt faced by unsecured supplier creditors and regrettably some 300 or so employees shown the door today apparently have been told they will not receive their salary cheques or other entitlements.

This is a monumental failure of a Value Add Reseller in the IT sector, indeed it’s the biggest I can recall in the UK in over 21 years.

2e2 grew at an accelerated rate through multiple acquisitions and almost wholly on borrowed money. It paid over 50m to acquire Compel and followed that with its acquisition of Morse Group in 2010, a business at the time of similar size to 2e2, paying a little over 70m for that business. Perhaps this was a fish too big for the acquiring fish to swallow. Its initial forays attracted Duke Street Capital and then Hutton Collins at around the time of the Morse acquisition

2e2 has not made a pre tax profit for many years. Indeed it the last five years to December 2011, its accumulated pre-tax losses amount to around 135m. Its interest payments over the same five year period totalled some 145m. Operating profit declined from 11m in 2009 to 7m in 2010 and finally 2m in 2011; this despite increases in revenue each year given acquisitions.

This is not the sort of news VC’s are happy with, more so given the avowed intention of many is to invest for a maximum period of 3-5 years with a view to exit.

Effectively, this has been the weight that has broken the camel’s back. Suppliers, who had shown concern for the group over a number of years found it too difficult to cut back exposures too quickly for fear of precipitating collapse and stuck with them, some perhaps less than others, more so recently given the re-statement, movements in senior management and rumoured banking covenant breach. The indications are that Distributors face exposure, largely if not wholly uninsured of at least 40m. Customers of 2e2 face the ongoing uncertainty in terms of their ICT provision and Administrators have a mammoth task in maximising recovery while still managing a measure of product and services delivery.

Employees as ever face the biggest worry in terms of will they be paid, how much and what their prospects of employment are in the short to medium term.

There is no escaping the fact that 2e2 was essentially a ‘zombie’, a category applied to many businesses saddled by enormous unsustainable debt and whose profits are simply unable to cope with interest payments. Sure, some interest payments may not be payable until VC exit but who in their right mind will look at the accumulated value of rising debt and take it on?

If sales had remained on an upward curve, they may have survived a little longer but the way in which technology is delivered today no longer delivers traditional revenue stream volumes. There is now greater emphasis on managed services, hosting, and mobility along with security and cloud services. These still deliver growth but not to those businesses whose volumes have predominantly been hardware and software.

2e2 was the subject of an approach by Cable & Wireless some years ago and O2 was also reputed to have looked them over. This was at a time when telecommunications and IT converged at a faster rate and one or two similar businesses were acquired in the United States by major Telecommunications companies. As it transpired, O2 did enter a joint venture agreement with 2e2 in early 2011, creating O2 Unity and was reported to be working well certainly in the early part of 2012.

Some local health authorities also outsourced their ICT functions with transfer of employees to 2e2.

It’s likely that O2 will find a way of continuing and supporting its unified communications business through O2 Unity but those who outsourced activity to O2 will require more time to re-engage or bring functions back in-house.

This failure will be seen as positive by competitors of 2e2 but will I’m sure alter the parameters and indeed the level of private investment in IT companies moving forward. We still see many ‘zombie’ companies in this sector but I hope VC’s and Banks show greater willingness to initially understand what they are investing in and exit accordingly without inflicting pain.