2e2 – Tech’s great,
but understand it better
Many years ago, I sat in the boardroom of a large OEM that
had just gone
through an MBO funded by VC's talking to senior managers I knew who had now
taken control and a Non Executive Director clearly representing the interest
of investors.
I left that meeting some three hours later convinced the investors that
stumped up the money to fund the MBO had little or next to no knowledge of
what the OEM's business was all about save for feeling happy with prior
results and that ''Tech' was a good place to be. My judgment was accurate as
things turned out. The business went downhill until rescued once more by the
temporary intervention of the original owner who booted out the incumbent
investors and brought others in.
Where's the connection with 2e2? When 2e2 began its assault on a buy and
build process it did so with support of Duke Street Capital at a time when
technology companies were a good place to invest, just after the minor
recession we saw at the beginning of the millennium. It grew this way until
it decided to chomp on Morse in 2010. This had historically been a very
profitable business but which by the time 2e2's interest flamed had begun to
lose its shine. To successfully achieve this acquisition it also leaned on
Hutton Collins as additional partners to fund this acquisition at a reputed
cost of around 70m.
Make no mistake, although 2e2's gross margins dipped to around 26% in
December 2011 and actual salary cost rose by almost 20m, SG&A costs somehow
still came down by around 10m and operating profit, prior to exceptional
cost write downs was still fairly healthy. On an accelerated buy and build
basis however one will always face exceptional costs and write downs
annually, a rise in intangible assets and significantly increased interest
cost on loans and borrowings. One's asset structure becomes weak and the
balance sheet begins to creak and groan rather loudly, often placing banking
covenants at risk and your ability to re-negotiate financing and loan
commitments.
In the year end to 2011, some 53% of 2e2's total assets were made up of
intangible goodwill on acquisitions and long term loans were at 126% of
tangible assets. It's working capital days had moved out in the last two
years but cash balances still appeared OK. I suspect, given the accounts
were filed in October 2012 and then senior managers including the finance
director were moved out soon after that current year performance to date has
fallen short unacceptably and Banks were no longer willing to provide more
flexibility. The accounts for 2010 also had to be re-stated.
The company's performance quite simply was inadequate to sustain this level
of debt and accrued interest. Additionally, public outsourcing agreements or
the JV with O2 were no longer enough to satisfy the banks.
This is a business that paid 70m for Morse and was then trying to sell
itself for more than 350m just over a year later. No-one in their right mind
would have paid this amount given the sheer scale of indebtedness despite
obvious operating gross margins. This is why I feel a sale of parts of the
business may yield a better return for creditors.
Nothing wrong with a sensible medium to longer term buy and build strategy
but you have to retain value in what you buy, integrate and see the return
on this investment before plunging onto the next acquisition. Engaging too
quickly heightens the risk of not integrating, losing value, focus on the
price you pay and creation of a debt pile you simply cannot service.
2e2 was an accident waiting to happen and alas there are others out there.
Hopefully this will not affect the real value of this sector. I still see it
as offering huge potential to investors, more so now indeed given the
changes in technology we see and consumer demand.
through an MBO funded by VC's talking to senior managers I knew who had now
taken control and a Non Executive Director clearly representing the interest
of investors.
I left that meeting some three hours later convinced the investors that
stumped up the money to fund the MBO had little or next to no knowledge of
what the OEM's business was all about save for feeling happy with prior
results and that ''Tech' was a good place to be. My judgment was accurate as
things turned out. The business went downhill until rescued once more by the
temporary intervention of the original owner who booted out the incumbent
investors and brought others in.
Where's the connection with 2e2? When 2e2 began its assault on a buy and
build process it did so with support of Duke Street Capital at a time when
technology companies were a good place to invest, just after the minor
recession we saw at the beginning of the millennium. It grew this way until
it decided to chomp on Morse in 2010. This had historically been a very
profitable business but which by the time 2e2's interest flamed had begun to
lose its shine. To successfully achieve this acquisition it also leaned on
Hutton Collins as additional partners to fund this acquisition at a reputed
cost of around 70m.
Make no mistake, although 2e2's gross margins dipped to around 26% in
December 2011 and actual salary cost rose by almost 20m, SG&A costs somehow
still came down by around 10m and operating profit, prior to exceptional
cost write downs was still fairly healthy. On an accelerated buy and build
basis however one will always face exceptional costs and write downs
annually, a rise in intangible assets and significantly increased interest
cost on loans and borrowings. One's asset structure becomes weak and the
balance sheet begins to creak and groan rather loudly, often placing banking
covenants at risk and your ability to re-negotiate financing and loan
commitments.
In the year end to 2011, some 53% of 2e2's total assets were made up of
intangible goodwill on acquisitions and long term loans were at 126% of
tangible assets. It's working capital days had moved out in the last two
years but cash balances still appeared OK. I suspect, given the accounts
were filed in October 2012 and then senior managers including the finance
director were moved out soon after that current year performance to date has
fallen short unacceptably and Banks were no longer willing to provide more
flexibility. The accounts for 2010 also had to be re-stated.
The company's performance quite simply was inadequate to sustain this level
of debt and accrued interest. Additionally, public outsourcing agreements or
the JV with O2 were no longer enough to satisfy the banks.
This is a business that paid 70m for Morse and was then trying to sell
itself for more than 350m just over a year later. No-one in their right mind
would have paid this amount given the sheer scale of indebtedness despite
obvious operating gross margins. This is why I feel a sale of parts of the
business may yield a better return for creditors.
Nothing wrong with a sensible medium to longer term buy and build strategy
but you have to retain value in what you buy, integrate and see the return
on this investment before plunging onto the next acquisition. Engaging too
quickly heightens the risk of not integrating, losing value, focus on the
price you pay and creation of a debt pile you simply cannot service.
2e2 was an accident waiting to happen and alas there are others out there.
Hopefully this will not affect the real value of this sector. I still see it
as offering huge potential to investors, more so now indeed given the
changes in technology we see and consumer demand.
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