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EXCERPTS
...
Nothing spells corporate disaster quite like a $100,000 kitchen
sink. The sink in question was no different to the many others installed
in the thousand-odd ABC Learning childcare centres across Australia,
but its price tag saw it plucked from obscurity during the marathon
public examination into the childcare operator's collapse. How do you
spend $100,000 on a sink?
It was one of many peculiar practices brought to the attention of
the Federal Court hearing into the collapse.
An ABC contractor, Queensland Maintenance Services Ltd, would
overcharge on capital items such as the sink and undercharge on cleaning
expenses. The understated expenses would, of course, overstate
earnings, while the inflated capital expense would overstate one of the
few tangible assets propping up ABC's balance sheet.
All of this was allegedly conducted at ABC's insistence, or, more
specifically that of its founder, Eddy Groves.
It was one of many not-so-subtle ways that ABC's financial facade
was massaged into shape.
The more controversial developer payments made to ABC was
another. According to the ABC chairman, David Ryan, this facade remained
intact until Groves was ejected from the company at the end of
September, 2008. It then collapsed, to reveal - much to everyone's
surprise - a company that administrators now believe may have been
insolvent for many months.
...
But did Groves - and ABC's byzantine business model - really
bamboozle ABC's other directors, and small army of bankers through most
of 2008 into believing the only challenge facing the childcare operator
was its debt load in the wake of a massively changed financial market?
This does not appear likely to satisfy the administrators who
conducted the examination. And if ABC is put into liquidation next
month, as expected, potential legal action against its banks, auditors,
and directors is among the only potential assets the liquidator can hope
for unsecured creditors.
...
Groves insists he was just an entrepreneur who relied on expert
advice which ultimately failed him. It is a point he emphasised in an
interview soon after appearing before the court earlier this month.
''I never claimed to be a corporate guru or corporate governance
expert or a finance expert. The opportunities presented themselves, and I
followed that dream and passion,'' he told The Australian.
For Ryan, who was head-hunted to ABC's board precisely because of
his corporate and financial expertise, there is no such excuse.
Especially since he chaired the audit committee which oversaw the
financial reports that were still being restated when ABC collapsed.
But Ryan has his story too. Apparently there were two ABCs. One
was behind the facade. It was a ''broken'' business model, as Ryan
describes it, reliant on a high-volume pipeline of centres developed
with closely related parties which became corrupted over time.
In interviews with regulators, Ryan says he later found out
payments to developers exceeded what the board was told, as were the
prices ABC paid for the centres.
The second ABC, the childcare fantasy that the directors were
aware of, was a far healthier operation which needed to sell assets and
de-leverage to appease the market gods in the wake of the global
financial crisis.
...
In the early weeks of the examination, ABC underlings described a
company being run with a wild abandon that would not have been
tolerated in its childcare centres.
All roads lead to Groves, who was depicted as the only one who
actually knew how the business worked - or, as it was later proven,
didn't work.
Cash constraints were apparent as early as April 2008 with
creditor bills going past their due date. This included tax payments
which opened ABC to the prospect of audits, ''which is the last thing we
need'', as ABC's acting finance chief, John Gadsby, told Groves by
email in mid-May.
Groves denies there were any cash constraints and says he didn't
think the late tax payments were ''an extreme situation''.
Ryan was also included in on the email and obviously disagreed.
''I agree, John, it's a real worry,'' said Ryan, who directed Groves to
make the payment. It may not have escaped Ryan's attention that ASIC
regards overdue taxes as an indication that a company is at risk of
insolvency.
What the banks were aware of at this stage is literally the
billion-dollar question, given the syndicate - dominated by Australia's
big four - received security over the entire childcare business from
ABC's board in June that year. They also insisted the agreement include
the direction of hundreds of millions of dollars from the asset sales to
pay back debt the banks had raised for ABC just six months earlier.
The administrators are expected to attempt to overturn the
transaction if ABC is put into liquidation, and may also seek the return
of the loan repayments.
For the board itself, the awarding of security is one of many
deals they approved during that tumultuous year that are under a cloud
as questions are raised about when exactly ABC was insolvent and who
knew exactly how much trouble it was in, and when. The who, what and
when could determine whether certain directors face criminal charges,
and personal liability for company debts.
...
On June 10, 2008, ABC's corporate adviser from Goldman Sachs
JBWere, Christian Johnston, sent an email to Ryan about an impending
capital-raising with a division of Morgan Stanley. The email reads:
''$80 million to $90 million probably not enough to give the company the
breathing space we think it really needs over the medium term. Having
said that, it is clearly better than going under in the short term...''
''I was pretty annoyed when I got this email,'' Ryan told the
court, describing it as being ''cobbled together quickly on the fly''
with Johnston taking ''an emotional position''. Ryan was asked what was
meant by Johnston's email. ''I think Mr Johnston was concerned that by
placing 15 per cent of [ABC] shares with Morgan Stanley, we would
forever damage the underlying value of the shares in the company.''
Ryan later added that when a corporate adviser is contemplating
loss of bidding tension in a takeover, they are not contemplating
insolvency. For Ryan, the transaction was part of a mission to ''de-risk
and de-leverage'' the business ''in a very difficult environment''.
''By August that mission had been accomplished,'' he told the court,
citing $800 million raised from various sales.
By the end of September Ryan had fired Groves as chief executive
and a director. Within weeks, ABC's new executive team slashed Grove's
forecast earnings before interest, tax, depreciation and amortisation
from $265 million to $62 million. Soon after, they would be explaining
to the banks that ABC would not be able to trade out of its troubles and
they would be placing the company into administration. That was the
start of November 2008.
But if Ryan's response to Johnston's email seemed strange, his
ignorance of the fact that it was entirely consistent with Goldman
Sachs's dire forecasts of ABC are even stranger.
Goldman Sachs presented a report to ABC's board on April 17, codenamed
Project Abacus, which highlighted liquidity concerns at ABC. The
investment bank became involved with ABC after its disastrous interim
results, released nearly two months earlier, triggered concerns about
the company from which it ultimately never recovered.
The report presented to the board that day included the dire
prediction that ABC would run out of cash by the end of June and breach
its bank covenants if it did not sell off assets or find some other way
to raise cash.
Ryan claims Goldman's dire forecast was only mentioned in the
executive summary, which was not brought to the board's attention at the
meeting. ''I did not read it, for if I read it I would have remembered
it,'' he told the Federal Court.
Groves and ABC's then chairman, Sallyanne Atkinson, say they were
aware of the report and these findings.
Atkinson, who left ABC the following month, even acknowledges
there were concerns about ABC's liquidity - something Groves and Ryan
deny.
These concerns were subsequently addressed with the asset sales,
she said. Mission accomplished, once again.
Groves and Ryan agree on one thing, though: both discount
Goldman's harsh forecast. ''I always felt there were other options for
ABC,'' Groves says. But Groves also believes that ABC was viable right
to the end and should never have ended up in administration.
He has no doubts where the problems began. ''I think the outside world
changed dramatically with the global financial crisis,'' he told the
court.
Groves says asset sales were the solution to the company's need
to neutralise the short sellers in the market, who were targeting ABC
due to its debt. ''The only way to do that was to de-risk and
de-leverage.''
...
Aside from the security given to the banks in late June, just
before Goldman Sachs forecast the company would run out of money, Ryan
acknowledged that ABC recorded a $278.5 million loss on the
deconsolidation of its US assets after selling a majority stake in the
business. It was an acceptable price to pay, Ryan says.
...
But testimony from representatives of ABC's bank syndicate
reveals there was certainly concern of some sort after the release of
ABC's interim results in February 2008.
According to the Commonwealth Bank executive acting as agent for
the bank syndicate, the earnings result was below the forecast given to
the banks just months earlier when they raised $1.43 billion for the
company.
This would have concentrated the minds of the banks. As most of
ABC's assets were intangible, its earnings profile was crucial to its
perceived credit risk with the banks.
''The credit metrics were no longer reflective of the position
put to them in November 2007,'' says Ian Wunderlich, who heads the
Commonwealth Bank's agency division. Senior executives within the bank
also closely scrutinised a compliance certificate from ABC which lobbed a
day after its interim results were released on February 25. The
document said ABC remained compliant with debt covenants.
By that Friday, February 29, Eddy Groves was flying to the US to
begin negotiations over the sale of the US assets, while ABC's banks
emailed the company requesting confirmation that it had maintained
compliance with its debt covenants ''at all times'' since December 2007.
The inevitable consequence of this was the security the banks now
required over ABC's assets. It effectively delivered the whole company
to them when it collapsed in November, and has left nothing but
potential legal actions for ABC's unsecured creditors.
More importantly for ABC, the interim result effectively shut down bank
credit as a source of cash for the company at a time when its operating
cash flow was negative and up to $200 million worth of centres were in
development that had yet to be paid for.
The $82 million share placement at rock-bottom prices in June signalled
that this was also exhausted as an avenue to raise cash which
emphasised, in retrospect, that without the asset sales it was game
over.
But it did not become apparent to the board that this was the
case until October 2008, when newly appointed executives had shredded
the credibility of financial information Groves had provided to ABC's
banks just weeks before.
Groves had already been turfed from ABC but was still available
to help out the new executive team, which included its chief financial
officer, Peter Trimble.
On October 9, 2008, the two met in a Brisbane office to try to
reconcile Groves's $265 million earnings figure with the reality they
were uncovering at ABC.
''He just wanted to understand the science behind my numbers,''
Groves told the court.
None of Groves's science bridged the $200 million earnings gap that the
new management team was uncovering. It would prove terminal for ABC
within weeks.
If Trimble was unimpressed with Groves's ''science'', then the
feeling was mutual.
He evidently was not impressed that ABC's new management team relied so
little on advice from the man who had built the empire from scratch.
When counsel for the ABC administrators, Michael Cashion, asked
Groves about his impression of Trimble from the meeting, he replied:
''Mr Cashion, he had not one clue.'' Plenty more would be happy to join
this queue.
- reprinted from The Sydney Morning Herald