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Opinion: Rug pulled out from Feltex investors

By Simon Louisson of NZPA

Friday 29th April 2005

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Those who bought the stock at $1.70 last year when the iconic company was floated are unhappy campers. At 66c, Feltex has lost 61% of its value.

It was already looking more of a dog than stag when its shares were trading down to $1.50 at the end of March. But real trouble came appropriately on April Fool's Day when the company issued a profit warning of an $8 million to $9 million shortfall in its previously forecast $21m to 22m profit.

That warning was hardened up on April 13 when it announced it had lost $880,000 in the March quarter against a $2.4m profit a year earlier.

A sharp slowdown in the Australian housing market was the identified as the main culprit, but currency issues, competition, and labour shortages were other problems.

What has happened to Feltex raises questions not just about the company's forecasts and management, but about the share broking industry in general.

Initial anger focused on the fact that the profit warning came less than six weeks after the half-year profit when the company said it was on track to meet forecasts despite encountering challenging market conditions.

"The trouble is the profit warning was so close after when their interim result. Lots of people said surely they were able to see what was going on and had some idea then that things were not going so well," said one analyst.

"Four or five weeks later they issue this massive profit warning."

It also raised a question about Feltex's internal controls and management's ability to see how their business is doing.

"You have to wonder that a company in the industry doesn't have a better feel for what was going on.

"Even though the company has highlighted the reasons why they had to downgrade their profit forecasts, people don't necessarily trust what the company says any more. There is a bit of concern we haven't see the end of it and there is some downside to come," the analyst said.

News that chief executive Sam Magill and three senior executives flew out with 24 top customers on a 10-day South African safari the day after the profit warning was not a good look either.

The fact that the safari had been arranged much earlier as a result of good sales the previous year did not mollify investors.

A company with a sharply falling share price usually has the blowtorch turned on its debt position and some investors will be looking carefully at Feltex's 39% proprietorship ratio and term debt of $112.3m.

Feltex's predicament so soon after it floated raises wider issues than the timing of the profit warning.

"There is certainly speculation that the issue price was over-hyped or window-dressed to make it look pretty attractive to investors at the time of its floatation last year," said one analyst, who declined to be identified.

Feltex was sold to the public by Credit Suisse First Boston Asian Merchant Partners. Private equity funds like this invest in a company such as Feltex as a turnaround opportunity by taking costs out, improving margins and installing good management.

CSFBAMP bought Feltex in 1996 and eyebrows were raised about Feltex's growth prospects given the longer than normal stint for a private equity fund to be involved.

"When managers are saying that after eight years of CSFB ownership they can improve margins significantly by taking out more costs, you have to be a bit suspicious as to why that hadn't been done under the tenure of the private equity firm," said the analyst.

The fact that Feltex was the biggest float in New Zealand since Contact Energy in 1999 meant the industry had a lot riding on its success. In addition, Feltex chairman Tim Saunders is a New Zealand exchange director.

With nearly 150 million shares on issue it came in as a top 30 company with an initial market capitalisation of around $250m.

The float was lead managed by First NZ Capital and Forsyth Barr and co-managed ABN Amro and Macquarie Equities. These firms had a vested interest in selling the issue, but also in its success with thousands of their private clients put into the stock.

CSFBAMP paid just $19.5m when it bought Feltex from BTR Nylex of Britain. Feltex had been listed in the 1980s until it was gobbled up by Allan Hawkin's investment company Equiticorp.

It was sold to Nylex by Equiticorp's statutory managers following that company's collapse in 1989.

A prelude to the float was a $50m bond issue in 2003. There had been scepticism about the quality of Feltex's numbers when the "junk" bonds were issued, but that mostly dissipated when earnings forecasts issued for that prospectus were bettered. However, that may have been the small fish to catch a bigger one.

The projection in the IPO prospectus of 13% growth in pro-forma operating earnings to $52m in the June 2005 year sounded alarm bells ringing for some analysts even though Magill described it as "probably conservative".

At the time of the float, Brook Asset Management's Simon Botherway questioned how long the company could expand margins.

When Magill told analysts at the half-year result the company was not too worried about revenues but was more focused on margins, one analyst said he became concerned.

"It's the first time I heard that from a CEO. It was a bit of a warning shot."

One major shareholder has been so incensed about what has happened to Feltex, he has called on the Securities Commission to investigate.

He said the commission would be failing in its duty if it did not investigate why the company would fall so far short of its prospectus forecast in such a short time.

The commission would not comment on whether or not it was investigating. It has a policy of not commenting unless it decides to act.

Some of Feltex's problems have rubbed off on fellow listed carpet maker Cavalier Corp. Its shares have lost a third of their value since peaking at the end of 2003. However, analysts said Cavalier's fall had been steady and in line with the expected housing slowdown in Australia and New Zealand.

"That's an indication that the problems are company specific on the part of Feltex rather industry-wide problems." said one.

The problems at Feltex are a major setback for the whole sharemarket because of the size of the IPO.

Under the leadership of NZX chief executive Mark Weldon, the exchange has been gradually winning back the trust of small investors lost in the 1980s through the likes of Equiticorp and the exchange's own lax attitudes.

At present, it looks like the Feltex vendors, who have strong connections to the broking industry through Credit Suisse First Boston, and the brokers that promoted the stock, at best over-hyped the stock, and at worse, sold investors a pup.

And that will make small shareholders more wary next time a company wants to raise money.

Said one analyst: "People are going to think `what happened last time I bought shares in a company -- they said everything was going to be great when they list? Well it was Feltex and now my shares are worth a third of what I paid."

Investors in Feltex have lost around $150m to date, but that may be small in comparison to the long term losses in the industry.

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