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StoreFund's Wayne Walden explains the IPO

-ASB Securities

Friday 11th June 2004

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StoreFund is currently trying to raise $25 million through an IPO. In this interview, Wayne Walden, a director of the company which managers StoreFund's asset answers some questions about the offer.

Q: How dependent is future growth on sales of spa pools continuing to grow as fast as they have in the past few years?Actually, future growth will primarily be driven by new stores and new product categories. This is already evident with the new Pakuranga super store which opened in May 2004. This has been followed by two more stores in Dunedin and Queenstown, both of which just opened this weekend. An additional store is due to open later in the 2005 financial year in Timaru.

We believe there is significant potential to open further stores, particularly in areas where the BBQ Factory is under represented following the termination of the Wrightson agreement.

Spa pool sales growth remains an ingredient, but consistent with the conservative approach we have taken in deriving the 2005 forecast, the growth assumption for spa pools is only 3.5% for the year which is significantly lower than the growth for 2003 and 2004 of 400% and 47.4% respectively.

Why didn't BBQ Factory pursue a stand-alone listing?
There are a number of factors here. Firstly, the BBQ Factory's small size makes this impractical and BBQ Factory is not ready for a separate listing - it has a smaller management team than is the norm for a listed company and does not have an independent board. Secondly, the fact that StoreFund provides BBQ Factory (and other companies in which it intends to invest in the future) with an appropriate infrastructure in the listed space was appealing to the company and the vendor.

For many vendors, a public listing is an intimidating process they are not equipped for. StoreFund provides these people with an attractive alternative.

Why does the projected FY2005 EBITA ($3.685 million) for BBQ Factory decline over the EBITA achieved for FY2004 ($4.097 million)?
In preparing the projection for BBQ Factory for FY2005 we have employed a number of assumptions that are inherently conservative. These include:

  • We have assumed lower gross margins, in line with the depreciation in the NZD/USD.
  • Sales forecasts are conservative - we have already discussed this above in the context of spa pools.
  • The three new stores are only forecast to break even in their first year of operation.
  • The difference in EBITA between StoreFund and BBQ Factory in FY2005 is approximately $930,000 - what do these costs relate to?
    Quite simply, $280,000 represents the base management fee payable to North Head (the manager). The balance represents operating costs for StoreFund including audit, accounting costs, legal fees, NZX fees and general overheads.

    Can you comment on how your offer costs, at 7.7% of issue proceeds, compare with those of other issues? They seem high.
    It is important to understand that there are effectively two transactions here - the acquisition of the BBQ Factory with all the due diligence costs and secondly the costs relating to the listing of StoreFund. So it's not a correct comparison to line the 7.7% costs up against the costs of other Offers which don't include acquisitions.

    North Head and the StoreFund board adopted a highly professional approach to the acquisition of the BBQ Factory. Accordingly, we conducted full and proper due diligence on the asset prior to acquisition in addition to conducting the IPO process as you would expect. Not surprisingly, this resulted in additional legal, accounting and other advisory costs.

    For example, the board of StoreFund commissioned two audits, including an unqualified audit report for the period ended 29 February 2004.

    There are also a number of other subtleties. Unlike the other recent listed investment company offers, which have commenced their existences as cash boxes, StoreFund will be two-thirds invested following the completion of the offer. Other LICs will have to incur brokerage to invest the proceeds of the offer post listing, for us these are reflected upfront.

    The important point in all this is "are investors getting good value for each dollar invested?", and with StoreFund, that's certainly the case.

    Okay, that explains the offer costs, but what about StoreFund's management fees. Are they higher than other funds of your type?
    Well again, we don't believe that to be the case. The initial base management fee of 1.75% is actually mid-range to below market for this style of product. A private equity fund, for example, may typically charge 2%. It is important to put the fees in perspective relative to what the manager will actually be doing.

    StoreFund's investment approach will require it to spend significant time and effort exploring and executing investment opportunities. The transactions in which it engages will have a significantly longer lead time than a relatively simple investment in listed companies. StoreFund's investment style will be very active with significant involvement in the management of investee companies, including having a seat on the boards of companies in which it invests. So basically, the fee is commensurate with a more active management requirement. Nevertheless, we have built in a reducing fee scale as the fund grows. If we get to our target fund size of $200 million, for example, the base management fee will drop to 1%.

    Are future capital raisings going to be dilutive for existing shareholders?
    StoreFund's primary means of raising equity capital going forward is likely to be via renounceable rights issues, in which shareholders can all participate equally. It's important to realise that we won't fund to create a war chest. Investors will be able to consider any rights issue on the basis of a live investment opportunity.

    Shareholders who don't want to increase their investment in StoreFund have the option to sell their rights in the secondary market. For example, a rights issue might just mean that a shareholder has one share worth $1.20 combined with one right worth $0.10, rather than a single share worth $1.30

    I'm keen to stress this point because the word "dilution" can in some places imply that value has been lost. In this sense, "dilution" is often referred to in instances of private placements, where a few select shareholders are given the opportunity to participate at a discounted price that is not available to other shareholders.

    In contrast, with renounceable rights issues all shareholders are treated equally and fairly. StoreFund intends on making acquisitions that are value accretive to shareholders - so a new acquisition financed by a rights issue should be enhancing to shareholder value.

    If there is an element of "dilution" with a renounceable rights issue, it relates to proportional holding size, rather than any kind of loss in shareholder value. If there is an element of "dilution" with a renounceable rights issue, it relates to proportional holding size, rather than any kind of loss in shareholder value. For example, if a shareholder elects to sell their rights rather than take them up, then they will end up holding a smaller proportion of the total shares in StoreFund - but this is compensated for by the proceeds from selling their rights.

    Why is StoreFund's NTA per share only 47 cents?
    NTA is not really a good measure of value for most companies and doesn't pick up aspects like goodwill - a crucial asset for retailers. Very few retailers trade near their NTA. For example, The Warehouse NTA is $1.13 vs its current share price of $4.30, giving a share price/NTA ratio in the region of 3.8x. Other retailers listed on the NZSX - like Briscoes, Hallensteins and Michael Hill - tend to have ratios of around 3 to 4 times. If we applied these sort of ratios to StoreFund's NTA our share price should be more like a $1.65. That's not realistic currently but I think it makes a point. Basically, we feel that NTA is an inappropriate measure of a company's worth in this sector.

    How confident is StoreFund of finding follow-on investment opportunities?
    We are very confident that there are other investment opportunities out there which meet our criteria. We spent a lot of time on the investability issue before bringing this concept to market. We remain comfortable with our investment target of $35 million per annum.

    Our belief in the StoreFund concept has been confirmed by the numerous direct enquiries that have been received since the Offer was announced. We believe there are a lot of great New Zealand companies in this space doing great things that investors can't currently get their hands on in the listed market.

    What level of information disclosure will StoreFund target in respect of its investee companies?
    StoreFund's board is committed to semi-annual reporting to investors. From the outset StoreFund will provide full disclosure for the BBQ Factory.

    While StoreFund itself will conduct due diligence on investee companies and have access to detailed information, we will sometimes be limited in what we can disclose to the public.StoreFund's policy is to seek a level of public disclosure from investee companies (where it does not have a controlling or majority interest) sufficient to enable the market to appropriately value these investments. Where possible, we will make it a condition of investing when negotiating with vendors that there is at least a minimum level of disclosure - sufficient to enable the market to value what we are buying.

    North Head is incentivised to achieve public disclosure and thereby ensure that StoreFund's share price performance is maximised.

    While StoreFund has stated that it will consider levels of shareholding between 20% and 100%, investments at the lower end of that range will not be the norm. Valid reasons will have to exist to pursue such opportunities - they'll need to be outstanding opportunities.

    So, if you had to wrap all this up, what would the key reasons be for investors to consider StoreFund as an investment?
    Well, if I was going to distill it, I'd suggest investors focus on these aspects of the StoreFund Offering:

    • It provides investors with access to quality unlisted retail companies with proven business models, strong cashflows and attractive market positions.
    • It offers them strong prospects for earnings growth, coupled with a projected gross dividend yield for 2005 of 10%.
    • The BBQ Factory is an attractive and compelling initial acquisition - it sets the benchmark for StoreFund in terms of future investments, and as managers we are focused on increasing shareholder value by careful investment selection and enhancing the performance of investee companies.

    This question and answer has been supplied by ASB Securities

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