Till debt do us part

By Fiona Rotherham

Monday 1st March 2004

It's no secret that two-thirds of mergers and acquisitions worldwide destroy shareholder value. Little wonder, then, that investors started losing faith almost as soon as New Zealand sharemarket darling Baycorp tied the knot with its Australian rival Data Advantage.

The share price was $7.45 when the newly merged credit information and debt collection company set up its primary listing in Australia in December 2001. Within six months it had fallen to $4.70. The announcement in August 2002 of a $A300 million loss, following write-downs of the value of the New Zealand databases and goodwill, sparked a further rollercoaster ride that has more than halved its original value. The share price dropped as low as 95 cents in February 2003 following successive profit downgrades, before recovering to around $3.23 mid-January ($A2.81 on the ASX).

Media on both sides of the ditch have called the merger disastrous. But was it really? For shareholders holding stock from the outset it has been, but the impetus for the merger - that Australia offered much better growth prospects for Baycorp than the mature New Zealand market - still holds true. And chairman Glenn Barnes claims expected synergy benefits of $A15 million over three years will still be achieved. The trouble is it is likely to take up to a year longer than planned.

What went wrong? A myriad things combined to make the merger integration a lot tougher than expected. First up, the company started out overvalued. It had a high price/earnings multiple of 36 at the time of the merger, which Barnes says was "unsustainable". As former chief executive Keith McLaughlin points out: "I hate to say it, but what would Baycorp's share price have been now if the merger had not gone ahead? It would not have stayed that high." He maintains the merger was the right thing to do but there were difficulties along the way - some anticipated, some not.

Another problem was that too much was taken on at once. While integrating the merger, the company simultaneously bought Commonwealth Bank's one-third share of debt collection business Alliance, and the troublesome $A300 million Telstra debt contract. Barnes admits that was "an error".

As the share price started sliding, integration costs ballooned, competition increased and margins fell in the debt collection side of the business. Factor in write-downs, losses in some divisions, and the departure of key management staff, including former Data Advantage boss David Grafton (paid a $A1.4 million golden parachute), and you have a recipe for - well, disaster really.

But, in disaster, some saw opportunity. AMP Capital Partners, for one, jumped in when the share price went down, buying up a 9.3% stake. New Zealand portfolio manager Nat Vallabh says although the "wheels had come off a bit", he liked the business model and thought the stock was undervalued last year. "It has a very solid database and good cash flow with not too much capital investment required. It's a great investment."

Baycorp's biggest shareholder, Chicago-based fund manager Harris Associates, emerged on the register in late 2002, building up to a 16.59% stake. It has since sold down to 13.4%. Harris's head of international equities, David Herro, refused an interview with Unlimited, but he told the Australian Financial Review last year the most attractive part of Baycorp Advantage was that it had a large chunk of the credit bureau business. The local market was wrong to undervalue that simply because earnings were volatile, he said.

Aussie takeover
The company is now Australian-dominated at management level. Original chairman Kiwi Roseanne Meo stepped down to the deputy's role in late 2002 and was replaced by the Australia-based Barnes. There are still three Kiwi directors on the board. Former boss Keith McLaughlin, a Kiwi, also resigned while announcing last year's $A19.4 million loss. The share price immediately spiked up 33c on the news.

There has been speculation he was pushed because Aussie institutional investors notoriously dislike Kiwi management, but Barnes denies this. "He decided after the strains of the merger and the way the market treated him that it was time for a break in his career." McLaughlin says he always intended standing down once the integration process was completed. He believes companies can get stifled with one person at the helm for too long.

McLaughlin began working with family company Baycorp 33 years ago, knocking on doors dunning unpaid bills, and has been a director for 18 years. The 49-year-old is on holiday while he considers his future. Although his contract runs through to June and he continues to get paid until then, McLaughlin resigned as a director on January 9, having worked on the handover for two months with successor Australian Andrew Want. McLaughlin retains a tie with the company - a small stake of 658,228 shares. The incoming chief executive got a golden hello of $A80,000 worth of shares to supplement his annual $A550,000 base salary plus incentives.

Before resigning McLaughlin had the satisfaction of producing a much improved second half in the last financial year, showing the merger troubles were some way resolved before he left. And the first-half result, to be announced by Want, will be due to McLaughlin's efforts.

Want was formerly managing director of global foreign exchange and payments group Travelex Australia. He successfully merged the Travelex and Thomas Cook financial services operations in Australia, New Zealand and Japan (see box). Ironically, in his former life as a lawyer, Want was involved in helping Baycorp exit from its disastrous foray into Australia in the 1980s. Barnes says the company was attracted to Want because he had the experience to drive growth offshore, not because he's an Australian. For his part, Want says Baycorp Advantage is an Australasian company. End of story.

Road to recovery
Vallabh says the body language at the annual meeting hinted strongly that the corner has been turned. "In terms of expectations going forward they were not saying much but they looked bullish about the outcome." Constrained legally from saying too much before the next result comes out, Barnes and Want remain confident. A return to profitability is expected this year and directors expect to resume paying fully franked dividends of 70%-90% of net profit after tax and goodwill. First-quarter earnings were up significantly on last year and ahead of plan, and that trend has continued. Both men say the full-year operating earnings will be at the high end of the $A42 million to $A47 million forecast, with emphasis on the high end. That's up from $A36.6 million last year.

But analysts say there is still a lot for the new chief executive to focus on. Costs control efforts - which reduced the cost to revenue ratio from 57% in the first half of last year to 51% in the second half - need to continue. Some $A9.5 million will be spent this year on the so-called "transformation project" in the company's cash cow division - the Australian credit bureau. New products will be introduced aimed at staving off new competition. And there will also be a significant technology upgrade to finally integrate the two merged companies' IT systems and bring it all in-house.

Driving the company's recovery are growing credit bureau earnings, thanks to the strong consumer environment in New Zealand and Australia, and the improvement in debt collection margins (commission rates have risen from 16% to 18%), says Citigroup analyst Ed Prendergast. But the earnings model remains complicated by peripheral issues such as losses in Asia and in the decisioning solutions division, which provides insights on how potential customers are likely to pay in future. "However the underlying trends in FY03 are cause for comfort after two years of highly fluid outcomes."

But what analysts and investors are looking for first and foremost is stability. Only that will restore the company's credibility.

Want is determined to deliver on that. "We've made it clear, and I think the message has got through, that our first job is to deliver on this year's forecast ... My intention is to give reliable results and no surprises." He describes himself as a caretaker of the current year's strategy, announced before he joined. With the company tracking well he sees no need to change that strategy now. He's not about to let the cat out of the bag on what he has planned, although he is gung-ho on growth in Singapore. The company holds 49% of the IHPL Group, which supplies software to the Singapore credit bureau. Though not yet as profitable as hoped, he says it is well positioned and the only one of the offshore ventures likely to immediately bear fruit.

Analysts' valuations of Baycorp Advantage vary widely. Goldman Sachs JB Were recommended a hold on the stock after valuing it at $A1.95 late last year, while at the other end of the scale Citigroup recommended buying and increased its valuation from $A2.70 to $A2.98.

Commenting on share price movements is a road paved to hell, Barnes says, but he likens the market to a game of golf. You have to feel good about your game and make sure the results match the rhetoric.

The Ocker
Andrew Want
42-year-old Australian lawyer
Married with two children

Previously ran the Travelex Australasia Group

Successfully merged the Travelex and Thomas Cook Financial Services organisations in Australia, New Zealand and Japan.

Prior to joining Travelex in 1997 Want was a partner in the Australian law firm Cowley Hearne Solicitors, responsible for managing the practise.

He is a director of the Fred Hollows Corporation, a member of the executive committee of the Care Australia Corporate Council and council member of the Australian British Chamber of Commerce (NSW chapter).

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