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hard lesson

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    Hard lesson

    Now it's question time

    1, 2008

    These former darlings of the market have a common thread - high-flying ambition, fuelled with debt, that came crashing down when the money ran out. Stuart Washington reports.

    Eddy Groves, the chief executive of ABC Learning Centres, last year took his beloved basketball team, the Brisbane Bullets, on an all-expenses paid, end-of-season trip to Las Vegas. By all reports Groves drives a Ferrari Superamerica, with a price tag of about $675,000, and flies in a Citation CJ3 jet, which cost about $7.5 million.

    Michael King, the former chief executive of the financial services and property empire MFS, spent an estimated $20 million building five polo fields at Elysian Fields in the Gold Coast hinterland. In July last year, King saddled up to lead his polo team, also called Elysian Fields, to win the Warwickshire Cup in Sussex, Britain. James Packer's Ellerston White played in the same competition; King's team featured the professional Chilean polo player Jose Donoso and Italian professional Marco Di Paolo.

    David Coe, the executive chairman of the structured finance specialist Allco Finance Group, lives in the historic Coolong mansion in waterfront Vaucluse, bought in 1997 for a then record $14.6 million. The intensely cultured Coe reportedly has a painting by the American expressionist Mark Rothko in his house and exercises his passion for art as the chairman of the Museum of Contemporary Art.

    These men shared the pages of BRW's Rich 200 edition last May: Coe on $380 million, King and his fellow MFS founder Philip Adams on $370 million, and Groves and his wife Le Neve on $295 million.

    They now share a less pleasant bond: their wealth has been decimated and their business empires are in flames. All three men borrowed heavily against their shares, adding to their substantial personal financial distress.

    King's wealth has been put at as little as $30 million after a now-infamous conference call in January that resulted in MFS's share price falling by two-thirds - during the call. This week The Australian Financial Review tracked him down to a Gold Coast coffee shop, reading a Dick Francis novel, Hot Money.

    Groves this week revealed that his entire stake in ABC has been subject to a margin call, meaning he may be forced to sell at fire-sale prices what once was an 8 per cent holding in the company he founded in 2001.

    There are more common themes between the companies these men founded. Heavy burdens of debt. Complex structures and unclear communications. Questions of appropriate disclosure of their financial arrangements. Almost inextricable ties between their personal fortunes, and persona, and those of their companies. Soaring ambition and hunger for expansion. And a market that turned harshly against them after a year in which they used cheap debt to grow their businesses bigger and bigger.

    These common themes are uncomfortably close to those that brought high-flyers from another era crashing down. In the 1980s, Alan Bond, Christopher Skase and Robert Holmes a Court all shared a penchant for heavy burdens of debt. They had complex structures. And the market turned sharply against them in the Black Monday sharemarket crash of 1987.

    As badly as it sits - and certainly without any suggestion of the improprieties that emerged from the '80s collapses - Groves, King and Coe have become the noughties poster boys of entrepreneurial excess.

    Add Centro Properties Group's former chief executive Andrew Scott - whose brainchild posted a loss of more than a $1 billion yesterday - Rubicon's Gordon Fell and Tricom's Lance Rosenberg and there are all the makings of a replay of history.

    In an unhappy coincidence for Coe, Allco Finance Group's structured finance and badly limping Allco HIT fund shares the same AHI stockmarket ticker as Bond's grandiose blimp business, Airship Industries.

    Behind all these entrepreneurs are the shadowy teams of bankers, all too willing to fund their rise and rise, but now scrambling to ensure their debts will be repaid.

    And in the aftermath, regulators will be picking over the role of auditors signing off accounts with substantial errors about the types of debts (Allco and Centro), the high levels of undisclosed debt over large directors' shareholdings (Allco, ABC, MFS) and rampant short selling, aided by the likes of Tricom.

    The most recent accounts show the now all-too-apparent flaws in their business models. ABC Learning: negative operating cash flow of $20 million in the December half. Allco Finance Group: negative operating cash flow of $26 million in the December half. (MFS is in a trading halt, after seeking a reprieve from filing its half-year accounts.)

    Without cash from refinancing or asset sales, these businesses don't have enough money to pay the bills.

    After credit markets turned so sharply, refinancing is no longer a given. And with banks unwilling to lend, financing for purchases is no longer available on terms that supported previously ambitious asset prices.

    The music has stopped.

    There is nothing that spells out the "fly too high, run too fast" nature of these businesses more than their rapid accumulation of assets in a short period of time.

    In retrospect, the businesses were shelling out top dollar for assets in the dying days of a bull market that started in March 2003.

    ABC spent $870 million on new businesses in 2006-07, more than double the amount spent the previous year, including almost $500 million on the US acquisition La Petite Holdings. In 2007, its US child-care centres rose from 357 to 1000.

    From June 30, 2006, its borrowings grew from $380 million to $1.8 billion.

    Allco and MFS also pursued rapid growth in assets - and had equally ballooning levels of debt. Since June 2006, Allco's debt has grown from $630 million to almost $6.5 billion. In 2006-07, MFS's debt grew from $76 million to $777 million.

    But it's not just the heady pace of growth that lies at the heart of the problems.

    The market lost faith in structures that were becoming increasingly complex and had more than a dash of financial engineering to achieve the financial goals expected by investors. This happened in infrastructure and structured financial products, but property trusts also serve as a handy example.

    In a detailed piece in 2006, the former BRW journalist John Kavanagh wrote about increasingly aggressive tactics used by property trusts to inflate their returns.

    The piece raised questions about the high level of gearing, property trusts relying on income from hedging strategies, purchases of buildings enjoying temporary rent contracts above the actual market rent and an overall expansion into riskier assets in overseas markets, including former eastern bloc countries.

    This was a marked departure from listed property trusts' previous practice of gaining rent from locally owned property and distributing it to unitholders.

    In the BRW interview, the man who was heading Rubicon and was subject to some of the criticism, Gordon Fell, responded: "We're not f---ing wood ducks." Yesterday Rubicon America Trust reported a net profit of $50.1 million in the year to December 31, down more than 50 per cent from $102.7 million in 2006. The profit announcement was marked by a halt to distributions to preserve cash, sales of up to $800 million in assets to reduce debt levels and unwinding of its foreign exchange hedges.

    The stock plunged 33 per cent from 28c to 19c on the news while its fellow funds - Rubicon Japan Trust and Rubicon Europe Trust - also fell heavily.

    Just how did we get here again? After all, the excesses of the dotcom boom are hardly a distant memory.

    Erik Mather, the managing director of the corporate governance service Regnan, says large institutional shareholders have to bear some responsibility.

    He notes the HIH royal commissioner Neville Owen's statement that shareholders have a fiduciary duty to be interested in their investments and what has gone on.

    "It's not productive to run around and play the blame game, as we get cramps in our fingers pointing at every other individual than ourselves," he says.

    "The reality is, for a significant number of people in the market, we have not exactly exercised ourselves by demanding transparency from companies in the normal course of events."

    Mather blames a trancelike state from investors "caught in the blazing headlights of 20 per cent returns".

    And he sees the selldowns in shares like Allco, Centro and MFS as a reaction to what has been lacking for a long time. "The market tends to discount share prices where share prices are lacking in a very significant way."

    But it's not as if there have not been warning signs, Mather says.

    "We would have to say, in terms of our efforts to promote transparency in the sector, we have been disappointed."

    Stephen Matthews, the deputy chairman of the Australian Shareholders' Association, also sees some warning signs that were ignored in the form of a powerful executive chairman such as Coe, or a powerful executive director such as King.

    In a letter to today's Herald, he sees boards without a clear majority of independent directors or a dominant founding executive director who has a large shareholding have repeatedly shown negative characteristics.

    These include undisclosed borrowings over large shareholdings, balance sheets that do not distinguish between current and non-current items, "mistakes" in disclosure of current and non-current liabilities (borrowings) and large intangible assets resulting from overpayment for acquisitions.

    "The most important thing retail shareholders can do to safeguard their investments is to make sure they elect a majority of truly independent and knowledgeable non-executive directors to the board and that those independent directors then elect a strong independent chairman," Matthews says.

    Of course, there will be winners and losers. Colin Bell, the executive chairman of Bell Financial Group, is in negotiations to buy the distressed business of Tricom after its bankers forced it to rapidly scale down its margin-lending business.

    "I suppose they would not be talking to us if business was booming," he says.

    "When the markets are rocking along, people with good businesses, they are happy where they are and they are not interested in selling."

    Bell also makes the valid point that the highly publicised corporate flame-outs also mask an overall retreat on the world's equity markets.

    "We're really inclined to be mesmerised by Allco and the ABCs and MFS. Our market has come down along with every other market," he says. "It's not like we have been a huge underperformer."

    But Bell makes a comment about retail investors that might usefully apply to the super-expansion undertaken by Allco, MFS and ABC over the past year.

    "People who have been hurt by it will have only got into the market in the last year and, perish the thought, got into it on a leveraged basis," he says.

    The heady times enjoyed by the once super-rich executives are likely to be sharply curtailed, and already the crash is having an impact. Late last year Groves sold four separate Queensland properties, worth a total of $14 million, including one in Labrador that brought $600,000 less than he paid for it. It's hard to avoid the impression that he needed the cash for something.

    Allco's Coe is subject to reports that the board want him replaced as executive chairman, although someone familiar with the situation said this week: "I can't see him walking away from this mess he's in now."

    And King is understood to be facing margin calls that could wipe out his remaining wealth.

    In the 2006 interview in BRW, Fell said in more optimistic circumstances as investors warmed to the highly complex Rubicon: "We have our critics but the market is voting with its feet."

    Two years on, he got that right - and the rush is towards the doors.

    But the veteran Bell says with the benefit of many years in the market: "There have been awful things in the market before and the market has come back."

    Stuart Washington is a director of KU Children's Services, a not-for-profit provider of child-care services
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