Bruce Dixon's marvellous medicine

In most cases such a large turnaround in profitability would beggar belief, but Spotless Group is an unusual case.

It is hard to argue with results and Spotless’ first results since emerging from its 15-month stint under private equity ownership are impressive.

There was some cynicism when the prospect for the reflotation of Spotless earlier this year was released because of the exaggerated turnaround in performance it was promising.

While there might still be some lingering doubts until the remainder of the “hockey stock” rebound in earnings promised for this financial year has been achieved, the initial results from the group Pacific Equity Partners wrested control of with the support of disgruntled shareholders in April 2012 are almost remarkable.

Former Spotless executive and now its chief executive, Bruce Dixon, announced a result that was marginally ahead of the prospectus forecasts today, with pro forma earnings up 3.1 per cent on a 2.3 per cent better-than-forecast sales performance.

It isn’t, however, Spotless’ performance relative to the prospectus forecasts that provides any kind of insight into what Dixon and his team, installed by PEP, have achieved.

In 2011-12 Spotless had earnings of $32.8 million and earnings before interest, tax, depreciation and amortisation (EBITDA) of $139.6 million. In 2012-13 its earnings were $54.9 million and EBITDA was $166.2 million.

Dixon today announced earnings of $106.6 million (after adjusting for the transaction and restructuring costs associated with the group’s privatisation, restructuring and subsequent re-listing) and EBITDA of $252.2 million for the 2014 financial year.

If Spotless is to continue to meet or better the prospectus forecast it will need to earn at least $141.8 million this financial year and generate $301.4 million of EBITDA.

In most situations the scale of the increase in profitability would beggar belief, but Spotless is an unusual case. It was Dixon who recognised the uniqueness of the opportunity Spotless represented and took it to PEP, which then spent nearly two years planning its takeover and the transformation of the facilities services group.

The former Spotless regime had been working their way broadly towards the end-game Dixon got to so abruptly, which helped create Spotless’ vulnerability. Spotless had been operating as a series of silos on an antiquated technology platform even as its business model shifted to an integrated services offer.

It had spent more than $100 million on a new technology platform, a pre-requisite for a significant re-basing of its costs and an enhanced ability to offer the full range of its services to large clients. It was nearing the final years of the restructuring program when PEP struck.

What Dixon has done the old Spotless probably couldn’t have done, particularly while remaining a listed company.

The first thing he did was to get rid of loss-making and under-performing businesses, where the former board hadn’t been able to bring itself to accept the offers it had received. He also cut a swathe through the administrative and management ranks, shedding around 800 staff, slashed the number of suppliers the group deals with, exited loss-making contracts and brought an intense focus to bear on labour productivity.

The results speak for themselves, particularly the top-line growth and an EBITDA margin that is nearing 10 per cent. The extent of the cost-cutting and the pace of change could have destabilised the company but there are no indications that they have.

Obviously Dixon will need to continue delivering against the aggressive forecasts for this year to completely convince the doubters but the underlying logic of what he has done – and what the former management was working towards, albeit at a far more leisurely pace – is compelling.

If he can leverage Spotless’ services businesses and their scale and coverage into large holistic contracts and over a much lower cost base there is potential for further significant revenue and margin growth.

PEP and the management shareholders retained ownership of almost half the company, subject to escrow conditions.

The first of those was the release of today’s results, with the shareholders able to sell a quarter of their shares after the result, if the volume-weighted share price over any 20 consecutive day period is at least 20 per cent above the float price of $1.60 a share. At $1.91 today, the shares are a cent below the trigger price.

Another 25 per cent can be sold after the 2015 financial year first-half results, with the same conditions, with the remainder freed of all conditions after the full-year results are issued.

That provides a meaningful incentive for Dixon and his team to continue to drive the group’s performance and assuages concerns that the quick turnaround between takeover and re-listing might represent a “pump and dump” exercise by private equity.

PEP and the management need a sustainable improvement in Spotless to maximise their returns. They are off to a very strong start.