When Peter Smedley, the last chairman of Spotless, looks through the prospectus for the refloating of the services group he may not be able to work out whether he should laugh or cry.
In some respects the prospectus is a major endorsement of what Smedley and the former management of Spotless, led by Joseph Farnik, were doing and saying before the group fell to a very hostile bid from private equity group Pacific Equity Partners, supported by Spotless’ institutional shareholders, in 2012.
Smedley was singled out for heavy criticism for holding out for a better price, with his institutional shareholders threatening at one point to call a meeting to get rid of him and clear the way for the PEP offer. He will feel some vindication from the nature of the change within Spotless, which supports the core of the arguments he made at the time of the takeover.
It is, however, doubtful whether the old listed Spotless could ever have achieved what PEP -- and the management team led by former Healthscope chief executive (and former senior Spotless executive) Bruce Dixon that it installed -- have been able to achieve within the timeframe between Spotless delisting in 2012 and its re-listing next month.
When Spotless finally surrendered to PEP on 30 April 2012 the private equity firm’s $2.71-a-share offer valued the group’s equity at about $720 million and gave it an enterprise value of about $1 billion. If PEP gets the offer away within its indicative price range of between $1.60 and $1.85 a share, the enterprise value implied will be between $2.35bn and $2.55bn.
In 2011-12, according to the prospectus, Spotless had net earnings of $32.8m and earnings before interest, tax, depreciation and amortisation of $139.6m. In 2012-13 it had net earnings of $54.9m and EBITDA of $166.2m. This year it is forecast to earn $111m and generate EBITDA of $248.8m, rising to $141.8m of earnings and $301.4m of EBITDA in 2014-15.
The hockey-stick nature of those numbers in a private equity-sponsored listing might generate some cynicism but PEP will retain 25 per cent of its shares at least until this financial year’s results have been released and another 25 per cent until after the first half results for the 2014-15 year have been issued -- and can’t sell unless the share price is at least 20 per cent above the final IPO price.
While the extent of the improvement in Spotless’ performance might raise some eyebrows its direction shouldn’t because it is consistent with the case Smedley and Farnik tried to make in defending against PEP’s assault.
In essence their argument was that Spotless, until Smedley became chairman in 2007 and remade its board and management, had been operating on a 30-year-old technology platform which dictated that its business units operated as independent silos and prevented Spotless from emulating the integrated services model its offshore peers had demonstrated could be very successful.
Spotless committed to a major SAP IT capital expenditure program -- according to the prospectus the spend on the program over the past three years has been more than $100m -- and argued that once that program was completed and the business was operating under the new integrated model its earnings would rise sharply.
PEP and Dixon have effectively pursued that same strategy but where the old Spotless board was talking about EBITDA of $150m to $160m "within three or four years", Dixon has already delivered above that range and is forecasting the group will generate roughly twice that level next financial year.
One of the first things Spotless did under PEP’s ownership was to do what Spotless had previously been unable to do. Spotless had tried repeatedly to sell its loss-making international coat hanger business, Braiform, but had been unable to attract an offer it was prepared to accept. Dixon, perhaps because PEP wouldn’t have factored any value for Braiform into its bid price, got rid of it within months. He also shut down the small, barely profitable, international business Spotless was trying to establish.
He also cut 790 administrative and management roles -- 50 per cent of the 2011-12 overhead expenses, got rid of 30 per cent of the group’s suppliers to reduce procurement spending, exited loss-making contracts, focused on labour productivity and nearly doubled Spotless’ EBITDA margin.
The organisational structure was, as Smedley and Farnik had planned, shifted from service-specific silos to a customer-centric and "holistic" model under which Spotless can offer a customer its full suite of services.
Smedley would find it ironic that the first illustration of the 'new' Spotless model in the prospectus is the integrated service deal the group struck before the takeover with the South Australian Government under a public-private partnership to be the facilities manager for the new Royal Adelaide Hospital when it opens in 2016.
Dixon had spent nearly two years analysing Spotless, devising his strategy and planning its execution and, it would appear from the prospectus numbers, has implemented it brilliantly. It is doubtful that so much change could be effected as quickly and ruthlessly within a publicly-listed company by conventional managers.
Smedley and Farnik were broadly on the right track -- the other examples of Spotless’ strategy cited in the prospectus were also agreed on their watch -- but it probably needed private equity rather than institutional ownership, and two years away from the public gaze, to do what Dixon and his team have done.