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Intelligent Investor

Keycorp hangs by a thread

This payments company is doing its best to appear calm, but there are red flags fluttering everywhere.
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By James Greenhalgh · 15 Mar 2007
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James Greenhalgh
By James Greenhalgh ·
15 Mar 2007
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Recommendation

Keycorp Limited - KYC
Current price
$0.58 at 15:57 (26 November 2010)
Price at review
$0.47 at (15 March 2007)
Business Risk
Very High
Share Price Risk
Very High
All Prices are in AUD ($)
A trading halt just before the release of a company’s half-yearly results isn’t usually a positive sign, so the omens weren't good when Keycorp requested its shares be placed in a trading halt on 26 February. The reason given was that the company was ‘currently engaged in discussions with third parties regarding financial restructuring’. Financial restructurings are always a worry and we’ll call this red flag number one.
Superficially, the follow-up announcement on 5 March titled ‘Keycorp restructures bank facility’ seemed pretty innocuous. This short-and-sharp statement said that Keycorp’s banking facility had been increased from $10m to $15m, which hardly seems cause for alarm, does it?
But, reading between the lines, we were indeed alarmed. Keycorp also released its half-year accounts the same day and, buried in the fine print of notes 12 and 22, was the full story of the bank facility. At balance date – 31 December – Keycorp was in breach of ‘financial undertakings’ made to the facility provider, Westpac. In other words, Keycorp wasn’t meeting certain unspecified debt or profitability ratios which the bank had required as a condition of providing the facility. Red flag number two.
Another downgrade
Banks tend to get nervous when their undertakings aren't met, as it usually means the business isn’t performing too well. And the accounts confirmed just that, with sales slumping 27% to $39m and the company reporting a loss of $4m for the half. While this was consistent with what the company had foreshadowed at November’s AGM, management issued yet another downgrade for the full year.
But what most concerned us – and presumably Westpac – was that the net cash position we lauded when we first commenced coverage on Keycorp has all but disappeared. The business bled more than $11m worth of operating cash flow during the half, which is red flag number three. This outflow explains why Keycorp needs more cash desperately, as well as why Westpac was reluctant to provide it.
How do we know Westpac was reluctant? The trading halt was the smoke, but note 22 to the accounts provided evidence of the fire – Westpac apparently agreed to extend Keycorp’s debt facility to $15m only because Telstra agreed to guarantee $7.5m of it. In other words, without 47% shareholder Telstra coming to the rescue, Keycorp might have been in serious trouble.
Senior management changes
Unfortunately we doubt Keycorp is out of the woods yet. A fourth red flag, if it were needed, is a reshuffle of senior management. After delivering more than his fair share of profit downgrades, chief executive Bruce Thompson has announced he will step down shortly. At least the company has recently appointed a new chief financial officer, because the last one was sent to Canada to manage the Optimal Services Group acquisition some months back.
Over recent months, we have been increasingly disillusioned by Keycorp’s failure to deliver on promises. We finally bit the bullet by downgrading to Sell on 30 Jan 2007 (Sell – $0.755). We won’t pretend we saw this severe deterioration coming, but Keycorp was already failing the smell test.
Companies rarely admit how bad things are – it scares away customers as well as shareholders. But, based on recent events, things look pretty bad to us. Perhaps Telstra will deliver Keycorp into the arms of a white knight, or perhaps the company will recover on its own, but all the red flags suggest things might well get worse. Even with the stock down 38%, we continue to recommend that you SELL.
James Greenhalgh
IMPORTANT: Intelligent Investor is published by InvestSMART Financial Services Pty Limited AFSL 226435 (Licensee). Information is general financial product advice. You should consider your own personal objectives, financial situation and needs before making any investment decision and review the Product Disclosure Statement. InvestSMART Funds Management Limited (RE) is the responsible entity of various managed investment schemes and is a related party of the Licensee. The RE may own, buy or sell the shares suggested in this article simultaneous with, or following the release of this article. Any such transaction could affect the price of the share. All indications of performance returns are historical and cannot be relied upon as an indicator for future performance.
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James Greenhalgh
James Greenhalgh
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