AA, which combines private equity-style debts with a stock market listing, already has a list of risk factors longer than a tow truck cable. But the newest danger is that stranded customers will remember the company exists. Half-year “underlying” earnings were flat at £192m, deflated by call-outs from members reminded by TV advertising that “AA” stands for roadside repairs as well as a grade of battery.
For once, the headline earnings figure favoured by the City suggested the trend was unfriendlier than old-fashioned profits before tax. Here, AA swung from £69m scrawled in red ink to £48m written in black. The main reason was a small reduction in finance costs on a £2.8bn debt burden almost double the company’s market worth.
This sensitivity to debt costs reminds us the AA is a glorious experiment that could yet fail ingloriously. The venerable British business was poorly served by cheese-paring private equity ownership during the noughties. Debts were high, investment was lacking and treatment of patrolmen was shabby.
Indeed, bankers regarded the AA as a basket case unsuitable for flotation alongside stable mate Saga, a travel and insurance group, in early 2014. But, that summer, ex-Green Flag boss Bob Mackenzie swept in with the backing of a fan club of City institutions to float the company. Net debts were still an eye-watering 7.1 times earnings.
All things being equal, every pound shaved off debt accretes to equity. In the next year or so, IT investment will attenuate alongside early repayment penalties on loans, permitting refinancing. At a leverage ratio of five times, roughly £700m of enterprise value would switch from debt to equity.
AA is an opportunity for stock market investors to show they are better stewards than the private equity firms they resent for exploiting their valuation errors. It is Mr Mackenzie’s chance to reap a bonus measured in tens of millions, if he can meet tough return targets. But the shares are well below 2015 highs.
The car repair veteran says AA’s advertising campaign will wash its face via future renewals. He claims that even as cars have become more reliable, they have got heavier, making motorists less inclined to change a punctured tyre themselves. He had better be right on both counts. Private equity owners and fund managers eject struggling managers without mercy. The only difference is that the bosses of publicly-quoted companies are jettisoned publicly.
Lombard Business School has long prided itself on instructing students in the real agendas of commerce. The European Commission has just announced an in-depth investigation into the merger between Deutsche Börse and the London Stock Exchange, providing a case study for students on the LBS M&A course. As they light roll-ups behind the bike sheds, they should note the following salient points.
LSE-Deutsche Börse offer to sell French clearing to appease EU
Groups offer to sell Paris-based part of LCH after regulators formally probe merger
The competition commissioner is Margrethe Vestager, a forthright Dane whose smartphone ringtone is rumoured to be “Ride of the Valkyries”. In recent months she’s spanked Tim Cook of Apple and Li Ka-shing. She will be tempted to don her horned helmet and wreak vengeance on DB/LSE too.
She says the combo could damage competition in these areas:
German stocks: Shorting the shares of Deutsche Bank is an important growth industry. It is vital elderly New York-based hedge fund managers are protected from rent seekers.
Repos: Here, members of the shadow banking community advance funds to borrowers who have already pledged the same collateral several times over. This supplies the liquidity banks are now prohibited from providing.
Rate swaps: Investors take radically different positions using these. One, for example, might believe UK base rates will stay at 0.25 per cent for 30 years. Another might contend faster economic output will push the figure as high as 0.5 per cent by 2036.
Exchange traded funds: Approval-seeking young people desperately need the jobs these products create on the delta desks of investment banks. Subsequent rogue trader cases provide employment for criminal lawyers.
Clearing: Barriers to entry are already high. Technology aside, clearing is excruciatingly dull. The necessity of attending industry conferences in Brussels is a deal breaker for many would-be entrants, who become frozen yoghurt entrepreneurs or burlesque performers instead. The systemic risks of pooling €150bn in margins will meanwhile worry central banks.
Cloud cuckoo land
A new report has awarded Switzerland the title “Most Competitive Nation”. It is moot whether any country can be described as truly competitive when it lacks a large, flexible workforce and a coastline. But it would be wrong to repeat the old insult that in 500 years of peace and democracy, all Switzerland has produced is the cuckoo clock.
First, it is a cliché. Second, the cuckoo clock was invented in Germany.