This week we have been focusing on a new tactical trade idea for Qantas. We…
Everyone has now heard the story of the collapse of Dick Smith and that there are more than 100 interested parties representing over 350 unsecured creditors, owed about $250 million. So what happened? On 4 January 2016, the board of directors of Dick Smith appointed Joseph Hayes, Jason Preston, William Harris and Matthew Caddy of McGrathNicol as voluntary administrators. Following this appointment, a syndicate of lenders, which hold security interests over Dick Smith and a number of associated entities, appointed James Stewart, Jim Sarantinos and Ryan Eagle of Ferrier Hodgson as receivers and managers. The receivers and managers took control of Dick Smith’s business and assets and announced expressions of interest for a sale of the business as a going concern. On 5 January 2016, the Australian Securities Exchange suspended Dick Smith’s securities from quotation.
This story is in the middle of negotiations but is a good one for debt & hybrid investors because it highlights how quickly a company (which was arguably viable in June 2015 at $450m market capitalisation) could go into administration with unsecured creditors looking like they will lose most of their money.
So what is an unsecured creditor and what does this mean for them? Generally speaking an unsecured creditor is someone (an individual or a company) which is owed money. A senior unsecured bondholder is an unsecured creditor. When a company goes into administration unsecured creditors rank lower in payment priority than secured creditors as they have no ‘security’ over company assets. The lenders (normally banks) hold first ranking security interests over all the assets and as such are entitled to the proceeds of all asset sales in priority to general unsecured creditors. The only exclusion to this rule is claims of priority creditors (e.g. employees) in regard to circulating (formerly known as ‘floating charge’) assets. Circulating assets typically include debtors, stock and cash.
In Australia the legal priority of payments has secured creditors paid in priority to unsecured creditors. Secured creditors may contract priority arrangements between themselves if there are different levels of secured debt within a company. There is an exception to this for employee entitlement claims. During a winding up of a company (or Deed of Company Arrangement (DOCA)), the entitlements of employees have priority over all other unsecured debts and claims, as well as those assets subject to a circulating security interest (also known as floating charges). The remuneration, costs and expenses of insolvency practitioners appointed will be afforded priority over all creditors’ claims, including employees.
So what does all of this mean? Well Dick Smiths unsecured creditor claims are about $250million and secured creditors are owed approximately $140m (NAB and HSBC). The business was hit by two profit downgrades late last year as well as a $60 million stock write-down in November that sent its shares trading as low as 20¢, down $2 from its $2.20 listing price. According to the Australian Financial Review Macquarie Group provided an emergency $30 million trade finance facility late last year which enabled the company to re-stock all-important Apple products leading into the Christmas trading period. This trade finance facility was very short term and Dick Smith agreed it would re-pay $10 million to Macquarie in December, and committed to another two $10 million installments in January and February. While this is all well and good it seems as though this was a key factor behind Dick Smith’s lenders (NAB and HSBC) decision to place the electronics company into receivership.
There is now a lot of finger pointing about who and what caused the downfall and whether or not the banks gave them sufficient time to trade through their issues. Ultimately, it does not matter as the company is now in the hands of administrators and given recent history we would expect unsecured creditors will take a major cut to their investment. An example of this is the recent liquidation of Gunns Group. In this example (albeit a completely different story) the receivers’ cash realisation from assets under their control was insufficient to produce any return to the ordinary unsecured creditors of the Gunns Group.
Ultimately there are no bondholders at risk in this example but if there was you can see how quickly the value of your capital will erode. It also demonstrates the power of a secured creditor when they want to protect their investment. This is why it is critical to understand the structure of any secured bank facility when assessing the credit worthiness of a unsecured bond (whether the bond is described as senior or subordinated) and how it may effect your investment.