In 2014, Quickflix was the market leader in streaming services but has trended downwards since due extreme competitive pressures. Netflix stormed the Australian market last year, followed by Stan and Presto which saw Quickflix sales plummet. This forced the group to restructure their obligations securing a release of $7.5 million of debts with its content providers and were looking to exit a period of contraction. However, in order to progress the company required new capital to fund its existing business while pursuing new opportunities. The catch was that the somehow the group had to restructure the existing Redeemable Preference Shares (RPS) held by competitor Stan Entertainment (a joint venture owned by Nine Entertainment and Fairfax Media).
The RPS were first granted to HBO in 2011 for a 15.7% stake in Quickflix for a $10 million investment. The stake was then acquired by Nine Entertainment in 2014 for an undisclosed sum which were subsequently transferred to Stan.
In terms of capital structure, preference shares rank ahead of ordinary shares in respect to dividends and priority of payment in the event of default. Preference shares are recorded as debt on a company’s balance sheet due to their debt like characteristics such as a payment of a fixed dividend (similar to an interest payment). As a result, new potential Quickflix shareholders were hesitant to dive into the proposed capital raising due to reduced protection.
What made the situation even more difficult is that the group was in no position to fund redemption of the RPS (face value of $11.7 million) due its declining customer base. Although Quickflix managed to achieved positive EBIT for the first quarter of 2016, the group needed to recapitalise its balance sheet which resulted in prolonged negotiations with Stan over a potential RPS restructure.
Stan’s proposition gave two options:
- Quickflix pays Stan $4 million in cash
- Quickflix pays Stan $1.25 million in cash, transfers all its streaming customers to Stan and agrees not to subsequently compete with Stan.
This left management’s hands tied. On one hand, the group was unable to fund the redemption (in regards to both options) and on the other hand, the group could not raise equity capital due to an unattractive capital structure (many potential investors required the RPS restructure as a condition). As a result, the company enter voluntary administration on the 26th of April 2016 and is looking to reposition itself in other sectors such as technology and ecommerce.
Quickflix were able to substantially reduce costs and restructure their debt payments, resulting a cash increase of $381,000 and positive EBIT, this performance was irrelevant to the group’s long term viability. This illustrates the importance of understanding liquidity and solvency. Liquidity refers to a company’s ability to meet in short term objectives and obligations while solvency focuses on the long term. Although Quickflix’s income statement and cashflow showed promising liquidity, the group’s balance sheet continued to deteriorate negatively impacting solvency. This demonstrates the key to credit analysis is understanding an issuer’s balance sheet and judging their solvency (probability of wind up) accordingly. This will allow investors to identify warning signs before they are made public (such as capital structure obstacles as seen in Quickflix) and avoid substantial capital losses when things turn for the worst.
Note: QFX Shares Trading Half in May 2015