Obvious and annoying questions for VTL
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Sometimes the simplest and most obvious questions are the ones most difficult to answer. "Why?" seems harmless but can lead to all sorts of problems with the answer. Simple and obvious questions have a rather annoying way of doing that – drilling right to the core of an issue.
Which brings us to VTL Group. VTL Group is a small listed company that has developed vending machine systems and technologies from its base in Auckland. It listed on the NZX in 2000 and has spent the past few years beavering away setting up franchise operations overseas, particularly in the United States.
The 2006 annual report was full of commentary that indicated the company was about to make a quantum leap in size and profitability. The report talks about "a growth platform that once converted will contribute to an estimated 500 per cent increase in annual revenue".
It's pretty heady stuff for an annual report and any casual observer would be looking at buying shares in the company because of the potential of profits to come.
But no. Instead VTL Group has signed a deal to sell its North American assets, part of which would have delivered the 500 per cent growth in revenue, for US$67.5 million (NZ$92.1 million).
This isn't a cash deal. VTL Group gets a 5-year convertible note in the purchaser, Bacon Whitney, paying 10 per cent interest. The convertible note can be converted at any time into shares in Bacon Whitney, at the option of Bacon Whitney, which would then see Bacon Whitney 72 per cent owned by VTL Group.
Now here comes the question: Why?
There is an asset sale in the accounting sense because assets are transferred and value is received. Convertible notes have two parts when it comes to value, the first is the value of the interest payments and the second is the option of conversion into shares.
In the case of VTL Group, the option to convert will give it control of the issuer. It is hard to see that anything has been sold, because VTL Group can get all the assets back, and probably a bunch more, from the option to convert.
That option is controlled by the issuer, and convertible notes have no voting rights, so it isn't a given that VTL Group will get control back. But it is a fair assumption to make.
The issuer of the convertible note is Bacon Whitney, a new company that appears to have been set up just to acquire these assets. US private equity firm Halpern Denny controls Bacon Whitney via one of its investment funds. A quick look on Google shows the only references to Bacon Whitney being the press releases from VTL Group. It really is a brand new company.
Halpern Denny also controls, via one of its investment funds, a company called Service America, in which VTL Group has a 17 per cent stake. As part of the sale of the North American assets, VTL Group is surrendering its interest in Service America, presumably to the Halpern Denny fund, though this isn't clear.
VTL Group has also agreed that if the convertible note converts into 72 per cent of Bacon Whitney, the Halpern Denny fund – as the then minority shareholder in Bacon Whitney – will be able to swap its minority position for shares in VTL Group, thus giving VTL Group 100 per cent control of Bacon Whitney.
One would be right to ask whether this means that VTL Group is getting US$67.5 million in value today only to spend it again (effectively) to buy back the assets it is selling. The accountants will treat this as two separate transactions, but it is more logical to think of these as one long series of transactions.
Add to that the fact that Halpern and Denny, the two principals of Halpern Denny, have a combined 19 per cent stake in VTL Group and things start to get interesting. There was a proposal for Halpern and Denny to acquire more shares of an exiting shareholder to get them to 42 per cent of VTL Group. But that deal has just fallen over.
But why sell the North American assets to a private equity fund that is likely to sell them back within five years? The answer is not obvious, as there is little chance of VTL Group ever seeing cold hard cash for the transactions.
However, one might speculate that the real beneficiary of these transactions is not VTL Group but Halpern Denny and its fund or funds. Private equity players are not going to get out of bed for a return of less than 30 per cent a year for this type of deal, and probably want something closer to 40 per cent.
Halpern Denny is in effect going to carve up VTL Group's North American assets, possibly keep the better bits for itself and then sell the rest back to VTL Group when it suits it.
Its exit is via a shareholding in VTL Group that will presumably be sold down within a short time. Hard to say at this stage what may happen, but it is a fair assumption to make.
This may be idle speculation, but the market generally has a fairly good nose for the value in transactions. What has happened to the share price of VTL Group since the announcement was made at the end of July? The share price leapt in the middle of July from the 75-cent range to about $1.05, and ended the month at 92 cents – a clear case of buy the rumour, sell the fact.
Since the end of July the share price has tanked and is now at 70c, a fall of nearly 25 per cent. Even adjusting for shaky global markets, that is still a major reduction in value.
It would seem investors in VTL Group have "voted" on this transaction and decided it does not create a lot of value for the company.
VTL Group will be holding a special meeting shortly and an independent report on the transaction will be produced. It would seem that the directors have a job ahead of them convincing investors of the merits of this transaction.
Bruce McKay is the director of niche banker Saffron Capital.
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