Can private investors spot the warnings signs of trouble?
Earlier this week AT Communications Group (LSE: ATCG) announced the suspension of its shares with that dreaded explanation "pending clarification of the Company's financial position". At worst, shareholders are now staring into the abyss of total loss. Many will have already seen the value of their shares substantially eroded. The share price had already collapsed by over 80 per cent in the year before its suspension.
Most of us, who've been investing for any significant period, will have experienced this scenario at some time in our lives.
So how can investors avoid these sorts of calamities? After all, only in March this year ATCG announced a significant disposal of part of its business, which was meant to slash its debt burden by more than two thirds. The Company boasted of "a refocused business, a strengthened balance sheet and a pipeline of new business, which will further enable the Group to grow in 2009 and beyond". How can investors see through the hype and spot these disasters before they occur?
It's the economy, stupid
ATCG describes itself as a supplier of Information and Communications Technology solutions. To you and me that's telephone systems. ATCG provides them and maintains them.
Unfortunately when the economy is going through a difficult patch, investing in a new telephone system isn't high on the priority list of most companies. It's the sort of investment that is easy for Finance Directors to defer. Instead companies are concentrating on reducing costs, paying down debt and defending their cash flow. Companies like ATCG, which provide discretionary capital items, are highly vulnerable in such situations. However good a company is, it can't be completely immune from its markets.
The message was rammed home to ATCG shareholders in early June when the Company announced that a major project, on which the Company had already recognised £6 million of revenue in last year's accounts, was being delayed by the customer. That's over 11 per cent of last year's sales.
Voting with their feet
It's always difficult for shareholders to know really what's going on in a company. However the people who really know are its management. Watching what they do, as opposed to what they say, can be very illuminating.
In the last 12 months ATCG lost two Finance Directors, its Chairman and its Chief Executive. All appeared to step down voluntarily. Suspicious? In retrospect it certainly seems so. If everything was proceeding in line with ATCG's bullish and optimistic announcements, why were so many of its senior managers jumping ship?
Debt is the killer
It is debt that kills companies and ATCG seemed to have plenty of it. In the previous two full years of operation, ATCG generated profits of £9.5 million (before non cash flow write-offs of goodwill). Yet it still recorded a cash outflow (before financing) of £5.5 million. As a result, despite raising £6.8 million from its shareholders and a £3.5 million sale and leaseback of a freehold property, borrowings remained stubbornly high at £18 million.
The sale of its subsidiary Rocom, which had been bought only three years earlier, seemed to be a last desperate attempt to free the company from the debt stranglehold that gripped it. The acquisition had been originally described as "a major step forward for the ATC business in both scale and scope and establishes ATC as a leading force in the business communications market", yet despite three years of apparent growth ATCG sold it for £5 million less than they paid for it.
Accounting presentation
Understanding a company's accounts can hard enough at the best of times. Yet sometimes it's clear in retrospect that things have been presented in a rather more optimistic fashion that we might have expected (or hoped).
Earlier this week ATCG revealed that it has received a claim for £3.6 million from the purchaser of Rocom. The claim appears to relate to problems with the written assurances that ATCG had given to the purchaser of the business (known as warranties). We do not yet know what these problems are.
The news follows on however from the earlier revelation that ATCG had included £6 million of sales in its accounts, which had not been invoiced to the customer and of which there will now be a delay in collection. ATCG admitted this formed a crucial part of its debt reduction programme with the bank.
In retrospect the disconnect between profit and cash flow seems a little more significant.
It's easy to be wise after the event. But the key thing from situations like ATCG is to try to understand what the warnings signs were. Only then can investors avoiding repeating those mistakes in the future.
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