Investor's Champion Blog
Provides refreshingly forthright, independent comment on predominantly small cap companies and specialist investment funds. Informed opinion, based on first-hand research, but pulls no punches in exposing management weaknesses.

SUPERGLASS-main market new issue. The super returns for the private equity boys and high levels of debt they have left are surely unacceptable!

I had an interesting meeting today with the management of Superglass, ‘the UK’s number 2 manufacturer of glass wool insulation products’, as their strapline goes!

Superglass is a profitable cash generative business which is seeking to list on the main market at a market capitalisation of £100m. For the year ending August 2006, turnover was £41.7m, profit before tax was £6.5m, earnings before interest tax and amortisation was £10.1m and operating cash flow was £13.8m. Estimates for the year ending August 2007 (they should be reasonably accurate as August isn’t far away) point to top line turnover of £46.1m and profit before tax of £8.1m.

The business appears to have excellent growth potential supported by Government efforts to improve energy efficiency. The group has a strong market position, makes operating margins in excess of 20%, is highly cash generative (yield will be c3.0%), has a flexible manufacturing facility and excellent organic growth opportunities with high barriers to entry.

Everything therefore looks rosy then for prospective shareholders, or does it!
Well the business does indeed present a compelling investment proposition, however, wait for this.

Superglass was the subject of management buyout from Encon Group in 2005 at an Enterprise Value of only £40m. The MBO was backed by NBGI Private Equity Fund and Investec. For Enterprise Value read 'Cost' as net debt prior to the buyout was only £2.3m and the business had underlying cash flow of £8.1m in 2005, so one can assume that there was virtually no debt at the time of the buyout.

A glance at the cash flow statement for 2005 reveals that MBO funding was £39.2m and additional funds raised through shares issued were only £400,000.

In a nutshell, it looks like management and supporting private equity shareholders effectively acquired this business for virtually nothing in 2005. Some 2 years later the private equity supporters are now selling out for a total of £70m-that’s not a bad return in 2 short years, especially as they didn’t actually have to put in any equity.

The bad news is that poor old Superglass is currently saddled with c£32m of debt and obviously little in the way of net assets.

I like the following line from the broker’s note:

‘Our proposed indicative Enterprise capitalisation of £130m is significantly higher than the £40m Enterprise valuation paid by the current MBO backers’.

You are telling me it’s higher, some £100m higher and unlike those prospective shareholders intending to support float they didn’t even put up their own money!

The key reason for this amazing deal back in 2005 appears to be down to former parent Encon’s forced sale. In the first place the Competition Commission blocked the sale of Superglass to Knauf and then Encon needeed to swiftly dispose of its manufacturing operations to facilitate its sale to Wolseley.

The business has clearly performed exceptionally well since the MBO and the outlook looks very positive. Valuations of all insulation stocks have apparently also increased materially over the past 2 years. However, I find it really hard to believe that new investors are prepared to support the float given the high level of debt the business now carries and the value that has effectively been stripped out of the business over the last 2 years. It’s easy to say that interest costs are easily supported but cash that should be there to support growth and expansion is simply there to pay down debt that wasn’t actually there 2 years ago.

Given the highly supportive market environment this business should surely be actively looking for ways to expand outside its current market. The excellent cash flow would ordinarily be there to service debt built up to support acquisitions. For the most part acquisitions will now need to be funded by future equity raisings.

I’m not sure of the solution here. The private equity boys (and management) are hardly likely to pay down the debt before they sell. Wouldn't it be lovely if they did!

Key institutions could decline the opportunity to invest which could force the company to pull the flotation. They could also dramatically cut the current valuation (and their own cut) and raise new money at the same time for the business to pay down debt. This will also give new shareholders encouragement for the future and provide some headroom to support expansion. However, institutions largely seem to be lapping up these private equity dumps on the market, high debt levels notwithstanding.

When will they conclude that the greed has become excessive and that enough is enough!


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