29 February, page-14

Any debt for equity swap (even if favoured by the banking syndicate) will be highly dilutive to the existing shareholders. Even then, this would only take care of some, not all, of the banking facility (due to working capital requirements needing to be maintained and resources). It would not however take care of any of the trade creditors or the legal creditors, the collective value of which exceeded net debt at Jun30.

In any event, previous discussion of debt for equity at a premium (rather than discount) has all but disappeared.

Retail finance will not happen or if it did, would be priced well above the current (Jun30) WAV of >2.5%. As it is, even if the existing finance is retained in place, with either terms, facilities, composition and /or quantum extended or increased, it will be heavily repriced for risk.

I'm more towards the view that if the banking syndicate does see this through (ie: supporting the business forward) it will do so by changing the terms, structure and nature of the existing facilities. In doing so, the weighted depriving would, in my view, edge upwards towards the 4-5% rang with risk factored for 200-250 basis points. Certainly, the existing rates against a heightened risk outlook (short and medium term) will not be maintained.

If so, then this would move the forward interest bill to $32-40m or higher, annually whilst also buying time and breathing space to ensure that the required restructuring efforts got under way. The banking syndicate would still (in my view) be pushing for a $100m+ OPEX reduction and a 10-15% headcount reduction. The efficiency opportunities that SGH should have been acquiring (and in SGS's case, clearly paid a premium for) have simply not eventuated to date, or even been pursued by management (of the 2015 variety).

Similarly, corporate bonds won't be pursued because the required pricing (to get these across the line) will likely be in the 500-800bp range, so extremely punishing to the Company going forward.

As well, a capital raising will not happen as the discounting and dilutive impact required for this to succeed would all but condemn the existing share holdings to permanent minority status.

So, where would this leave the business going forward?

I'm of the view that the banking syndicate will support SGH rather than tip it over. The price of doing this however will be felt in:

1). The depth and extent of the required OPEX cuts (I've said $100m+ is required).

2). The extent to which permanent headcount reductions are required (10-15% is my view against the Dec15 reference of 5500, up from 5359 at Jun30).

3). New or extended facilities will be agreed to which pushes back the 2018 (near 1/2 required repayment) by 3 years.

4). The extended facilities will be repriced in the range of 400-500bp, so effectively at double the current WAV rate, evident at Jun30).

5). Areas of exit will be encouraged both in terms of discontinuation and divestment.

6). Acquisitions will firmly be taken off the agenda.

7). Dividends will be suspended for H16, F16 and pretty well F17, as well.

8). Management changes will be required either through existing people leaving or a new layer of experienced management being put into place. The Board will also be heavily changed. Note, no UK NED has yet been appointed despite this being referenced since May /June last year.

9). Numerous other changes will also be required and things such as WIP, goodwill etc will all need to be right sized (ie: reduced). The banking syndicate will not like, for example, the fact that these days have continually moved out since 2011+ and are now averaging >100+ days more than they were back around then).

Clearly, SGS (even if not considered a mistake) was overpaid for at the time of acquisition. Both the revenue multiple as well as the EBITDA multiples were well in record territory for the transaction and in comparison to other transactions that preceded as well as followed after SGS. However instead of recognising for this, too little has been done to date to rein in effectively what (so far) has proved to have been a very costly acquisition indeed. This though will not be enough for the banking syndicate to dump SGH, but rather as a catalyst to ensure that the syndicate is sufficiently protected for risk, exposure and pain, all of which points to the banking syndicate being firmly in control of the future even if not operationally so.

Expect therefore an extremely comprehensive announcement on the 29th which will equally shock as it will also lay out the foundations of the future. But as for financial and SP recovery, this will be a very long way off indeed, as the syndicate looks to safeguard its exposure and risks first and foremost.

So, I'm saying seriously wounded with egos well and truly punctured, but with survival /recovery to occur after an extended period in intensive care.

As for the likely write offs however consider this - post SGS being acquired, SGH was priced at > double the value of the SGS acquisition. So (as illogically as this argument might sound) any reduction to SGS' acquisition values would (if this were to be closely paralleled) be considered in the 35-50% range. A full write off will not happen but some very sharp reductions indeed will likely occur. And that's before you consider the WIP argument in circumstances where the average days should be <300 (remember SGH's own argument re: 9-15 months, etc, etc in many of the SGS areas of activity).

Survival- yes. But in need of radical surgery - yes.

As for recent media stories regarding the legal sector recovering in 2016 that was in reference to the large commercial /corporate practices and reflected a Sydney centric outlook. The Melbourne outlook (same report) was subdued to down. So, no silver lining there for SGH either way of the discussion.