Out at $1.20

I am traveling and trying to catch up on RFG today what I see is a horror show. There are two isssues that make me sell immediately, at a horrible price that really undervalues the business:

1) There is in the conversations here - and in SMH today - a *potential* specific allegation of fraud around the use of the management firm exit57. The problem I see here is as follows:

a) If this function is intrinsic to the business, you put it in a subsidiary if it must be run with separate financials.
b) If there is a valid accounting reason to run this as a separate entity - off the company's financials - then you MUST MUST MUST disclose that in your related party transactions. At very least, the analysts then have a chance to ask you why you are doing that.

If you don't run it internally and you hide the fact that a related party runs it externally at very least you are creating the impression that you are hiding facts that you do not want shareholders to see. This last report with the large write-down was really the last chance they had to come clean on this issue and be potentially forgiven. Now they have left this dangling, and whether it is an intentional fraud or not, the vultures are going to circle and just pick this apart. If you get tired of watching CNN news network spend 12 hours a day running a long editorial on why Trump shouldn't be president, that's pretty much what the media will do to this story if it gets picked up. I have a rule that allegations of fraud - even unproven and only circumstantial - are an immediate sell. So I sold.

2) The company's EBITDA covenant cannot possibly be met. Why? They likely have short-term EBITDA reductions associated with such a large number of store closures. They are doing exactly what they need to do. They are focusing on business quality instead of quantity. But the practical reality is they probably do not meet their EBITDA guidance, and that means they will have no choice but to do a large capital raise. And it may end up being a horror show of multiple capital raises at each shrinkage of EBITDA, until the business is stabilized.

Here is what should have happened. Back when they negotiated extension of their debt maturities in December, they should have raised minimum $100M AUD to completely pay back the $100M obligation. That would have left them with a very manageable debt situation and given them a lot of wiggle room for EBITDA reductions. That raise would have been done at a decent valuation and would have stabilized the shares greatly. They lost that chance.

I was positive that Plan B would be to do that capital raise together with the writedowns on the last release. Think about it. They could have done a $100M offering at a $1.80 AUD share price, giving the buyer a significant discount and also setting a real floor on the share price for the next year. I log in today and see the release and see that there was no capital raise. Oh my God. What a nightmare. Now the share price implodes as a response to the bad report, and they will be forced to raise capital at horrific prices.

If you look at the chart since the release, it is extremely clear that there are institutional blocks getting sold, so there are large holders making exits here, and I strongly suspect that most of those are exiting because of reason 2), but once reason 1) gets a deep inspection in the public media, I would expect another round of implosion.

This is just a disaster. This company was not that hard to save and the situation - while tricky - could have been controlled. Now I see massive downside risk together with a two-year period of very tricky recovery. I believe the business can survive this, but it is not the time to be in the shares.