pierpont does kiaaaaaaaaaaaaaaaaaaaaaaaaa Bright Knight turned...

pierpont does kiaaaaaaaaaaaaaaaaaaaaaaaaa Bright Knight turned black
12/09/05


Knights Insolvency Administration Ltd had just two problems. First, it was an insolvency expert that became insolvent. Second, it was an accountancy firm that didn't produce accurate accounts.
Apart from that there was nothing much wrong, except maybe its prospectus.

Let's deal with those points in reverse order, and start with the prospectus. The prospectus issued by Knights in June 2003 raised $8.5 million in 50c shares.

Reading the document, your average investor could have been forgiven for thinking that Knights was a highly professional accountancy and insolvency outfit.

The opening page said that Knights had averaged 45 per cent revenue growth during each of the past four years. For 2003-04, Knights was forecasting revenue of $16 million and a dividend of 4.5c, so that the 50c shares were being issued at a 9 per cent yield and on less than seven times forecast 2004 earnings.

Knights was based in Brisbane with offices in Sydney, Melbourne, Adelaide and around regional Queensland. Proceeds from the issue would fund its further expansion in Australia and overseas, with New Zealand, England and Malaysia being mentioned.

Which proves yet again that investors should read prospectuses from the back page and ignore all the bright forecasts at the front. Because back on page 53 was a history of Knights share capital, showing that a new Knights company had been formed at the end of 2002 with just one issued share, which had then been split into 800,000.

That new company then bought the Knights insolvency business by the issue of 1.6 million shares. Then the 2.4 million shares (800,000 plus 1.6 million) were further split to become 35 million shares.

It was the new company that was floated as Knights Insolvency Administration Ltd. The 35 million shares were founder shares held by John Schmierer and Adrian Duncan, who were the vendors of the Knights float.

Now that our enlightened legislature has abolished par values for shares, it is impossible to say what their value is when being issued in this fashion.

The only asset of any sort behind these shares was the Knights business, which had been acquired for 1.6 million shares. At the ultimate issue price of 50c, that therefore had a valuation of $800,000.

As the vendor shares had exploded to 35 million in the float, that implied the value of the Knights business was $17.5 million. In hindsight, Pierpont's figure of $800,000 looks a lot closer to the mark. Indeed, the value may even have been negative.

Anyhow, the vendors received 35 million shares (and had all their debts to Knights repaid), while punters put up $8.5 million in return for roughly one-third of the equity.

The subscribers did not include Pierpont. Your correspondent is a great student of history, and the track record of Queensland accountancy floats was dreadful. The only two such floats had been Harts Australasia and Stockford, and both had hit the wall soon after launching.

Further, the whisper around the Croesus Club was that the Knights business model was unsound, because the insolvencies Knights specialised in tended to be small and speculative.

The prospectus listed the Knights Referral Method as one of its great assets, but without describing exactly what it was. This great asset is so intangible that the voluntary administrator, Tony Sims of Sims Partners, can't find it.

He told Pierpont: "If any of your readers sees a black box marked 'Knights Referral Method' in the street will they please call me, because we'd like to find it."

As Pierpont understands it, the referrals came mostly from a network of small accountants whose clients became financially embarrassed. That meant Knights was tending to deal with corner shops and the like.

This is confirmed by Tony, who says his preliminary inspection has discovered Knights had 861 files, which represents the number of insolvencies on its books. There are very few hard assets among them, and he expects to recover only half a million to a million dollars from the whole lot, which indicates to Pierpont they must all be small and fairly hopeless.



The trouble with small businesses is that when they go belly-up, there's nothing much left in the way of cash or assets. When big firms such as Ferriers or PPB move into an insolvency, they always have their foot on some assets that can be sold for cash.

If, as a result of their investigations, they later manage to get a lawsuit going alleging that some creditor received a preference or directors had committed fraud or traded while insolvent, that's a bonus.

When Knights moved into a business that had few or no assets, it was relying on a possible lawsuit to cover its costs. If true, that was a speculative way to run an insolvency there being no bigger gamble in Australia than a lawsuit.

For all these reasons, Pierpont ducked the Knights float and then watched slack-jawed as the shares performed brilliantly.

The stock listed in August 2003 and ran to a peak of 85 c The company's first annual report, released at the end of September 2004, declared a profit of $3.7 million and a dividend of 4.5c.

The opening page of that annual report said in large capital letters: "THIS HAS BEEN A YEAR OF SIGNIFICANT PROGRESS, ACHIEVEMENT & DEVELOPMENT, THE BENEFITS OF WHICH WILL BE EVIDENT IN COMING YEARS."

Also, in September 2004, investors subscribed $5.3 million to a placement of 8 million Knights shares at 66 ?. But only 3 million of the shares were issued by Knights. The other 5 million were a sell-down by John and Adrian, who pocketed $1.65 million each.

That was the end of the ball game.

In January this year, Knights announced it would make a $3 million loss and that John had stood down as managing director. Three months later, the signals became even more dire when Ian Ferrier was called in as a consultant.

Now Pierpont treasures the company of his old chum Ian, who has rescued and reconstructed many an ailing company. However, he is mostly known to the public as Australia's top liquidator, so his arrival at Knights was not taken as a positive sign. If an investor is praying for his company's health, he doesn't want to see Australia's best-known corporate undertaker at the doorstep.

From there on, the news just kept getting worse. Knights wrote $6.7 million off its work in progress.

In the insolvency business, work in progress represents the amount of time your staff has spent working on the job. If an accountant charges $300 an hour and spends 20 hours working on an insolvency, he charges $3000 and that becomes work in progress in the balance sheet. But the $3000 is only really an asset if it can be collected and too many of Knights's debtors weren't recoverable. Also, the firm has to pay tax on the cash it collects.

This raises a few questions about Knights's accounts. Knights's work in progress was always worryingly high.

At balance date in 2003, Knights was carrying a net $3 million work in progress, compared with cash receipts of $1.2 million. At balance date in 2004 work in progress was shown as $9.1 million compared to cash receipts of $10.1 million.

On these numbers, it looked as though Knights was taking a year or more to collect its debts. That's too long for an insolvency business, where the rough rule of thumb is that work in progress should not be more than 30 per cent of cash receipts.

Small businesses such as those that Knights was handling should be turned over quickly, so the ratio should be even lower.

The $5 million profit reported in 2004 is deeply questionable. In terms of cash, it received $10 million, but spent $11 million running the business. It then added $6.5 million work in progress to the receipts and reported revenue as $16.6 million. As Knights subsequently wrote down work in progress by $6.7 million, it may well be that its true result for 2004 was not a profit, but a loss.

In which case, Knights should never have paid the dividend, although Pierpont can think of 35 million reasons why the board might have decided otherwise.

Let's wind up with a big-picture summary. Knights's listed life was a little over two years. In that time, the billings it collected totalled $19 million, but it spent $29 million on operations. The $10 million gap was funded by the capital it raised in the float and the September 2004 placement.

The number of accountancy groups to list in Australia in recent years now totals three and the number that have hit the wall after an exceedingly short listed life also totals three. Wild horses couldn't drag Pierpont into the next one.