Some passing thoughts on Victory Offices, and criticisms of the attempt by Baxter to somewhat opportunistically convert debt into shares.
By now those that have invested their money, time or interest in the company will be across the basic details of the proposed transaction, and have likely poured over the Independent Expert's report. From some of the comments made on this forum and elsewhere it is clear not everyone thinks the terms of the deal is fair.
The sentiment is not without reason, as:
- Yes, this will result in dilution of existing shareholders, and;
- Yes I believe the indicative pricing of the deal is a good deal for Baxter.
Based on my own estimates of underlying earnings for Q4 and FY22 (which I feel are realistic, if not overly conservative), converting debt to equity reduces the per-share value (for existing shareholders) by up to 26%. And I can say with great certainty that Baxter and his advisers know the business much better than I do, so there stands a good chance the arrangement is sweeter than I imagine.
But I also see this is as a reasonably fair deal for existing investors.
Growing the pie:
The proposal results in an immediate change to VOL's capital structure provides an immediate improvement to cash flow and their balance sheet, stabilising the business and providing alternatives for future financing. In effect, the conversion is equivalent to "disappearing" the debt, giving the business the option of using leverage to grow the business. We should note too that pre-pandemic Victory demonstrated an ability to scale their service, and while we are yet to see whether they return to the same trajectory the question investors should be asking is whether they want a smaller piece of a bigger (and more financially secure) pie, or more of a smaller (and riskier) pie.
(Even more) skin in the game:
While I think of it, there is also the argument that this means Baxter has more skin in the game. Yes, that is true (as his entitlement to claim moves down the rank from credit to equity), but there is a risk of reading too much into this. As I've previously pointed out, the company's key risk is their lease liabilities; if the business were unable to become profitable again there is a good chance that creditors would end up out in the cold, along with equity investors*.
Valuation:
Based on their last trading update and my own forward projections**, I estimate the business is fairly valued*** at roughly $34m without the conversion of debt to equity, or about $61m with the conversion. On a per-share basis that works out at around $0.416 (81.8m SOI) and $0.387 (157.8m SOI) respectively.
Summary:
The point, if any, that I am trying to make is that there can be situations where even what seems like an "unfair" offer produces a better outcome for both parties.
I noted above, there are scenarios where the effective discount is up to 26%^. But even this seems a fair price to pay for a more certain future, and much greater likelihood the business will be able to resume their path to becoming, hopefully, one of Australia's major players in serviced offices and related business services.
If the path to get there means others end up with a bigger share of pie, then I'm ok with that.
DYOR, form your own opinion.
All the best.
Notes:
*For Baxter, the conversion makes absolute sense, so long as there is a belief the company has the ability to last for a period of time longer than it would have otherwise taken to draw down on the loan that had been offered, net of repayments to other related party loans (repayment terms are reported in the footnotes of past financial reports).
**PV CY22 end.
***Note these are different to the valuations discussed by the Independent Expert, which focused on net assets, and everyone should make their own assessment of the value (or lack of value) according to their own assumptions and expectations.
^This was the result of but one of the scenarios run; average put the discount at approximately 14%. This is an important point, but obvious enough that it mostly goes without saying. Were they to raise capital externally you can bet the offer price would be lower, and given the small size of the raise, fees would come to 6% or more. The primary beneficiary of raising external capital would have been Baxter himself as (temporarily at least) the injection of cash would provide enhanced security/collateral for payment. To put it another way, if Baxter and his advisers thought the business' failure was likely, raising external capital would be the more financially sensible (albeit, ethically questionable) choice.
