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Connect's debt worry

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I’ve been asked the following about Connect (LSE:CNCT):

“Are you overlooking the debt? The debt of 256 million means the NTAV is minus 94 million.
Be good to get your thoughts here…Surely the argument to pay down debt is better than paying such a high dividend. Imagine if the business was transformed into a low debt business and refocused onto growth areas?

Are the directors mismamaging here, as Glen, you and I would be paying off or negative equity debts and not lining the dividend seekers as that’s dead money. Case of mismanagement?”

These are certainly issues that need addressing.  I’ll set out some quick thoughts on this Saturday morning (got to take down scaffolding in a few minutes).  These are rough ideas so I would welcome other views.

Let’s start with some balance sheet data.

£m February 2018   August 2017   February 2017   August 2016
Non-current intangible assets 101 107 133 165
Other non-current assets 49 51 55 62
Trade and other receivables 92 98 154 139
Other current assets 21 84 108 52
TOTAL ASSETS 263 340 450 418
Trade and other payables -136 -136 -213 -199
Other current liabilities -48 -91 -122 -83
Non-current liabilities -72 -88 -104 -123
NET ASSETS 7 25 12 13

The balance sheet is definitely one of the most unusual I have seen. Due to all it acquisitions it has lots of intangible assets, goodwill. Tuffnells goodwill accounts for £89m of that.  In reality, Tuffnells goodwill is probably zero.

Also the BS is heavily dependent on very large amounts of credit granted by its suppliers – mostly publishers. Connect does not pay for newspapers and magazines until sometime after its customers have paid them.  Newsagents pay via weekly regular direct debits but across the Group the average credit period taken by customers is 24 days.  However, the average credit period taken by Connect from its suppliers is 32 days.  When turnover averages £4.4m per day the excellent cash-conversion cycle produces about £35m of useful cash.

So a concern would be that this positive cash cycle is interrupted, meaning that Connect would need to borrow more from banks.

There is reassurance in the contract terms with publishers – they contain clauses granting long credit periods, and the contracts last for five years.

Bank finance is over £80m.  This is not supported by collateral, but merely by cash flow stability.  Historically, this has been extraordinarily good.  There is a danger that it sto…………

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