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Connect Group – a dangerous-looking balance sheet

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Connect Group (LSE:CNCT) has not had an attractive-looking balance sheet for many years. It had/has very high levels of intangible assets, especially goodwill, due to paying excessive prices for acquisitions. Even after including those doubtful “assets” in its balance sheet it could barely report a positive net current asset value.  On top of that, it carried over £100m of bank debt. Now that it has written-off large chunks of goodwill and other intangibles it shows a negative net asset value, NAV, of £46m.

Even after the write-offs it carries a lot of intangible assets of doubtful real value:

  • “Goodwill” £11.7m
  • “Customer relationships” £14m
  • “Trade name” £19.3m
  • “Internally generated development costs” £1.8m
  • “Computer software costs” £4m

If all of this was written-off the BS would be down to a negative NAV of £97m.

Balance sheet data.

£m   August 2018   August 2017   August 2016
Non-current intangible assets 51 107 165
Other non-current assets 44 51 62
Trade and other receivables 82 98 139
Other current assets 32 84 52
TOTAL ASSETS 209 340 418
Trade and other payables -128 -136 -199
Other current liabilities -64 -91 -83
Non-current liabilities -63 -88 -123
NET ASSETS -46 25 13

How it survives its poor balance sheet

The BS is heavily dependent on very large amounts of credit granted by its suppliers, mostly publishers; trade and other payables are £128m. Connect does not pay for newspapers and magazines until sometime after its customers have paid them.  Newsagents pay via weekly regular direct debits, and across the Group the average credit period taken by customers is 20 days.

However, the average credit period taken by Connect from its suppliers is 31 days.  When turnover averages £4.2m per day the excellent cash-conversion cycle produces about £46m 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.

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

Net bank debt

While the company has brought it bank debt levels down by selling businesses and by applying some of its positive free cash flow to debt repayment, the indebtedness numbers are still very high.

£m   August 2018   August 2017
Opening net debt -82.1 -141.7
Free cash flow to equity +20.2 +28.7
Pension deficit recovery -4.7 -4.8
Dividend paid -24.1 -23.6
Disposal proceeds +12.9 +58.2
Cash flow from discontinued business -8.8 -1.1
Finance lease creditor and other +3.2   +2.2
Closing net debt -83.4 -82.1
Net debt/EBITDA 1.8x 1.2x

Covenants on bank loans:

  • Net debt/EBITDA less than 2.75. In 2018 it was 1.8.
  • Interest cover: adjusted EBITDA/net interest better than four times. In 2018 it was 9.6 times
  • Adjusted EBITDA/Fixed charges greater than 1.75 to 1. In 2018 it was 2.3.

So, clearly, bankers are lending on the

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