Connect Group – the deal to sell Tuffnells

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Last week Connect Group (LSE:CNCT) announced the sale of its Tuffnells division. At first, investors greeted the news with enthusiasm, pushing Connect’s shares up 50%. But the following day they were back down where they started because the details of the deal revealed that Connect wasn’t getting much out of it other than removing Tuffnells’ future losses from the Group’s P&L accounts.

© Image copyright lodeez

The sale of Tuffnells has been long awaited.  When it was bought in 2015 it made a decent amount of profit, but in the last two years it has it lost money month after month and the management team seem to be bereft of ideas and skill to sort it out. (Losses were over £1m per month in the year to August. Rumours are that this lose rate have doubled during the Covid-19 crisis).

And it seems that Tuffnells’ managers can’t even stir themselves to take advantage of the current shortage of parcel delivery services in the country.

A quick sale to a rival or private equity group would be a neat solution, even if the price achieved was zero, because this would take away the financial drag of Tuffnells, releasing Connect to concentrate on collecting the fairly predictable profits from it local monopoly newspaper and magazine distribution business, Smiths News.

(Previous newsletters on Connect: 29th Sept – 4th October 2017, 24th -29th January 2018, 19th May 2018, 14th June 2018 14th – 27th June 2018, 11th – 15th Dec 2018, 5th Feb 2019, 13th – 18th November 2019, 3rd February 2020, 23rd – 27th March 2020)

But the sale is far from neat

The buyer is a special purpose vehicle set up by Broad Oak Support Services called Palm Bidco. It has agreed to buy Tuffnells for £15m.

Well that sounds good, you might think.  But the £15m will not arrive for quite some time – in three tranches: £6.5m in 18 months, £4.25m in 27 months and £4.25m in 36 months.

And there are real risks that the new team will not be able to make a go of the standalone Tuffnells, and so the £15m might not arrive at all.

Then there is the problem that Palm Bidco doesn’t have much cash. It is so badly off that Connect’s directors have agreed to lend £10.5m of Connect’s shareholders money to it.

From the point of view of the shareholders of Palm Bidco the deal has tremendous upside: if they return Tuffnells to profits of £15m per year then their shareholding will be worth over £150m.

If it goes wrong, then they receive large salaries until it goes under.

They’ve ensured that the organisation that has committed the most to Palm Bidco is Connect.  It faces the possibility of being in the unfortunate position of a creditor in a liquidation and then very unlikely to get back its £10.5m.

There is another problem: Tuffnells rents most of its depots. Naturally, the landlords will not be happy if the only guarantor that the rents will be paid is this poorly-capitalised loss-making Palm Bidco. Thus, landlords will refuse to allow transfer of the leases from Connect and the deal will collapse.

To get around this problem Connect agreed to guarantee that the rents will be paid, thereby putting itself on the hook for millions of pounds of rent each year should Palm Bidco falter.

And another thing: the guy who has been paid a great deal of money by Connect since November to turn Tuffnells around, Michael Holt, has jumped from the Connect ship to the Palm Bidco ship. Michael Holt will receive 5% of the equity in the new company for managing it (other Tuffnells’ executives might obtain equity totalling 25%).

He was ostensibly putting his heart and soul into getting Tuffnells on the right road for the benefit of Connect shareholders.

As a future 5% shareholder in Palm Bidco would he be most interested in the special purpose vehicle paying a high or low price for Tuffnells? and therefore would he be most interested in getting Tuffnells numbers turning up or turning down?

I make no accusation, merely raise the questions.

One comfort might be that the other Connect directors excluded him from discussion regarding the sale.

Another downside: Connect will settle Tuffnell’s £16.1m overdraft and pay about £2.6m in Palm Bidco’s transaction costs.

Despite all these negatives I stil……………To read more subscribe to my premium newsletter Deep Value Shares – click here


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