After all, Chemring has some world-leading niche operations. It is the world's largest supplier of 'expendable decoys'; that includes the flares and chaff that the Eurofighter Typhoon and the F35 Joint Strike Fighter throw off to fool enemy missiles. It is a world leader in so-called 'energetic' systems; supplying, for instance, the flares that mark the frighteningly brilliant descent of a Red Devils' freefall parachute team, or - rather sinister - the smoke grenades and baton rounds used in crowd control. So, how come these enviable positions, which are in markets that tap the 'consumables' spending of defence budgets, can't translate into a top-notch performance?
Successive generations of bosses bear most responsibility. How often does the boss fritter away the cash flows -– both present and future - of great subsidiaries on acquisitions that promise so much and deliver so much less? For the past 20 years or more at Chemring this has been a way of corporate life, resulting in a scale of value destruction that's something to behold.
For example, in the past 10 years the company has spent £464m on acquisitions. During that period management has needed to charge £174m on restructuring and writedowns, telling us that these acquisitions hardly turned out as planned. Worse, with the share price now down to 175p, the market value of the entire group - at £334m - is almost 30 per cent less than the amount gorged on dealmaking.
Viewed from another angle, all this dealmaking followed by downsizing has entailed a continual process of raising debt and equity, then paying off the debt and writing down the equity. Group net debt rose from £53m in 2005 to £313m by 2010. Thence it shrank and was down to £136m a year ago, although has climbed back to around £160m during the financial year just ended. Similarly, aided by £160m-worth of new shares, shareholders' funds soared from £52m in 2005 to £475 in 2011. Since then, partly because of disposals, they have declined to £296m.
This combination of shrinking equity and stubborn residual debt means Chemring's bosses are now travelling a familiar road. For the third time in eight years, they are asking shareholders for more equity. In a bleak profits warning last week, chief executive Michael Flowers, who has been with the group since 2005 but only became the boss in June 2014, says the company will raise £90m by way of a rights issue early next year. It's a big ask, even though the amount has already been underwritten by City banks.
Given the deep fall in the share price - down 22 per cent since the profits warning - Chemring might get its rights away around the current share price, especially if it can juice up the issue next year with some good news; for example, that further contracts have been added to its order book, which stood at £606m in September, an encouraging 21 per cent increase on April's level. And i's a given that Chemring must report that the details have been sorted out on a £100m-plus contract to supply ammunition to a Middle Eastern customer, the postponement of which prompted the latest warning.
However, the thought also occurs: will Chemring actually need its right issue? That's code for saying that, by signalling its rights call so far in advance, Chemring's bosses are really saying to its competitors and to private equity: 'Come and get us'. True, technical issues connected with the group's debt meant the rights issue could not go ahead immediately. But that does not fully explain why Chemring's bosses felt the need to announce the issue now. Normally, these things stay behind the City's 'Chinese walls' until the salesmen hit the phones to persuade and cajole the sub-underwriters. And recall that the company was in bid talks with private-equity house Carlyle three years ago also after a profits warning. Those talks came to nothing, but then the company's share price was more than twice as high as currently
This leaves investors in a quandary. It's not just that the share price is now 76 per cent below its all-time high, there is a sensible case to be made for Chemring as a recovery play, spiced with the possibility of being taken over. Two years ago (Investors Chronicle, 1 November 2013) I reckoned that the 'earnings power' in Chemring's operations was worth more than 200p per share and that was when the group was encumbered with £300m of debt. Do the calculations today, and the end result would change just a little and the adjustment would be on the upside.
But the dilemma is whether to commit capital knowing that there is a cash call on the way, the effect of which is either to coax more capital out of an investor or to force him into a part disposal (by selling the rights) that he may not want. I'm not sure, but if I were running a recovery fund, I would think very hard about adding Chemring shares.
