A look under the carpet at Victoria

Durability is an important property in both carpets and companies. Aim-traded Victoria (VCP) is a good example of the latter and a fairly renowned producer of the former. Founded in 1895 and first listed in 1963, for much of its history it has plugged away as a high-quality if low-key business. That was until 2011, when things abruptly changed. In December that year, not long after making the red carpet for the royal wedding, Victoria's board told shareholders a consortium was preparing to replace several non-executives with a new management team.

So began the dramatic transformation of a sleepy firm trading at less than half its £38m net assets to a highly acquisitive stock market darling worth £229m. At the centre of this story is a man named Geoff Wilding, one member of the consortium that eventually took over the company in 2012. Since then, the private equity veteran has turned a £20,000 bet into a £90m fortune and now sits as executive chairman of a sprawling collection of cheaply acquired carpeting and flooring businesses.

This column looks at how Victoria made this journey, and - with one eye on recent results - asks whether its acquisition strategy is threadbare, or the magic carpet ride investors hope it to be.

Divisions, challenges

In 2011, Victoria was divided. Its Australian business contributed the bulk of profits thanks to a strong local economy and dollar, while the effects of a lengthy recession here weighed on UK sales. Victoria shares were nonetheless the standout performer in Simon Thompson's picks for the year, returning 39 per cent.

But the company remained undervalued against its assets. When the board learned of the possible coup, it moved to realise that value by selling the business. The tussle sent the shares up to 385p in January 2012, around the time the board reportedly received an indicative offer of 425p from a third-party. The consortium - comprising Mr Wilding, former chairman Alexander Anton, Sir Bryan Nicholson and Lady Katherine Innes Ker - rejected the attempt to sell, and garnered sufficient shareholder approval to force out half the board.

Further twists were to come. During a strategic review - in which the company opted for expansion over a sale - Anton, Nicholson and Wilding proposed an incentive package that would reward them with 50 per cent of all returns above 300p a share from a break-up of the company within two years. The board refused, sparking the trio's resignation.

Wilding, along with Anton and Andrew Harrison, a lawyer specialising in boardroom takeovers, soon returned to oust the board for a second time. Wilding was then swiftly appointed executive chairman with a mandate to cut costs and "directly link performance and reward of key personnel to the creation of wealth for shareholders".

The following February, he made good on this pledge in a highly unusual move. Mr Wilding persuaded the company to enter into a complex contract for difference (CFD) - more common among forex traders than board members - in which he promised to return £3 per share to investors. In exchange for a £20,000 premium, the terms of the deal gave him the opportunity "to accrue value" above 300p a share and "a share of additional shareholder value". With that side of the incentive package agreed, the new board set about improving the company's cost structure and market value.

Corporate tapestry

In December 2013, Victoria began buying companies. It snapped up Yorkshire-based tufted carpet manufacturer Westex for what looked like a bargain. With a five-year lock-in commitment from Westex management, Victoria paid £16m for a company with £3.8m cash and recent annual pre-tax profits of £4.5m from sales of £18.7m.

Victoria also decided that owning real estate yielded few competitive advantages. In the year to March 2014, it raised £11.7m through several property sales, preferring a leaseback model. Then, after the year-end - and with the shares above 300p - Wilding called in the CFD, triggering a £21m special dividend, equivalent to 292p a share. To pay this, and settle the £10m liability with Mr Wilding, Victoria borrowed from Barclays, which agreed to pay out on the condition that the executive chairman bought shares with his windfall.

In just over a year, Mr Wilding had gained a 50 per cent holding in Victoria. Fast forward to today, and after three acquisitions, several share placings and a £10m unsecured loan note facility from the Business Growth Fund, that stake has netted him £90m in paper and cash profits. In August, he banked £11m when he sold 1m shares to fund the £18m acquisition of Quest, leaving him with stock worth £79m.

Acquisitions under Wilding

Source: Whitman Howard analysis, Victoria plc, company accounts

This chapter - while breathtaking - is now closed. What is so striking about Mr Wilding's takeover and incentive plan, however, is that it rewarded him enormously and at little personal risk, for a modest increase in the share price. The subsequent gains have therefore multiplied that initial payout, wildly generous even if we accept that between 2012 and 2014 Victoria reached a turning point. It's also a wonder why Mr Wilding was prepared to put so little skin in the game in the deal (he faced a penalty of just £100,000 if the shares didn't reach 300p) given his earlier business successes, including the £105m sale of the New Zealand print firm he founded a decade ago. In his defence, Mr Wilding flags the deal's approval by more than 90 per cent of shareholders, while his press team say £1 invested at the start of his tenure would have grown to £15.79. And to the detractors? "With respect, I don't care what market commentators think."

One of the consortium's criticisms of the previous board was that it handled debt poorly. That's compared to a recent activity that has involved borrowing £20m to pay out £10m to Mr Wilding and a 292p-a-share dividend. Victoria's previous board were more cautious. In March 2012, before the takeover, net debt was £7.75m, equivalent to 19 per cent of the equity or 1.4 times cash profits. Interest payments were covered by Ebitda 12 times, which had fallen to less than five times a year (a restructuring and a takeover) later. Asset sales flattered the net debt position in the year to March 2014, but following a £21m payout and acquisition spree, gearing stood at 151 per cent of the total shareholder equity at the start of October.

Cash generation

Borrowing to acquire new businesses is of course no bad thing, if assets generate cash and offer a better return on investment than interest costs. And in Victoria it is this potential for free cash flow that attracted Mr Wilding just as it did Mr Buffett when he bought Shaw. Carpet manufacturers can do this owing to a combination of short payment windows, and - to quote Victoria's 2015 financials - "attractive payment terms" for raw materials and the "relatively cheap" cost of equipment.

It's a wonder then that there aren't more competitors out there, or why management at the five companies acquired by Victoria were happy to sell out for an average of 4.5 times cash profits. In response to the latter, it may be due to the fact that the operating margin in the last year of solo trading for Westex, Abingdon and Whitestone Weavers was between 24 and 52 per cent higher than the average of the four previous years. In Interfloor's case, 2015's operating margin of 11 per cent was three times the average of the previous four years.

Mr Wilding says these companies are even more profitable now that "massive" management salaries have been stripped back, and dismisses the suggestion that acquisitions to date display "hockey-stick" profit profiles. As for how these companies can combine to greater effect, Victoria is initially focused on logistics and bulk purchasing of raw materials, which it said helped it save £1m in the six months to October.

That's a start, but highlights a key challenge for the group. All of the firms acquired have been bought for the quality of their management, who have all agreed to lock-ins of three to five years. For now, these businesses have been granted operational autonomy, before "later getting together and thinking how they can start to improve their results", in Mr Anton's words. Mr Wilding also says he has little to do with each subsidiaries' operations, and is instead focused on further group-level M&A.