If any of the approaches ever came to fruition, it would not mark the first time that AA (formerly The Automobile Association) has been put in private equity hands. The organisation demutualised midway through 1999 to go private but was bought later that year by Centrica (CNA). The British Gas owner ran the business for five years before flogging it off to two private equity outfits – CVC Capital Partners and Permira – for £1.75bn.
Apart from private equity coming in to assume the debt, management is also looking at other potential refinancing options, including the possibility of raising new equity. But you feel that shareholders are in a bind whatever the option. It boils down to either throwing good money after bad or accepting derisory terms from the private equity bidders. I suppose you could always live with diluting your stock, particularly as the shares have already shed 92 per cent of their value over the past five years. It rather depends on what point of the downward leg shareholders entered the fray.
The group, which booked non-GAAP trading cash profits of £350m in 2019, maintains that it is well within its financial covenants, though the conditions attached to its various classes of loan notes differ significantly. The bottom line is that net debt now stands at £2.65bn, more than a third of which is payable within the next two years. To put it another way, the group’s enterprise value is now equivalent to 18 times its market capitalisation.
Group chairman John Leach said that “the board believes that it must now prioritise reducing the group's indebtedness to provide the business with the right long-term capital structure". Hardly revelatory, but it is conceivable that noteholders may agree to extend the maturities. A group subsidiary, AA Bond Co Limited, recently completed the refinancing of £200m outstanding Class A3 notes due 31 July 2020 using proceeds from a Senior Term Facility.
Some may liken this to rearranging the deck chairs on the Titanic, but the possibility also exists that the banks may give a sympathetic hearing on the back of what the chairman describes as “significant improvement in the underlying performance of the business”. Unfortunately for Mr Leach, bankers are not usually given over to sentimentality, and you should always be a little more apprehensive about companies which readily resort to non-GAAP accounting measures to highlight their improved trading performance.
Like so many businesses, AA has had to contend with the Covid-19 outbreak, and the government’s increasingly impulsive reaction to it. Conditions for the breakdown service have not been ideal given the UK’s roads were virtually devoid of traffic for the best part of two months. New membership sales softened accordingly, but at least the group’s insurance arm (15.5 per cent of group revenue) will benefit from a reduction in accident claims, thereby supporting underwriting profits. Happily, AA has no business lines with direct claims cost exposure resulting from Covid-19.
To their credit, the group’s roadside assistance professionals did not sit idly by as the situation unfolded, instead providing maintenance and repair services to the London Ambulance Service, while assisting over 2,500 NHS staff. This was undoubtedly a wholly laudable response - and unbeatable PR - but given group finances, management could have been forgiven for arranging a whip-round among the health workers.
AA was struggling to manage its debt burden long before Covid-19 arrived, but with risk appetite waning, the group may struggle to adequately address the situation through corporate actions or senior debt. Shareholders are on the hook one way or another.
With the tide rolling out, the AA will be just one of many businesses, both public and private, which will fall within the cross hairs of private equity. But we could witness a more acceptable face of capitalism than you might imagine. Private equity firms are increasingly taking long-term strategic positions rather than simply cashing out on their investments as quickly as possible. And with an estimated $1.5 trillion at their disposal, they could play a key role in restructuring debt and preserving businesses which otherwise may have gone under – we shall see.
