I am, of course, talking about the AA, whose shares plunged this week after it announced a dividend cut alongside a strategic review of the business – we had suggested selling the shares only a week earlier, on the basis that large amounts of investment would be required to restore the group’s flagging fortunes, particularly in its roadside assistance business, but the scope to make this investment would be severely curtailed by its massive debt pile. The implication was that its dividend – which generates a fat 8 per cent yield – could be in jeopardy.
The case of the AA is an interesting one, for two reasons in particular. First, and most simply, is that it reminds us that an unusually high dividend yield can be a useful indicator of coming distress, especially where the PE ratio has also slumped. Share prices move every day, dividends are declared – or not – much more infrequently, so the high yield can be a mirage. Always dig deeper into the cash flows and balance sheet when such temptation arises.
Secondly, it shines a light on the role of private equity in the public markets. Such investors have developed a reputation for frequently dumping over-geared assets onto unsuspecting share investors, and the case of the AA only serves to reinforce this notion. It was brought to market in 2014 by private equity backers including CVC, which quickly sold their entire stake.
This should have been a major warning triangle that could have helped investors avoid a nasty pile-up – recent studies have suggested that PE-backed IPOs where the original backers retain a stake in the public company tend to do much better than those that don’t. And while warnings from former private-equity-backed companies seem to come all too regularly, this is more indicative of the high proportion of IPO flow that they account for – studies in fact show that in aggregate shares in private-equity-backed IPOs in fact go on to outperform the wider market, so investors should be careful not to throw the baby out with the bath water.
But in the case of the AA it does look as though the market was sold a lemon; not just a business overburdened with debt, but one that had underinvested in its operations at a time when competitive pressures were mounting. And while it’s good to see the salvage operation now beginning in earnest, the situation is nevertheless reminiscent of some other slow-motion car crashes the stock market has witnessed in recent years. Even if recovery does come, investors could be waiting at the roadside a long time for it to appear.
