Woolworths - How Dick Smith Got into Trouble - Case Study Example

Dick Smith Student’s name Code & Course Professor’s name University City Date Background Founded in 1968 by Dick Smith, the company has undergone a couple of buy outs the first being in 1982 by Woolworths. In 2013, Dick Smith went through a makeover before listing on the Australian Stock exchange. In addition, in 2015, the company had heavily invested in marketing activities in a bid to resurrect the brand but were hit with a large surplus of stock. In late December, it engaged in massive sales that led to a deficit in stock. Cash generation and sales were below what the management would normally expect and continued to early 2016. This prompted the appointment of a voluntary administrator which raised concern among consumers who were quick to use their gift cards before the company was placed under receivership. In a bid to quickly restore its funding requirements in a short-term period, the directors almost did the impossible to speed up the company’s float before any inquiries on the retail chain could be made on its actual performance (Richards, 2016). The information provided to some investors as well as the information in their balance sheets seemed to have some discrepancies and believed to be inaccurate. How Dick Smith got into trouble Despite having a $38 million profit report in the year 2015 and making a dividend declaration of 5 cents per share, the company still went under receivership three months later (Johnson, 2016). The supposed profits for their last financial year had a negative free cash flow of $35 million. This is the reason that made the banks reluctant in issuing more credit to the company. Dick Smith’s woes can be said to have started back in 2012 when it was bought by Anchorage Capital: a private equity firm from Woolworths which was its previous owner. $20 million was paid as a down payment to the electronic retailer and $80 million would be paid later (Murphy, 2016). In the years 2012-2013, it had a $140 million profit after tax which is more than what was paid for the ownership of the company. Inventories fell to $170 million when Anchorage bought the business from $300 million and rose again to $250 million and $300 million in 2013-2014 and 2014-2015 respectively. They were able to open 10-15 new stores and sold 80% before the annual report and later sold the remaining 20% ten months later. When Dick Smith went into administration, it was only worth 15% of what Anchorage initially bought it for. It is said Anchorage wrote down the value of the inventory, the plant and equipment. They also liquidated the inventory as quickly as possible so that the cash could make Dick Smith ‘buy itself’ (Ong, 2016). The write downs were the cause of all the inflated profits and lowered the charges related to depreciation. When the inventory was liquidated to pay for the purchase price, it was never replaced. A habit was made of writing down on the stock value and selling it without restocking. In 2012, Dick Smith’s inventory was valued at $371 million but had been written down to $312 million. It dropped drastically in 2013 to $171 million (Ryan, 2016). This boosted the cash flow and made the company look financially stable on the outside (Beckford, 2016). According to Roger Corbett, former Woolworths Chief Executive Officer, the company had made profit in hundreds of millions but opening of too many stores was the cause of all their problems (Hatch, 2015). Dick Smith is also said to have had the wrong products on the shelf. It was a business suicidal mission to use working capital to stock up things people had not demanded for. They planned to cut down on prices and increase their advertising avenues by running daily advertisements on both televisions and radio stations to advertise their highly discounted prices (Clendinnen, 2016). The reduction in prices and increased advertising itself is a wrong business move as they are supposed to maximize profits and minimize costs but they were doing the contrary.                          Reasons for Failure With the exit of Anchorage, Dick Smith was left with almost no stock. The company had to restock to continue business activities hence had to finance the stock by borrowing. Looking at their accounts, it had the wrong sort of products in large quantities. Instead of focusing on how to stabilize their business, they quickly began to work on their ambitious plans of expanding so as to add an additional 25 stores. They failed to properly manage their working capital which is normally the best indicator on the financial health of a business (Mitchell, 2016). A company can report profits but have issues when it comes to liquidation creating difficulties. According to stock market experts, the company had diverted way too far from its known market niche and was unable to compete with other retailers (Colangelo, 2016). Part of the reason they had a surplus in stock. As early as October, before their expansionary plans, the company’s board was experiencing excessive surplus of stock, tight competition, weak sales and tight margins. It had to result in a decision to downgrade its forecasted profit and wrote down its stock value. In a survey conducted by Canstar Blue; a consumer satisfaction group, Dick Smith was rated the worst among seven electronic retail companies and received a three star rating (Colangelo,2016). They embarked on fire sales ahead of Christmas 2015 at bargain basement prices. Their plan however failed and their sales were below their projected expectations. The company owed more than $140 million to NAB (National Australia Bank) and HSBC. Other debts included over $200 million to creditors (Low, 2016). Their financial creditors were reluctant to offer any more credit as a total of $135 million had been lent in June and it was all withdrawn by December 2015 (Boyd, 2016). The banks were further aggravated by the fact that Dick Smith was quick to repay Macquarie an unsecured loan that was provided to cover the Apple stock even after it had withdrawn its supplier credit (Loi, 2016). This left the board with nowhere to turn to and was left stranded.                          Procedures taken After denial of funds from banks to restock, the company was forced to appoint administrators: McGrathNicol to run the firm as restructuring and sale options were being explored. Voluntary administration commonly happens to companies that are facing cash flow problems and are experiencing trouble in paying off their debts. The administrator is normally an external one whose main job is to do an analysis of the company’s assets and make an evaluation of the business so as to come up with the best course of action to solve the situation (Lui, 2016). The main aim of voluntary administration is to give the company in question some space to restructuring or recovering without the constant pressure of dealing with debt collectors. The administrator will offer recommendations to the creditors who will have the final word. Some of the recommendations may include; I. Liquidation of the company in order to pay off their debts. II. Execution of a deed of company arrangement where a compromise of the debt is made somehow to allow the business to continue existing. III. Returning the company to the directors for full control. The administrator will also prioritise the recovery of debts for different classes of creditors and as long as the company continues in trade, the affected parties should be able to recover their money. The move to voluntary administration however, was not taken lightly by Dick Smith’s lenders as they made a move to secure their financial interests hence appointed receivers. Customers who previously had gift cards from 2015 were assured of them being honoured (Knapp, 2016).                         Legal record of Dick Smith Dick Smith considers funding a class action against Anchorage and demands a refund for all the now worthless gift cards. The claim is that Anchorage were dishonest as they knew things in the company were not going well (Chung, 2016). Legal experts are however against the class action as Dick Smith would have to provide proof that the directors failed to avail market sensitive information or investors were given misleading information regarding the financial health of the company. McGrathNicol is also charged with the responsibility of reviewing the accounts over concerns on the financial health of the firm as it is still unclear how Anchorage was able to convert $10 million to $52o million in a span of just two years (Ryan, 2015).                           Conclusion The board failed to properly manage the inventory, cash flow and debtors (Knight, 2016). In a desperate attempt to regain its previous status, they heavily discounted their items. The items were not in demand by the consumers hence they failed to follow the demand rule. It would be easier to sell products that are actually demanded because the consumers need and want them hence no need to heavily discount them to make a sale. They should have also undertaken a market research to find out the needs of the market before blindly stocking up on items. Their strategy to stock generic brand electronics was not welcomed by the customers so Dick Smith ended up with a surplus in goods and losses since it was quite costly to acquire the new stock. It is however unfair to put all blame on Dick Smith as Anchorage also played a part by their strategy. Given the history of Anchorage as a private equity firm with the case of Burger King in New Zealand where it made losses between $2 million to $7.5 million in the years 2012-2014. In 2007-2008, a similar case happened to the Canned Fruit Company Golden Circle whereby after it was sold to an American Company, three plants were closed and over 300 workers lost their jobs. With these cases in mind, they should have been more cautious and questioned more on their activities such as the write downs and the non-stocking. Dick Smith could have prevented the receivership knowing that Anchorage would soon make an exit and employed a turnaround management strategy to try and save the company. The receivership may not be for long as their main aim is to get as much money as possible to pay the banks or get a buyer for the business. If not, they may be forced to sell some of the shops to recover (Beckford, 2016). One can only pity the 3,300 jobs that are at risk in all of its 363 stores in Australia and New Zealand and the customers about to become unsecured creditors if they don’t get their money back. Reference List Beckford, G. (2016). How Did Dick Smith Get Into Trouble? Radio New Zealand. Boyd, T. (2016). Dick Smith Receivership gets the Drums Beating on Risk. Financial Review. Canning, S. (2016). Dick Smith in Receivership and for Sale as Crisis Bites but Atomic 212 Says Business as usual. Mumbrella. Clendinnen, G. (2016). The Greed and Christmas ‘Knock Out’ Sale that finally KO-ed Dick Smith. Newmatilda.com Colangelo, A. (2016). Dick Smith Placed in Voluntary Administration. The New Daily. Chung, F. (2016). Australian Entrepreneur Dick Smith says He will Consider Funding a Class Action against Anchorage Capital Partners, the Private Equity Form Which Floated his Former Company on the Stock Market in 2012. News.com.au Harper, J. (2016). The Herald Sun Hatch, P. (2015). Dick Smith not Surprised Dick Smith Shares Have Bombed. The Sydney Morning Herald. Janda, M. & Ong, T. (2016). Dick Smith Enters Receivership due to Bad Sales, Banking Woes. ABC news. Johnson, S. (2016). Why Banks Pulled the Pin on Dick Smith. Forager Funds Management. Knapp, J. (2016). The Ugly Story of Dick Smith from Float to Failure. The Conversation. Knight, E. (2016). The Anatomy of Dick Smith’s Decline. The Sydney Morning Herald. Low, C. (2016). Electrical Storm: How Dick Smith went from a $520m sensation to the Bargain Bin. The Sydney Morning Herald. Low, C. (2016). Dick Smith Could Have Survived with the Support of its Banks According to Sources Close to the New Collapsed Chain. Sydney Morning Herald. Lui, S. (2016). Dick Smith Enters Voluntary Administration. How Will This Affect You? Life Hacker. Mitchell, S. (2016). Dick Smith’s Crisis a Lesson in Why Cash is King. The Sydney Morning Herald. Murphy, J. (2016). Dick Smith has Entered Administration and that is a Big Joke for Some People. Ong, T. (2016). Dick Smith Collapse: Kogan Buys Struggling Online Business. ABC News. Richards, D. (2016). Why ASIC Needs to move on. Dick Smith Today Before Information Disappears. The Smart Company Source. Ryan, M. (2015). Dick Smith is the Greatest Private Equity Heist of All Time. Forager Funds Management. Read More