Bob Willott on the bottom line

BOB WILLOTT

Reports that The Engine Group may be back on the fund-raising circuit suggest not only that chief executive Peter Scott might wish to be able to take advantage of the recession to make a few global acquisitions at appealing prices but also that the group may be seeking some additional permanent share capital to replace or augment some of its existing borrowings.

First there were reports that Engine had retained two corporate finance specialists Ingenious Media and Jefferies International to help find some more money.  Then this weekend there were reports that the group was contemplating a stock market flotation (or “initial public offering” as it is now commonly called).   It’s hardly the best time for either, and the whole exercise begs two questions:  why the hurry and why isn’t the previous private equity backer - the AIM listed Guernsey-based Loudwater Trust - interested in putting up some more cash until market conditions improve?

Part of the answer may rest with Loudwater’s declared policy of investing in companies which are expected to achieve an IPO or a sale within a short term time horizon.  Having invested £8 million of extra share capital in 2007, perhaps Loudwater is yearning for a profitable exit rather than wanting to pump in more cash.  Michael Spencer’s Incap Finance may also be eager to realise some or all of its near 10% stake.

But, equally likely, both Engine and its financiers may be worrying about its profit performance.  Although the group has not filed its 2008 accounts, a press release acknowledged that it lost money last year after moving offices and writing off some lease-related costs.

Engine’s bank facility was increased to £37 million by the Bank of Ireland in February 2008 which added about £24 million to the level of borrowings available on top of those actually utilised at that date.  Out of those additional funds the company has spent an estimated £20 million in cash on subsequent acquisitions and its office move.   That would have been fine if the group had generated lots of cash from its trading operations during the period, as might have been expected, but after announcing a loss is this still likely to have been so?   Responding to this question Engine said that its debt at the end of 2008 was £23.2 million. "We are well within our borrowing capacity", finance director Ian Day added.  That's fortunate because now is not the easiest time to increase borrowings, however cheap new money may be.

Some of the factors that would-be lenders might take into account include the extent to which profits cover interest charges, the ratio of borrowings to cash flow, and the ratio of borrowings to shareholders’ funds (in other words the proportion of financial risk being born by shareholders by comparison with that of bankers).

Engine’s 2007 accounts implied that the Bank of Ireland's original facility agreement in November 2005 imposed only one specific financial constraint which is not precisely the same as any of the three referred to above.   According to the company, it had to ensure that borrowings did not exceed 2.5 times "rolling 12 months EBITDA".  EBITDA normally means profit before interest, tax, depreciation and amortisation, but the Bank of Ireland may have taken a more generous view.  Certainly the revised facility agreement made in February 2008 defined EBITDA as also excluding share incentive charges and empty property costs.

Engine reported that its borrowings in 2007 were 1.7 times “rolling” EBITDA and therefore well within its bank covenant at that time.  In its press statement this week it claimed to have achieved a similar ratio at the end of 2008.  But even if there is no explicit requirement to earn sufficient profits to cover interest charges and more, the out-turn for 2008 will not have been very comforting.  Indeed last year’s loss means that, while the bank’s investment has been increasing, the investment from shareholders has been eroding.  Taken together, these factors would provide a powerful motive for raising more permanent share capital.

Engine will have to publish its 2008 accounts by the end of October.  The sooner that happens, the sooner a full - and hopefully reassuring - picture will emerge. 

© Fintellect Ltd