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https://www.ft.com/content/76915519-238c-4080-b5cb-24a2c7cef263
The AA, the British roadside recovery group whose adverts once said it “gets someone out of trouble every eight seconds”, is in talks about a rescue of its own.
Six years after it was brought to the public markets with levels of debt investors would normally deem too risky, the juicy returns hoped for by management and new shareholders have failed to materialise.
As the coronavirus pandemic has hit earnings, and repayment deadlines edge into view, the company is finally attempting to bring its more than £2.6bn of debt under control. “It's a business towing an iceberg,” one adviser said. “It's really hard. ”
Simon Breakwell, a former Uber and Expedia executive who took the helm at the AA in 2017, is considering raising equity or returning the company known for its distinctive yellow vans to private equity ownership.
“The AA is in a difficult position now and has been since the IPO,” said Calum Battersby at Berenberg. “Private equity had underinvested and two different sets of management have not managed to return it to earnings growth.”
The attractions for the private equity firms keen to take the wheel of the 115-year old business are clear. The AA has been able to make money, regardless of its debt. Even after interest repayments — which amounted to £128m in the year to January 2020, equivalent to more than two-thirds of its £190m market capitalisation — the company generated a free cash flow of £83m up from £12m the year before.
If debt can be reduced, the AA offers a reliable source of cash, a strong British brand and a relatively loyal customer base.
Offers are likely to be pitched at around 40p-50p a share, according to a person familiar with the situation, about double the level before interest emerged from private equity firms, Centerbridge, TowerBrook, Platinum and Warburg Pincus. This could value the AA at more than £250m.
But those close to the talks said this would simply be an “entry cost”. AA’s management want any takeover to come with a sizeable cash injection, to invest in the business and reduce debt, more than £900m of which must be repaid within two years. That could push the total cost up to about £750m, according to one adviser.
Drew Dickson, founder of Albert Bridge, the AA’s largest shareholder, with 17 per cent, said Mr Breakwell had done “a really good job in right sizing the cost structure”. But he added that the debt had weighed on the company’s position in the market. “The tail is wagging the dog on the share price because of the threat of having to do a big refinancing.”
Albert Bridge would support a takeover from private equity at a “reasonable price”, he said, indicating that he saw the company as undervalued.
“We think the numbers being thrown around the press are fairly opportunistic and we suspect it’s worth more,” he added, pointing to the free cash flow.
“That’s a lot of money coming off for a £200m valuation. [Private equity] have been somewhat opportunistic coming in at these levels. We feel there is a great deal of value for shareholders . . . compared to the current price.”
However, Mr Dickson said he was not convinced the business needed an equity fundraising that could dilute existing investors.
Several of the potential private equity buyers have a record of investing in distressed debt or companies in need of a turnround, and it is not certain they would be willing to inject equity to fund organic growth.
“They are not all renowned for putting their hands in their pockets,” one adviser said.
The irony that the AA is seeking refuge in private equity is not lost on advisers, former executives and analysts, who have little doubt the current problems for the company started when it was last owned by the industry.
Nor is it lost on staff, said Paul Grafton, an official at the GMB union, who used to be an AA patrolman and now represents its employees.
“The staff I’ve spoken to say it’s like groundhog day,” he said.
The AA’s origins lie in a meeting of early motor enthusiasts at the Trocadero restaurant on London’s Shaftesbury Avenue in 1905. Concerned about the introduction of speeding penalties, they arranged for cyclists to patrol main roads and warn members of speed-traps ahead. Within four years, the AA’s uniformed patrols operated across the UK.
It continued as a mutual until 1999, when Centrica, the owner of British Gas, bought the company in a £1.1bn deal. Centrica sold it to private equity firms CVC and Permira for £1.75bn five years later, which then loaded the business with extra debt to take back most of the equity used to buy it.
Larger paydays followed. In 2007 CVC and Permira merged the AA with Saga, the over-50s insurance and travel specialist then owned by private equity firm Charterhouse, and the three buyout groups took a combined £1.8bn dividend. Saga listed separately in May 2014.
The following month brought another payout for the private equity firms, when a group of 10 institutional investors, including Aviva, BlackRock and funds run by Neil Woodford, bought a 69 per cent stake, then quickly listed the business. This unconventional “accelerated IPO”, led by broker Cenkos, returned £1.3bn to the private equity firms. AA floated with £3.4bn debt.
At that time, “no one was too scared about the debt,” said one person briefed on the management’s thinking. “Debt is fine as long as the business is going in the right direction”.
The plan under the new management team, executive chairman, Bob Mackenzie, and chief financial officer, Martin Clarke, seemed straightforward: drive profits by adding members and investing in IT and customer management to improve efficiency and cut costs. Debt would be reduced as a result. For a breakdown service still using paper and pen, the management saw some early wins with new digital systems.
“Investors bought in behind Bob and Martin. It was a classic turnaround of a business that had been underinvested and undermanaged before,” one person close to the team said.
But earnings remained stubbornly hard to improve and consumer members continued to decline. Pre-tax profit almost halved between 2014 and 2020, while membership numbers fell from almost 4m to 3.2m. Those involved pointed to regulatory changes that increased costs and made growing membership harder. “It all cost a lot more than thought,” another added. It culminated in a profit warning in 2018. By then, the management had changed. Mr Mackenzie was fired for gross misconduct in the summer of 2017 after a physical altercation during an off-site strategy review. He has disputed his sacking, and is locked in a high court battle with the business over his departure.
Mr Mackenzie’s successor, Mr Breakwell, planned to focus on technology, taking the AA “from a company helping when you break down to one actually predicting when you might break down”.
He appears to have had some early success, stabilising the fall in consumer membership at around 3.2m and meeting earnings targets.
But the coronavirus pandemic has brought upheaval and financial pressures loom — AA needs to refinance its next tranche of bonds in 2022. “AA’s ability to refinance debt is increasingly difficult,” said Mr Battersby. “It’s in a pretty precarious situation . . . new equity is the only real solution.”
Lenders are bracing themselves. “If the company goes into a restructuring scenario, then it’s highly likely that bondholders could get compromised,” one fund manager who owns the company’s bonds said. “Whoever leads that process will dictate the terms and try to make it as difficult as possible for other investors to get the upside.”
