Commander collapse highlights the perils of growth for growth’s sake: Boyd

The collapse of Commander Communications shows the dangers of setting business goals that have no connection with profitability as well as giving us a timely reminder of how easy it once was to borrow money from Australian banks.

Commander, a telecommunications and IT services company with 1300 staff, collapsed on Friday owing Westpac, the Commonwealth and NAB about $360 million. The banks will take a big haircut while unsecured creditors owed about $100 million will get next to nothing.

We may find out the size of the bank haircut on Wednesday when CBA reports its full year results. CBA, which is owed about $110 million, was believed to be the driving force behind pulling the plug on Commander.

Westpac is the company’s lead banker and is owed about $145 million. NAB has about the same exposure as CBA.

The collapse will have implications for about 60,000 small businesses using Commander phone and network systems, several state and federal government departments that have long term outsourcing contracts, and some big companies using Commander’s IT management services.

The collapse will also have an impact on many suppliers of computer and network hardware. Commander had turnover in the year to June 2007 of $1 billion. It claimed to be the largest distributor of Hewlett-Packard equipment and a major supplier of products from Cisco Systems and Toshiba.

Management of the company is now in the hands of three McGrathNicol partners, Peter Anderson, Chris Honey and Joseph Hayes, supported by about 30 of their staff. They will be under pressure from the banks to quickly sell the business either in its entirety or break it up.

The banks appointed McGrathNicol to protect their interests after the board, led by Elizabeth Nosworthy, appointed Steve Sherman and Max Donnelly of Ferrier Hodgson as joint voluntary administrators.

The banks will want the receivers to move fast in order maintain the confidence of customers, to preserve the value of the existing business and save on professional fees.

A list of potential buyers is already available following an informal sale process initiated by the board last year and handled by ABN Amro. That sale process failed to get traction.

Telstra and Optus have previously looked at the business and may be tempted back for the fire sale. Other smaller listed companies may be interested in parts. The prime attraction is a big foothold among Australia’s estimated 220,000 small to medium sized businesses and a share of the $6 billion phone, network and data markets.

A purchase of the business by Telstra would be intriguing as Commander was founded in 1998 through the purchase of Telstra’s PABX phone supply business.

There are three divisions in Commander. A franchise network supplying voice and hardware networks to small businesses, a corporate business supplying IT and network services to mid-market companies, and an enterprise business servicing government, universities and ASX100 companies.

The banks lost patience with Commander late last year after a series of profit warnings and revisions to earnings guidance. The banks, however, gave the company six months to engineer a turnaround and the board appointed new management led by Amanda Lacaze.

Lacaze was close to Commander’s largest single shareholder, Hunter Hall, which owns 20% of the company. Hunter Hall was instrumental in bringing in Lacaze to fix up and sell Orion Telecommunications in 2007.

The first problem the new management had to fix was the IT hardware resale business, which was bleeding cash. In the six months to December 2007, this business accounted for most of the negative cash flow from operations of $100 million.

Pulling back from the resale business helped slash negative cash flow for January and February to $100,000. The tougher approach was reflected in inventory write-offs of $17 million, $29 million in bad debts written off the receivables portfolio, and a $129 million write-down of goodwill. Until February bad debts had been running at about $5 million a year.

The February half yearly results, with a bottom line loss of $245 million, did not reflect well on the former management led by Adrian Coote. Under Coote, Commander went on a five year expansion strategy that was not accompanied by investment in back office systems.

Various presentations to analysts and annual reports showed the emphasis placed on revenue growth rather than profit. Lower margins in hardware reselling were explained away as being in the interests of securing customers or for cross selling other products.

Coote joined the company in March 2003 when Commander bought a company he partly owned, RSL COM, for $72 million. Other part owners of RSL COM Carl Russett and Lakshman Mawalagedera joined Commander in senior executive positions. There were many acquisitions of various sizes over the next four years. Most involved Commander taking on more debt.

Commander’s biggest deal was in 2006 when listed IT services company Volante was purchased for $147 million. It finally allowed Coote to boast that revenue had topped $1 billion. The Volante purchase was mainly debt funded.

The top line growth came at a cost. During Coote’s four years as CEO the amount owed to the banks soared from $58 million to about $360 million at 31 December 2007. Total financial liabilities rose from $195 million to $511 million. Debt as a proportion of equity rose from half the equity to 18 times the equity. Coote resigned on 10 December 2007.

The bank’s nervousness about Commander’s rising leverage was shown in October last year when they demanded a first ranking fixed and floating charge over the consolidated group in return for an increase in interest rates and an extension of the debt facility by $45 million to $385 million.

The banks were slow to pick up on the fragility of Commander’s cash flow situation. Cash flows from operations, investments and financing at Commander were barely positive in 2004, 2005 and 2006 and were negative in 2007.

It is believed Commander earned about $8 million in the six months to 30 June before interest, depreciation and amortisation. Cash flows from operations were positive.

But with an annual interest bill in excess of $35 million the company could not survive. The banks were faced with the choice of either forgiving a large proportion of the debt in order to keep Commander alive or pulling the plug.

They would have faced criticism whatever they did. A quick sale of the business by the receivers and equally quick write-off of the debt will allow the banks to claim they have come clean on another lingering exposure.

This article first appeared on Business Spectator