There’s a new sport in financial circles, and it’s called `pick the next corporate failure.’

Cruel perhaps, but interesting, and with the number of casualties mounting by the day, speculating on who will be the next victim of hedge fund manipulation or over-enthusiastic borrowing practices makes an interesting diversion from reading the Financial Review.

Investors, not to mention lenders, are finally realising that the good times (in sharemarket terms at least) don’t go on forever. 

A case in point is fresh-faced founder of kiddy minding operation ABC Learning Centres, Eddy Groves.  Eddy probably won’t read this – at the moment, he’s somewhere in the US of A trying to salvage his company, which is sinking under a mountain of debt.  To be fair to Eddy, he isn’t alone; Generation X seems to be genetically predisposed to bouts of exuberant borrowing.

As Eddy tours the financial capitals of the globe, there’s slight chance he might bump into Tasmania’s own John Gay in an airport lounge somewhere.  Gay doesn’t own any childcare centres yet - just a few sawmills, a winery and the odd hardware store, but he’s done plenty of travelling recently spruiking the benefits of his world-class pulp mill.

And the pair have a lot in common, although that mightn’t appear to be the case at first blush.

Groves managed to convince the banking fraternity to fund a massive expansion of his childcare empire, despite having a business case that, in hindsight, appears a little fragile.  Now that things aren’t going as well, it seems the bankers want their money back.

Gay has also been doing the rounds trying to raise money.  A year ago, it might have been a little easier.  But when Gunns released its half-year profit result last week, the company’s chances of wandering into the local credit union and picking up a cheque for $2 billion shrank considerably.

Half-year profit, which just three years ago totalled more than $37 million, collapsed more than 27% to less than $15 million.  It’s been quite a few years since the company managed to produce any semblance of earnings growth, and despite assurances that the full-year result will be more pleasing, not everyone is convinced.

And read the small print, and it soon becomes clear that Gay isn’t aware, or doesn’t care about something called a global credit crunch.

Current debt stood at $317 million as at the end of December.  For those unfamiliar with financial jargon, current debt is the equivalent of borrowing from your teenage daughter to buy a six-pack of Boag’s Draught.  Convenient, and sometimes necessary, but forget to pay the money back and the consequences can be dire.

At a corporate level, carrying a degree of short-term debt can be a useful way of managing fluctuations in cashflow.  But as a number of property groups are discovering, being unable to rollover short-term debt can produce interesting results.  Like attracting hordes of angry pin-suited jackals demanding repayment of their loans.

Most of Gunns’ debt lies with ANZ, who kindly granted them a line of credit early last year, secured by a fixed and floating charge over all the company’s assets.  In addition to the $317million, they also owe a further $731 million in long-term debt.  Plus an unexplained $56 million in `trade and other payables.’

In all, Gunns’ total liabilities stand at more than $1.5 billion.  That’s nearly $900 million than three years ago, when the company was making far more profit.

True, they have more assets as well.  Trees, until you chop ‘em down and mulch them into woodchips, tend to rise in value each year.  Gunns has also bought Auspine, handing them ownership of a couple of obsolete sawmills and a handy parcel of South Australian real estate.

They paid too much for Auspine of course – Gunns is yet to clarify what it plans to do with all that land, and milling pine profitably takes more talent than carting old-growth forests to the woodchip mill.  Former Auspine head honcho Adrian de Bruin doesn’t mind though – he’s reported to be so happy with the price Gunns paid that he’s bought an airline to celebrate.

And then there’s that pulp mill.  John Gay said in the half-year report that, pending approval of finance, construction of the mill should begin in June.  Lead bankers ANZ are still to give the go ahead to funding, but Gunns have conducted their own assessment into whether the project meets the Equator Principles, so everything should be fine.  According to Gay, that is.

Let’s do the sums.  Existing liabilities - $1.5 billion.  Borrowings needed to finance the pulp mill - $2 billion, plus capitalised interest. That’s total debt when the mill is completed of around $4 billion.  Profit – less than $15 million for the half-year, and shrinking.  I could provide a more detailed analysis, but the raw figures tell the story, and anyway, I’m well into another bottle of Tamar Ridge chardy.

Those sorts of numbers would leave the average homebuyer choking in their Weeties, let alone more conservative banking types, who, having been stung by a string of company failures, are finally being a little more conservative in their lending practices.

Gunns’ shareholders are a passive bunch.  They’ve sat back and done nothing while profit has collapsed, debt has soared, and the cost of the pulp mill – touted as being Gunns’ saviour – has doubled.

Even the company’s loyal institutional shareholders have failed to publicly question Gunns’ direction.

Opponents of the pulp mill project have been far more vocal, although they possibly shouldn’t worry so much.

Forget dioxins.  Forget secret wood supply deals with Forestry Tasmania.  Even the angst over the last year’s dodgy fast-track approval process will fade in time.  Gunns simply don’t have the financial capacity to borrow the funds to build the mill.  They could probably pull something off by issuing around $1 billion in new equity, but existing shareholders would squeal, and Gay has ruled that out, anyway.

So where to from here?  I’m guessing we’ll see an announcement within weeks saying the project has been put on hold until financial markets are more stable, although preliminary site works will continue.

Then it gets interesting, particularly waiting for Paul Lennon’s response….

JARVIS COCKER
HOBART

Jarvis Cocker

Forget dioxins.  Forget secret wood supply deals with Forestry Tasmania.  Even the angst over the last year’s dodgy fast-track approval process will fade in time.  Gunns simply don’t have the financial capacity to borrow the funds to build the mill.  They could probably pull something off by issuing around $1 billion in new equity, but existing shareholders would squeal, and Gay has ruled that out, anyway.

So where to from here?  I’m guessing we’ll see an announcement within weeks saying the project has been put on hold until financial markets are more stable, although preliminary site works will continue.