Questions and anger at Feltex meltdown

Forsyth Barr managing director Neil Paviour-Smith must have wished it was an April Fools' day joke.

Landing after a flight from Wellington to Dunedin on April 1, he switched on his phone to be greeted by a message from Feltex Carpets.

He learned the company had just told the sharemarket its annual profit would be up to $9 million below the projections outlined in a prospectus for the company's $254 million float last year.

As co-leader of the initial public offering, Forsyth Barr had put clients into tens of millions of dollars worth of Feltex shares.

That day alone Feltex had 30 per cent wiped off its market value with shares crashing 46c to $1.04.

"It had just started going bananas," Paviour-Smith recalls. "We were as shocked, if not more shocked, than anyone else."

The profit warning came after a rocky start on the stock exchange last June. Returning to the market after a 15-year break, Feltex shares were sold to investors for $1.70, the bottom of the indicative price range. And then, on the day of listing, Macquarie Equities, a member of the float syndicate, dumped almost 4 million shares at 10c below the issue price.

The April Fools' day forecast that annual profits would be between $15 million and $16 million compared to the prospectus profit projection of $23.9 million.

It represented a cut in forecast second-half profit of about 70 per cent.

Feltex blamed tougher market conditions than expected, a shortage of carpet-laying contractors, low store traffic, increased price competition and the strong New Zealand dollar.

What really irked investors was that the warning had come within weeks of Feltex's February 23 interim results, when management said they were confident full-year prospectus projections could still be met.

They struggled to work out how things had turned so bad in a month. February sales figures, below expectations for the second consecutive month and available well before April 1, should have been taken as a sign all was not well.

ABN Amro analyst Dennis Lee reckons management was too focused on a misguided bullish Australian consumer sentiment survey and guidance from the Australian Housing Industry of Association, rather than internal Feltex data showing falling sales.

Feltex makes about 75 per cent of its revenue in Australia.

"Only towards the end of March did it dawn on management that the market was deteriorating rapidly and its margins crunched by escalating raw material costs," says Lee.

Peter Hall, executive chairman of Australian fund manager Hunter Hall, Feltex's biggest shareholder with a 9.5 per cent stake, says: "Ultimately what has happened is extremely disappointing."

Hall had viewed a 15.4 per cent increase in half-year dividend as a sign of high confidence within the company.

Now, he reckons, management is on notice. Feltex has an open share register and the company could become a takeover target.

"It would be a great shame for people who put their money into the float to be confronted with a bid from someone at a much lower price," Hall says.

Meanwhile, at least one shareholder is mulling legal action to try to recover lost money. And some analysts are calling for the Securities Commission to investigate just what has gone wrong at Feltex.

With this backdrop the company brought forward its third-quarter results by about three weeks to Wednesday and gave a fuller explanation of the April 1 downgrade.

A third-quarter loss of $888,000 compared to profit of $2.4 million in the same period of last year. The company again cited a shortage of tradespeople and said it learned of an additional increase in synthetic raw material costs on March 31.

The strong New Zealand dollar, delays to commercial contracts, increased imports, aggressive competition and lower residential carpet demand "will continue to present significant challenges to the company".

Investors were nonplussed and Feltex shares were trading at just 77c yesterday.

Speaking to the Business Herald on Wednesday after the third-quarter results, Saunders maintained Feltex got the April 1 profit warning out as fast as possible - after a management presentation to the board two or three days earlier.

"Clearly things were turning very quickly so we said, 'We better do a complete rehash of the projections'."

Feltex received no prompting from the Stock Exchange or Securities Commission to release a more detailed explanation of the April 1 downgrade. And Saunders stands by the IPO earnings projections, calling them the best estimate of the future the company could have made at that time. "I have no doubt on that. I'm absolutely comfortable with them." 

Chief executive Sam Magill, finance boss Des Tolan and the rest of the senior management team retained the board's full support, Saunders said.

Magill did not return calls, but curiously he was one of the biggest losers from the warning. He bought 40,000 Feltex shares on March 30 and 31, for $1.47 each, taking his total holdings to 2.46 million shares and 1.8 million options.

Attention is now also beginning to focus on Forsyth Barr and First NZ Capital, its co-lead broker in Feltex's initial public offering.

"When firms like Forbarr trumpet the Feltex float as being the biggest since Contact Energy as they did, when things go wrong they should be held accountable for it," one analyst suggests, summing up widely held views.

He reckons the IPO earnings projections always looked optimistic and describes Credit Suisse First Boston Private Equity, the seller in the IPO, as a "very aggressive" vendor.

The analyst notes the company made losses in 2001 and 2002 and the CSFB fund seemed to sell as soon as it could after getting the company back into the black.

Some in the financial markets claim First NZ Capital and Forsyth Barr were paid "extraordinarily large fees" to get the float away. Total IPO expenses were close to $20 million, including the cost of redeeming "junk bonds" previously issued by the company.

There are also mutterings that the relationship between CSFB and local affiliate First NZ Capital was too cosy. Rob Hamilton, head of investment banking at First NZ Capital, rejects any conflict of interest. Although the two are aligned, working together primarily on cross border deals, CSFB has no ownership interest in First NZ Capital.

"We were not working with CSFB in relation to Feltex, we were working for them as a client and we were working jointly with Forsyth Barr," Hamilton adds.

Hamilton also dismisses talk his firm received excessive fees. He says broker, management and firm allocation fees totalled $5.5 million, which is 2.2 per cent of the float value.

Paviour-Smith says such fees are "absolutely standard" for an IPO of that nature.

Both also say their firms received no warning from Feltex of the April 1 profit warning.

Paviour-Smith could not confirm market estimates Forsyth Barr clients, including institutions, bought $90 million worth of Feltex shares in the IPO.

"Whatever the number was, it was a bloody big number, and it's still of great concern to us that our clients who are shareholders in Feltex have experienced this loss," Paviour-Smith says.

Adding to the embarrassment, Feltex was one of Forsyth Barr's five stock picks for this year.

Meanwhile, the Shareholders' Association criticised the absence of performance hurdles in the management share option plan.

Magill's 2004 salary, including bonuses and a $1.54 million payment from CSFB to stay on after the IPO, was $2.49 million.

FROM HUMBLE BEGINNINGS

Feltex started out as a felt slipper-maker in Wellington during the 1920s. It began manufacturing carpets in New Zealand in the 1940s.

Feltex listed on the sharemarket in 1945.

During the 1980s, Colin Reynolds' Chase Corporation had a 19.9 per cent stake in Feltex. This was acquired by Allan Hawkins' Equiticorp in 1985, which eventually built it up to 78 per cent.

In 1989, British conglomerate BTR Nylex bought Feltex, then part of Feltrax International, in a $460 million deal two weeks before Equiticorp collapsed into statutory receivership.

Another change of ownership came in 1996 when Credit Suisse First Boston and a management team paid $19.5 million for Feltex. CSFB sold out in last year's $254 million float.