Jenny Ruth: Fresh start dilutes the red ink

If you looked only at the bottom-line losses, you might think little except the name had changed since technology company investor Strathmore Group's metamorphosis into Media Technology Group in January this year.

Its net loss for the six months ended September was $337,000 compared with $2.5 million in the eight months ended March. The company changed its balance date from July to March when Strathmore became the backdoor listing vehicle for Media Technology. The loss for the year ended July 2003 was $3.8 million and followed net losses of $4.3 million in 2002 and $3.9 million in 2001.

Another sign of financial ill-health is that operating cashflow was negative, although only to the tune of $13,000, in the latest six months compared with a $493,000 deficit in the eight months ended March.

But behind these figures is the reality of a basic change in what the company does and the only significant link to Strathmore is that Media Technology, as its name implies, operates in the same broad sector.

Chairman Phil Norman oversaw the winding-up of Strathmore's affairs and actively recruited Media Technology to use the resulting shell as a backdoor listing mechanism.

The only alternative was probably liquidation. Strathmore reached a compromise last year with its creditors, who included entrepreneur Eric Watson, to pay them 50c in the dollar. The $650,000 in cash needed to pay this and the Media Technology transaction costs was provided by a new director, Scott Gilmour, a professional investor who holds 6.4 per cent as a result.

Norman describes the transition thus: "Strathmore was an investment company specifically focused on investing in technology businesses in a raging bull market ... What we now have is a business with a single focus. It's been in business for 15 years. It's got an established base of blue-chip customers. It operates on both sides of the Tasman. Most of those client relationships go back many years."

Media Technology's customers are an impressive bunch, including Microsoft, Hewlett-Packard, Telecom NZ, Telstra and Navman. It recently secured a contract with AusPOST to sell its range of specialised CD and DVD mail packaging through its retail shops. Sales from that contract are expected from the March quarter next year.

Its business includes mass duplication of CDs and DVDs - it built the first CD manufacturing plant in New Zealand - and packaging and logistics management of digital media generally.

It bought a New South Wales business in 2000 which had operated since 1981 and has since expanded into Brisbane and Victoria.

But for all that, Norman would like the company's past to be forgotten.

It is inevitable that some baggage will be carried forward. In the past, more often than not, companies have regretted such back-door listings. Hellaby Holdings, which sprang from the ashes of Renouf Corp, is a notable exception, achieving an enviable profit track record since its transformation.

You might think that Media Technology managing director and founder Allan Morton would have preferred to have simply floated his business directly.

It is obvious that it needs to raise fresh capital and a straightforward float would have done that as well as achieving listing status.

The backdoor method meant selling the business in exchange for shares. Morton's interests own 68.2 per cent and director Chris Due owns 13.1 per cent - and the intention is to raise fresh capital through a share placement to one or more professional investors.

But Morton says he has no regrets.

"[Strathmore] had a good shareholder spread. It also had people who I guessed had some understanding of investing in companies that do technology. That had some merit to us. It was also a pretty cost-effective way of going into the public arena."

Morton and his partners had spent more than a decade financing the company's growth but it was reaching a point where it was beyond their resources.

And becoming public also provided the company with a mechanism to reward staff by giving them a stake in the business (the staff share scheme now owns 7.1 per cent).

The company needs to raise fresh capital for a number of reasons, not least to meet the stock exchange requirement that at least 75 per cent of the shares be in the hands of other investors than the two major shareholders (who own 81.3 per cent).

The stock exchange has given the company two waivers from this rule to allow it time to meet it, but the second, granted this month and lasting until July 12 next year, strongly suggests it won't get another.

If it can't achieve the required investors in that time, the exchange "will consider whether it is appropriate for [Media Technology] to remain listed", the waiver says. It adds that the exchange generally won't grant such waivers for longer than six months "without exceptional circumstances being present".

A placement will also improve the company's balance sheet. At September 30, it had total assets of $11.4 million and total equity of just over $5 million, but $6.4 million of its assets were intangible.

"It's no secret we're actively looking for a placement. We're certainly and actively exploring options with some New Zealand-based investors," Norman says. He expects a placement will be completed within three or four months.

He challenges my suggestion that it will have to be done at a deep discount and says stock exchange rules prevent a company from placing shares at more than a 10 per cent discount to the market price over the preceding 20 business days.

Gilmour paid 12c a share for his stake and the shares issued to Morton and Due were at a nominal 12c. They were trading yesterday at 10.5c, having steadily declined from 21c after the transaction.

For all that, Media Technology is a real business with real customers and a history of making profits, rather than the smoke-and-mirrors affair Strathmore had been, the trend over the past few years since it entered the Australian market has been downhill.

Earnings before interest, tax, depreciation and amortisation (ebitda) fell from $1.55 million in 2001 to $1.12 million in 2002 and $1.07 million in 2003. Its ebitda was $1.08 million for the six months ended September 2003 and it fell to just $573,000 for the same six months this year.

Last year's independent report by Horwath Porter Wigglesworth blames that trend on declining sales and profit margins in 2002 compounded by a substantial increase in operating costs. It notes that while the New Zealand operations were comfortably ahead of forecast in the six months ended September 2003, the Australian operations were below.

This year's first-half report talks about a challenging competitive situation in Australia and says that "management is according priority attention to addressing these revenue and margin issues".

It appears that like many a New Zealand company expanding to Australia, Media Technology has found the process less than plain sailing.

The Horwath report says: "The longer-term perspective suggests that the extent of Media Technology's Australian business will increase over time while [the New Zealand business] is expected to remain relatively stable."

It expected gross margins to improve in both countries and operating expenses to increase proportionally.