Jenny Ruth: Blue Chip buys up key partners

Buying the businesses that are crucial or important to its success should make Blue Chip Financial Solutions a far more transparent and easily understood company.

Its minority shareholders also have a level of comfort about the price they will pay for these businesses that subscribers to floats such as Vertex and Feltex would envy: The price will depend on the three businesses' earnings in the three years ending December 2008. The maximum price is also capped.

The three businesses are three mortgage-broking companies which effectively operate as a single business under the Tasman brand, Tasman Insurance Brokers and Ingot Holdings' property procurement operations but not its property development activities.

At present, 80 per cent of Tasman's mortgage-broking business is obtained through its relationship with Blue Chip. The insurance business provides insurance on the properties Blue Chip manages.

But it is Ingot which is the linchpin of Blue Chip's operations: It provides the residential properties which Blue Chip then sells to "mum and dad" investors who finance the purchase using the equity in their own homes.

Blue Chip then assumes the tenancy risk by guaranteeing the investors an income, takes care of all the maintenance and then shares in any capital gain at the end of the investment term.

Until this proposed transaction, Ingot, being a private company, looked like a "black box". Without any insight into its performance and prospects, judging the worth of the Blue Chip business was extremely difficult.

If the profit forecasts for the three businesses are met or exceeded, Blue Chip founder Mark Bryers, who also owns the three businesses being bought, will be $26.64 million richer.

But if the businesses' performance falls short of the forecasts, Blue Chip will be paying less. Indeed, independent expert PricewaterhouseCoopers thinks that if the mortgage-broking operations record average net losses over the earn-out period, Bryers will end up paying Blue Chip, which will still continue to own that business.

Given the forecasts, particularly for the mortgage-broking operations, I'd say that's just as well. PricewaterhouseCoopers is relatively polite about those forecasts: "Given historical and current activity levels, we believe that the mortgage business' ability to achieve growth rates set out above is questionable.

"However, as the proposed acquisition price will ultimately be set based on actual (rather than projected) performance, we have not investigated the forecasts further."

The mortgage-broking operations' actual net profit in the year ended March was $54,000 and in the eight months ended August it was $81,000. The latter was below the $125,000 result budgeted.

In just four months ending this month, that $81,000 profit is expected to rise to $223,000.

That may not be as fanciful as it looks. Blue Chip chief executive Jonathan Woodhams says that more than 70 per cent of his company's business this year will be settled in the second half. Those settlements will flow through into the mortgage-broking business.

PricewaterhouseCoopers also note that management attributed the shortfall against budget to delayed settlements.

In 2006, the mortgage-broking business' net profit is forecast to rise 80 per cent to $401,000. It will then jump nearly five times to $1.9 million in the year ending December 2007, the forecasts show. For the final year of the earn-out, the forecast shows only 60.4 per cent growth to $3.1 million.

Woodhams and Blue Chip chairman Jock Irvine said those results could be achieved if the potential synergies with Blue Chip could be realised, but that they and the other independent directors were not prepared to rely on those forecasts.

"It wouldn't have been a credible transaction. We could conceivably have been paying for something that didn't materialise," Irvine says.

Getting to the present proposal took up to nine months, he said.

"It's been a long and hard negotiation. We've ultimately achieved a position which we think is fair to shareholders at large and gives the directors the comfort of knowing we're not paying for something that may not perform."

Blue Chip will pay $540,000 up front and a maximum of $3.34 million for the mortgage-broking operations.

PricewaterhouseCoopers estimates that if profits remain at the level estimated for the current year during the following three years, "the investment actually provides a net return of around $212,000 in the earn-out period and also leaves the asset in Blue Chip's ownership at the end of the period".

If the forecasts are met, "the investment would prove to be highly attractive and largely, if not entirely, self-funding", the accounting firm says.

Blue Chip is to pay $804,000 up front for the insurance broking business and a maximum of $3.29 million under similar earn-out provisions.

Interestingly, accountancy firm PricewaterhouseCoopers says the insurance operations were acquired from May 2002 for a total of $3.8 million. That works out at 18.8 times the $202,000 net profit that business earned in the year ended March this year.

Its earnings are forecast to rise to $985,000 in the year ending December 2007. The accounting firm notes that the 2007 forecast includes a possible new business stream which is "as yet unproven and may or may not eventuate". But it also concludes that otherwise, the management forecasts appear "to be broadly reasonable".

Ingot's net profit is forecast to rise from the $107,000 recorded in the year ended March this year to $3.9 million in the year ending December 2008. While Blue Chip will pay a maximum of $20 million for the business, it only has to pay $100,000 up front.

PricewaterhouseCoopers says that the minimum price "compares favourably with historical profitability" and that otherwise the price is entirely performance related.

It views the maximum price as high, but notes that if it is paid "Blue Chip would have enjoyed extremely strong growth".

Woodhams said the independent directors definitely didn't want Blue Chip to buy Ingot's property development operations.

"We would've liked it because it's more profitable, but the market doesn't like that," he says.

As well as protecting the minority shareholders' interests, the purchases will resolve the related party issues that have bedevilled Blue Chip since its backdoor listing through the shell of Newcall Communications in mid-2004, clearly one of Irvine's aims.

The related party issues "were causing confusion in the minds of analysts and journalists like yourself. That was very understandable," he says.

The company has also resolved another of its headaches: The stock exchange had given it until the end of this year to dilute the interests of Bryers and his associates from 92 per cent to below 75 per cent.

Bryers' interests are now down to about 61 per cent, thanks to hisselling shares in exchange for real estate and to placements Blue Chip made in October to Australian investors Macquarie Bank and CVC. The PricewaterhouseCoopers report shows Macquarie owns 3.5 percent and CVC 4 per cent.

One of Blue Chip's aims in listing was to gain greater credibility and to give its clients and the professionals they deal with greater comfort that it is a reputable company abiding by the stringent corporate governance rules which apply to a listed company. Having such investors on its register certainly boosts its credibility.

Transactions due to settle, including the three Bryers' businesses, will reduce his interests to about 53 per cent.

Blue Chip is also seeking shareholder approval to sell up to A$30 million of new shares to the public in Australia early next year to support its expansion in that country. That will further dilute Bryers' shareholding.


Who, what, where

Blue Chip Financial Solutions.

Headquarters: Auckland.

Profile: Blue Chip provides the residential properties which are then sold to "mum and dad" investors who finance the purchase using the equity they have in their own homes. Blue Chip assumes the tenancy risk by guaranteeing the investors an income stream, takes care of all the maintenance and then shares in any capital gain at the end of the investment term. Ingot provides Blue Chip with those residential properties while the Tasman mortgage broking business arranges mortgages for Blue Chip clients and other parties and the insurance broking business arranges insurance cover.

Market capitalisation: $52.5 million.

Latest results: Reported a $2.4 million net profit for the six months ended June on revenue of $23.4 million. It was not listed in the previous comparable period but the company says pre-tax profit of $4.4 million was up 20 per cent on the previous first half.

Management: Chief executive Jonathan Woodhams, executive director and company founder Mark Bryers, chief executive of Australian operations Andrew Murray, corporate affairs and strategy head Brian Rankin and chief financial officer Gregor Duncan.