Those vexatious pre-packs

I’m sceptical of the merits of pre-packaged administration, where the sale of a struggling business is arranged in advance of administration and executed almost immediately. The justification is the business goes on trading with minimum disruption, saving jobs. The losers, are the company’s creditors, suppliers and landlords who will probably not be paid everything they’re owed.

Of course, shareholders in the company lose most, or all of their investment, and shareholders in rival companies face a new rival with fewer liabilities and, perhaps, new investment from a new owner.

In principle, there shouldn’t be a problem. Administration is handled by licensed insolvency practitioners appointed by the court to get the best deal for creditors. If there is money left over for shareholders when the assets are sold, they should get it. If the company was genuinely insolvent and the insolvency practitioner does a good job, there should be no complaints.

The trouble is pre-packs look a little convenient. One day the company is insolvent, yet the shops or factories are still open, run by the same people. Ownership has changed hands though. Often, through buy-outs, it’s transferred to the managers who put the company into administration, or parties connected to them. It happens so quickly, and with the emphasis on saving jobs and keeping businesses going, how can we know that the pre-pack solution was the best one for creditors and shareholders?

Unfortunately, I don’t have the answer to that question. But the pre-packs of clothing retailer Alexon and Brintons, a carpet manufacturer, are bothering me now.

According to one report, private equity company Carlyle bought Brintons out of administration after it bought the company’s senior debt and triggered insolvency enabling the company to shed its pension deficit of ''10.5m. Carlyle is investing ''20m in the new company, Brintons Carpets, and the company will take on a similar amount of debt. Brintons’ finance director, who keeps his job, is delighted because:

…The jobs are preserved, all the creditors are being paid, and the company’s moving forward and it’s got new money to invest in the future.

As a potential investor in rivals Victoria and Airea, though, it seems to me the pre-pack system has circumvented the Darwinian mechanism that should see weaker companies go-under in tough times, reducing competition in the market and securing the recovery of stronger ones. Now Victoria, which has invested heavily in factories and machinery, has a new competitor flush with cash.

While I do have a social conscience, I wonder not only about the jobs saved at Brintons but the ones that may be lost at other companies in this very competitive business, which has just got more competitive.

Alexon troubles me because Avril Palmer-Baunack was a non-executive director there. She lost that job when the company went into administration, and as far as I can see she’s doing well stabilising struggling vehicle logistics company Autologic, a member of the Thrifty 30. Autologic isn’t in danger of insolvency now, but it could be one day if Palmer-Baunack doesn’t turn it around, like she did Universal Salvage.

Mindful of her experience at Alexon I thought I’d use Expecting Value‘s Holding Ratio, which compares a director’s annual salary to the value of her shareholding as an indicator of whether, if administration at Autologic became a possibility, she’d think more like an employee, or more like a shareholder.

It will probably never happen, and no doubt Palmer-Baunack is more high-minded, but the unsettling truth is she owns no shares at all, and she’s very well paid.

The answer of course, is to avoid companies that may fold by using measures like the F_Score and Z-Score. But no statistic or analysis is foolproof, especially when trawling for bargains. Checking management has more to lose than reputation alone by arranging a pre-pack sale is probably a good second line of defence.