Down 95%: Oliver’s Real Foods

There’s been some water (mostly radioactive) pass under the bridge since I last wrote about Oliver’s Real Foods (ASX:OLI). I’m sitting on I believe my first ever position that is down 95%.

It’s worth a brief recap of how things got to this point. After my earlier presentation, I felt that the company was on the right track. The menu was improved, social media was improved, steps were taken to substantially shorten the customer wait time and improve per-transaction spend, and a variety of initiatives were taken to improve internal controls and lower operating costs. I believed that these would lead to important growth in foot traffic and volume.

(This brought out some other problems, for example colleagues & I established a few weeks ago that the OLI external social media agency was using bots to generate fake buzz around the company’s brand, but that’s a story for another time.)

I felt that former CEO Madigan had a decent grasp of the business and steps to improving it. When the recent downgrade and news of store closures came, I purchased more shares in Oliver’s at 2.3 cents as I felt that the company was being substantially mis-priced.

At 2.3 cents (and at 3 cents today) Oliver’s is priced for bankruptcy (where it may well end up, if not careful). Certainly the business was doing well enough pre-IPO. If it does not go bankrupt it will be worth some multiple of today’s price, which I thought was a reasonable bet with an asymmetric outcome.

That is a big if, and it just got bigger, for reasons I’ll get to shortly.

A Palace Coup

Two weeks ago I was preparing a letter to the OLI Board to encourage them to more aggressively cut expenses, achieve financial stability, raise capital on more shareholder friendly circumstances (a raising at these prices would permanently impair the value of Olivers shares). I also felt Directors should take a substantial fee cut for what I felt was their historical role in the company’s underperformance. After adjusting for the cost of store closures, directors on half fees would get the company measurably closer to break-even.

Then Jason Gunn returned as NED and now CEO, while the Board and CEO Madigan resigned. His return is not unexpected. As the founder and largest shareholder, Gunn has seen his paper wealth annihilated and the business has not had a good run over the last 12 months in terms of its financials and announcements.

However, today’s Chairman’s First Announcement ASX release struck me as a bit disingenuous. A number of the claims struck me as questionable:

“Bloated head office and overhead structure that was not focused on its core business…company has been internally focused, key frontline people were ignored by management”

• Jason Gunn has run this company since before IPO in June 2017. Most of the new stores were opened and most of the shareholders’ capital raised was spent under his guidance. Former CEO Madigan was hired in May 2018. You tell me who did the damage.

“The new board has also undertaken a detailed investigation…and identified and confirmed overhead reductions almost equal to the cash burn rate…”

• This of course overlooks the multiple millions in savings implemented by prior management. If CEO Madigan could find substantial savings – and for that matter if current management can find savings – it begs the question of why these things were not implemented a year ago.

“Outside consultants and advisors being paid fees and charges with a dubious relationship to outcomes…”

• This is true. It overlooks however that at least some of these outside advisors were hired to prevent things like this happening:

This is not an outlier and is a relatively mild example of historically a shockingly bad social media presence. (lets not get started on the anti-vax comments…)

“A hopelessly inadequate accounting structure is being replaced…”

• Who was the CEO and a Director since IPO? What were the rest of the Directors doing? What was the previous CFO doing with his time?
  
  

“(our new Director’s) tireless work over the past 10 days has brought a sharp focus on the challenges facing the business that until now have eluded management“

• I too, often come to realisations within ten days that have eluded management for two years
• Either this comment is nonsense, or previous management was not particularly bright (remind me who was management for most of the past 2 years… and in fact most of the past 10 years…?)

“We intend to liquidate the many assets that are currently underutilised…”

• I sure would love to know what these are, because the balance sheet looks thin. Yes, there’s ~$11m in property, of which $5.8m is leasehold improvements, $4.1m is plant and equipment, $0.9m is motor vehicles, and $0.5m is land and buildings.
• Maybe the “underutilised assets” being referred to is the $3.4m in cash? Or perhaps the company will divest the Red Dragon Organic brand that it spent $$ acquiring not so long ago… 

So what next? 

Jason Gunn built the business. It was by all accounts doing well enough before IPO. He is presumably competent. As a large shareholder and by taking a substantial pay cut, he is certainly incentivised. There is the added benefit of having all the old directors resign and having a temporary CFO, so the corporate overheads are substantially lower. The former CEO made a number of what I think were smart decisions which may make some contribution. I am not inspired by Mr Gunn’s return, but it is possible I have misread the situation (clearly I have). I’m inclined to hold, but certainly not as inclined as I was a year ago.

Oliver’s has four key problems in my view.

1. It is priced for bankruptcy and financially fragile. Capital on reasonable terms is unavailable. If any capital is required, existing shareholders will probably lose most of their investment.
2. Sales are too low relative to the cost of operating a store. 
3. Corporate overheads were too high.
4. It’s unclear that the concept and the offering is really clicking with customers.

In my unsent letter to the Board, I wrote (among other things):

Getting the business back to cashflow break-even in 2019 will already be a Board priority, but succeeding will open the company up to further financing, either from lenders or equity markets. I believe the Oliver’s share price would increase closer to 8c (~$20M market cap) – at which point a further capital raising – or additional equity investment from a strategic investor – would not be so punitively dilutionary to existing shareholders.

In times of crisis, raising capital is a confidence game. Cutting Director fees will help boost confidence, attract external investment, and reach financial sustainability…

…Please stop focusing on EBITDAI. If the near term focus is on cashflow (it is), I can appreciate the use of this metric for a while as a proxy for operating cashflow. However, it is not an appropriate metric for measuring a company’s true economic performance…It is particularly galling to see Olivers using Earnings Before Interest, Tax, Depreciation, Amortisation, and Impairment, as though historical decisions to allocate capital to failed ventures and loss-making and closed stores somehow does not count towards earnings. 

I would also add that a good narrative can lower the cost of capital for a hyped business. For a business with a track record of missing guidance, trying to spin the narrative with disingenuous comments such as these will in fact increase the cost of capital – which is highly suboptimal given that Olivers may soon need to raise money. In situations such as these, transparency and honesty pay better. You need people to believe in your vision but also to trust you when you say the company has learned from its mistakes and will execute better in the future.

Those are the things I hope Olivers management is thinking about. Food for thought.

I own shares in Olivers’ Real Foods. This is a disclosure and not a recommendation.