The "Dummy's Guide" to IPO red flags

The wild ride that was Sargon Capital's foray into the staid world of trustees and custodians, ensnaring the likes of OneVue Holdings (OVH) along the way before its collapse, was linked to a small marketing and IT consulting company that floated on the ASX in 2018. 

The prospectus for that company, GrowthOps (TGO), was, in hindsight, a "Dummy's Guide" to what to expect from Sargon and key red flags in an IPO. 

Later financial disclosures from TGO provided further guidance!

Discrete Disclosure

TGO and Sargon shared a common founder and managing director, Phillip Kingston, and some common ownership. Sargon was described in the TGO prospectus as a customer of its "growth-oriented technology consulting services".

The TGO prospectus set out the following:

• The promoters took a significant “free-carry”, with the projected post-IPO shareholder structure table showing them holding a $33.8m stake (at the IPO price of $1.00 a share) as their reward for organising the IPO and related acquisitions that were to be paid for with shares and cash from incoming IPO investors.
• TGO used proceeds to buy a business associated with the founder for $618,000, half in cash and half in shares; to pay a business vendor that owed TGO's founder $0.5m (proceeds "may" have been used to repay that debt); AND to buy a company for $1 that held $5m of loans made by the promoters and associates to that company (said to be covering $2.1m in pre-IPO costs and $2.9m for "developing the GrowthOps opportunity").

Later on, in TGO's FY19 accounts, we learned that:

• TGO made $6m and $3.5m loans during that financial year to an entity controlled by Sargon, charging an interest rate of 5.55%.
• Those loans were made despite TGO sailing close to the wind with its own facilities - TGO disclosed in these accounts that in August 2019 it exceeded the financial covenant ratio required by its debt provider, Westpac.
• TGO booked $4.6m revenue from servicing Sargon in FY19, of which $1.2m was not yet paid at the balance date.

Other People's Money

From these few pieces of information you no doubt have formed your own views on the ethics and practices of the leadership at TGO and Sargon and the use of "other people's money".

• Shuffling funds between entities that have different ownership. 
  
• Relegating to footnotes the detailed disclosure of substantial funds to be paid to the promoters. 
  
• Pushing the limits on debt facilities.
• Misalignment of interests with shareholders (i.e. losing half the value of an equity interest that you didn't pay hard cash for still leaves you ahead while external shareholders lose).

Against this background, its hard to imagine now that Sargon had been pitching its own IPO during 2019, targeting a valuation of more than $1 billion.

Sargon's receivers, Wexted Advisors, last month estimated a potential insolvent trading claim of at least $3.5m against Sargon's directors. Sargon's board of directors included Mr Kingston, former senator Stephen Conroy and former Crown Resorts chairman Rob Rankin (who ceased to be a director in January 2020).

Never assume someone else has done the work

Often nobody is scrutinising small IPOs and listed micro-caps. The governance consultants stick to large stocks where it is easier to get paid well by large institutions. Brokers have little incentive to research them.

But the fact that high profile individuals with reputations to protect were happy to put their names to Sargon serves as a great example to investors that you can never assume someone else has done adequate due diligence that you can piggy-back on. Surely if these Sargon associates reviewed the publicly available information on TGO in detail, they would have had second thoughts! 

But wait there's more

It is now extremely interesting to read in the recent report from Sargon's receivers Wexted Advisors that: 

"At or around this time  , a HKD$653M loan (A$107.4M) was provided by Taiping Trustees Limited to Mr Kingston in his personal capacity, Trimantium International Holdings Pty Limited (TIH) and other associated entities to be used to fund other parties acquisitions of shares in Trimantium GrowthOps, working capital for GrowthOps and the Company, and the acquisition of Australian Executor Trustees by the Company (Personal Loan)..."

Of course, there does not appear to be anything in TGO's prospectus disclosing that some IPO participants were being funded in like this. 

It should be a matter of great public interest to understand how “other parties acquisitions of shares in Trimantium GrowthOps” were funded and what, if any, impact this had on the success of the IPO and on the secondary market.

TGO's stock price is now languishing at 4.5c, compared to the $1.00 issue price for the March 2018 IPO. 

Despite having pitched the IPO on the strength of solid and growing earnings, TGO's March quarter cashflow statement shows the company continued to burn money and carry net debt of around $10m. Figures in that cashflow statement indicated that TGO's available funding would last less than two quarters at the then-current run-rate.

Final Words

Iress chief executive Andrew Walsh has no doubt had to dig into the circumstances of Sargon given the announcement this week of the proposed acquisition of OVH by Iress (OVH sold a business to Sargon for which it did not receive full payment). 

Mr Walsh summed up the Sargon collapse for us, as quoted in the Australian Financial Review: "We have done extensive diligence and we are across the details but agree it is pretty sordid."

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