Photon faces earnings downgrade

PHOTON GROUP is poised to reveal another earnings downgrade this week as it clears the decks for a last-ditch restructure of its capital and management which is designed to garner the confidence of its investors – and ensure its survival.

Led by its new chief executive, Jeremy Philips, the PR and marketing services company will embark on a roadshow with institutional investors today.

Sources confirmed last night that Photon would concede some $90 million in write-downs related to goodwill impairment in its internet division. Photon spent $150 million on acquisitions but will now shut down this side of its business.

Its executive chairman and architect of the rapid expansion, Tim Hughes, is expected to relinquish his position in favour of a non-executive seat on the board today following pressure from institutions. His likely replacement is a former Austereo executive, Brian Bickmore. Besides the present four directors, another three directors will be appointed.

Should Photon’s restructuring plan be acceptable to investors, a capital-raising of $200 million will be undertaken, likely to be priced about 25¢ a share – a far cry from the last traded price of $1.02 . The recapitalisation, however, remains touch-and-go. The main shock in today’s revelations will be the magnitude of the expected earn-out payments.

Guidance for earnings before interest, tax, depreciation and amortisation will be downgraded from about $89 million to less than $80 million, but earn-out payments (to businesses acquired during the buying spree) are anticipated to surpass $170 million – well up on previous expectations of $50 million.

Further to the restructure, Photon intends to move from five divisions spread by business type to a simpler structure based on geography. Under its former management, the group had engaged in a roll-up strategy which entailed the acquisition of more than 50 firms over the course of a decade. Gearing rose to uncomfortable levels, mostly via bank debt with ANZ.

Among the more notable failures, Photon spent $25 million cash buying out the minorities in Dark Blue Sea – which owned a suite of domain names but had a broken revenue model – in a takeover offer. Dark Blue Sea was barely profitable before the acquisition, and Photon failed to elucidate a strategy for turning it around.

Characterising Photon’s acquisitions, the earn-out payments are typically made about three or four years after the initial deal had been struck and they depended on the profit growth of the acquired business over the period. Photon bought some big businesses in 2007 that went on to be real winners, among them the advertising agencies BMF and BWM, and the consulting business Naked.

These are now due to receive massive earn-outs, possibly as high as eight or nine times EBITDA. Photon has never disclosed the terms of the earn-out commitments, making it impossible for the market to judge just how big the future payments – which are almost all made in cash – were going to be. The biggest driver of the capital-raising will be this blow-out in earn-out liability estimates.

Getting investors to come to the party on a highly dilutive $200 million raising will be a challenge for Photon’s new management, and its bankers Macquarie and UBS.

And further down the track, the spectre of performance will linger, as businesses acquired along the way will have less incentive to perform once their executives have banked their cash earn-outs.

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