The Dick Smith debacle has drawn wide-ranging commentary regarding the causes and culprits behind its collapse. This is not unusual given the receivership of a retailer, which by virtue of its high public profile, is far more relevant to the general population than the collapse of building supplies company, for example. However, the presence of private equity has added to the intrigue, coupled with the fact that Dick Smith was floated only two years ago amongst a sea of optimistic projections.

Of all the contributions, the Financial Review’s Tony Boyd was the most surprising. Chanticleer is generally considered the most valuable and respected financial real estate in the country, previously occupied by Australia’s best business journalists, including Alan Kohler and John Durie. Boyd (with whom I’ve appeared on business panels over the years) seems to have taken a more business-friendly approach. This led to an almost comical Chanticleer column last week in which Boyd defended the role of private equity in the Dick Smith fiasco, appearing to blame pretty much everyone else for the collapse.

Dick Smith was sold back in 1982 by the chain’s eponymous founder to Woolworths for $30 million (which is probably equivalent to around $100 million in today’s dollars). Woolworths transformed the chain from a specialist electronics shop for tinkerers to a store/warehouse concept (it maintained larger independent stores and smaller stores in shopping centers). The performance of the business eventually deteriorated, leading Woolworths to sell the business to Anchorage in November 2012, for what appeared to be the paltry sum of $20 million (plus what was effectively an earn-out style kicker if certain metrics were hit).

The real purchase price was only $10 million in cash, and Woolies would eventually receive $115 million in total after the performance of the business ostensibly improved. Famously, Anchorage would float the business in December 2013 and depart the register in 2014, netting a tax-effective $500 million. Just two years later and Dick Smith has collapsed, likely leaving shareholders and unsecured creditors (including customers) with nothing.

Boyd was strident in his defence of Anchorage, noting:

“Putting a target on the back of Anchorage is silly. Saying it will never be able to sell a company to the equity market is even sillier …

“It requires an extraordinarily convoluted conspiracy theory to support the argument that Anchorage’s representatives on Dick Smith’s board, Phil Cave and Bill Wavish should be responsible for the disintegration that happened in the past three months.”

First, there’s the super obvious. The disintegration occurred under the watchful eye of CEO Nick Abboud. Abboud was appointed by Cave and Wavish and worked for Wavish at that other private equity disaster, Myer. Dick Smith’s chairman, Rob Murray, was also effectively appointed by Anchorage (and had successfully run Lion Nathan for eight years), has unfortunately accumulated a resume that now includes not only Dick Smith, but also Southern Cross Media and Metcash. (Dick Smith had quite a bizarre board of six members, including two executives, plus Murray’s former CFO at Lion Nathan and a 38-year-old lawyer who had never been on a public company board). So even in the most basic sense, Anchorage were responsible for putting in place the management team that presided over the disintegration. But the real culpability went far deeper.

The now infamous back story on Dick Smith was written by Matt Ryan of Forager Funds, entitled “The Greatest Public Equity Heist of all Time“. Forager predicted Dick Smith’s demise in October, contrasting Boyd’s notion that poor management suddenly caused a strong business to fall off a cliff.

Let me digress for a moment, to make a brief observation about private equity (PE). While I’ve been critical of PE for a decade, well before it become fashionable (in 2009, before Myer, Spotless or Dick Smith) I noted “when that time comes, retail and institutional investors will no doubt be mindful of their previous PE experiences and recall that buying into a private equity float is like buying an asset from Kerry Packer — probably not a good idea”.

It’s important to note that not all PE firms were created equal. Some, like Chris Hadley’s Quadrant, which is backed by the Future Fund, have a stellar record of delivering long-term investor growth (both at the front end and after exit). The difference between a “good” PE fund and a “bad” PE fund is that the “good” PE houses tend to buy illiquid family or tightly held businesses, provide growth capital and expertise, and then sell the company via trade or float to continue to grow the business. “Bad” PE firms take more of the Gordon Gekko approach, buying poorly performing (or even well performing) public businesses, adding debt, stripping out cash, selling assets, dressing the company up for sale and selling it at the peak of the asset cycle.

But back to Dick Smith. As Forager discovered simply by reading Dick Smith’s annual reports (doing the work that Dick Smith investors, like Fidelity, clearly seemingly didn’t bother to do), Anchorage only tipped in $10 million originally to buy Dick Smith. It paid the other $10 million to Woolworths out of Anchorage’s own cash balance (this is straight from the playbook of “bad” private equity). Anchorage then immediately wrote off $113 million from inventory and equipment and took another $8 million in provisions.

The write-downs appear to have had the benefit of allowing Anchorage to sell off stock cheaply, generating significant cash flow that appeared to be semi-profitable, but really wasn’t. To draw an analogy, let’s say you bought a shoe shop and the previous owner had shoes in a warehouse that cost $10,000 (which would typically sell for $20,000). If you then claimed the shoes were only worth $5000 and sold them for $15,000, it would look like you made a great profit, but in reality, all that happened was you made less money and hurt future margins (but generated some quick cash flow).

This is pretty much what Anchorage did, except, it cleared its stock at a discount for two reasons. First, it was able to pay out Woolworths (which cost another $94 million) and secondly, it gave the business a lower profit base, so it would be able to show what appeared to be growing earnings before tax.

The problem of course, is Anchorage’s actions essentially destroyed Dick Smith in the longer term — it’s just that no one realised at the time. Retail businesses need to buy inventory (and then churn that inventory as quickly as possible without dropping margins), and the problem for Dick Smith is that it sold all its inventory down to pay Woolworths. Moreover, by writing off its plant and equipment, Dick Smith was able to point to higher earnings before tax in 2013 and get the float away for what was an outrageous $500 million.

This is not a sustainable way to run the business, however, and Dick Smith needed to spend money to replace the inventory that Anchorage liquidated. To do that, it first leaned on shareholders, then suppliers (which led to its accounts payables skyrocketing) and then turned to NAB and HSBC for debt to continue to fund its basic working capital needs. As Forager explained:

“Come the end of 2015 financial year, however, it really comes home to roost. Operating cash flow was negative $4 million, as inventory increases further and suppliers demand payment, decreasing accounts payable. The business is required to take on $71 million in debt to fund a more sustainable amount of working capital. As the benefit of prior accounting provisions taper-off, profit margins fall, and the company reports a toxic combination of falling same-store sales and shrinking gross margins in the recent trading update.”

In its 2013 prospectus, Anchorage boss Phil Cave stated:

“Nick [Abboud] and his management team have driven a comprehensive program of strategic, customer, operational and cultural initiatives which … have already delivered substantial improvements to financial performance and have positioned the company for future growth.”

Abboud and Anchorage certainly re-positioned the company, but it wasn’t for future growth.

Despite Tony Boyd’s claims, like a black widow, Anchorage’s action caused the death of Dick Smith and the corporate raiders collected an almighty inheritance. So yes, there were plenty of culprits in the Dick Smith tragedy — from the board to management to investors to rapacious banks. But it might be time to put a target on Anchorage’s back after all.

Adam Schwab is the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed, published by John Wiley & Sons in 2010.