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Speaker 1: Welcome to the Fear and Greed Business Interview. I'm Sean Aylmer.

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Speaker 1: The future of Star Entertainment remains in doubt, with the

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Speaker 1: company's shares suspended until it can secure financings to stave

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Speaker 1: off collapse or otherwise. That might be some time before

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Speaker 1: you find out exactly what's going on with the casino

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Speaker 1: operated missing a deadline to finalize its accounts having been

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Speaker 1: unable to secure a rescue package. If Star Entertainment goes undone,

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Speaker 1: it certainly won't be the first listed company to do so.

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Speaker 1: I wanted to take a look at why these big

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Speaker 1: collapses happen, how regularly they happen, what they mean for investors.

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Speaker 1: Remember this is general information only, and you should always

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Speaker 1: seek professional advice before making investment decisions. Damon Callahan is

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Speaker 1: Partner Investments at ECP Asset Management. Damon, Welcome to Fear

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Speaker 1: and Greed. Thanks heving, Sure, so, just very quickly start.

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Speaker 1: I don't really want to talk about start too much

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Speaker 1: because it's on the brink. But when a company is

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Speaker 1: on the brink for whatever reason, is it mostly about

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Speaker 1: but finance? Is it mostly about trying to find funding

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Speaker 1: at the last minute?

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Speaker 2: Yeah, Look when they're on the brink. It's usually because

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Speaker 2: investors have given up confidence in the ability of a

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Speaker 2: certain business to sustain itself over the long run. You know,

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Speaker 2: you can be a bad business, and investors can, for

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Speaker 2: perhaps the wrong reasons, continue to fund you and support

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Speaker 2: equity raises until they ultimately learn that this business is

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Speaker 2: going nowhere and give up. So some businesses last longer

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Speaker 2: than they should. Whether or not now star has lost

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Speaker 2: investor faith and will be able to recapitalize a self

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Speaker 2: remains to be seen. But you know, sure, I think

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Speaker 2: you hit the nail on the head.

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Speaker 1: So you're talking about equity raises there, but there's also

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Speaker 1: debt financing. I presume at this point for a company

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Speaker 1: that's really desperate, it'll do anything, and I mean equity raising.

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Speaker 1: It's hard to go to the market and our shareholders,

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Speaker 1: you know that have boarded at a buck to pay

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Speaker 1: seven cents for a share. I say, you suppose you've

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Speaker 1: got to get some sort of guardian angel or something there.

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Speaker 1: But is it mostly about debt financing at this point?

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Speaker 2: It's just about the ability to recapitalize yourself. So every

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Speaker 2: business case is going to be different. But if you

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Speaker 2: are burdened by a lot of debt, then that's going

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Speaker 2: to be potentially more or equal to your actual value

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Speaker 2: of your business. So there might not be any value

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Speaker 2: left for the pre existing residual equity holders. So you

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Speaker 2: have a recapitalization the debt holders. Debt will convert to equity.

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Speaker 2: It'll be worth something less than the value of that

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Speaker 2: original debt. But ultimately, whether that of itself will hold

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Speaker 2: any value just comes down to the future owner of

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Speaker 2: this business and whether or not they believe it can

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Speaker 2: turn a profit into the long term. If it's a

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Speaker 2: business that's going to burn cash forever, theoretically it has

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Speaker 2: no intangible value, it will be sold for pieces. I'm

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Speaker 2: not saying that's the case with Start, but that's generally

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Speaker 2: how these things go.

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Speaker 1: Okay, so we're just talking about Start, but more broadly,

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Speaker 1: companies on the A six do fail, don't they. And

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Speaker 1: I'm not just talking about those at the bottom end

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Speaker 1: of it. I mean top two hundred companies have failed

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Speaker 1: over to time or come close to collapse.

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Speaker 2: Yeah. Look, so I mean obviously, by the time you've

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Speaker 2: gotten into the ASEX two hundred, you have become a

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Speaker 2: big business, and at some point in your life. You know,

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Speaker 2: you were a profitable entity, and so it's unusual to

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Speaker 2: see businesses fail because their economics just don't work anymore.

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Speaker 2: Things can change though, and start I mean, we don't

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Speaker 2: want to talk about that, but it's just a case where

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Speaker 2: regulations can change and change the sustainability of a business.

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Speaker 2: Then sometimes there are macroeconomic forces. So you know, miners

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Speaker 2: can become very large when there's a bull market and

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Speaker 2: commodity prices are high. But if you aren't a low

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Speaker 2: cost producer, then your sustainability is a question. And then

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Speaker 2: when ultimately commodity prices go down, you may not be

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Speaker 2: able to turn a profit. And if that happens for

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Speaker 2: a long enough period of time, you can run out

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Speaker 2: of cash. Most of the time, though, you know the

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Speaker 2: should say in those rare instances that blue chip companies disappear,

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Speaker 2: it can be due to poor execution from management and

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Speaker 2: usually financial mismanagement, so taking on too much, going offshore

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Speaker 2: into unprofitable ventures and blowing up cash flow, doing what

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Speaker 2: Stars done with cost blow arts and developments in Australia

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Speaker 2: that have added to their list of problems, and so

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Speaker 2: you know, those execution management execution events can be the

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Speaker 2: cause of device, but it usually links itself to financial mismanagement,

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Speaker 2: debt and then no room for equity value.

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Speaker 1: And then occasionally it's actually frauds. So HEYHH was a

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Speaker 1: good example I think in Australia where Ray Williams, who

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Speaker 1: was the CEO back then ended up in jail as

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Speaker 1: a result. That's kind of a one offer. I don't

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Speaker 1: know of any other examples of actually fraudulent behavior as

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Speaker 1: opposed to changeing regulation or kind of unable to access

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Speaker 1: finance or mismanagement as opposed to fraud. Is that right?

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Speaker 1: Do we often see fraud? Is really my question?

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Speaker 2: Not the ASEX two hundred, But there are plenty of

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Speaker 2: cases on the ASEX over a long history of fraudulent

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Speaker 2: from behavior from management. You know, I recently wrote a

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Speaker 2: piece publicly you can find it on our website that

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Speaker 2: talks about not quite fraud as close as to it

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Speaker 2: as you can get, with a particular Australian small cap

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Speaker 2: where they ended up having to rewrite all the historic

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Speaker 2: financial accounts because of dodgy accounting practices. The consequences of

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Speaker 2: that were the market no longer trusted management and what

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Speaker 2: might have had some piece of a viable business within it.

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Speaker 2: It was completely written off by the market to be

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Speaker 2: worth nothing. So it does happen, but rare in the

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Speaker 2: ASX two hundred shuan.

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Speaker 1: We'll take a quick break, Damon and be back in

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Speaker 1: a moment. I'm speaking to Damon Callahan from ECP Asset Management.

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Speaker 1: We have spoken about Star and we touched on HH.

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Speaker 1: You just mentioned a small cap. What about companies like AMP?

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Speaker 1: It certainly didn't go under, but it, for whatever reason,

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Speaker 1: shrank really quickly. Do many companies do that? I mean

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Speaker 1: that was a blue chip, ain't no more.

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Speaker 2: Look again, in the large world, radical changes only have

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Speaker 2: when there is unsustainable practices that a business is exposed

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Speaker 2: to take for example, casinos, gambling, gaming machines, things that

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Speaker 2: don't necessarily add value to society, and or waiting for

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Speaker 2: a regulator to come and tighten the screws. So AMP

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Speaker 2: specifically wasn't in an industry that's feeding off society, but

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Speaker 2: they had unsustainable elements to their business that back in

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Speaker 2: twenty twelve with regulatory changes to financial advice, impacted the

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Speaker 2: profitability of their model. And as industries change, usually due

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Speaker 2: to understandable practices. I've said, with regulators trying to tighten

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Speaker 2: the screws. You can go from having a viable business

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Speaker 2: to a business that finds its struggles to turn a

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Speaker 2: profit and keep operating. And so one of the first

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Speaker 2: things we look at when we're investing is how does

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Speaker 2: a business make money from its customers? Is it adding

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Speaker 2: value to society, adding value to its customers, or is

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Speaker 2: it feeding off them? And it's a very simple way

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Speaker 2: to sit back and try and think about the exposures

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Speaker 2: that are business might have in the future, because you

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Speaker 2: can have gambling businesses for example, that can be monopolies

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Speaker 2: and large and profitable businesses. But you're sitting there in

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Speaker 2: the best case scenario of regulatory settings that that business

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Speaker 2: is exposed to. Any changes from you will only make

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Speaker 2: it harder. And you do not want to be exposed

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Speaker 2: to businesses where you can look forward and theorize how

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Speaker 2: things could be made a lot worse by factors outside

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Speaker 2: their control.

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Speaker 1: So it's the flip side. True is that part of

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Speaker 1: the reason why the banks do so well in Australia

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Speaker 1: is that they are probably the most highly regulated sector.

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Speaker 2: That's true, but once again, and this hasn't proven to

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Speaker 2: be the case, where competition has eaten into their profitability.

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Speaker 2: But that is as good as it's going to get

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Speaker 2: for the banks. You know, the regulatory settings won't change

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Speaker 2: to make competition harder for them. So if you're looking

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Speaker 2: at how profitable they are, you know, putting the macro

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Speaker 2: cycle aside, it's probably as good as it gets to

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Speaker 2: the market.

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Speaker 1: So, as an investor, if I am looking at a stock,

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Speaker 1: what are the warning signs do you think? I mean,

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Speaker 1: you've sort of covered them at the beginning, But as

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Speaker 1: an investor, what are the warning signs for companies that

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Speaker 1: are not necessarily going to go under but certainly look

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Speaker 1: like they're going to struggle to be a finance themselves?

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Speaker 1: You know what am I looking for? What are you

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Speaker 1: looking for?

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Speaker 2: Yeah, Sean, I'll give you four really easy things that

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Speaker 2: are worth stepping through for any investor as a starting

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Speaker 2: point to just reduce your risk. I'll really mentioned the

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Speaker 2: first one, which is just thinking about the way they

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Speaker 2: make money from their customers. As I said, are they

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Speaker 2: adding value to their customers or are they feeding off them?

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Speaker 2: And if they're feeding off them, it's just a business

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Speaker 2: that's just not something you want to be exposed to.

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Speaker 2: Their business model might be a profitable day but someone else,

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Speaker 2: a regulator, the government can change that in the future.

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Speaker 2: The second thing that's very easy is the balance sheet.

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Speaker 2: If you can have a quick look at the balance

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Speaker 2: sheet and not understand it, and that can be the

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Speaker 2: case for a lot of financial institutions. And it takes

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Speaker 2: a lot of sophistication and training and technical skill to

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Speaker 2: be able to understand banks or financialsotion such as Challenger

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Speaker 2: that sells lifetime annuities, just to be able to understand

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Speaker 2: their balance sheet. If you can't understand it, put it

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Speaker 2: in the too hard basket because you don't know what

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Speaker 2: sort of leverage you're exposed to. If it's a clean

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Speaker 2: and simple balance sheet, you know, that's a great step

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Speaker 2: you can pass through. If there's a lot of debt,

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Speaker 2: then you have to start thinking about how much debt

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Speaker 2: is their relative to the profitability of this company. The

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Speaker 2: third thing is the cash flow of the business. So

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Speaker 2: does the cash flow equate to the profitability of the

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Speaker 2: organization over time? So be technical on this. Over time

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Speaker 2: roughly the free cash flow of the organization, So it's

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Speaker 2: the operating cash flow of taking away the capex, now

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Speaker 2: I should roughly equate to the net profit of the

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Speaker 2: business over time won't be the same in every passing year.

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Speaker 2: But if you seeing enormous discrepancies, then you know that

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Speaker 2: the accounting profit isn't worth a whole lot to you.

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Speaker 2: It's not something that can be relied upon. Cash is

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Speaker 2: usually king, and so that's the third easy element to

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Speaker 2: pass through. It is just looking for that consistency. And

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Speaker 2: the last really easy one is management continuity. If there

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Speaker 2: is a revolving door of senior executives at the top

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Speaker 2: of an organization, it's assigned that it's a floundering organization.

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Speaker 2: There's a lot of instability within the ranks, and it's

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Speaker 2: usually an organization that's not necessarily going backwards, but it's

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Speaker 2: not going anywhere. It's not going to get bigger and

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Speaker 2: more profitable through time, at least in the short term.

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Speaker 2: And it's an easy one to avoid. If you just

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Speaker 2: follow those simple full steps, you can substantially reduce the

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Speaker 2: risk of being exposed to a lot of things. But

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Speaker 2: that is just a starting point trying to figure out

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Speaker 2: how to get exposed to compelling companies that are growing

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Speaker 2: their profitability. And this is where we get to talk

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Speaker 2: about quality organizations and how to define quality that is

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Speaker 2: a more interesting conversation from my perspective.

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Speaker 1: That will be the subject of the next podcast. Aim

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Speaker 1: and thank you for joining us this morning on Fear

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Speaker 1: and Greed.

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Speaker 2: Thanks you, Tom Shaw.

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Speaker 1: That was Damon Callahan, Partner Investments at ECP Asset Management.

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Speaker 1: This is the Fear and Greed Business Interview. Remember this

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Speaker 1: is general information only and you should see professional advice

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Speaker 1: before investing. Join us every morning for the full episode

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Speaker 1: of Fear and Greed. Daily business news for people who

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Speaker 1: make their own decisions. I'm shot a Elmer. Enjoy your

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Speaker 1: day was