16 October 2023
Breaking news
Smiles Inclusive
The examination of a company is normally brought about by liquidating accountants to find out where the money went. In this case, two persistent dentists—Dr Arthur Walsh and Dr Jon Camacho—after a difficult campaign eventually bought and paid for the examination. It has been a revelation.
The last of the series of examinations had KPMG partner Adam Twemlow in the dock. Despite the fact that KPMG had concerns, it aided Smiles Inclusive’s IPO. One email presented to Mr Twemlow from a KPMG colleague contained a comment that Smiles’ revenue projections were “unrealistic”. It went on to note that KPMG would require up-to-date information yearly to verify other revenue projections.
Mr Twemlow suggested KPMG auditors were quizzical as to where Smiles’ revenue was expected to come from.
Smiles had told KPMG it expected to make $7.3 million more than previously stated in earlier pre-IPO documents it had provided. That was an increase of 15 percent (of revenue) based on calculations that examining counsel Vicki Bell described as “lacking in detail”.
Where is it all headed?
I expect that in due course a legal class action will be mounted on behalf of those shareholders and dentists and possibly others who collectively lost a lot of money. The examination, while limited in its legal scope, has pointed to numerous failings by Smiles Inclusive’s board members, the accountants providing the relevant input to its prospectus, the stockbrokers who put the float together and distributed it to their clients as well as the share registry and the bank who financed Smiles.
In these types of matters, lawyers representing members of a class action are likely to concentrate on those involved who have professional indemnity insurance or who have deep pockets.
Creditors examination of failed dental corporate Smiles Inclusive directors, advisers and lenders in the Federal Court of Australia.
On day one, as reported in the Australian Financial Review of 3 October and the Australian of the same date, during the cross examination of former chairman David Usasz a major discrepancy concerning practice numbers and fees was revealed. Pre-float investor documentation, which detailed raising $3 million pre-float, claimed that Smiles had 95 heads of agreement with practices having a turnover of $110 million but this was followed by an update by Smiles Chief Financial Officer that 61 heads of agreement remained live with a turnover of over $65 million. Asked about the discrepancy. Mr Usasz said he could not recall the investor document. He pinned the blame on former chief executive Mike Timoney saying that “What was true and what was repeated by him wasn’t always the case, this is something I’m finding out here as well.”
“Mike was very compelling with his ability to convince people that he had the answers”, Mr Usasz told the examination. Asked about a forecast of a 10 percent increase in revenue from “day one”—i.e much more than inflation—Mr Usasz said Mr Timoney was “an excellent salesman who said he could make every one of those (clinics) much more efficient…He could easily change to allow them to make more money.”
Ms Bell asked Mr Usasz whether he was aware of a report by an industry expert that referred to Smile’s bizarre financial forecasts that “stretched credibility.” Mr Usasz said the report was not put in front of him by Mike Timoney because of personal enmity between the expert and Mr Timoney.
The industry expert referred to is understood to be myself, i.e Graham Middleton. I examined the financial forecasts in the prospectus at the time and concluded in a Synstrat newsletter to dentists that the forecast profit was unachievable within the stated timeframe. However, I was subsequently astonished at the volume of Smiles Inclusive Ltd’s massive losses and its rapidity of descent into insolvency and administration.
Smiles Inclusive raised $35 million in an ASX float in April 2018 with over 50 dental practices and fell into voluntary administration in November 2020 having produced substantial losses. Along the way its shares were suspended from trading on the Australian Securities Exchange due to its inability to provide current audited financials.
I reported on the demise of Smiles Inclusive in a newsletter of 18/6/2021 available at grahammiddleton.com
Day Two of creditors examination of Smiles Inclusive Ltd – chief financial officers.
Although Smiles IPO was oversubscribed, Smiles initial chief financial officer was questioned on an agreement with Bartercard to provide up to $3.8million in contractual revenue through its non-cash vouchers. The promised revenue failed to materialize with only about $300,000 worth of Bartercard’s non-fiat “dollars” used following the IPO in April 2018. At one stage the firm had less than about $100 in its bank accounts. The court heard that Smiles Inclusive shared a building with Bartercard, and that the founding Smiles chief executive was experienced with the Bartercard system.
Examining barrister Vicki Bell asked former Smiles Inclusive CFO Paul Innes whether he recalled advising the board on the risks of using Bartercard to lift revenue assumptions.
Mr Innes later advised the board that there was “very little certainty” that the promised Bartercard value could be achieved despite it being included in budget assumptions.
Mr Innes said he did not recall how a forecast of practice revenue of between $80-$100 million was generated prior to the IPO. The actual revenue achieved was $52 million. He said he was surprised that a year after the company listed its major bank appointed insolvency advisers to look at its operations.
Emma Corcoran, who replaced Mr Innes as chief financial officer in 2019, told the court that a substantial amount of work needed to be done as it swiftly fell victim to board infighting, departure of key executives, profit downgrades and a crippling debt burden. Its troubles included court action by the corporate regulator ASIC, lawsuits and suspension from the ASX.
Brisbane-based stockbroking firm Morgans underwrote the Smiles IPO and its clients subscribed to the majority of its $35 million capital raising. Shares issued at $1.00 in 2018 plummeted to 4.8 cents by early 2020 and were virtually untradeable because of its suspension from the ASX.
Note: Smiles Inclusive struggled to achieve $1 million of revenue per practice in 2019 financial year. By comparison, the listed Pacific Smiles Ltd achieved over the counter revenue per practice of $3.7 million in the same year. It is apparent that in the rush to get a respectable number of practices together for the IPO, many small and rundown dental practices were included.
Day three of examination; Morgans (stockbrokers) feels blowtorch at Smiles Inclusive collapse inquiry
Stockbroking firm Morgans allegedly used shareholders’ proxy votes without their knowledge in a board room coup at Smiles Inclusive that kept one of its long-standing clients as chairman.
The public examination heard claims that a Morgans orchestrated campaign to organize shareholder votes at an extraordinary general meeting to remove former CEO Mike Timoney and David Herlihy from the board and keep chair David Usasz and his supporters in position.
Mr Usasz, a long-term client of Morgans and former tax adviser to Morgans chairman Tim Crommelin, was subsequently kept on as chairman at the EGM in May 2019.
Morgan executive director, corporate advisory, when questioned by examining barrister Vicki Bell referred to voting records that showed that there was an unusual pattern of voting all in favor of the Usasz side, but was unable to account for shareholders who claimed not to have voted even though the records showed their votes were lodged in favor of the Usasz side by Morgans.
Questions were also asked about a $200,000 emergency interest free loan by Morgans to Smiles Inclusive who were confronted by a cash flow crisis.
Former Smiles Chief Commercial Officer Keith Nicholls gave evidence that in terms of guidance, the company produced material to share with traders in ASX announcements that he disagreed with.
He stated, “in terms of the guidance, particularly around forecast, I thought they were quite ambitious at times… Frankly, in my opinion, I knew we weren’t going to be able to deliver on those”.
Link Securities, the share registry, was examined and admitted to pressure from Morgans to withhold share registration from enquirers.
NAB Examination.
The examination of Senior National Australia Bank (NAB) manager Michael McBryde was next examined. The examining barrister Vicki Bell produced an email to Mr McBryde from dentists Dr Arthur Walsh and Dr John Camacho in which they outlined their concerns surrounding Smiles, and suggested NAB was facilitating an allegedly dishonest company to continue operating.
“I think (that’s) speculative,” Mr McBryde said, commenting on the allegation NAB was allowing Smiles to continue to exist. He said he would need the details.
When asked if he had seen or was aware of such emails to NAB management, Mr McBryde confirmed that he was familiar with the emails.
Ms Bell’s attention turned to Deloitte, which conducted an independent business review (IBR) into Smiles back in 2019.
“I don’t recall. My understanding is that the IBR was done and… it should have been on the file,” Mr McBryde said.
An October 2019 Deloitte report made before Mr McBryde became responsible for the Smiles file was tendered to the court, with Deloitte reporting Smiles as underperforming and that it had made limited progress in improving its financial position.
Deloitte also said it expected Smiles unchanged management structure to perpetuate internal issues beyond FY20. The accounting firm noted Smiles would need more funding support in FY 20 “in all scenarios tendered.”
There was much more in the examination of Mr McBryde.
Next is an examination of the accountant responsible for the accountant’s report in the Smiles Inclusive prospectus. This was the reported profit forecast which Graham Middleton/Synstrat said was unachievable.
Australia meeting its clean energy targets by 2030 is impossible say lots of experts.
The pace of adding renewable energy, back-up capacity and transmission is falling further behind the schedule of what is needed to achieve the targets. The national transmission rollout is already 1200 kilometers behind schedule. According to AFR 10 July 2023, by 2030 only 3,000 kilometers of the total 10,000 kilometers will have been completed. Nowhere have I seen an informed expert who says that our targets can be met. Meanwhile state governments are quietly contracting to have the planned closures of some coal fueled power stations postponed by several years due to the impossibility of producing sufficient renewable powered electricity production.
The reported high cost of nuclear generating plants will be massively offset by the huge saving in high voltage transmission lines if nuclear plants are built alongside old coal fired electricity generating plants and the existing transmission networks are used. Rational informed debate is required.
In the short-term, indecision and delays mean electricity costs will rise steeply risking destruction of a horde of manufacturing and fabrication businesses.
Affinity taking on EQT in potential Vet Partners’ sale
Private equity investor Affinity Equity has hired Macquarie Capital’s bankers to advise it on its attempt to win the contest for Vet Partners EQT is being assisted by Morgan Stanley Partners. AFR 11/08/2023 reports that bidders are being pressured to hasten by sell side adviser Jeffries due to plans by US parent National Veterinary Associates to float the left-over business which is apparently surplus to current owner California-based National Veterinary Associates global operation which suggests that stripped of the normal window dressing the Vet Partners business may not be travelling as well as they would like to portray. I know of many privately conducted Veterinary practices which have gained many clients after a veterinary corporate has bought a nearby practice. Staff often do not have the same output after owner vets sell to corporates and depart.
Genesis Capital reportedly joins potential buyers competing for Ekera Dental
Genesis Capital is reported as having investments in eight healthcare companies already including Impression Dental. Ekera has 46 dental clinics nationally and is owned by private equity firm “the Growth Fund”. According to the AFR 5/9/2023 BGH which purchased New Zealand’s Abano in 2020 and also partnered with Ontario Teachers’ Pension Fund in purchasing formerly ASX listed 1300 Smiles. Abano previously purchased Maven which was formerly known as Dental Partners. There had been disruption within Abano when shareholders objected to it continuing to buy practices for Maven which were no longer earnings accretive. More recently listed Australian company Pacific Smiles overreached, purchasing too many practices and having its earnings turn South. There was of course the short and disastrous life of Smiles Inclusive Ltd as a listed Australian dental company which was unable to go remotely close to making a profit in any six-monthly period before being placed into administration. Some remnants survive having been sold off by the administrator.
Extracting significant profits from corporatized dental practices is a great deal more difficult than most people might think and in the recent past corporates have shed a number of practices.
Competent dentists with good personal communication and clinical skills who work in private practices, eventually owning successful practices, have far better financial outcomes over their dental careers than do dentists working as contractors to corporately owned practices. Managing staff in corporate practices without owners as lead dentists is “challenging”. The vast majority of dental treatment in Australia will continue to be provided in privately owned and operated dental practices. Anybody believing otherwise is extraordinarily naïve.
Have our big banks passed their market peak?
The Commonwealth Bank’s annual results announcement of 10 August 2023 showed that while full year profit was up that was due to the first half-year to 31 December and the second half was disappointing. Overall net interest margin or NIM was down. In addition to its $2.40 fully franked dividend, the CBA has indicated that it will buy back $1 billion of its shares on the market over the next 6 months. The CBA is finding difficulty in employing its capital. Lots of analysts rate it as sell. Analysts are also cool on ANZ, NAB and Westpac.
A quick look at analyst recommendations of 25/08/2023 indicated the following:
· ANZ trading on a price-to-earnings ratio of 16.66, 11 analysts rated as buy, 5 said hold and 3 said sell.
· Commonwealth Bank trading on a price-to-earnings ratio 16.9, no analysts rated as buy, 6 said hold and 5 said sell.
· National Australia Bank price-to-earnings ratio 12.4, 5 analysts rated as buy, 7 as hold and 9 as sell.
· Westpac price-to-earnings ratio 12.6 only 2 analysts rated as buy, 9 as hold and 9 as sell.
This was an uninspiring view of the four major traditional banks.
We do not hold any of the four in our superannuation fund. We do hold Macquarie group which is a vastly different business being predominantly a global asset owner manager with a mix of traditional funds management and home lending done without a branch network. We continue to own Commonwealth Bank outside of super because its embedded unrealized capital gain requires holding.
Is China’s economy in deep trouble?
The largest property collapses in global history, shrinking demand for steel, over 21 percent youth unemployment in its big cities, shrinking imports of iron ore, an ageing population and shrinking exports of finished goods are leading to predictions of deflation as scared consumers hang onto money rather than spend. China consistently announces substantial growth percentages but many economists doubt the accuracy of its figures. It spells bad news for Australia’s major iron ore producers BHP, Rio-Tinto and Fortescue. In turn this is a reason for Australia’s weakening currency. In a sign of worsening youth unemployment China has recently stopped updating the number of youth unemployed.
Real estate investment trusts (REITs)
The REITs which are heavy in office space are facing the progressive reduction in tenancy as businesses with heavy work from home staffing reduce their space requirements when lease renewal options fall due.
Shopping centers are suffering from reduced consumer spending as higher mortgage payments occur.
Industrial property REITs heavy in warehousing are in demand.
Office conversions to housing not easy or quick.
There are not a lot of totally vacant office towers ready for conversion despite reduced demand for office space. Where a building owner wants to redevelop but the building is partly occupied by a residue of tenants with lengthy leases and renewal options those tenants have to be induced to move which invariably means offering significant financial incentives to relocate. This takes time and is expensive. Only then can the major work of converting a building into individual units on a strata plan commence.
The commercial property crash of 1990/91 produced costly lessons.
1. Unlisted property trusts were found to be unsuited to an environment of overbuilt office supply, high interest rates and a weaker share market. Many imploded.
2. The better ones listed onto the stock market and the market created a new but lower value for which units could be bought and sold.
3. Some office buildings in Melbourne’s CBD did not regain their pre collapse value for over 20 years.
4. Conversion to housing was quite rare.
A golden rule for investors: don’t buy any investment which lack a ready market to on-sell.
We can usually find buyers for our house. We can sell shares in well-known companies on the stock market, but tiny speculative companies can evaporate and should be treated as illiquid.
Listed real estate investment trusts like shares fluctuate in value but are readily saleable in the stock market. But right now, unlisted property REITS are suspending or restricting unit holders’ redemptions.
Unlisted asset failures.
The ending of the 1980s stock market and real estate booms taught us valuable lessons:
· Units in unlisted real estate trusts which had been lapped up by investors in a rising market assisted by then high inflation became unsaleable as investors in them struggled with rising interest rates and buyers disappeared. A few of the bigger and better ones were able to list on the stock market and created a market for investors to sell out but usually at substantial losses. Some properties in Melbourne’s CBD owned by unlisted trusts and syndicated partnerships value plummeted and were still under water 20 years later.
· Syndicated pine tree and eucalypt plantations were massively sold by unscrupulous accountants for massive commissions and volume bonuses but became economic deadweight losers. There were never adequatesecondary markets and buyers were trapped in them. Ultimately most fell into administration and were wound up and sold off with massive losses by investors which far outweighed the tax write offs on which they were sold. Many times on meeting new clients for the first time I found that they were burdened with these timber lot investments. I never met a single one who did not regret their involvement. Dentists and medical specialists were targeted by the operators of these plantations who desperate to keep cash flows going offered huge commissions including volume sales bonuses to accountants who were prepared to recommend them to their clients.
I recall being told by an organization selling eucalypt plantation investments that I had made it impossible to sell them to dentists. That was one of the nicer compliments I received.
· Syndicated viticulture trusts.
Owning a portion of a vineyard had emotional appeal but many turned out disastrously as Australia produced a glut of grapes and much of the grape harvests of some vineyards became unsaleable at a profit.
Vet Partners for sale! Timing the market?
Recent Australian Financial Review “Street Talk” reports that Vet Partners US owners are looking to sell. This means investment banking advisers are working through the options of possible trade sale or initial public offering (IPO) and ASX listing. It has 267 practices of which 14 are emergency facilities. Gross Fees and sales for 2023 Financial Year are reported as $661 million.
The explosion in pet numbers during the Covid era may well have run Its course with cat and dog shelters overwhelmed with pets handed back. Increasing interest and lifestyle costs are being felt by pet owners. While traditionally pet owners have been prepared to place pet welfare before personal needs there are limits. Those facing sharply increased home mortgage payments and an array of increased living expenses may sacrifice their pets. Veterinary fees in corporate predominantly small animal related practices are likely to have passed their zenith. Australia is undergoing a substantial retraction of discretionary spending power.
The myth about corporate veterinary practice.
Contrary to what corporate owners would like potential buyers to believe, corporate ownership is beset with a multitude of problems. The economies of scale have often proved negative across corporatization of professional practices including accounting, dental, medical and veterinary practices. I spent 26 years as founding partner of an accounting and financial services group with its two major client bases being dental and veterinary practices. I observed a great deal of evidence that rather than there being economies of scale there are more likely to be diseconomies of scale.
I once made a newsletter observation that the best place to start a privately-owned practice was close to a large corporate practice. A vet rang me up about 18 months later to tell me that he had followed my advice and his start-up had gone from zero to over $1 million of veterinary fees in its first twelve months!
I have since seen the experience replicated many times. A veterinary company buys a practice and the vendor vet complete their handover employment period which these days can be as short as twelve months. Personal relationships with long term clients are severely impacted; the employees relax and have longer consultations. The staff become reluctant to have appointments close to end of shift so as to guarantee early finish. Treatment that was done in house is referred out and clients find themselves paying more for inferior service! Pretty soon many long-term clients are asking their friends whether they can recommend another vet practice. A corporate practice ‘manager’ is often a former vet nurse or sometimes a dental nurse which is a big step down in knowledge from an experienced vet leading a practice and knowing many of its clients! While the former veterinary owners did a lot of surgeries themselves now lots more is referred out while the former owners often provided more treatment than two other vets. Meanwhile remote higher-level management tend to be unaware of the erosion of service and profit in their previously privately-owned practices.
Question:
Would I buy shares in a Vet Partners float?
Answer:
I definitely would not but a person wiser than me observed that “there’s a sucker born every minute!” so I will not be surprised if it is polished up with a good story and sold at IPO at a big multiple of profit only to subsequently disappoint investors.
Passing the Vet Partners parcel!
The AFR 21/08/23 reported that that Swedish private equity investor EQT was considering whether to bid for Vet Partners but its local advisers have to decide hurriedly whether to lob an offer because of its own impending IPO. This begs the question as to how changing ownership from one company to another can improve performance? In reality, in a business very heavily dependent on three-way relationships between vets, pet owners and pets, there is no magic ‘pixie dust’ that new corporate owners can sprinkle.
Back to the 1980’s?
Australia’s long discredited 1980s entrepreneurs played “passing the parcel” until the October 1987 global stock market collapse revealed them to have grossly overvalued assets mired in huge debts and one by one they collapsed. Many of the most prominent 1987 entrepreneurs had sad endings, some dying in exile, some jailed and a number bankrupted.
Interest rates will remain higher for longer.
Recently the message from the US Federal Reserve and the Bank of England is that they will maintain current higher interest rate settings. Australia is forced to follow unless capital is to flood out of the country. Expect housing interest rates upwards of 6.5 percent to persist.
The real limitations on corporatizing health professionals.
Whereas types of big business create efficiencies by replacing human labor with bigger machines (e.g. mining) or with elaborate computer systems such as self-service checkouts in supermarket chains, a veterinary surgeon can only treat one patient at a time and a dentist can only drill one patient’s teeth at a time. In reality, corporate veterinary and dental practices add to labor costs. There are diseconomies of scale rather than economies of scale. Corporatizing of medical practices relies on the ability to harness the outward referral of valuable pathology and radiology testing as well as milking Medicare. Effective veterinary practices contain most treatment internally and there is no Medicare for them to milk. The real fee growth of dental and veterinary growth has simply come from buying up more practices rather than organic growth. That is finite in scope as other vets and dentists start or build up privately conducted practices which more often than not give better service and have owner operators who build up long term relationships with dental patients and with pet owners.
Inter-generational report indicates dire outlook for government spending.
The report indicates greater spending on aged care, health and defense etc. That prompted the expected call by annuity providers for superannuation to be converted to annuities. That won’t be rushed. The practical responses are:
1. Left alone the nation’s superannuation balances continue to grow.
The mandated employer contributions have grown slowly from 4 percent of salary to 11 percent. It will be many years before most of the workforce will have had superannuation contributions above, say, 9 percent for their entire working life let alone the target of 12 percent for most of their working lives and hence the superannuation pool is still growing.
2. Stop subsidizing retirees home extensions and global holidays with the age pension and healthcare card with attached benefits.
At present, Mr and Mrs Citizen reach pensionable age and are advised that their savings including superannuation are above the point at which they gain part age pension and healthcare card. They decide to put an unnecessary extension on their home thus transferring part of their wealth to a non-asset test assessed and capital gains tax free asset and they splurge on an expensive overseas holiday then hey presto they become eligible for part pension and benefits. A Government with sense and a modicum of political courage would count recent major expenditure in the two years prior to pension application as an add back to the assets test. Why should taxpayers subsidize major home renovations/extensions and extensive overseas trips via the pension’s asset test?
3. Continue to encourage older citizens to remain in the workforce for longer. Noting that our generation is living significantly longer than our parent’s generation and needs to work longer to reduce the burden on government.
Financial Success for Dentists
Financial Success for Dentists: Rules for How to Approach Your Dental Career sets out the key strategies which make dentists successful. It is specifically written for those dentists and dental specialists owning their own practices and for those aspiring to own practices. Among the topics included:
· Understand key practice valuation criteria.
· Learn how some dentists inadvertently reduce the value of their practice by $500,000
· Avoid long term errors when purchasing your practice.
There are many accountants, financial advisers, marketing consultants, web site designers and practice advisers who give advice from their particular disciplinary experience, but very few have the wider breadth of experience to define for their clients the key rules to follow to optimize their practice and their long-term financial outcomes. An otherwise competent financial adviser may have little understanding of what makes one practice much more successful than another. Many accountants have detailed knowledge of the taxation rules but cannot identify if a dental client has broached invisible barriers to practice growth or a threat to practice goodwill value.
I spent 33 years examining dental practice financial outcomes and reviewing the key strategies and decisions which separated successful Australian dental practices and practice owners from the less successful and this led to relevant conclusions and advice to dental practice owners.
A complete and comprehensive career guide for mature and aspiring dentists.
Based on real life situations and a lifetime of dealing with dental practice ownership outcomes this book is worthy of Text Book status for every dental teaching school.
—Merv Saultry, Founder Dental Innovations Network
To Obtain a Copy:
· Go to the Delany Foundation website at http://www.delanyfoundation.org.au
· Click on the Donations tab and make a donation of minimum $60. This is easiest by Mastercard or Visa.
· Email graham.george.middleton@gmail.com confirming that your donation has been made, as well as your name and mail address
· A copy of the book will be mailed directly to you
All production costs and mail costs are met by me personally, so all money donated goes to the Delany Foundation which contributes toward the running of schools in Ghana, Kenya and Papua New Guinea. Naturally donations above $60 are welcome.
The donation to obtain this publication will be the most cost-effective practice advice most dentists will ever receive.
Please Pass On
If you like these newsletters, please pass them on to colleagues. Past newsletters and articles in Australasian Dental magazine on business issues are at grahammiddleton.com. I can be contacted directly at graham.george.middleton@gmail.com
Independence And Disclosure
I am not a representative of any accounting practice, financial planning firm, business or marketing consultancy. I spent 33 years as a business and financial adviser to mainly dental, medical and veterinary specialist and general practitioners. Since I retired as a director of a financial services group, of which I had been a founder, on 30 June 2020, I am no longer licensed as an investment adviser. Readers should treat the above as general advice and take professional advice as required.
General Advice
I sold my interest in a financial services and accounting group on 30 June 2020 and have no intention of starting another financial services business. I own, via my family superannuation fund and investment portfolio, some of the stocks mentioned in this newsletter. My website is now available at grahammiddleton.com.
Those who find my newsletters of value to them are asked to consider making a donation to the Delany Foundation, a registered charity which assists schools in Papua New Guinea, Ghana and Kenya. Delany Foundation c/- Holy Cross College, 517 Victoria Road Ryde NSW 2112.
Best wishes to all
Graham Middleton
