By Craig Martin*
The warning signs that Ellies was in trouble came as early as 2012, when net outflow of working capital was around R330m. A further R200m net outflow occurred in 2013, followed by R236m in 2014. Management continued to sell the story around the company’s prospects and tried to convince the market that rising debt levels and net outflows of working capital were temporary.
In the Biblical account of Samson, this mighty man so badly wanted to believe that Delilah loved him that the truth about her was impossible for him to see. It ultimately led to his downfall. Ellies CEO, Wayne Samson not only shares a name with history’s strongest man, but one wonders whether he and the Board were in Delilah-type denial that Ellies was flirting with danger.
A quick glance at the financials for year to end of 30 April 2014 would have revealed that nearly R400m worth of current interest-bearing liabilities suddenly appeared on the Balance Sheet, with R106m payable within 12 months and R289m payable after 12 months. This is not taking into account the R131m bank overdraft and R467m that was owed to Creditors.
Hindsight is an exact science, but it could be asked why Ellies management didn’t foresee that a rights offer would have assisted in recapitalising the business. Surely when the share was on the rise, reaching a high of 990c on 17th of May 2013, it would have been the ideal time for a rights issue. But it looks as though management might be forced by their bankers into a rights issue that could be as low as the 120-130c range.
Group CEO Wayne Samson and numerous other Directors, namely Grant Davis, Ryan Otto and Grant Melville, had been serious sellers of Ellies throughout this period of free-fall.  Then on the 31st of August, Andrew Brooking, an executive Director of the companies sponsor, Java Capital, resigned from the Ellies board. But, Samson is not the major shareholder in Ellies. The founder of the business and Chairman, Elliot Salkow still holds more than 30% of issued capital and he hasn’t been an active seller, even during this period of free-fall.
A lot of hope for Ellies future was placed on Megatron Federal, which it acquired in 2008. When Megatron was first acquired, there appeared to be a strong order book (mostly with Eskom) and exciting opportunities in the rest of Africa. According to Ellies website, “the opportunities include the development of alternate power solutions, telecommunication towers and data centre infra-structure. Substantial alliances with international technology and product leaders in industrial battery power storage, modular data centres, and it seemed as though telecommunications and telecommunication towers had already been secured.”
Well, the facts were that Megatron Federal did initially have some great orders, but the work seemed to be project-based and rather erratic. If Ellies want to avoid completely diluting its shareholding with a significant rights issue, we would think that management will need to consider selling its infrastructure division, which includes Megatron Federal. At present this division contributes approximately a third to group profits, and there should be a number of potential suitors for this business.  The company has signed a number of infrastructure projects in the DRC, Ghana, Mozambique and Cote d’Ivoire and it would be sad to see this part of the business sold.
Another option could be to just sell off part of the business, like the Telecommunications projects sector, which mainly deals with towers. However this would obviously fetch far less than a sale of the complete infrastructure division.
A sale of Megatron will leave Ellies as a consumer-focused business involved in satellite installations and rentals, and some video and electrical consumer products. Hardly exciting as it takes Ellies back to where it started 30 years ago, but now it is not just offering DSTV’s offering, but Altech’s Node and e-TV’s OpenView HD. It is also not just selling connectors and components for your television and video use, but also a number of green products, such as rechargeable batteries, LED lamps and other energy-efficient solutions.
Management of Ellies could be forgiven for hanging around waiting for ICASA to finally switch from analogue to digital. Ellies were always of the view that they would be significant beneficiaries when this happened as all television signals were to be scrambled. So if you wanted to view SABC 1, 2, or 3 – you would require a set-top box. Unfortunately ICASA have delayed this move causing management at Ellies to sit with sunken research and development costs and a lost opportunity.
There is an international agreed-upon deadline of June 2015 from the International Telecommunication Union (ITU) by which to switch off analogue TV broadcasts. If ICASA have their way with ensuring that this digital signal is scrambled, then it is likely that illegally imported set-top boxes and existing digital televisions will all still need a set-top box to pick-up the “free-to-air” channels. Â Â The results of this will only be seen in Ellies results in the second-half of 2015 and by then the financial effect may be a fraction of what management thought it may bring had the switch occurred a few years ago.
Ellies is sitting on far too much inventory (R737m as at 30 April 2014) and has made this mistake on numerous occasions in the past. It did have more than R420m due from contract customers and so we would expect that if it manages to fetch a good price for Megatron Federal, if it reduces its inventory holdings and collects on its contract contractors, then we would think that the rights issue would be in the region of R150-200m. However, considering that the market-cap is currently only around R470m, this would result in a significant dilution for existing shareholders.
Had Ellies raised the funds necessary at 900c instead of at 120-130c (still to be confirmed) shareholders would be in a completely different position, debt would be under control and the share price would probably be rated based on prospects for 2015 and ahead. Now though, existing shareholders have lost patience and confidence in management and I think that it will take many years for shareholders to have any conviction in the company’s future.
* Craig Martin is an entrepreneur with investments in information technology and financial services. He has experience as a discretionary Portfolio Manager, and has worked for ABN-Amro, Aurica Asset Management and Guardbank in the past. He currently investments for his own account and operates as an independent equity analyst.Â
