Saga (OTC:SGPLF) is a U.K.-based company focused on helping people over fifty with some specific activities, especially insurance and travel. After a torrid year, the old boss is coming back to invest on a big scale. That is a positive development, but Sage remains a risky punt.
Saga: The Makings of a Great Business
At the end of last year, when Saga shares were trading in the low fifty pence area, I looked into it as a possible investment.
The attraction of the company was that it seemed to have a solid moat: selling big-ticket items to a well-heeled, growing audience of retirees whose interests were underserved by the broader market. With its own magazine and specialism in the age group, the company could make good profits. As well as insurance, it sold cruises on its own small fleet of ships.
The value at that point seemed compelling. In its most recent annual report (2019), it had declared a dividend, which, while down 56%, was still 4p, while underlying earnings per share had been 13.1p. The basic earnings per share had been -14.5p, which was less attractive, but that was due to a goodwill writedown in the insurance business which led to a non-cash charge of £310m. Cash flow also seemed strong, although the company’s use of alternative reporting measures – always a red flag – meant that it took time to dig into what the free cash flow was, versus its preferred measure of “available operating cash flow”.
Once I dug into the company more, I realized that I didn’t like the way it had been run of late or the lack of financial foresight available to its shareholders. The company had also appointed a new chief executive in Euan Sutherland, whose mixed record elsewhere made me think he lacked the deep business skills or cultural fit required for a successful turnaround of a business facing the challenges that Saga did. I read a bit on Sutherland’s stint at the Co-op bank and decided Saga with him at its helm wasn’t a suitable investment for me.
That turned out to be a prescient move, as today’s share price of 13p is just a quarter of what it was when I ran the slide rule over Saga at the end of December. It’s another good example that something that looks cheap can in fact still be very expensive.
Source: Google Finance
COVID-19 has been a challenge to a lot of companies, but obviously for a company selling travel, it’s hard, and if its target audience is older – the group warned of being most at risk – it becomes harder still. Add into that Saga’s specific focus on the most affected part of travel – Saga had launched its own two owned cruise ships for the first time, in the past year – and it becomes easy to see why Saga shares look even more bombed out this year.
COVID-19 Has Hammered Saga
The insurance business has held up decently well during this year. While the number of policies has fallen, as travel insurance demand has fallen, overall, the business is performing alright, based on the breakdown in the company’s most recent trading statement.
Travel, however, has been a disaster will all travel on pause since March. The company also exited healthcare for a nominal sum, which shows its struggle to monetize seemingly attractive areas for its brand.
The company claimed “The Group’s liquidity position remains strong and benefits from diversified sources of income” in its trading statement, the first part of which I think is plain wrong. The statement detailed that the cash balance at 31 May of £30m had fallen from £92m at the end of March, a fall of over two-thirds in just two months. There was also £50m undrawn on the company’s revolving credit facility. However, the company had given £56m cash support to its travel business in the space of those two months. If it continued at that rate, as the travel business remained closed, its £80m of available liquidity would be gone in three months, by the end of August, so to claim its “liquidity position remains strong” as it did was disingenuous at best. I actually think it shows the fact that current management regard shareholders as mugs.
Saga Will Raise More Funds
Just as the end of August approached, as it happened, it was reported in the press that its former boss was to return as non-executive chairman. He had been at the helm for twenty years, is the founder’s son, and had sold it for £1.3 billion in 2004 to private equity buyers who later floated it.
As part of this development, he will invest around £100m pounds for a 20% stake, which will be part of a wider fundraising by the company.
He will spend £60.6m on 20% of Saga shares at 27p per share, and up to £39.4m in share placings at a maximum issue price of 15p per share.
The company reportedly also revealed that it had recently rejected an offer which valued the company at 33p per share.
Details of this were in the press, but there has been no regulatory news update over the bank holiday weekend, so shareholders are somewhat in the dark.
However, it boils down to good news and bad news for share price valuation. At 27p per share, the new stake values the company shares at twice their Friday closing price. However, the rest of the stake suggests an issue price close to their current price. Additionally, the company’s long-suffering shareholders will be diluted.
It looks more positive for the company’s prospects, I assess. The founder’s son and former boss investing a sizable chunk of money in the business obviously means he should be motivated to help steer it to better waters. He also has deep pockets should the company need more money. Plus, I’d speculate that there is a fair chance the chief executive gets the chop, and having a chairman who previously ran the business ready to take over day-to-day executive control on an interim period at least is helpful.
On a side note, by the way, it’s interesting that Saga’s sorry tale somewhat echoes that of the AA (OTCPK:AATDF), another strong brand with solid lines like insurance, acquired by private equity, later listed only to see the share price head ever further south. I think there’s a systemic challenge with the approach of private equity who rely on retail shareholders as suckers to some extent. If you are interested, you can read the AA parallel case here: A Case Study Of A Low P/E Trap: AA. Note that Saga, at least, isn’t as dangerously highly geared as the AA.
Conclusion: Avoid the Saga Mess Unless You Assess the Risks Thoroughly
Saga is a great brand and a great business concept. It also has some very solid businesses – the insurance business has real value, while the travel business, although currently suffering badly, could bounce back at some stage. Managing the company well with the assurance of ample liquidity will bring the company back to sustainable health, and that will likely be reflected in its valuation.
However, I am skeptical as to how much of that will accrue to smaller shareholders. This situation is one for the big boys, in my opinion. The company clearly doesn’t respect its retail shareholding base, based on the way in which it communicates with them. If you are already a shareholder, the news means share prices may finally reverse their previously inexorable fall. But if you are looking to invest, buoyed by the news of the new investment and a sign that it may herald a turnaround, caution is in order. Saga likely will recover, its valuation will increase, but how much of the value unlocked will end up with minority shareholders is very hard to forecast at this point. Share price gains in triple digits percentage-wise are possible at current prices, but they are very far from certain and carry a high risk. In the interest of a margin of safety, I would avoid Saga.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.