Directors' margin loans must be disclosed, fund manager says ::

Date: February 29, 2008
Source: Source - AM – ABC.net.au
By Peter Ryan

It has been a tumultuous week for the childcare operator ABC Learning Centres, after a shock profit downgrade sent its shares into a damaging plunge on Tuesday.

While it remains likely the company will be broken up, there is some positive news after the Singapore Government's investment arm came to the rescue yesterday - increasing its stake to 15 per cent stake.

But serious questions are still being asked about ABC's disclosure about its true health and the dumping of the company's stock by three directors, including the company's founder Eddie Groves, who had their margin loans called in.

Fund manager Roger Montgomery of Clime Capital is one of many market watchers who now believe margin loans used by directors need to be fully disclosed, especially in a volatile bear market.

In an interview with AM's business editor Peter Ryan, Mr Montgomery said ABC Learning Centres was only one of a number of companies that have been trading at levels more than the company is worth.

RM: "I think that there is merit in directors disclosing when they have borrowed money to buy shares, simply because it can appear to investors that if a director buys shares that things are going well and that the director has a lot of faith in the company. That's one of the things that a lot eof investors look for when buying into companies - are the directors large owners and have they recently bought more?

"But if the director is borrowing money from someone else to buy those shares, using someone else's money to do that, well there might be a lot less risk for them in doing so, yet the appearance is that things are going well.

"And so in that regard, I think there's merit in shareholders knowing that they've borrowed money to do that and the terms on which they've borrowed."

PR: So in that case, what do you think about the scenario where we've had - three directors of ABC Learning, including Eddie Groves, being in the situation where they're selling shares on Tuesday, and even one case where one of the directors sold 2 million shares on Friday before the disappointing profit result?

RM: "If they were forced by margin sellers to sell, those shares would have been sold out from under them and they wouldn't have had a lot of choice in the matter. My understanding is that there's some dispute as to whether or not they were actually sold by margin sellers or whether it was something he did of his own accord.

"If it was something he did of his own accord, then it doesn't look good. If it was sold out from under him by a margin lender well, you know, he may not have had a lot of choice in the matter."

PR: How damaging has that been in what is a very volatile market?

RM: "If the business is performing well, the directors are never going to get into that situation in the first place. If the business isn't performing well, then it's going to be an issue. It goes back to the quality of the business and the quality of management and quite frankly, ABC's business performance never justified its price, and that's why directors find themselves in this position."

PR: Do you believe that ABC Learning will eventually be broken up and sold to parties that are now circling?

RM: "I think some assets will have to be sold because they have been overpaid. Eddie made the comment at the media briefing a couple of days ago that he can't understand why the shares have been savaged when he's got such great assets. The issue is not whether the assets are any good, the issue is that this particular entity may have paid far too much.

"And in fact, if you look at the numbers that are being produced in the latest half-year result, it seems that he did pay too much. And so the issue isn't the quality of the asset, it's what you pay for those assets. It's a very simple rule in investing: the higher the price you pay, the lower your return.

"And the returns for ABC have been declining for five years, suggesting that he's been paying too much for assets. The lesson is, don't buy businesses that are declining in value." PR: And as far as companies that are overvalued at the moment, do you think that ABC is on its own?

RM: "No, no absolutely not. There's some other examples at the moment that have a similar profile in terms of their return on equity or their decline in profitability, and some of them are very, very large companies that are trading at double what the business is actually worth."

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