Everything but the kitchen sink - what went wrong at Cobham
16 February 2017 • 9:06pm
“This is not ‘a kitchen sinking’,” said Cobham boss David Lockwood. “It’s a horrible phrase and this is not one.”
Whether investors agree is a different matter. Shares in the aerospace, defence and technology business dived 20pc on Thursday morning as the recently installed chief executive issued Cobham’s fifth profit warning in 15 months. The unscheduled announcement’s warning profits that will be £20m below expectations might even be seen as the good news on an awful day for the FTSE 250 business. As well as the profits bombshell, Mr Lockwood - who took on the job two months ago - also revealed £179m of cash charges and a whopping £574m of writedowns.
But he insisted it wasn’t a kitchen sinking - the term given to a new chief executive parcelling up all the bad news and problems in a business at once to get it out of the way, and often blaming their predecessor for a company’s woes. “If it’s a kitchen sinking you would see provisions everywhere,” the straight-talking Mr Lockwood said, adding the amount of cash the business generates would also be boosted by such a move. “I’m not proud of it but I want people to understand and have realistic expectations.”
His argument that it’s not a kitchen sinking argument might hold water - there are signals that Cobham hasn’t yet thrown out everything. The update also warned of “many operational issues” which mean 2016’s already pared-down performance will be “challenging” to match in 2017. If that wasn’t bad enough, saying that “the balance sheet is clearly not strong enough to properly support the operations of the group” will be seen by some that investors could again be tapped up, despite a £500m emergency rights issue last year. The question is, where did all go wrong for Cobham? To answer that you have to look much further back than the first of the profit warnings. In 2011, Cobham won a contract to build the in-flight refuelling systems for the US Air Force’s new fleet of KC-46 air-to-air tankers. This is a $40bn project for 179 aircraft, with Boeing leading it and Cobham a sub-contractor. The Dorset-based company’s expertise is crucial - the company was founded in 1934 by Sir Alan Cobham as Flight Refuelling Limited and its techniques made possible the first non-stop regular transatlantic flights.
However, the KC-46 deal hasn’t worked out so well and was behind the bulk - some £150m - of the writedowns revealed on Thursday. Mr Lockwood said technical complications and “onerous” terms meant Cobham is on the hook to pay for the delays and troubles. “There is no danger of losing the contract,” he added, noting the job is the company’s biggest piece of work. “The system has flown and the US needs it.” The KC-46 isn’t the only problem. The company also took writedowns of £196m on its wireless division, £186m against integrated electric solutions and £192m against semiconductors. Much of these writedowns were on the 2013 and 2014 acquisitions of antenna business Axell for £85m and US communications group Aeroflex for £870m, which includes the debt attached - and was seen by many as paying hugely over the odds. “They are good companies,” said Mr Lockwood, though he refused to be drawn on whether his predecessor Bob Murphy had overpaid. “We paid what we paid and we have got what we got.”
However, others were more open. “It’s a matter of perspective - with hindsight you can say they paid 30pc too much, but at the time it might have seemed a good deal,” said Jefferies analyst Sandy Morris. “In two year’s time it might seem a very good price.” Either way, the strain of the acquisitions was too much for Cobham’s balance sheet and in April it announced a £500m right issue - at a 45pc discount - to stop it breaching is debt covenants. Last month the dividend was scrapped to help bolster its finances. “The company got hooked on the drug of buying businesses and big restructurings,” said Mr Lockwood, adding that trying to swallow up such large acquisitions made it “difficult to get a simple set of operational numbers and just run the company.” Mr Morris concurs. “The villain of the piece is wireless [into which Aeroflex and Axell went],” he said. “The question is whether it is a bad business or integrating them was the issue.” Along the way Cobham made more mis-steps - not least an accounting scandal in April when it emerged two senior directors in the wireless division had been dismissed after what then-chief executive Mr Murphy described as “mistakes” with revenues from contracts. This error caused a £9m charge. Turning Cobham around is a “long-run thing”, according to Mr Lockwood, and he expects the work to last “into 2018”. Visits to factories during his two months in charge have been positive, and he believes that it’s a simple process of fixing basic operational issues and concentrating on running the Cobham in a simple way. “When we fix those, things will better quickly,” he said. If Mr Lockwood can deliver those fixes, then Cobham’s positions in defence, aerospace and communications markets that are growing mean it could be set for a strong future - if the company can survive.
No doubt vultures are circling, ready to pick off what they see as the best bits, and the chief executive admits that some parts of the portfolio could be sold. A prime candidate is the aviation outsourcing business whose contracts include servicing remote mines in Australia, an industry struggling because of the downturn in commodities. But Mr Lockwood is upbeat about business. “We can turn this from a laughing stock into a rock star in a couple of years,” he says, but admits that it will come at a personal cost to him. “Am I still pleased I joined? Well, it’s not what I expected,” he adds. “I told my wife at Christmas that I would hardly see her and would let her down repeatedly - so far I have been true to my word.”