RJH writes...

Context & Company:
Sanctuary has seen bid talks broken off recently; it has renegotiated finance terms with lenders; and has issued disappointing trading updates. If it is to be bought, and that is surely what lenders are craving, the plc has a serious negotiation to undertake from a weak position.

The Sanctuary Group plc described themselves in their last annual report thus:

Sanctuary is one of a kind. We are a diversified international music group with a unique approach: we call it the 360 degree business model.

The shares have declined from 42p in mid-June to 9.5p today - a 77% drop in less than 3 months.

Yet Sanctuary manages an impressive array of popular artists (amongst other related activities). Can the equity behind such popular products really stay depressed? Or is a share snapback due, even if only on a contrarian basis?

Opinion:
[Background track, Guns N Roses, Ain't it fun]: Red carpet interview quote - colourful and glossy reports, man. Dude - possibly the best posed board photos in town (check out Merck "Bad Boy" Mercuriadis' shot). And - mate - hip, fly, cool, wicked "passion for music" company products. Yeeeeaaah!

[Background track, Jadakiss, Kiss of Death]: Shareholder view - who has been (not) running the company? Read the interims - did the £88m of debt appear as unexpectedly as the prose suggests? Now management says it is at "a higher level than the Board is comfortable with going forward."

[Fade to Elton John, I guess that's why they call it the blues]: Part of this debt increase financed the acquisition of Twenty-First Artists from Sir Elton John. Yet turnover is still declining at the half (-4.5% and a frightening -12% pre-acquisition). The interim report talks about slippage but that's a veritable slip, collapse and hospital job.

[Fade to Robert Plant, Trouble your Money]: And what does this sentence from the interims mean?

"In line with its strategy, the Group has stepped up its infrastructure to support its longer term expectations in growth of sales and profits."

If it quacks, it's a duck - and that is unidentified, unquantified additional cost already en route. Swiftly on the heels of that declaration comes:

"The Board intends to cut costs, but not at the expense of damaging the Group's prospects".
Hardly meaningful contributions to managerial science or transparancy by the Sanctuary board; and less helpful than unambiguous commitment and plans of What They Will Do.

Financial Condition
Of course, much of what was in the interim report has been overtaken by events. Nonetheless, potential investors ought to consider more than the possibility of a bid from Warner (or whomever).

[Fade to Groove Armada, But I feel Good]: When goodwill is 60% of fixed assets, balance sheet liquidity is often worth looking at. Net current assets are £26.6m shy of long term liabilities at the half. Ignore goodwill and intangibles (yes, arguable since it's the Sanctuary record product catalogue) from the fixed asset total and saleable gear sits at £31.7m. And they'd never get close to that in a fire sale. Now, while this may be an original view of liquidity, some investors like their comfort. Especially when management are in an uninspiring phase.

[Fade to Slayer, Hell Awaits]: Liquidity is threatened by cash bleed, hence (so it seems) the urgent need for a bidder. Cash lost at the half totaled £7.3m, and you may want to read note 8 of the accounts. When (and during a poor top line period) finance managers and/or the board reduce creditors and increase debtors, shareholders are entitled to wonder what is going on. This combined action hemorrhaged £22.3m of cash and deserves more explaining and remedial plans than are evident in the report. Does anyone actually manage working capital month in and month out?

[Fade to The Who, The Real Me]: The scribe would feel more forgiving if Sanctuary did not have episodes resembling previous (Editor: note for non-UK readers - as in "previous convictions"). The 2004 annual report speaks touchingly of the "360 degree" model and its subsets, one of which is entitled "Financial Discipline". This scribe reads the blurb, looks at the numbers and concludes this is a plc run by the marketing and sales functions. What kind of financial discipline is it, for example, to issue loan notes of £28.3m in Feb 2004 (in itself an interesting story) followed by a £11.4m provision against these a bare 7 months later (see note 13 of the 2004 annuals for the detail)? This was classed an exceptional; but similar risk assessment methods will cause more such platinum non-musical hits going forward.

Redeeming features?
[Fade to Destiny's Child, Show me the Way] If the divi is maintained (ah, recall that cash bleed in urgent need of attention) yield is 5%+. The Capital Chronicle screening model (warning: eps & divi based, not holistic) likes it up to 12.8p. So at the current 9.75p it looks good - bombed out, even, at current PE levels (3.1 now, 4.2 next year - but based on eps estimates made prior to the latest trading updates).

Large trade bidders with proven, long-term financial management skills (and stronger balance sheets) must surely be eyeing-up Sanctuary as a tasty morsel ripe for integration into their businesses. Four times '06 earnings? And the buyer gets the 150,000 tracks in the Sanctuary music catalouges?

For their part, shareholders should hope existing Sanctuary management can pull a cat out of the bid-bag at a lot more than the current share price. But don't bet (much) on it, negotiations have failed once already.

Finally, as a go-it-alone proposition potential shareholders should factor in the company's recent financial management position / record / ability; and condition of the prevailing retailing environment, at least in the UK. On that basis the shares are a contrarian bet too far for this correspondent.

[Fade out with James Blunt, Tears and Rain]


NB: All background music the work of artists - sorry, arteests - currently associated with The Sanctuary Group plc. Value that.

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