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Cobham – Convalescence Ahead of Slow Path To Recovery? By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

The RNS announcement this morning in respect of Cobham’s statutory operating loss of £779.1 million said it all – “impacted by weaknesses in management and financial controls, contractual and commercial failures and, in a few businesses, more challenging market conditions”.

Impairments of £573.8 million together with other charges of £236.8 million had a devastating impact on FY16 results and particularly the balance sheet but, what has been announced today is thankfully no worse than the company had warned a couple of weeks ago.

Neither is the fully underwritten £500 million rights issue that has been announced this morning and that comes just nine-months after a similar £500 million call on shareholders by the previous hapless management, unexpected. I should say here and now that back in June 2016 and in failing to announce that the dividend would be suspended, that particular rights call is one that I regard as being one of the most appallingly handled that I have ever had the misfortune to witness through my long analyst career.

I have no great desire to unnecessarily harp-back into the past in detailing what went wrong at this once highly respected company. Let’s just reason failure by saying this was due to management being ill-equipped and qualified for the job, poor leadership qualities, questionable strategy that was poorly executed and that led to dramatically overpaying for acquisitions, poor financial controls, lack of transparency and communication, contractual issues some of which belonged to Cobham and some that did not but that caused programme delay and so on.

What matters now is Cobham’s future and on that score and despite not knowing much about his more recent past at Laird Group, I am bound to be pleased that new CEO, David Lockwood, has lost no time getting to grips with some of what needs to be done and in correctly timing a decision to call on shareholders for another £500m – an amount that I actually view as being the right level of call on shareholders in respect of what the company needs to see it through the beginnings of its recovery.

Whatever, be under no illusion that progress at Cobham in terms of bottom line performance progression will be anything other than slow. Various factors have caused the company to say this morning that delivery of even similar performance to that of 2016 during this year may be challenging. But for all that, I do think we will see the beginnings of Cobham moving through the worst during this year and into a period of convalescence. As to being taken over by another company – maybe but unless someone was to strike very soon, on balance I think that the answer is probably that a year from now Sir Alan Cobham’s legacy will still be independent.

As it should be and quite the opposite of the June 2016 call on shareholders, Cobham dividend has now been suspended until further notice. For the record, year-end net debt stood at just over £1 billion while shareholders-funds (net assets) halved to £489.9 million – hence the need for another rights issue.

Before attempting to answer the questions that may be on many lips today such as can Cobham survive as an independent; Is this the turning point; Is the completely new top management team under Chairman, Michael Wareing, Chief Executive Officer David Lockwood and Chief Financial Officer, David Mellors up to the job of turning this once superb company around – allow me to first remind that we are not talking about a company here that in terms of its not salvageable in any way. Cobham can and will be brought back to health.  Indeed, note that the underlying profit before tax of £175.2 million, halved as it was from that of the previous year, is at least a profit and that it comes from revenue of £1.94 billion which is only fractionally down. Margins too, although again down, are still relatively good compared to some of its peers. Finally, take heart that Cobham took in over £2 billion of orders last year and that the year-end order book stood at just short of £3 billion.

Cobham is certainly no slouch then when it comes to being an important player in the markets it serves and indeed, in regard of future potential. Yes, there may be an increasing level of maturity in some areas of activity but plenty others are still growing.

While it can hardly be ignored that the quality of Cobham earnings has been severely damaged in more recent years through a mix of poor management ability and business execution, Cobham remains a situation in my view that over three years can and will be successfully turned around.

Simplicity may be the order of the day from here on and in the process of turning the business around, I would anticipate that through the wide range of current business activities stretching through aviation services, advanced electronic solutions, mission systems, communications and connectivity divisions, some of these might also be slimmed down by Lockwood or maybe sold. However, let me repeat, if the company is allowed to remain independent and if Mr. Lockwood and his new board team really are the right people to do the job of turning it round, I have no real doubts that Cobham has a really good future ahead of it.

Back to the questions laid out above though – in respect of retaining its independence I suspect that the answer is yes it can and will retain that. I may well be wrong but knowing that several companies have probably trawled over I am not sure that there is the willingness to take on risk. Clearly, if Cobham was to be bid for by a US or maybe UK player I sense that in order to sell the potential of making a bid to their own shareholders a break-up meaning selling the notion on the basis that the sum of the parts is greater than the whole would be required. The trouble is that alongside this notion there is another requirement, one that says notwithstanding the rights issue, with so much debt taking on Cobham is not without risk.

So, is this the turning point? I hope and believe that it is but in saying this I also hope that Mr. Lockwood has the right level of stamina required. Do I believe that he has? Until I meet him for the first time, I really cannot say.

I am however satisfied that as a top team you have the making of all that is required to turn this situation around. Those that should have never been allowed near such a good company as this was, however well founded and recommended by some that they might have been, have all now thankfully gone. Good riddance to all of them too! Cobham shareholders deserved very much better than they got over recent years and particularly through the torrid period in 2016. I might add that calling on the former Chairman to fall on his sword and to take responsibility for what had occurred under his watch and for those that he allowed to be brought in to run the company, something that I felt obliged to do rather publically six months ago, is not something that I did lightly or indeed, would wish to do again unless of course it became very necessary.

Back to the realities of the situation and I personally found that what David Lockwood said in the statement this morning reassuring. He and his new senior management team have after all only been in the job for a matter of weeks and while I have no doubt that each of his senior team have been shocked with some of what they found that had occurred previously, they appear to have grasped not only the severity of the situation but also begun to conclude what is necessary to turn the fortunes of the company around.

David Lockwood told investors in the statement today that 2016 was challenging “due to significant management, execution and market issues”. He talked of “weakness in management and financial controls, contractual and commercial failures and reporting structures and that responsibility allocation had become overly complex and unclear. “

He mentioned duplication, reduced accountability and slow decision making that have contributed to sustained operational and financial challenges. Furthermore, he said that with hindsight, Cobham management had misread cycles within its markets and within its businesses, making poorly timed acquisitions (a reference to Aeroflex in the US which Cobham had paid £870 million plus taking on internal debt) and then failed to integrate them properly.

Importantly, Lockwood said that, “we will reduce complexity and duplication in the business by simplifying systems, processes and reporting and, with this in mind, we are also commencing a review of the breadth and shape of the Group’s portfolio.  By aligning this reduction in complexity with strong and visible leadership, we will build a sense of momentum and clear purpose among Cobham’s management and employees.  This will also improve accountability and enhance the speed and quality of decision making”.

CHW (London 2nd March 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue

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