SKE half yearly, page-92

Madam, you say with regard to THO: "My understanding of the business that SKE acquired was that it was a maintenance outsourcing business, whose fortunes largely depended on the variable whims of whether its major customers wanted to do things themselves or to get outsiders to help them do it." Is this not a problem which tests SKE similarly? Although looking at track records of the two, one is led to believe that SKE has an embedded advantage which ensures clients keep using their services, a reputation advantage for quality perhaps.

THO and SKE are somewhat different models:

THO actually carries headcount on its books to physically perform maintenance services for its clients, which THO has previously contractually priced. On the other hand, most of Skilled Group’s businesses, including the core Skilled brand business, as well as TESA, Swan, and Skilled (formerly Origin) Healthcare are essentially simple labour sourcing and placement businesses.

In other words, THO was largely a fixed cost business with a large payroll that needed to be serviced, and running with contract pricing risk, thereby garnering a “manufacturing”-type margin (and all the risk it entails).

Skilled Group was/is essentially a catch-and-pass, distribution business with a largely variable cost base, and one which merely clipped a “distribution” margin.


"SKE has never recorded negative Free Cash Flow in any financial year (even the GFC saw FCF breakeven)." I have FCF for 2008 as -$13.1m as opposed to breakeven - not sure where I could have differed from you? I have excluded acquisitions from investing CF.

Yes, technically that’s a good pick up (at the time of posting I wondered if I should draw attention to this given Operating Cash Flow in that particular year contained one or two quirks, but I thought to omit doing so for the sake of brevity).

Yes, while Free Cash Flow (as calculated from reported figures) was indeed negative $13.1m (derived from OCF of $14.7m less Payments for Property, Plant and Equipment of $11.9m less Payments for Intangibles of $16.0m), if you look at the composition of the OCF in that year, you will notice that Income Taxes Paid came to a whopping $32.536m (up from $14.0m in the previous year and compared to the Income Tax Expense in the P&L of just $18.9m in FY2008 and $15.6m in FY2007).

The reason for the large discrepancy was due to the payment of pre-acquisition tax liabilities for businesses acquired in that year (notably OMS), as well as an element of tax “catch up” in relation to the FY2007 year.

MY memory is a bit blurred, but I did at the time query this figure with the then-IR person and I have just checked and found the e-mail response which stated that “…it would not be unreasonable to suggest that the “normalised” tax payment would have been closer to $17m….”

Which means $15m of the tax payment in that year was “excessive” on a pro forma basis. Lo and behold, I’ve just checked my spreadsheet and there is a note along this very line which I recorded at the time.

Netting the -$13.1m figure off this $15m adjustment gives a small surplus, essentially breakeven for all intents and purposes, I thought when compiling my e-mail, and given the subtleties and complexities involved in the situation, compared to the relative immateriality of the amounts involved, I chose to not mention it in my earlier post.

So, technically, you are right. There was one year – FY2008 – when the company didn’t generate positive Free Cash Flow. But at the same time, there were some extraneous reasons for this.

For further context, the company has never paid anywhere near $33m in tax in any year (the closest was $28m, in FY2013, when it reported Pre-Tax Profit of more than $80m (compared to FY2007’s $45m and FY2008’s $58m).


Finally, I am at-odds with your FY16 EV/EBIT multiple. Based on the $70m EBIT broker forecast, $1.25 share price, $180m NIBD, 236m shares, gives EV at $475m. Therefore I am getting closer to 6.8x for EV/EBIT FY16 rather than the 6.1x you are getting. I am not arguing the cheapness of the company, on that I certainly agree.

Yes, I see what you are saying: I wrote, “…for purposes of looking at SKE as an investment prospect, it is currently trading on a FY2016 P/E multiple of 6.9x, an EV/EBITDA multiple of 6.1x and an EV/EBIT multiple of 6.1x…”

Clearly EV/EBITDA cannot equal EV/EBIT given the company records some $15m of D&A charge, so it was clearly a typo. I was quoting EV/EBITDA being 6.1x. Not EV/EBIT. (I suspect I was incorrectly quoting EV/EBIT for FY2017, which is – in fact – 6.1x (well, to the extent that forecasts that far out have any meaning.))

Apologies for all the confusion.


The final hurdle that I am struggling to overcome, is committing capital to a company with leaders that have proven to continually make acquisition blunders. The underlying ROIC of SKE proves that it is more than just an average business, but the management actions appear to be masking the ability of those returns to make it through to wealth creation for LONG TERM holders. Perhaps that for this reason, this business will be better suited to an active approach with the finger never far from the trigger should further acquisitions unfold.

You’ve hit the nail on the head. As I have implied at length: this ain’t no long-duration growth company like RMD or RHC or REH. It is a cyclical business, operating in a cyclical industry, with a cyclical investment (read: “acquisition”) cycle.

Recall: “…let’s not kid ourselves, this is not the world’s greatest business. Far from it. It is cyclical, operates as skinny margins, has little pricing power and the only way it can grow through the cycle is by acquisition (on which it has not executed very well.) Its redeeming feature is that it consumes very little capital relative to the cash flows it generates.”

To that end, based on precedent the time to buy it is when all the damage has already been done, in anticipation of the repair phase, and the time to sell is when the acquisition spree is in full flight again.

But it should never be an overly large part of any personal portfolio. I have 3.7% of my invested capital in the stock. And I don’t think I’ll get to much more than that, absent any dramatic outperformance of the stock.