Briefing: Is GRP really Towergate II?

GRP’s wildly diverging numbers – a tripling of underlying profits but a similar-sized increase in its statutory net loss – may bring to mind the consolidators of old.

These companies, among them Giles and the pre-restructuring incarnation of Towergate, championed earnings before interest, tax, depreciation and amortisation (EBITDA) as their key performance measure, and dismissed the statutory losses they were making as essentially meaningless. GRP does the same.

It is also tempting to draw parallels between GRP and the old Towergate because of the two firms’ common heritage. Peter Cullum had a big hand in founding both. Cullum is GRP’s chairman and one-time Towergate chief executive Andy Homer is a non-executive director of GRP’s retail broking business.

And GRP, like the old Towergate, is aiming to grow mainly by buying up smaller brokers across the UK with private equity backing.

The problem is that Towergate almost collapsed, and Giles was sold to Gallagher in a weakened state, suggesting observers should have paid closer attention to the statutory numbers.

So does GRP deserve to be tarred with the same brush, and should observers be watching its statutory loss more closely than its EBITDA growth?

Accounting penalties

Let’s take the financial question first. Statutory accounting punishes acquisitive, private equity backed brokers in two key ways: amortisation and interest.

Acquisitive brokers build up a lot of goodwill, which has to be devalued – or amortised – over time in much the same way that the value of physical assets such as computers depreciates.

Goodwill is the difference between a broker’s measurable assets and what it was sold for. If GRP buys a broker that has £1m of assets for £10m, it has to record £9m as goodwill.

The amortisation of this goodwill is accounted for as a cost, which hits the broker’s statutory profit. The more deals a broker has done, the more goodwill it has and the bigger the amortisation charge.

Statutory accounts for the year to 31 March 2015 show that GRP had a £1.2m amortisation charge. GRP has not yet filed its accounts for the year to 31 March 2016, but it is likely that the bill will be bigger.

Then there is the interest associated with private equity investment. Private equity firms often like to invest using loan notes rather than buying shares.

Loan notes are treated as interest bearing debt for accounting purposes. Even though the company will only pay the interest back once it is sold or listed on the stock exchange, for accounting purposes it shows up as an annual interest bill, which eats into the statutory profit.

This is why acquisitive private equity backed brokers prefer EBITDA as a key performance measure. It gets rid of the problems caused by interest and amortisation. The company is not actually paying out any money for these interest and amortisation bills – it is simply an accounting treatment.

Standing out

The problem is that EBITDA excludes the interest bill entirely, not just the bit associated with the private equity investment. So if a company is heavily laden with debt on top of its shareholder loan notes, it can still be seen to be performing well at the EBITDA level, but actually be struggling to make ends meet.

This is one of the areas where GRP differs. It has so far relied solely on money from its investors and has not yet used any debt to fund its deals. Therefore it cannot be crippled by large interest bills.

There are also other key differences in approach. Before its financial rescue last year, Towergate often rewarded the senior management of the companies it was buying with shares in Towergate. At GRP, deals are often structured so that the management of the target firm retains a stake. This means they are rewarded for their own actions, rather than the aggregate actions of all group companies.

It is too early to call GRP a success. The real measure will be its value on sale or refinancing. But its statutory result is a poor guide to how it is performing.

One thing is clear – Towergate II it isn’t.