The Blue Chip scandal: The franchise deal

The major effect of this arrangement was that BCFS received a substantial portion of the NZ franchise's cash flows but could not be called upon to meet its liabilities. If the NZ operation got into financial difficulties, BCFS could carry on with its Australian operation, having already had the cash upfront from any NZ sales.

www.stuff.co.nz
May 18, 2008

The Blue Chip scandal: The franchise deal

On September 10 last year, listed company Blue Chip Financial Services spun off its New Zealand operations to a newly created entity called Diem Ltd.

Diem was owned by the three senior managers who ran the NZ operation, Neil Bell, Rikki Flowerday and Blue Chip's co-founder Bob Bangerter.

The arrangement was that Diem would run the New Zealand business on a franchised basis and pay the listed company a fee of $22,500 for every property investment package it sold.

The deal was sold to BCFS's shareholders in jargon-loaded terms which talked about "quarantining legacy issues within the NZ franchise" without explaining exactly what those legacy issues were.

But the main selling point for BCFS's shareholders was that the deal would provide the listed company with "significantly improved operating cash flows".

There is no doubt that the new deal was beneficial to BCFS and its shareholders.

Under the old arrangement, BCFS received most of its income from the deposits investors paid when they signed up for a new property package and the balance of the purchase price when the property was completed.

From this income the company had to pay all of its operating expenses, such as paying the developers for the apartments it was on-selling, the commissions of its sales staff and other marketing expenses and all of the other costs associated with running the business.

And there could be considerable delays between the time the company received the initial deposit from an investor and the final cash draw-down when a property was completed.

The longer the delay, the more pressure this put on the company's cash flows.

The franchised deal meant that all of the NZ business's operating costs would now be borne by Diem or companies it subcontracted work to.

And Blue Chip structured the deal so that it would have first call on any money received from any new sales.

Disclosure documents BCFS filed with the ASX, stated that the franchise fee of $22,500 was to be "paid directly to BCFS from the proceeds of sale BEFORE [the company's emphasis] contribution to NZ Franchisee cost base".

What this meant was that the moment an investor signed up for a new property package, $22,500 would be deducted from the deposit and paid to BCFS.

The NZ operation would then have what was left over and would have to wait until the property was completed before receiving any more cash.

In the meantime, it was required to pay all of the operating costs of the NZ operation.

Effectively this meant BCFS got paid upfront, even if a particular project did not make a profit or, as some investors were later to discover, was never completed.

The sale of the franchise also created a $38m debt back to BCFS.

This also had to be repaid from the cash flows of the NZ operation, which would have put further pressure on its finances.

Adding to that pressure was the fact the NZ franchise was saddled with the mysterious "legacy issues".

While the nature of these issues was never satisfactorily explained, it is clear from company documents that they were liabilities.

So as well as having to part with cash flow upfront when a deal was signed and repay its $38m debt, the NZ franchise also inherited BCFS's NZ operating liabilities.

"Legacy issues quarantined inside NZ Franchisee mean significant reduction in liabilities for BCFS," the company said in documents which outlined the plan.

The term "quarantined" implies that these "legacy issues" or liabilities would not be able to impact on BCFS.

The major effect of this arrangement was that BCFS received a substantial portion of the NZ franchise's cash flows but could not be called upon to meet its liabilities.

If the NZ operation got into financial difficulties, BCFS could carry on with its Australian operation, having already had the cash upfront from any NZ sales.

It did not take long for that to happen.

A few weeks after the franchise deal was completed, reports started to filter out which suggested the NZ operation was facing cash flow difficulties.

By the end of last year the trickle had become a flood and in February companies in the NZ franchise operation were being tipped into liquidation.

What the liquidators are finding is companies with lots of liabilities but not much in the way of realisable assets.

But BCFS, which has since renamed itself Northern Crest Investments, has been able to carry on with its Australia-based business operations.

This raises the question of whether the separation of the NZ operation was a truly commercial transaction or merely a way for the listed company to escape its mounting liabilities while at the same time maximising its cash flows.

The answer to that question may depend on whether the NZ franchise ever had any real chance of being commercially viable.

Although recent events suggest it did not, decisions made at the time did not have the benefit of hindsight.


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