“The old sucker trade”: What the implosion of Nuix can teach investors about IPO listings

There was a saying in the 1990s: it was along the lines of never buy anything that Kerry Packer was selling. Packer has largely been replaced in the last decade by private equity firms as vendors you shouldn’t buy a business from.

There are two obvious reasons for this advice. First, PE firms consist of incredibly smart operators whose job is to deliver a strong alpha (above market return) to LPs (limited partners, which are generally superannuation funds, sovereign funds or endowments). Second, private equity operators are not only whip smart, but also possess years of inside information gleaned from sitting on the board of the business being sold, in particular possessing a deep understanding of its market, growth rate and profitability.

There are two ways PE firms sell their stakes in investee companies. The most common route is via an IPO (which Scott Galloway delightfully describes as “flinging faeces at investors visiting the unicorn zoo”). Occasionally, PE firms will be forced to offload their stakes to other PE firms (this is sub-optimal as other PE firms aren’t as gullible as retail investors, so it tends to only happen when a selling PE fund has reached the end of its fund life).

The recent implosion of Nuix is a classic example of the old sucker trade.

Three of Australia’s best journalists, Adele Ferguson, Kate McClymont and Neil Chenoweth teamed up this week to deliver a stinging expose of the unusual behaviour of Nuix and its main funder, Macquarie Bank, prior to the float.

While the Nine investigation focused on the conviction (and subsequent overturning) of former Nuix chair Tony Castagna for tax evasion, the more pertinent revelations was the horrific performance of the company prior to the IPO.

In particular, the journalists revealed Nuix lost “almost 30 per cent of its engineering staff, the heart and soul of the business, with savage turnover in the key product area” while “December [2019] half sales were running 20 per cent below budget”. 

Investors in the float were of course not privy to these dire goings on — instead, the company’s prospectus boasted that the business was “led by an experienced management team with a track record of achieving strong revenue growth, supported by low customer churn.” 

After listing at $5.31 per share in December, the share price quickly jumped to $11.86 by January, valuing the business at $3.8 billion. However, within three months the Nuix share price lays in tatters, with its market value dropping to only $1.1 billion as the company was forced to downgrade revenue numbers. Macquarie was able to reap $565 million by selling shares in the float — those shares would be worth hundreds of millions of dollars less just months later. 

Adore Beauty was another glamour stock to list during the COVID-19 e-commerce boom late last year. Founded by legendary entrepreneur, Kate Morris, Adore would list in October with a market value of $614.8 million, based on an eye-popping valuation of 181 times forecast profit or 96 times EBITDA. As a comparison, private equity firms typically pay around 10-20 times EBITDA for e-commerce marketplaces, depending on factors like revenue growth, total addressable market and defensibility.

What made the Adore float more unusual was that Quadrant, one of the shrewdest private equity operators in Australia, had bought a 60% stake in the business barely a year earlier for $110 million. During that same period, the business’ sales increased from $90 million in 2019 to $158 million in 2020 (with the 2020 increase boosted by COVID-related lockdowns). This suggests that, in the eyes of some investors at least, a short-term sales increase of 75% justified a valuation jump of almost 500%. 

Adore Beauty shares have since dropped as shoppers returned to bricks-and-mortar retailers. Morris and her husband James Height deserve enormous credit for building a business worth $318 million, however, some investors have now been left nursing 50% losses.

The history books feature a conga line of PE floats gone wrong. Arguably the most famous PE disaster was TPG’s brilliantly timed sale of Myer in 2009 for $2.3 billion. Myer shares never traded above their IPO price (ever) and the business is now worth $246 million — a drop of almost 90%. Your columnist warned readers not to invest in Myer before its float (and should have taken his own advice and shorted the stock at the time).

A close second was the disastrous float of Dick Smith by Anchorage private equity in 2014 which netted the PE firm $500 million. Within two years Dick Smith was dead.

While PE backed floats can be successful for investors (JB HiFi is one rare, but notable, example), that is more likely by accident than design. Let’s face it: PE vendors are a lot smarter than you or I, and privy to far more information about the business they’re flogging off. And it’s usually hard to outsmart someone smarter than you.

Adam Schwab is a founder, director, angel investor and the author of the best-selling Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed. He is also the host of the From Zero Podcast.