Three big reasons Phones 4u went bust

Yet another UK high street retailer met its demise this week.

This time it's the mobile phone retailer Phones 4u, which went down with little more than a whimper, leaving nearly 6,000 employees facing the axe.

What looked like a successful business in a successful space has sunk like a stone. The obvious question is: why?

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Today we'll look at three reasons. As you'll soon see, Phones 4u had all the hallmarks of classic business cock-up

1. Its business plan was at the mercy of the few

First things first, when assessing a business, the bottom line (revenues minus business costs, taxes, interest on loans etc.) is usually where we focus most of our attention. But it's the top line (gross sales and revenue) that shows a firm's real potential.

And if you drill down into the top line a bit, you can get answers to some really important questions. Like: does this firm have a wide customer base and diversified income stream?

Now, with Phones 4u, this was no problem, the company had a wide and varied stream of punters.

But what we did see was something quite unusual. And that is a business beholden to just a few key suppliers.

As you probably know, in Britain the mobile phone game is dominated by a small number of big players. It's an oligopoly that's considerably tightened its grip over recent years, too, through mergers and partnerships.

Three pulled its business from Phones 4u in April 2012. O2 withdrew in January this year. That left Vodafone and EE to sever relations over the last few weeks. Oops! The network providers clearly don't see the need for a middleman taking a slice of the pie.

And I'd say that Phones 4u's private equity owner, BC Partners, saw that the writing was on the wall.

After all, in September last year they sneakily decided to let somebody else carry the can.

2. It was unloaded by the private equity mob

Phones 4u raised £205m in bonds placed by on the Irish stock exchange last September.

Yielding 10%, I guess there were quite a few buyers feeling they'd got a bargain. I mean, this was a business producing profits in the region of £100m.

But maybe bondholders should have smelt a rat. The private equity group that owned the business immediately took the cash as a special dividend.

Thus the business was left with a £635m debt mountain. And of course, dependent on key suppliers, which as we now know, walked.

I should point out here that BC Partners, which bought Phones 4u in 2011, refutes any suggestion of foul play.

But, well let's just bear in mind that they got their money out with a handsome profit just before things went wrong. They knew how negotiations with the network providers were going. They left the business with a £635m debt pile.

You decide for yourself whether they were being sneaky!

3. It didn't have a clear path to survive and grow

There are many ways of valuing a business.

For a property company, you'd probably just take the value of its holdings (net asset value (NAV)as per accounts), and then apply a premium if you think they're doing a great job. Or a discount to NAV if management isn't consistently adding shareholder value.

But for most businesses, book value isn't the first place we look. It is, of course, profits that we're after. We say to ourselves, "how many years' worth of profit am I prepared to pay?"

This is the basis of the price/earnings ratio (PE).On a PE of ten times, it means you're paying ten times profits.

But this only works if you reckon on profits being repeated. It's what the City folk like to call earnings visibility'.

Take a business like Diageo, the multinational alcoholic drinks company. Investors currently pay 18 times earnings.

In my day, we'd probably not pay more than ten to 14 times but these aren't normal times. The world is getting used to perma-low rates and returns. Still, punters pay the multiple as they can see how Diageo will continue to make profits in the future ie, they get earnings visibility.

Diageo's brands are wide and varied. Its geographic markets are, too. And there's no way this business is going to be beholden to any one supplier. On the contrary, its suppliers kowtow to Mr Diageo.

Now, just compare that to Phones 4u.

Earnings visibility is dreadful in the new world of technology, which leaves a trail of corporate disaster as progress bounds forward.

I notice that Sony has just delivered its sixth year of losses and scrapped its dividend for the first time ever. Sony has been trying desperately to turn its fortunes around as demand for TVs and compact cameras slumps. Tech is moving forward quickly keep up!

No longer is it just a matter of a phone and a contract. All manner of devices are available, and all sorts of contracts spin out of them, including broadband and TV.

The network providers aren't going to leave this all to any middleman. Technology is moving forward, and the big players are moving with it.

So what lessons can we learn?

There are a few points in all of this that private investors like us would do well to learn.

First off, if you're looking at a business with just a handful of key contracts, then be very wary. The loss of just one key contract could be terminal.

And be very careful about who's been involved with the business, too. Often, a stock market flotation is the exit route for the private equity boys. Hmm, I wonder why?

Financial engineering is rife these days, so place particular attention on the balance sheet of any business that's had a private equity group near it.

Last, make sure you understand how a business you invest in will grow and move forward. And if it's not clear to you, it may not be clear to them either.