Keystone Group: Overpaying for debt-funded acquisitions

In recent weeks, one of Australia’s biggest hospitality groups, Keystone Group, has gone into receivership. Keystone Hospitality runs 17 establishments across Australia and employs around 1200 people. Although a private company, the company’s fall highlights some important lessons in debt management.   The Keystone story is a case of the company that grew too quickly. Two years ago, the group undertook a major expansion program and that included a number of acquisitions, including the takeover of the publicly owned Pacific Restaurant Group (PRG) in 2014. Lenders, KRR Asset Management and Olympus Capital Holding Asia, loaned Keystone approximately $80 million to fund the PRG acquisitions and some industry insiders believe Keystone overpaid for the transaction.   The corporate activity was funded primarily out of debt which has become unserviceable. Management have attributed this to changes in the local market, including lock out laws in Sydney (where 10 of the group’s establishments are located) but more specifically, the group was unable to reach an agreement with a syndicate of lenders regarding key aspects of Keystone’s financial structure. As a result, on the 28^th of June 2016, Keystone announced that it would be going into receivership.   The outcome included a breach of its debt covenants as the group reached net liabilities of $14 million and a working capital deficiency of $93 million. Although the lenders agreed to a restructure of the business including a $5 million equity raising among other asset sales, only the Newtown Hotel was able to be sold off. This was partially due to the Sydney lockout laws and subsequent impact on demand for bar and restaurant real estate.   Surprisingly the Keystone Group portfolio is well operated. Instead, the receivership was caused by unserviceable debt levels. In other words, the income statement appeared sufficient but the balance sheet was broken. With these healthy operations, all venues continue to operate and should be attractive assets once put on the open market by liquidators (assuming individual asset debt levels do not erode the market value). The portfolio is expected to be worth over $100 million.   Overall, Keystone demonstrates how one poor transaction can result in a company’s demise. Put simply, the group overpaid for its expansion and was unable to service the accumulated debt. While Sydney lockout laws played a minor role in the downfall, the financial health of the company was ultimately put at risk by the ambitions of management and reflects the importance of measuring debt capacity with appropriate stress testing.   Keystone Venues for Sale: