How have Ion’s management and the auditors escaped major criticism so
far? Real, relevant questions were asked by Union boss Bill Shorten,
however, the receivers moved quickly to silence the Unions with a deal
guaranteeing employee entitlements would be paid. Silence has since
followed.
Without notice, $200 million of shareholder funds were almost certainly
destroyed following the appointment of receivers to ION Limited last
week.

While creditor claims appear to be largely covered, shareholders appear
to have been left empty handed as a previously unheralded $200 million
blow out in costs was revealed by administrators.

Given the speed, and surprise, of events over the past week, it is
highly likely that shareholders will shortly be seeking retribution for
their loss. Where will their anger be directed?

Had the banks, as Australian Workers Union national secretary Bill
Shorten stated, “panicked”? Had ION management “panicked”? Have ION
management failed to fulfil their obligations and misled the market
about the true financial position of the company? What role do Deloitte
Touche Tohmatsu, the company’s auditors, have to play in ION’s
corporate collapse?

These questions will undoubtedly be answered in the months ahead.

In the interim however, significant public information exists to help shareholders to draw their own conclusions.

ION Limited’s financail position

“ION is a securely funded Australian industrial company.”

On face value, ION’s website statement appeared fair. ION’s annual
report indicated there were sufficient assets in the business to absorb
a blow out in costs. Audited Net Assets at 30 June 2004 totalled
$297.1m. Allowing for the reported $127 million of project overruns,
$170m of net assets remains in the business (this may in fact be higher
given the $30m+ of assets already written off at 30 June 2004). In
addition, ION last week agreed to sell Energy Services to CHAMP Private
Equity for $151m – a reported $50m premium to Book Value. Assuming the
sale is completed, some $220 million of net assets should remain.

Did the banks panic?

Had the banks, as Shorten described, “… decided, with a stealth of the
night ambush, to jeopardise a perfectly viable company and put these
jobs at risk?”

Or were asset values simply overstated in the accounts by management and auditors?

The appointed receivers have outlined that the current Book Value of
Tangible Assets ($720 million) far exceeds creditor claims ($550m + a
possible $92m of committed Capex). On face value it appears that
approximately $80 million of surplus value exists in the company (prior
to restructuring / advisory costs). Taking into account the Energy
Services sale, this figure increases to $130 million approximately. If
other businesses, such as ION’s Wheels division, can also be sold at a
premium to book value (as expected), this surplus should increase
further.

The issue for shareholders is that any surplus is reliant on the
receivers realising Book Value for the remaining ION assets. The
reality however is that ION’s receivers are unlikely to receive Book
Value for the assets (in particular the Engine Component assets at
Altona and Wingfield). The surplus will likely be eroded as significant
carrying values are written off. This is undoubtedly the reason why
banks pulled ION’s funding.

If this occurs, ION’s Directors and Auditors will likely be asked to
explain why non-current assets in the accounts were overstated and not
reported at their “recoverable amount”.

Director’s responsibilities

ION recently introduced a “Corporate Governance Statement”. Its purpose
is mainly to ensure Directors’ responsibilities to stakeholders are met.

A number of interesting anecdotes are contained in the Statement including:

“The Board’s primary role is the stewardship of shareholders’ funds with the objective of creating long term shareholder value.”

“The Board aims to ensure that shareholders are kept informed of all major developments affecting the company.”

It appears that management may have failed to satisfy these, and
possibly other, principles. Unfortunately, the directors may have made
a noose for their own necks. Responsibility for such action is
addressed in ION’s Corporate Governance Statement:

“The Board accepts overall responsibility for corporate governance…”

For many shareholders, it is inconceivable how a $200 million “hole” in
funding could appear in the space of 1 month (the date since ION last
disclosed information to the market).

As Shorten questioned:

“How is it that this company needs voluntary administration in barely
40 days after the annual general meeting, where the CEO, the chairman
and the auditor said this business is fine..”

“Someone must be guilty of gross optimism, gross stupidity or even worse.”

It appears that directors have either misled shareholders by not
disclosing material information in a timely manner or directors were
simply inept and had no understanding of the underlying business and
the issues it was facing. Either way, it appears that the Board may
have failed in its responsibilities to shareholders.

ION has had numerous opportunities over recent months to brief the market on its true financial position, including:

  1. Citigroup Small Cap Conference (10 November 2004)
  2. Chairman’s & CEO’s Address To AGM (26 October 2004)
  3. Annual Report (Signed 17 September 2004)
  4. Earnings Guidance (April 2004)

On each of these occasions, while problems relating to the Capex
programme and softer demand were recognised, the full financial impact
was not declared. Despite the issues present, ION continued to spin its
growth story, ultimately to the detriment of its shareholders.

For example, only three weeks prior to receivers being appointed, ION
Limited still forecast Capex at $379m for 2005 and 2006 (an estimated
$85m understatement to the latest numbers).

At ION’s AGM, five weeks prior to the receivers being appointed, the
Chairman estimated 2005 EBITDA at $90 million. The receivers now
estimate 2005 EBITDA at $57 million (a $98 million reduction since
May). The Chairman also revealed that the Board expected Capex
requirements would increase by only 15% (to $379 approximately).

The Chairman told the meeting that he had to “tell it like it is”.
Unfortunately, it appears that this is not how it was. It was not
remotely close.

Newly appointed CEO Roger Flynn alluded to the financial and operating
issues facing ION. Again, however, the true financial impact was not
disclosed. Shareholders placed faith in Flynn’s comments that:

” We have a revenue base at around $700 million pa. which is set to
grow in both our automotive and energy services businesses in the years
ahead.”

The Annual Report, signed by Directors and Auditors in late September
2004, is littered with claims of continued business growth and wealth
creation:

“Ion now has over 3,000 employees across four major business units,
which over the next three years should expand revenue to in excess of
one billion dollars.”

There was little evidence of the pending explosion in Capex costs, or
revenue loss, that would lead the banks to pull ION’s funding 10 weeks
later:

“There has not been any other matter or circumstance, other than that
referred to in the financial statements … , that has arisen since the
end of the financial year, that has significantly affected, or may
significantly affect, the operations of the consolidated entity, the
results of those operations, or the state of affairs of the
consolidated entity in future financial years.”

Unfortunately, it seems inconceivable to the average man on the street
that the funding issues were only incurred post-September. How were
ION’s directors and auditors not aware of these issues as late as
September?

If anything, it appears that ION’s annual report was misleading. The
Annual Report has simply provided shareholders with a wealth of
evidence to pursue losses through appropriate legal channels.

The financial issues facing ION appear to have been long term problems
with continued capex increases and demand softening over the past year.
It appears that this did not stop previous management from overstating
ION’s financial position either. In April 2004, management provided
guidance to the market on future earnings and operations.
Unfortunately, ION’s unbridled enthusiasm has now been proven to be
horribly misleading:

“Sales revenue in 2004/5 is forecast to increase by 10%, and in 2005/6
by more than 20%. These sales revenue forecasts are based on supply
contracts held for approximately 93% of the 2004/5 forecast sales
revenue and 75% for the 2005/6 year.”

“Earnings per share are expected to be not less than 24.0 cents in 2004/5 on the enlarged capital base and increasing in 2006.”

“On current estimates, the completed cost [of Wingfield] will be $74m,
an overrun of approximately $6 million or 9% compared with previous
guidance.”

“The Altona Block Plant is scheduled to commence production in August
2005. Current capital cost estimates are approximately $125 million in
line with previous guidance.”

2004
2005 2006
Forecast Capex 125 238 98
Forecast Gearing Ratio
39-40%
48-50% 50-52%

“The Directors currently consider it unlikely that an equity-raising will be required to fund the existing business plan …”

“Fully franked dividends for the next 2 financial years are forecast to be not less than 12 cents per share per annum.”

Turbulant times ahead

Creditors, shareholders, customers, suppliers and governments are all
awaiting the fallout from the ION crisis to determine what action, if
any, will need to be taken.

Ultimately, ION’s directors (current and former) and auditors must be
hoping for a successful recapitalisation of, and/or turnaround in,
ION’s operating fortunes over the next 6 months. Failing this, a
shareholder Class Action seems inevitable in an attempt to retrieve
over $200 million of shareholder funds lost.

Interesting quotes from management over the past year

1. Citigroup Small Cap Conference – 10 November 2004

“Potential based on substance”

Capex (05/06) – $379m

2. AGM – 26 October 2004

Chairman’s Address

“It is estimated that EBITDA will be approximately $90 million for the full year before significant items.”

“Yesterday, the Board accepted an external consultant’s report on our
major capital programme. This report increases the previous allowances
on the major investments currently being undertaken by approximately
15%.”

“Several of the things I have noted are not the things I’d like to be
saying to you … but I owe it to you to ‘tell it like it is’.”

CEO’s Address

“We have a revenue base at around $700 million pa. which is set to grow
in both our automotive and energy services businesses in the years
ahead.”

““ION remains a company with growth and performance potential in competitive industries.”

3. Annual Report – 17 September 2004

Audited Financial Results

Net Assets – $297.1m

“…the attached financial statements and notes thereto give a true and
fair view of the financial position and performance of the company and
the consolidated entity” – page 28.

“..in the directors’ opinion, there are reasonable grounds to believe
that the company will be able to pay its debts as and when they become
due and payable.” – page 28.

“Non-current assets are written down to recoverable amount where the
carrying value of any non-current asset exceeds recoverable amount. In
determining the recoverable amount of non-current assets, the expected
net cash flows have been discounted to their present value.” – page 36.

“The carrying value of the plant is at a value believed by directors
and management to enable fair economic returns throughout its expected
business life.” – page 4.

“An assessment has been made … of the carrying value of assets, and a
write-down of fixed assets … and deferred research and development
costs … has been made …. The directors believe that after these
adjustments, the carrying value of assets represents their economic
worth when measured against current and future trading expectations.” –
page 6

“Ion has recently negotiated term bank financing of $440 million which,
…., will provide the funding to complete the strong development
strategy now committed.” –page 4.

“There has not been any other matter or circumstance, other than that
referred to in the financial statements … , that has arisen since the
end of the financial year, that has significantly affected, or may
significantly affect, the operations of the consolidated entity, the
results of those operations, or the state of affairs of the
consolidated entity in future financial years.” – page 28.

“In our opinion [Deloitte’s], the financial report of ION Limited is
…giving a true and fair view of the company’s and consolidated entity’s
financial position as at 30 June 2004.” – Deloitte.

Business Summary:

“Ion now has over 3,000 employees across four major business units,
which over the next three years should expand revenue to in excess of
one billion dollars.” – page 6.

“It is our [Chairman & CEO’s] intention to continue to build ION in
a way that delivers superior long term returns to our shareholders,
consistent with meeting the reasonable expectations of our customers,
employees and other stakeholders.” – page 11.

“The longer term outlook for the group has been enhanced by
considerable progress on three major Greenfield aluminium casting
businesses… These projects are largely underpinned by having more long
term automotive contracts and are located at Wingfield (SA), Altona
(Vic) and Warsaw (Kentucky, USA).” – page 2.

“Both the Energy Services Group and Automotive Group are forecast to
grow in the 2005 financial year and beyond as revenues from the major
capital projects, now under construction, achieve expected returns. The
major projects, namely:
– Wingfield …
– Altona …
– Kentucky …
– Albury …” – page 5

“Significant new business won which will help build our future includes:
– the lightweight alloy engine block … for the new Holden High Feature V6 engine
– The differentials for the new VZ Commodore to be introduced in 2006
– The premium large diameter alloy wheels to be manufactured in Kentucky, USA
– The growth of energy services …” – page 4

“The lessons of Wingfield have been thoroughly absorbed.” – page 6

Automotive Wheels (Pages 7 & 13):

“…strong sales are forecast for the 2005 financial year based on forward schedules provided by Ford.”

“Significant new contracts have been won with Ford in North America which underpin the start-up of the Kentucky plant.”

“.. the Harley-Davidson supply agreement was extended to 2010.”

“The strong sales recovery predicted for Auckland in the 2005 financial
year, the continuing strong demand from Harley-Davidson and the
start-up of the Kentucky plant combine to enable ION to predict strong
sales for 2005. Beyond 2005, as Kentucky sales increase in accordance
with contracts held, Auckland continues to supply at current rates and
the Harley-Davidson business continues to grow, ION can expect strong
aggregate growth from this business unit.”

“ION has volume demand and an efficient and well disciplined
manufacturing process. At completion of the Kentucky plant, ION will
have wheels manufacturing capacity of 4 million wheels per annum and
sales, based on contracts already held, are set to grow strongly in
2005 and beyond.”

Driveline Systems (Pages 8 & 17):

“In June, ION executed a supply contract with the Shenzen Minghe
Trading Company (SMT) of China for the supply of the existing 4 speed
transmission. This contract is for a five year period with minimum
volumes of 20,000 to occur in calendar year 2005. Ion is confident that
demand will grow quickly from this base and will provide a long-term
future for this mature low cost robust transmission.”

“In summary, a year of great progress with new products, new customers,
lower costs and relevant research and development combining for a sound
future.”

“When ION acquired the Albury facility, it was assessed that new
investment in plant and machinery was required, that lean manufacturing
must be introduced and that cost reductions were necessary. All of
these have been completed.”

“2005 will be a year of consolidation with expansion predicted thereafter.”

Engine Components (Pages 9 & 15):

“Engine components will become a major growth area for ION following full commissioning of:
– … Wingfield …
– … Altona …”

“New revenue from engine components by 2007 is forecast to be over $150 million. Growth prospects beyond this are promising.”

“ION has assembled a team of in-house casting expertise and has drawn
on the powerful resources of Holden, and its parent General Motors, to
ensure that the project (Wingfield) will yield great benefits to ION in
the years ahead.”

“…production units increasing from 600,000 in 2004 to 1.25m in 2005, with 1.5m plus pa. of products in the period beyond 2005.”

“The Altona plant is due for start-up in the latter part of the 2005
calendar year. The process and plant and equipment will be at world
leading edge in both quality and cost of manufacture and will provide
very strong income flows and profitability for ION for the long term.”

“ION acknowledges that the start-up of Wingfield was disappointing with
cost overruns and production delays. However, the recruitment of a
quality team and collaboration with expert experienced engineering
resources will result in these one-time issues being overcome.”

Corporate Governance (Pages 6, 21-25, 28):

“The Board’s primary role is the stewardship of shareholders’ funds with the objective of creating long term shareholder value.”

“The company has established policies and procedures designed to ensure …”
– all investors have equal and timely access to material information
concerning the company, including its financial position, performance,
ownership & governance;
– company announcements are factual and presented in a clear and balanced way.

“The Board aims to ensure that shareholders are kept informed of all major developments affecting the company.”

“The company regularly publicly discloses to the market events that are
likely to influence future operations and financial results.”

“ION will keep the shareholders appraised as to progress of these major operating plants [Wingfield, Altona, Kentucky].”

4. Earnings Guidance – April 2004

“Sales revenue in 2004/5is forecast to increase by 10%, and in 2005/6
by more than 20%. These sales revenue forecasts are based on supply
contracts held for approximately 93% of the 2004/5 forecast sales
revenue and 75% for the 2005/6 year.”

“Earnings per share are expected to be not less than 24.0 cents in 2004/5 on the enlarged capital base and increasing in 2006.”

“On current estimates, the completed cost [of Wingfield] will be $74m,
an overrun of approximately $6 million or 9% compared with previous
guidance.”

“The Altona Block Plant is scheduled to commence production in August
2005. Current capital cost estimates are approximately $125 million in
line with previous guidance.”

2004
2005 2006
Forecast Capex
125
238 98
Forecast Gearing Ratio
39-40
48-50 50-52

“The Directors currently consider it unlikely that an equity-raising will be required to fund the existing business plan …”

“Fully franked dividends for the next 2 financial years are forecast to be not less than 12 cents per share per annum.”