A bottom-fisher is all cashed up with somewhere to go - but is the EZCorp deal merely a case of preaching to the converted?

PAWNBROKING chain Cash Converters International, which has built its business on lending money to the marginalised, seems to have done a big favour for its largest shareholder - and possibly at the expense of other investors.

In November, Cash Converters' shareholders approved handing 30 per cent of the company to US pawn and payday lending specialist EZCorp, in exchange for $54 million. The cash was needed to replenish the group's coffers, which had been run down due to its policy of gradually buying back franchised stores, and other licensing arrangements, as well as expanding operations here and in Europe.

When the share deal was finalised on November 6, EZCorp had more than 100 million shares of Cash Converters and two seats on the board. It made strong commercial sense for Cash Converters, linking it to a ''big buddy'' in an industry that prefers to see itself as a micro-lender ''helping people to get on with their lives'', rather than bottom-fishers.

Some might recall that ''micro-lending'' was originally a concept of making tiny loans to business entrepreneurs in poor countries and areas, designed to give them a chance, until opportunists began to exploit the concept - often charging outrageous interest rates.

Companies like Cash Converters and EZCorp have their place, though, because their customers are higher risk, and need only small amounts of cash - usually immediately - which rules out big bank and traditional personal loan providers.

EZCorp is strong in its US home base, has a market worth of about $US1 billion ($A1.12 billion), and is clearly like-minded about overseas expansion. Conditions in North America and Europe mean there is no shortage of potential customers with, hopefully, short-term cash-flow problems. These are people who want/have to swap their sound systems, jewellery or TVs, as well as coming pay/welfare cheques, for spending money.

Three-quarters of Cash Converters' customers - who tend to be women aged 25 to 45 - are either single mothers, or single-income families earning less than $50,000 a year.

It is a lucrative business. Cash Converters, which will not report results until late next month, estimated in early May that it would earn $21 million net profit this year, up from $16 million in 2009.

Barely a fortnight after that prediction, Cash Converters announced a further share issue to EZCorp. The clock had only just ticked over on the six-month anniversary of EZCorp's original allotment, which meant that it was legally allowed to acquire up to 3 per cent of the company without having to make a takeover offer.

The companies had signed a subscription agreement on May 18 stating that Cash Converters ''finds it desirable to obtain certain additional capital in order to fund execution of its corporate strategy''.

Directors (excluding the EZCorp representatives) had ''considered the available alternatives … and the interests of the company's shareholders taken as a whole''.

Cash Converters' press release to the market put the story a little differently - saying that EZCorp had approached it with a ''desire to increase its shareholding'', and that Cash Converters believed that selling it new shares, rather than EZCorp buying stock on market, was a good deal.

So Cash Converters structured an issue to sell EZCorp just enough shares, 16.2 million, to give it 33 per cent of the expanded capital. The issue does not breach the black letter law on ''creep'' acquisitions, although it seems to raise questions about complying with the ''spirit'' of the code.

Central to determining that is whether Cash Converters really needed the money. Its last published balance sheet for the six months to December 31 showed it had almost $58 million cash and equivalents in the bank. On Cash Converters' own figures, it still had just short of $40 million cash before making the issue. In a company turning over about $120 million a year, that seems ample.

According to a presentation made in early June by managing director Peter Cumins and chief financial officer Ralph Groom, the company has spent a little more than $10 million acquiring stores here and in Britain since December, so it is well financed and lowly geared.

EZCorp could simply have appointed a stockbroker and increased its stake by buying shares from fellow investors far more cheaply, so it must have found the logic of giving almost another $10 million to Cash Converters compelling.

Had it chosen to wade in and buy 3 per cent of the ''old'' Cash Converters stock, it needed to buy just under 10 million shares. Even assuming that pushed the price up from about 52¢ to the above-market 60¢ it ended up paying for ''new'' shares, the total cost would have been only $6.5 million.

To have spent $10 million buying that same 3 per cent in the market, EZCorp would have had to push Cash Converters' share price up to about 90¢ - something investors, including Cumins's family, might have found far more attractive than the current 55.5¢.

It is safe to say EZCorp would have been killed in the rush had it offered anything close to 70¢ a share, based on recent trading history. Still, EZCorp paid a premium to increase its grip, while Cash Converters raised cheap cash that it did not seem to need immediately.

The transaction makes some sense if Cash Converters is about to make a modest-sized acquisition that would deplete its bank account. It is yet to announce one, but is believed to be close to finalising a $20 million deal to buy 10 or more additional stores.

Still, that would only gobble up about half the cash it had before issuing more stock to EZCorp. Why not use its shares as cash - either by issuing them to the vendors or making a rights issue to all investors? That route might involve some extra costs and time, although speed was clearly not critical when it did the EZCorp deal.

It is arguable that EZCorp is now a better-treated, hopefully not better-informed, shareholder than its nearly 5000 fellow investors on Cash Converters' register.

Those other investors are entitled to a premium if control of their company is being acquired by someone else. How EZCorp acquires its next 3 per cent, when legally able to do so in late November, will be interesting.

imcilwraith@theage.com.au