Unprecedented corporate restructuring took place in a range of sectors in 2009, and the turnaround specialists are about to get busier as deals struck at the height of the boom come up for review.
The term ‘elephant in the room’ has
been voted the most infuriating
business saying of the year. But if you
are looking for the real corporate elephant of
2010, it is surely the mass of businesses that
struck highly leveraged deals at the top of
the market and are rapidly approaching a
review of their payment terms. And when
those payments start outstripping cash flow,
as they surely will for many businesses, UK
plc has a sizeable problem on its hands.
Banks will doubtless try as hard as they can to hush the problems up and come to some kind of agreement to avoid administrations. But as Tim Simpson, partner at Park Place Corporate Finance in Leeds, alludes, we could end up with a mass of companies that are paralysed from growing.
“How the banks manage their positions is hugely important on many levels. I fear we could end up with a lot of zombie businesses that cannot raise financing, say, through the private equity route, because their existing debt blocks a deal being done and further growth. We are seeing a lot of businesses that are still profitable but are hampered by their funding structures. However, banks are not recognising the writedown. They are extending the term of the debt and pretending you do not have to write it off.”
Dan Butters, restructuring partner at Deloitte in Leeds, has been one of the busiest in his trade over the past 12 months, advising a string of companies in the retail, real estate, housebuilding and industrial arena on restructurings. One of his most high-profile deals was the restructuring of Heywood Williams, the listed distributor of branded building products, whose banking syndicate (Lloyds and National Australia Bank) agreed to write off £21m of the group’s debt. The company also reached agreement on a new payment schedule for its defined benefit pension scheme.
Butters says Heywood is a classic example of a strong business strangled by its debt and pension deficit. “This is a good example of the kind of deal we have been doing. We have been spending a lot of time focusing on businesses that have been overleveraged, either private equity buyouts or plcs,” he says. “As part of the rescue, vendors have been taking far more economic ownership of their businesses to avoid substantial losses.”
Butters expects all these structural features to remain in 2010, adding: “We will continue to see a glut of businesses that are overleveraged and continued demand for restructuring services. Likewise, I expect an increase in insolvencies as companies struggle to fund working capital requirements as we come out of the recession.”
The figures appear to be backing this up. Acquisitions of insolvent businesses in Yorkshire are running at their highest level in recent years, according to research by Corpfin. During the fourth quarter of 2009 a quarter of all deals completed in the region involved companies acquired out of administration or other formal insolvency procedures. During the year as a whole in Yorkshire, one in every five deals involved acquisitions of distressed businesses. Andy Wood, Yorkshire regional chairman of R3, the Association of Business Recovery Professionals, says: “Acquisitions of insolvent businesses remain at high levels. While prepack administrations account for some of these deals, others will be acquisitions by canny buyers picking up bargains while values are low.”
The credit markets remain tough. “At the moment it is difficult to borrow money, yet companies will be looking to lenders to fill working capital requirements,” says Butters. “There is a nucleus of businesses that will struggle to raise money this year.”
In terms of the refinancings to come, Butters says some will be relatively straightforward, but in cases where there is either a substantial deficiency in the market or impending payment defaults, more widespread restructuring will be required.
The size of the pending restructuring market in 2010 is typified by the size of corporate restructuring teams operating among the major accountancy players. For instance, Mark Firmin, head of restructuring in the north at KPMG, heads a 120-strong team in Leeds alone.
He believes 2010 is going to be rather different from 2009, when the fall in business activity and the drop in working capital demands was cash positive so there was little call on funders for new money.
“The region’s underperforming businesses, unable to squeeze further cash out of working capital, and those seeing an increase in demand and rising working capital requirements will need additional funding,” he says.
“We are talking to some clients in Yorkshire about their strategy for releasing cash as they plan for the upturn. An important message is to increase the variable proportion of the cost base. But some businesses will be pursuing refinancing deals to plug the widening gap between their working capital demands and available cash. This, coupled with a lack of access to finance as activity levels rise, causes more businesses to become insolvent on the way out of the recession.”
In short, Firmin says this year may vividly highlight this scenario given the lower level of liquidity in the region’s funding market. He has this message for business: “It’s important for management teams that are responding to higher demand to put the right funding structure in place and ensure their funders fully understand that the reasons for their cash requirements relate to growth as opposed to financing further losses. They also need to take advice about the opportunities in their businesses to release cash tied up in working capital.”
As new money in needed in the coming months, Firmin anticipates a lot of turnaround deals, in the form of refinancings, in 2010 rather than the debt-for-equity swaps and covenant resettings of 2009. “But given the limited liquidity, demand is likely to outstrip supply, which means some of the region’s businesses approaching funders for more cash will be unable to secure it and the consequences will include insolvency.”
Businesses that survive are those that act early to ward of impending doom. Butters says: “Companies that survive restructuring recognise the issues and act on it. The worst thing you can do is pretend that the problem will go away.”
Martin Lunt, head of Yorkshire corporate banking at HSBC, insists that the credit markets are open for business. He speaks from a position of strength because HSBC was one of the few to emerge relatively unscathed from the banking turmoil. “We have a liquid balance sheet and are knocking on doors for business,” he says.
But he has noticed a change in the behaviour of management teams. “Managing directors want to bring debt payments forward because they want certainty. Companies are prepared to pay a higher margin because the cost of money is less at the moment.”
He says the refinancing landscape is no different in the UK to elsewhere in Europe. “There is a mountain of debt to be refinanced across Europe from 2012 to 2015 and we are starting to pick that up. Companies are also being far more varied in terms of how they raise money. Those with an international offering are looking at raising funding in different jurisdictions because they have revenue streams in that country and want to hedge against currency movements.”
Martin Jenkins, corporate finance partner at Deloitte, doesn’t think the expected rush of restructurings has happened to the scale some thought it would, but believes a second wave of restructurings is on the way. “Some of these will be deals that went through the mill in 2009. Banks will either decide that it is time to get out or they will have to revisit existing deals. We will get more casualties as we come out of the recession but we have to hope that it does not undermine the recovery.”
Confidence is certainly still under threat. As Jonathan Proctor, partner at law firm DLA Piper, says, now quantitative easing has stopped and a general election is looming, the inevitable fiscal tightening and the potential for inflation and consequential interest rate rises make for a difficult year.
“These factors can also give banks and companies reasons to sit on their hands rather than address their issues,” he says. “That said, there is a rising sentiment that banks are starting to look outwards again. Banks are not reacting like the last recession and just selling off at whatever price but are looking to retain their assets and restructure balance sheets to make companies viable.”
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