Recent asset-based lending activity in the US has further reinforced this finance tool as a popular mainstream option with recent deals for well-known companies such as Levis Strauss, Sachs of Fifth Avenue and Polaroid funding some of their business development this way. While UK and continental European deals may be a long way off the $600m working capital facility completed by San Francisco-based Levis Strauss last year, many deals are now topping £100m and so are appealing to larger companies than before. There are strong expectations in the market that a deal in excess of £200m will be signed in Europe before 2004 is out. Anthony O’Connor reports
As well as larger companies becoming attracted to asset-based lending, it is spreading across borders with clear signs of a pan-European market and US-European market gaining momentum. One deal completed last year covers both trends and illustrates that UK-based asset-based lenders are acting as a finance hub for US and European companies. London-based Bank of America Business Credit Europe underwrote a £75m deal for IT distributor Ideal Hardware Limited, the UK subsidiary of NASDAQ-listed Bell Microproducts Inc. Covering seven countries including the UK, France, Italy, The Netherlands and Scandinavia, the deal allowed the company to continue with its expansion programme and to accelerate payments to its 80-odd suppliers.
UK-based General Motors finance arm GMAC Commercial Finance completed a $30m finance package comprising confidential invoicing and a working capital facility for Purolite, a player in the global ion exchange resins market based in south Wales. That deal covered finance needs for seven different countries: France, Germany, Italy, Romania, Spain, the US and the UK.
The growing cross-border nature of asset-based lending is being driven by a number of factors. One of them is the relatively limited size of the UK market, the deal flow in which was dampened by tough market conditions for much of last year. “Essentially the market was flat in 2003. There were just not enough deals to be done, which was a reflection of the economy at large,” says Stuart Parker, chief executive of GE Capital Commercial Finance in Reigate.
Deal flow gained some momentum during Q4 of last year, however. “I would say it was quiet from March to mid-summer, but it has picked up quite a lot since. I’d be surprised if we don’t do a deal as big as £200m soon,” sys Paul Hancock at Bank of America Business Credit in London.
The half dozen players in the UK are looking to Europe as a source of more deals. Finance products such as invoice discounting and factoring, which asset-based lenders typically combine with working capital facilities, have been embraced in countries like France, Italy and The Netherlands. But reflecting the strong focus of asset-based lenders on asset-heavy companies in the manufacturing sector, the next big boom market is set to be Germany, which has large regional pockets of these types of companies. With Germany’s own economic problems well reported in recent years, large companies there are expected to shave-off unwanted and non-core businesses, which could in turn offer some MBO, MBI and acquisition opportunities. While some of these restructurings will fall into the remit of venture capital deals, others will fall into the asset-based lending model.
In addition, asset-based lending is offered to companies in turnarounds and for general refinancings. Lenders generally focus on manufacturing, wholesale, distribution and importing and retail. Those companies are likely to have some of the following trading conditions: high levels of stock; high levels of debtors; undervalued plant and equipment; seasonality of trading cycles and requirements for letters of credit. “We ourselves have an operation in Germany which is doing well targeting the mid-market [companies] with a turnover of €25m upwards,” says James Cullen at Lloyds TSB Commercial Finance. “We are also looking at a number of other countries in Europe as well as in the US.”
Germany is not the only country generating interest among asset-based lenders. Spain and Poland are being targeted too. With just months to go before Poland accedes to the European Union, a run of cross border acquisitions is expected to start, particularly given the country’s large focus on manufacturing and other asset-dominated sectors. GMAC Commercial Finance, for example, has announced it is setting up offices in Warsaw and in Frankfurt this year to take advantage of local market opportunities.
Elsewhere, Royal Bank of Scotland is active in factoring and invoice discounting in the UK and in France and Close Brothers is also active in France. GE Capital Commercial Finance has a factoring company in France, a joint venture with ING Bank in The Netherlands and other joint ventures in Spain and Portugal.
Executing deals covering a number of European jurisdictions can be difficult in some cases because of the diverse legal systems across the region. Dennis Levine at Burdale Financial in London says his company is looking to Europe, but certain issues have to be resolved. “We are looking at researching pan European deals and are looking at the issues with our lawyers and people on the ground. Germany and The Netherlands seem like the most user-friendly countries,” he said.
Like with many other forms of cross-border finance, asset-based lending across Europe is not always a straightforward proposition. What is acceptable in one country will not work in another. Asset-based lenders can basically buy a company’s debt or they can lend a given percentage of funds based on the company’s future receivables. The economic effect is more or less the same whichever route is taken.
A big concern is the whole issue surrounding how receivables should be treated and under which governing law deals should defined. There is a tendency to prefer English law because of its friendliness to creditors. Essentially, what appears to be holding up the expansion of a fluid pan European market is foreign law risk. “In France, for example, you may see different cultural priorities, such as employee needs, competing with those of creditors on an insolvency,” said Graham Wedlake, a partner in the banking group at law firm Barlow Lyde & Gilbert in London. “In Europe, the need for receivables over which security is to be granted to be specifically identifiable can discourage asset-based lending. But everyone in different European jurisdictions understands a straightforward sale and purchase agreement.”
Although many deals in the UK have been purely domestic in structure in the last couple of years, the growing trend in multi-jurisdictional deals, which is going to be one of the main growth markets for lenders, needs a framework that will allow deals to work without too many structuring headaches. “A possible alternative to financing each European subsidiary directly is to centre the transaction in the UK,” explains Wedlake. “The UK parent could act as the group treasurer, buy receivables from its European subsidiaries and simply raise finance in the UK based on its enhanced asset pool.”
Some deals are being originated in the US and being co-arranged with both US and UK elements. Polaroid’s $100m was deal co-arranged and agented by Bank of America and Citibank. Bank of America acted as agent on the European piece.
For many of those countries joining the European Union later this year, a suitable legislative framework needs to be put in place in order for asset-based lending to be more secure. The European Bank for Reconstruction and Development is working on a collateral law which will act as a blueprint for companies based in central and eastern Europe. The objective is that a common legal framework will be adopted by those countries.
In addition, the whole issue of receivables is being addressed by a working group in the United Nations Committee for International Trade (UNCITRAL). Although this will address the subject on a long-term basis and is not likely to result in a rapid change to the legal framework differences that still exist across Europe.
The internationalisation of asset-based lending reflects fresh activity among US companies looking to expand or restructure operations, as well as UK-based companies incorporating their US subsidiaries in deals. The US is said to be around nine to 12 months ahead of the UK in emerging from its economic downturn and this is placing some pressure on asset-based lenders in the US to look for higher margin business elsewhere, because margins have dipped at home. There is expectation that some of those US companies may look to the UK and continental Europe, placing pressure on an already competitive UK-based market.
“You would think that those players in the US, if they are seeing pressure on margins, would be looking to Europe for deal opportunities. You’ll see more companies generally looking at Europe, particularly at opportunities in Germany,” said Hancock.
According to the lawyer in Hamburg, the market could see an increase in activity from German players, already active in invoice discounting and factoring. One such company is Siemens Financial Services, a subsidiary of Siemens AG. While Siemens Financial Services does not offer a defined package of asset-based lending as such in Germany, it is an active player in the US. It does offer invoice discounting and factoring in Germany.
With the growing trend in multi-jurisdiction deals, it is not surprising that deal sizes are increasing as companies seek to find finance solutions for subsidiaries across several countries, rather than organising separate deals in each jurisdiction. The very minimum deal size is around £2m, which would equate to an annual turnover of around £25m and upwards. However, awareness of the product is now filtering into companies with turnovers of as much as £750m to $1bn.
“Five or six years ago asset-based lending was all based on small business,” says Nick Leitch at Ernst & Young in London. “That’s all changed and now deals are focusing on the Ernst & Young market place and we’re working with larger corporates.”
For the accountants – the big four and also the medium-size firms – sourcing deals for asset-based lending is becoming a good source of business in the UK and is linked to a greater relationship play not only with the user of this finance tool but also the provider. “Historically, people have first thought about going to a VC to raise funds because that was the thing to do. Asset-based lending isn’t lending based on a promise, it’s based on actual business activity,” said Leitch. “One of the key advantages of asset-based lending is that management can raise capital without giving away equity.” What Burdale Financial’s Levine describes as “comprehensive lending” can range from £10m to £200m in a debt package, and is currently priced cheaper than mezzanine.
The asset-based lending community has tended to work on an informal club basis where they agree to split a deal once one of the arrangers had secured a mandate. However, with increased deal sizes and more sophisticated users, the underwriting and syndication market is starting to emerge out of its infancy in asset-based lending. “In the future there are also going to be much bigger syndicated deals as knowledge of asset-based lenders increases,” says Cullen.
One such deal is believed to be in documentation right now. Arranged by Lloyds TSB Commercial Finance, the £120m deal is said to feature strong participation from Burdale Financial. It is expected this will be syndicated among the UK-based lenders. As a rule of thumb, an underwriter will retain around £25m of these types of deals on its own books. This was the case when Bank of America Business Credit Europe fully underwrote the £75m for Ideal Hardware, £50m of which was syndicated down. “This particular deal didn’t allow us to build a club of lenders at an early stage because the customer was keen to fully test the market,” said Hancock. “However, what we hold onto depends on a deal-by-deal basis and it also depends on what the customer wants.”
Legal changes introduced in the UK are likely to benefit the syndication processes in the asset-based lending market. “The abolition last December of stamp duty on debt transfers will encourage the development of a syndicated invoice discounting market,” said Wedlake.
What may have been a single label covering all financing from invoice discounting right through to the more complex asset-based lending deals looks likely to fall away as the market matures and deal types look set to take on their own characteristics. “We may well end up with an industry with two distinct elements,” says Wedlake. “Smaller invoice discounters and factors at one end of the market and asset-based financiers offering larger and more complex products at the other end.”
The growth of this market, which is being compared to whole business securitisations but for smaller-size companies, has been attributed to a lack of appetite by the business banking community, which has balked at the idea of lending against stock, plant and debtors. If, for example, a company is going through an MBO approached its bank, there is anecdotal evidence that overdrafts would not be available. A stressed management team going through an MBO may not have the time it needs to monitor all of the financial issues. This is where the asset-based lenders offer a very useful service, at a higher cost than bank debt, by offering ongoing financial monitoring of the company.
As the concept of asset-based lending finds new appeal among companies, the existing lenders may be facing another form of competition as the UK’s clearing banks may use their deep pockets and experience in factoring and invoice discounting to enter the market. As the market looks to 2004 for greater deal flow compared to last year, the asset-based lenders are citing an encouraging uplift in M&A activity and a healthier business environment as some of the key drivers.
Quick view definitions
Asset-based lending is when money is advanced against a selection of one or more of the following assets: debtors; stock; plant, machinery and equipment: land and freehold property. It is typically offered with an invoice discounting facility.
Factoring is the provision of cash against unpaid sales invoices, which can be accessed immediately after the invoice has been raised. A degree of credit management is also built into a facility.
Invoice discounting provides cash against unpaid sales invoices and is fully confidential. There is no intervention into current credit management systems.