While the English legal system provides an ideal framework for providing the security ABL providers need, legal systems and business cultures across Europe throw up a number of hurdles and in some cases proverbial brick walls, making deals very complicated to structure. “The need to leverage European assets is much higher today than it was five years ago. But for this
market to really grow, you need a truly pan-European market,” says Bob Rubino, marketing manager for Bank of America Business Capital Europe.
The potential in store for Europe’s ABL market can be gleaned from a brief look at the size of the US market. The latest data available, compiled and published by the Commercial Finance Association (CFA) in New York, shows for the calendar year 2004 there was an estimated US$350bn of outstanding ABL facilities in the US. Canada was the next largest market with approximately US$10.5bn outstanding. However, given the comparable economic size of the European markets to the US, the European ABL market was a tiny percentage compared with that market in 2004 with around US$4.5bn outstanding. CFA data for the 2005 calendar year will be available mid 2006.
A range of estimates for 2005 from ABL practitioners in Europe suggests the market will top US$5bn, with as much as a 10% to 15% growth in 2006. With many deals remaining undisclosed, however, these figures, as in the US, are more of a market indication than an actual representation of volumes. “It’s still very complicated; we’re not the United States of Europe,” says Brent Osborne, joint managing director of Landsbanki Commercial Finance based in London.
“The use of asset-based finance is still nowhere near where it is in the US where it is a mainstream part of the acquisition process,” says Dennis Levine at Burdale Financial Limited in London. “However, I think comprehensive asset based financing is gradually becoming better received, people really are more receptive to it. The combination of asset based finance and unsecured senior debt is slowly becoming more popular in Europe,” says Levine. “However, the overall growth of asset-based finance in Europe is still restricted because of the differing laws in different European countries.”
The mainly London-based ABL market is gradually moving into continental Europe, with the largest economy in the European Union squarely set to play a primary role in their expansionary strategies. Germany is an archetypal old economy with a strong manufacturing base, which has shown macro economic improvement in recent years. Labour costs have been managed down and more companies are showing signs of recovery compared with just a few years ago. The country has clearly been flooded with private equity sponsors, and ABL players are increasingly vying for a position on the back of that activity, despite it being slow to materialise.
“The composition of the German economy has a very large manufacturing base, which increases potential for ABL,” says London-based Tanya Grubic, a senior client manager at Bank of America Business Credit Europe. Her colleague Rubino shares the same view: “Germany has positioned itself to be a very receptive ABL market.”
German manufacturing is undergoing major changes as the European economy heaves itself into the twenty-first century. Many manufacturing groups are also looking east to Asia and China to reposition some of the activity there, in some cases hiving off divisions and core assets, boosting the German buyout market.
Overall, the German market, particularly the small-to-medium-size business community, is facing some tough changes as the culture of personalised business banking changes. These changes are raising major funding issues for the many of the country’s 2.5 million-plus businesses. Gone are the days when bank managers were able to lend to companies in such a freestyle way as they have traditionally done, sometimes based on old school ties or social affiliations.
Also, ahead of the implementation of the Basel II accord, German banks have been forced to clean up their balance sheets, and this wide-sweeping process is having an impact on the sources of funds for many German companies. “Our initial move into Continental Europe will be to Germany where we see lots of opportunities,” says Osborne. His bank, which has been active in ABL since August 2005 after three key players joined from GMAC Commercial Finance, is setting up a German office in Q1 2006.
Landsbanki will not be alone in Germany as ABL players like Lloyds TSB Commercial Finance, GE Commercial Finance Business Finance and Bank of America Business Credit Europe are all firmly established there.
“It seems to us there are enough pickings in well developed countries in Western Europe. The reason we want to be in these countries is that we want to offer crossborder full service to companies,” says Martin Ward, senior international manager at Lloyds TSB Commercial Finance based in London. “We’re able to piggy back on VC and turnaround guys and that’s where we’re getting most of our work from,” he says.
Without venture capital and private equity sponsors generating an increased flow of deals, the scope for ABL providers would no doubt be limited in Germany. But according to professionals in the German market, private equity has become such an important part of the country’s economy that, indirectly, it is the second largest employer across the country after the public sector.
In a special report on the economic impact of private equity in Germany, written by Ernst & Young partners Joachim Spill and Wolfgang Taudte, they say private equity has become an established part of the German economy and has become increasingly accepted by the management of Germany’s companies. “This conversion is not complete and private equity investors have been subject to criticism in the media by those wary of its motives and methods,” they state in their report. “However, the rationale for private equity activity in Germany remains strong due, in part, to restricted access to debt and the restructuring requirements of some of Germany’s major industries.”
The international financiers are entering markets where traditional sources of finance may be drying up for certain companies and also in their favour is a lack of real competition in the ABL space from banks in countries like France and Germany.
“In terms of the buyout market, we are probably most developed in the UK, France and Germany,” says John Jenkins, CEO of GE Commercial Finance, Business Finance UK, based in Reigate, England. “The dynamics in the French and German market are different and the clearing banks there don’t seem to be that involved in ABL.”
There is anecdotal evidence that some local German banks are reacting adversely to German companies being owned, in part, by international sponsors. And coupled with the general pressures on the German banking market, some companies are finding that ABL is one of the only viable sources of leverage finance open to them.
Despite the concerns of a crossborder market in Europe being very complex, Landsbanki, for example, has completed an eight-country deal that referenced parts of the same company from north America to Romania.
The bank is currently working on a manufacturing industry deal that references a company with facilities in France, Germany, the Netherlands, Switzerland, Sweden and the UK. The way this type of deal is structured is that with the VC investment in place, a co-ordinating UK-based lawyer oversees and manages the bigger picture. Then separate documentation is drawn up for each jurisdiction, which is completed with legal advisers on the ground in those countries.
Bank of America Business Credit Europe is working with hedge fund investors on completing a multi-jurisdictional deal that totals €200m, one of the largest deals to date in the European market.
“Because ABL deals are very closely monitored, you really need local platforms to cope with the legal aspects of deals and to monitor them,” says Jenkins. “The key is to know what to do and what not to do in a specific country.”
Receivables and revolving credit facilities work well in Germany, but there are concerns over fixed assets. This is based on the potential for very drawn out administration processes in the country. The idea is that by the time an administration process may have been completed, there are doubts that an effective asset sale could be achieved.
“You have to be careful of certain provisions on fixed assets,” says Rubino. “It’s not whether you can take a security issue, it’s having someone with enough experience on the ground to workout a situation should it arise.” Ward says: “We prefer to have legal documentation completed in each country so if anything goes wrong you know enough people in that country for a legal workout.”
Why Germany has become the next big ABL market in Europe after the UK is not just because of the size of the economy, it would appear to be more to do with a general acceptance of this form of finance. ABL players are finding that local consultants, law firms and accountants are happy to embrace their financing techniques, market them to local companies and, perhaps an obvious observation, yet one that makes a lot of difference to UK and US asset-based lenders, there is a general willingness to work in the English language.
While factoring registers at the top of the creditor list in France, government debt always supersedes any other creditor claim, should a company go into administration. At this stage, the main ABL offering in France would seem to be receivables deals. Even inventory financing is difficult because of some very complex issues. There is little doubt that in the grand scheme of things that US equity sponsors are finding the French market a tough one to break into as are ABL providers.
“Spain is becoming a more open market and I’m receiving more applications from Spanish companies. They are willing to use British and US finance products,” says Ward. “However, Italy will be another tough market to crack.” One of the specifics of the Italian market is that receivables deals can be multi-factored, allowing one company to have as many as five financiers at any one time. The issue here is that while companies are obliged to disclose all of their financing agreements, ABL players question if such information is always made fully transparent, particularly when a business faces financial difficulties.
It is more likely that in the UK, France and Germany that a receivables deal would be awarded to just one financier.
The UK market is the home of ABL in Europe and although its use continues to increase, the British are not carbon copies of their American counterparts. “Although there have been some US sponsors involved in asset-based lending for the last 20 years in a wide range of deals, the UK VCs are a little more conservative and they tend to like a mixture of cash flow, mezzanine and equity,” says Osborne.
However, there is a growing trend of VCs looking to ABL to release equity in portfolio companies, allowing investors to take a return. There is an associated leverage upside for VCs looking to releases equity using ABL, in that those deals tend to require less equity than in more traditional cash flow deals, for example. And because a lower level of equity is required, a VC’s IRR will increase. “More VCs and private equity players are now embracing the concept of ABL, especially at the lower end of the market where they want to minimise equity and maximise the debt element,” says Jenkins.
In a new investment, the last thing a sponsor wants to do is start paying down debt while it really should be pushing the company to achieve as much growth as possible. This is where ABL providers say they come into their own. However, there has been criticism levelled at ABL companies by some VCs and private equity sponsors that they might be inclined to walk away from a deal when the going gets tough. “The fact that we are doing cash flow means that we are not able to walk. In fact, most conversations with PE houses stem from our willingness to do cash flow,” says Jenkins.
With increasing attention given to more complicated acquisitions that have a turnaround story, there is the possibility traditional sources of leverage might tend to shy away, which is good for the ABL market, its participants say.
A cash flow lender does not tend to leverage inconsistent cash flows. This can be a problem when a sponsor acquires as hived-off part of a company or a division that really has no precise valuation. “In cases like that, ABL becomes a good valuation tool for diversified companies,” says Rubino.
ABL has tended to focus largely on manufacturing and distribution, where they are strong receivables, sizable inventory and plant and machinery. But on the back of deals like the Toys R Us deal in the US, the market is opening. “I think the spread of the asset based lending market has always been rather broad but recently deals in the retail industry have opened up,” says Osborne.
ABL providers tend to stay clear of construction and high tech companies. And any industries where the sales process is subject to potential after-sales disputes, amendments or scrutiny. “We continue to rely on the basis that we do deals and don’t have to worry about after sales issues,” says Osborne.
The size of deals being offered in Europe typically ranges from €10m to €200m, but at the higher end the close-knit ABL market continues to develop relationships in club deals, and in the UK, a syndication market is emerging. Although an ABL syndications market is a long way off becoming a commoditised financing product, deals are being done more frequently on a club basis, and the trigger volume would appear to be in the region of £50m. “For ABL deals, the syndication approach is still on an informal approach. There’s an understanding that to get into the next value band we have to do a club deal,” says Jenkins.