For many businesses and individuals, the economic hardship of the latest recession appears to have subsided; for the turnaround industry that benefited from helping companies navigate through the struggles of the last three years, their recession has just begun.
During the recent economic crisis, credit markets were shut tight. Banks didn’t lend, and they were attempting to figure out which borrowers required their attention most. Private Equity firms weren’t investing as values plummeted and financing leverage disappeared, and they were challenging portfolio companies to align cost structures to the new reality of declining top lines and evaporating profitability. During this period of economic decline, turnaround firms enjoyed escalating business and significant growth, helping banks assess borrowers’ business plans to determine the severity of their problems and viability, assisting companies reduce cost structures to get ahead of their declining revenue curve, and facilitating restructurings to resolve leveraged capital structures that were no longer affordable.
This scenario inundated the banks with problems. How did they react? The term “extend and pretend” emerged to best describe their response. After all, what were their alternatives? With financial institutions not lending, forcing a borrower to refinance them out wasn’t an option; without leverage and adequate returns on equity to attract investors, a forced sale option wasn’t going to provide any better results. Thus, as long as banks viewed their borrowers as viable with an achievable plan and turnaround in sight, capable management and generally stable liquidity, they were willing to modify or extend existing credit terms, allow the use of proceeds from non-core asset sales or align debt service payments with cash availability, if any. Financial institutions absorbed significant losses with the sub-prime and housing crises; they didn’t want to take any more hits to reserves, and regulators weren’t forcing them to do so.
Today, credit markets have rebounded strongly and private equity firms are actively raising fund s and seeking new investments. The lending market is frothy, with competitive activity resembling the good old pre-recession days: pricing is low, averaging libor plus 250 bp, and structures are light or non-existent. Cash-flow lending is back, and multiples have returned to four times. Characterizing banks’ memory as short-term would be generous; no memory is more like it.
Companies seeking new financing certainly aren’t all creditworthy despite being plentiful in number. Nevertheless, a sizable volume of financial institutions are chasing them in order to rebuild assets after the dearth of lending over the last three years. At the same time, although having gotten accustomed to working with borrowers, engaging in extend and pretend, they are starting to loosen the reins on selling off higher risk or non-performing credits and recognizing losses. By now, distressed loans in banks’ portfolios have been addressed in some fashion, most liquidated or restructured. Combined with the absence of making new loans in recent years, which abolished a segment of new troubled loans, banks now profess their portfolios are “clean” or free of problem loans. This is the genesis of the turnaround industry’s current counter-cyclical recession woes.
All companies are, of course, run by people who by definition are fallible, i.e., management isn’t perfect and external pressures appear limitless. The housing market remains in the doldrums, high unemployment lingers, and consumer confidence continues to be vulnerable despite modest revenue gains. Commodity prices have been on the rise, notably oil and grains, causing companies alarming increases in raw material costs. Without the ability to timely pass on such costs to customers through increased selling prices, margins are dissipating. For multinationals or domestic companies with export businesses, keeping close eye on the fiscal crises in select European Union countries is critical; for those reliant on product produced in Japan, the disruption of continuous supply caused by the recent natural disasters can be devastating.
Thus, in a perverse sense, because there are looming threats to the economy overall, hope is not lost for the turnaround industry. The return of highly competitive, undisciplined lending combined with the aforementioned residual economic pressures is rebuilding the pipeline of opportunity. There will always be situations demanding outside assistance serve as the catalyst for change, or the need to insert an interim CEO or CRO to acquire a moratorium from creditor pressures and leadership for a late stage distressed company workout. At the same time, strong liquidity exists in the private equity market and acquisition activity is returning. Turnaround firms can play a pivotal role to facilitate both sell-side and buy-side transactions.
Getting A Better Price
Basic axiom for a seller: maximize the company’s value and return on investment. However, not all companies for sale are created equal. Many are fortunate to have achieved strong performance and growth; others have been less fortunate. When companies have suffered operationally and the causes of their problems have been largely unaddressed, value is impaired. Engaging an operationally adept turnaround consultant to effect improvement in the short-term and dress the company up for sale can drive up value and yield significant returns, greater than the consulting costs incurred.
Whether in a consulting or interim management role, a turnaround manager can both enhance and verify the credibility of the information provided to a buyer. Aside from reviewing strategies and competitive positioning, diligence focuses heavily on financial and operating data. Buyers spend considerable time and money validating and evaluating the data provided. Especially in troubled company situations, the operating results could be skewed by the influences of the distress and actions of interested parties; moreover, the people knowledgeable of the rationale behind the numbers may no longer be available to share their insights and explanations. The independent turnaround manager can fill that void, share an objective account of events and their causes, and minimize diligence risk and costs.
At other times, management may still be present, but possess an agenda based on self-interest. The company could be privately owned, its sale forced by creditors, and management seeks to thwart the sale; perhaps they themselves want to buy the company. Additionally, management could be skewing information to prop themselves up to potential owners in the hope of future employment. The turnaround manager responsible for overseeing the sale process and involved in all management presentations and discussions can insure management’s cooperation and mitigate divergent objectives.
When the tables are turned, and eyes are set on an acquisition target and diligence teams are formed, the perspective provided by operationally skilled experts can be invaluable. Private equity groups experienced at performing diligence on companies are savvy and know most of the right questions; they prove particularly proficient at tackling strategic, commercial and financial analytic issues. Typically teamed up with large accounting or consulting firms to perform financial due diligence to review quality of earnings, financial management, systems and taxes, most areas of risk are covered.
However, the turnaround consultant, who’s been in industry, run companies and has unearthed and addressed countless times the hidden evils plaguing companies, can provide substantial cost-saving insight. Incurring additional diligence costs when attempting to limit potential “dead deal” costs requires thoughtful consideration, but so does obtaining veteran assistance to detect operational risks and opportunities. For firms without operating partners on staff to add operational knowledge, the usefulness of adding qualified support is self-evident; however, it’s of equal value for firms with operating partners whose years of experience are limited to a small handful of companies and whose focus may be spread thin.
–All potential acquisitions should address these critical issues:
–Is the business plan achievable?
–Are the underlying assumptions of the plan reasonable and attainable?
–What are the key risks to achieving the plan?
–What opportunities exist to increase company value and returns?
–Is cash flow sufficient to implement the business plan?
–Can this management team execute and drive the plan?
Depending on the diligence team’s strengths, the added help from a turnaround consultant could be centered on top line strategies and tactical plans, manufacturing and distribution effectiveness or integration assessment and planning, should the target be an add-on to an existing platform company.
Many companies don’t achieve internal consensus on market strategy, which creates sub-optimal performance and waste. In order to maximize revenue performance, questions need to be asked:
–Is there a defined sales and marketing strategy and plan?
–What are the risks to achieving the sales and marketing plan?
–Are the right people in the right positions?
–Does the tactical sales plan support the company’s core competencies?
–Do compensation programs and incentives support the marketing and sales strategy?
–What is the return on investment for sales and marketing dollars spent?
–Are appropriate metrics and performance accountability measures in place?
The use of Lean/Six Sigma and other methodologies can be particularly effective in flushing out waste and non-value added activity. These process improvement approaches can create opportunity, and help achieve customer satisfaction and plan goals. Surprises on the cost side of a business can shrink margins and profitability and squander working capital. Issues to evaluate include:
–Is quality measured, and what’s the cost of poor quality?
–Do wasteful, non-value added activities inflate product, service or delivery cycle times?
–Is equipment down-time analyzed and change-over time measured?
–Are there capacity constraints, which could prohibit meeting plan aspirations?
–Do consolidation opportunities exist?
–Are the plant, warehouse and distribution facilities’ layout and infrastructure optimal?
–Does the company analyze and understand product and customer profitability?
–Are global sourcing and business process outsourcing employed appropriately?
–What is the skill level of employees, and do turn-over or training issues exist?
–Is customer satisfaction measured, and how?
–Are key operations metrics and effective management reporting established?
Statistics reveal that seventy percent of mergers fail to meet their target objectives, largely due to poor integration planning and execution. The time to consider integration plans for maximizing synergies and shareholder value is during the diligence phase. Deal strategy and integration objectives need to be aligned, and careful consideration must be given to risk factors and cultural issues. The time to identify integration goals, value drivers and appropriate metrics is when the key premises of the deal are formulated.
With portfolios containing fewer distressed companies, qualified turnaround professionals can still play a pivotal role by assisting private equity groups on the front end of acquisitions with diligence, and post-closing by helping management teams implement identified strategies to eradicate risks, achieve objectives and improve performance and enterprise value.
Like the economy overall, the turnaround industry will emerge from its own recession leaner, and with a new focus on growth and opportunity.
Bill Henrich is co-chairman of Getzler Henrich & Associates LLC, an advisor to troubled companies.