1. Distressed M&A –Supply Chains and Working Capital Solutions?
Igor Zax, CFA, Sloan Fellow (LBS)
Managing Director- Tenzor Ltd
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2. Who and Why Do Distressed M&A?
Buyers: specialised distress PE, hedge fund/PE distressed debt investors, corporate
Sellers: PE, banks?, corporates
Principal approaches: “pure” debt restructuring, liquidation play, operational turnaround, integration
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Why Turnaround?
Insolvency may be an efficient solution if there are substantial assets in the business (based on actual liquidation value) and they can be easily secured.
Otherwise, one needs to keep the company as going concern as the best way to recover- and this is not only lender’s decision.
To do so, one needs to answer why the company exists and how is it linked to its environment.
Bank lender makes a one-off decision to lend-supply chain partners making their decisions (including granting credit) every time
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Five “C” of Turnaround
Control
Creditors seek to control assets and decision making
Capability
The team (existent, new or interim) need to be capable for the task
Credibility
Turnaround plan and the team need to have credibility with all stakeholders
Clarity
What is the company’s core business, how it fits with the industry structure and does the business model match it
Co-operation
Lending group are not the only stakeholders. Ongoing support from suppliers, customers, distributors and others are vital for survival
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5. Industry structure and Supply Chain
Global industry structures changed massively
Platform companies "Produces nowhere but sells everywhere... know where the clients are and what they want and where the producers are. Platform companies then simply organise the ordering by the clients and the delivery by the producers (and the placing of their logo on the product just before delivery).“- GaveKal
Integrated and collaborative supply chains.
Contract manufacturing, outsourcing, muli-tier distribution
Changed structures are often ignored by analysts
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6. Supply Chain- Distribution of Risk and Reward
Customers!
Component Manufacturers
Component Distributors
Contract Manufacturers
OEM
Distributors
VARs
Understanding the supply chain is core to determining the future of the company.
How is wealth and risk distributed?
What is outsourced to whom? Who does financing- is the company a bank? Should it be?
Is the issue overall health of the chain, distribution of rewards and risks at particular layer or just company specific issues?
Who can “shortcut” the chain and what would be consequences?
Who is going to loose the most if company disappear and what can they contribute to rescue?
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Rise of ABL
Cash flow lending was the main trend in the past. Today, EBITDA is much more volatile- not only reducing multiples, but also making cash flow lending unavailable in many areas.
Lending against assets becoming more used, especially where the value can be clearly determined.
Illiquid and long term assets are difficult to lend against-shorter term is easier.
“New Financial Engineering”- how to reduce the risk in transactions
Still, constrains on supply of ABL credit.
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8. Credit Insurance and Receivables Financing
Trade Receivables
% Insured
% Financed
Europe 35 5 UK 30 6 US 4
In Europe, credit insurance is extremely important (domestic and export)
The supplier may not be the one making decisions
If cover is withdrawn, company can try to negotiate with insurer (to restore cover) and/or supplier (to continue sell uninsured) IF debt is current
If the payments are overdue, supplier may not supply or risk the claim not being paid...
Receivable financing is underutilised by suppliers-they paid for taking off the risk but did not use the financing available!
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9. Working Capital Management
Loosing supplier credit is the major risk-do not provoke by late payment (but try to negotiate longer terms) and keep good communication. No supplier’s support-no deal.
Receivables are major asset- they need to be managed properly and financed were appropriate. Both quality and financibility of receivable book may be key in pre-deal due-diligence.
Manage inventories-but understand that many optimisation models assume risk free counterparties.
Analyse the product mix not only from profitability standpoint, but also working capital effect –and go out of products you can not afford
If the company is not right place for financing and risk, find one in the supply chain who can take it
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10. Redesigning the Model -Distribution example
Credit Insurance?
Factoring?
Securitisation?
What credit limit?
Sell
purchase
Distributor
Supplier
Payment
Risks:
Distributor credit risk
This risk may be highly concentrated
Customer credit risk (if distributor has little capital)
Product liability (any case)
Provides:
Marketing/Sales
Logistics
Service
Working Capital Finance?
Risk mitigation???
Diversified risk?
Low concentrations?
Single vs. multi tier?
How do you finance receivables in EM?
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Distribution example
Credit Insurance-easier to obtain?
Invoice discounting?
Factoring?
We are in Europe!
Sell
Supplier
Provides:
Marketing/Sales
Logistics
Service
Collections?
Performance risk mitigation?
Distributor-now agent?
Diversified risk?
Low concentrations?
Single vs. multi tier?
No need to finance in EM?
Low working capital needs!
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12. Why Do You Need Working Capital-Business Model?
Working Capital needs are related to structure, not necessarily value added
Supplier’s upmost concern now is risk
Learn the core lesson from banking crisis- the fact that you transferred risk on paper DOES NOT mean you transferred it if counterparty is or becomes week
Variety of legal structures to mitigate risk, while reduce working capital needs
Similar models can be applied to contract manufacturing, printing, material processing, etc.
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Example-Printing
Paper Supplier
Printer
Publisher
What business the printer is in?
What worries the Paper supplier?
What worries the Publisher?
What worries banks/factoring company/credit insurer?
Would acquisition resolve any of these?
Is there alternative model?
Whom do you need to speak about what?
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14. Supply Chain and Turnaround Financing
The supplier (even a highly distressed) is a lender, providing next step in the chain (distributor, manufacturer, end user etc.) with credit through payment terms (sometimes they are the only or main source of credit).
Buyer of the goods can effectively provide money to the seller through reduced payment terms without taking risk (providing supplier fulfilled the contract).
This may provide a workable alternative to DIP (Debtor in Possession) financing, allowing in some cases to provide funds to distressed company without being affected by possible bankruptcy procedures
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15. Supply Chain-its importance to creditors and turnaround investors
Company’s working capital needs depends from business model- and this can be changed (meaning less money needed to support the turnaround)
Instead of distressed financing of troubled company, one can often finance healthy one (such as its distributor) with the same net effect but different cost and risk
One needs to be aware of cross border differences- for example there are more solutions for financing sales to Emerging Markets from the West than for domestic financing within Emerging Markets.
Sick companies in healthy chains have much higher chances of survival than in sick chains.
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16. Why Vertical Integration?
Recent years show a global trend to “platformisation”
This was driven by lower transaction costs, supply chain coordination and general low risk environment
This is changing now, as risk is again high on the agenda, and transaction costs are up
Deals start coming - small and very large
Cost of acquiring supply chain partner may be lower than switching cost
Resolving of concentration problem- getting away from excessive dependencies.
A lot of supply chain optimisation techniques designed for a “risk free” world
In a risky world it is cheaper to have a solution within a firm- the very reason firms exist (Richard Coase, Nobel price in economics 1991)
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17. Vertical Integration- Working Capital Implications
Buying a week player up the chain- moving from concentrated non- financeable receivables book to diversified
Merged company can finance receivables- target on its own find it difficult because of operational risks.
Inventories – can be managed down on elimination of bullwhip effect and reduction of safety stock to cover supply risks
Payables. If target facing withdraw of lines from suppliers or credit insurance, restoring of these can provide immediate working capital boost.
Conclusion: Working Capital may change tremendously in a successful acquisition, providing cash boost instead to cash drain to acquirer
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Thank You and Good Luck!
Igor Zax, CFA, Sloan Fellow (London Business School)
Managing Director, Tenzor Ltd. (London)
Tel:
Web site:
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