Restructuring in a Down Economy
Helen Mallovy Hicks
Dave Planques, leader of the Corporate Advisory & Restructuring group, discusses some of the key differences between restructuring a company in good times, and in bad.
Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.
Helen: And I'm Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.
Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today's hottest issues related to the economic crisis. In today's episode, Restructuring in a Downturn, we'll be speaking with Dave Planques, National Leader of our Corporate Advisory and Restructuring Practice. Dave will be speaking about key differences between restructuring in good times and in bad. Welcome, Dave.
Dave: Thank you.
Helen: Dave, within the Corporate Advisory & Restructuring Group at PwC, you've helped companies in various countries and industries restructure for a number of reasons. What would you say the top three reasons for restructuring a company are and have these changed with the current economic downturn?
Dave: Yeah, there's been an enormous shift this time in terms of what the restructuring business used to be and what it is now. Probably the most pervasive issue is the significant decline in consumer demand. We started to see it last summer and early in the fall with Canadian manufacturing companies that were selling into the US housing market. Anybody selling furniture, building products — it was like somebody had turned off a shift and over a period of a couple of months, the demand turned off very quickly.
For companies selling into the US market, one of the significant problems they were faced with was, as the demand dropped, there was an enormous amount of inventory that had been stockpiled, and that stockpiling inventory exacerbated the problem that you had with the significant decline in demand. We're still watching these companies who are still on demand when it comes to US demand for consumer products, especially relating to the housing industry. The other really significant issue that everybody's aware of is the state of the credit market. There is just no liquidity out there. We're seeing some really good, big companies hit the wall because they got bond debt that they would typically just roll, and they're not in the position to roll the bond debt anymore. We get calls from large companies saying, we've got two weeks before we are gonna have to file...
Dave: ...because we're not going to be able to deal with it. The other problem you've got is that there was so much liquidity before and the banks — including a lot of the US asset-based lenders — were stepping all over each other for every deal that was out there. We've got some ridiculously highly leveraged balance sheets, so you layer on a significant drop in demand where earnings have fallen to less than half of what they were before, and tie that together with a significantly higher leveraged balance sheet, and it just doesn't make any sense anymore. So there's a number of balance sheets that have to be restructured.
Dean: Dave, with a tight economy and tight credit, it must make it pretty difficult to restructure a company in that environment. What are you seeing as far as ideas to get around this, and the challenges that are perhaps presenting themselves?
Dave: Yeah, it's tough right. I mean, it used to be restructuring was a relatively easy thing to do because there was always lots of money out there, so raising new money was always a big part of a restructuring. That's not the case anymore, in fact, it's the opposite: there is no money, and a lot of the lenders that are in there involved with companies are trying to get their money back out.
So it's become very difficult to do a restructuring. Bottom line is: you're working with what you have. Typically there isn't new money going in. The only real new money going in is either from banks who are supporting an existing client because they don't like the alternative of having to liquidate - or DIP financing, and there's only been a handful of DIP financing deals that have been done, and they've been done at really high pricing. I mean the pricing is four times what it would have been a year ago.
Dean: Which is interesting given DIP financing generally is primed right at the front of the bus of the security.
Dave: Yeah, exactly, you're taking what was always considered very secured money and you used to get a pretty reasonable rate for that. Now the concerns that lenders have "are the companies going to be able to exit", like dip financing is usually lasts for about a year. The question is: are you going to be able to get your money back after a year?
Helen: Dave, what are some of the major differences between restructuring a company in good economic times, and restructuring a company now, in these not so good economic times?
Dave: It is significantly different this time. It used to be that restructuring was very much sector focused and whether it was a forest industry, pulp and paper, mining — but now it's across the board, and there's very few companies across the board who are insulated from the problems. And there's also the issue of money, right? It used to be that what restructuring meant was new money coming in, and usually that new money came in as equity, or it came in as a different type of loan where you had the asset-based lender who had advanced more than the traditional lenders. But you have no new money.
You have wide spread problems across all industries, and you have a number of lenders and deals who need to get their money out. So when you had lenders who wanted to put new money in to a restructuring, or private equity entities wanting to put money in, it was easy to get a restructuring done. Now you've got a syndicate with five lenders, two of them may be based in the US, and both are looking to get their money back out. So it significantly changes the complexity of getting a restructuring done, but the bottom line is you're working with what you have on the balance sheet, and trying to cut a deal that allows everybody to just sit tight and ride this out.
Helen: Are you finding there are pockets of capital anywhere?
Dave: There's pockets of capital. It's very expensive, but what I see — and I've talked to a lot of the private equity people who all say they're interested in doing distress deals, but they're all sitting on the sidelines. Everybody seems to be waiting, not necessarily for the bottom, but for the uptick. They actually want to know that it's still not a continuous ride down. And I think until you start seeing more of a shift of people investing in distressed situations, there's not going to be a whole lot of liquidity out there at all.
Dean: Now, Dave, when a company breaches its banking covenants, often times they way banks are set up, they move it to what they call their special loans unit, and a lot of companies' CFOs, CEOs are not used to dealing with people in those groups. What type of advice would you give them for dealing with those types of lenders?
Dave: That's a good question, because you've got a number of companies who've never dealt with these types of issues before. A lot of them are sales and marketing focused — they've never breached a covenant in their life, they've always been able to roll their bond debt — and that's a different kind of management team: growth oriented, marketing focused management team — so they don't really understand what the banks' issues are. I mean, one of the things that's critical to the banks is making sure that you just don't make your problem their problem. To go in with an identification of the problem — a realistic identification of the problem — and table up a solution for the lenders.
Really what the lenders are looking for are focused on a couple of things. One is security erosion. If you've got a company that is going to continue to decline and eat up its working capital to fund its operating losses - that's not a good deal for the bank to hang in there. On the other hand, if you can get the company so that it's producing some positive EBITAR or positive earnings and you can show the bank that the decline in working capital — as you reduce the receivables and the inventory or sell off assets — is going to be used to pay down the bank loan. That's a much better proposition for the bank, and much easier for them to buy into. Most of the restructurings that we're doing right now: that is the proposition to the banks. My suggestion is be realistic about your current situation. Be proactive; tell them how you're going to deal with it; how you're going to address the problems, and focus on the issues that are important to them, which is erosion of security, and also debt service. Are you going to be able to continue to service the interest?
It's a crazy market right now; the pricing is way out of whack. When you look at the origination discounts that are included, some of the DIP financing is coming close to a 20 percent return. I think what that reflects is the fact that everyone's concerned about whether or not you can get an exit on a DIP financing a year after you put it in. Also, a lot of the players have backed away. There were a lot of big players in DIP financing that used to be there — a lot of the US banks — they're not there anymore. There are some distress US hedge funds that have stepped up to the plate on DIP financings.
We've seen a couple of the large US banks lead some DIP financings, but they've been at very high rates. It'll be interesting to see how this market changes, I mean DIP financings are fairly secure financings, and probably don't justify the kind of pricing they're getting right now. It's just really a function of the lack of credit that's out there. I'm hoping that some of the Canadian banks are going to come forward with DIP financing in the next little while. I've talked to a couple of banks who said they're interested in getting into that market space. I think that we'll see a big shift over the next three or four months in terms of the availability of DIP financing and hopefully a decline in the pricing.
Helen: Tell us some of the things you're doing with your clients.
Dave: It's been really interesting trying to work restructurings in this environment. I have one significant manufacturer who sells into the US market. A good sized company; did a high-leverage deal - had never had a bad earnings quarter, let alone year. And in the last six or seven months, their earnings have just absolutely plummeted. They breached covenants all over the place. And it's a syndicate of lenders, and right now, if you have US and Canadian and European lenders all in one syndicate, it can make for some awkward discussions because everyone's got a different view. I think clearly the US banks have a much more pessimistic view than the Canadian banks do. So we had some lenders who just wanted to take their money and go home, even though it meant significant losses. We had some Canadian lenders who were quite supportive, only because they didn't want to take the hit right now. Their belief is that this will pass, and that if you restructure the company properly, that it'll come out the other end, and that they'll still have a client on the other end.
So it made for very difficult discussions and negotiations. There's barely enough money to service the interest, so all of the lenders have had to put their capital payments on hold and they've had to actually defer some of their interest payments. But at the end of the day, it's actually interesting because forbearance agreements that used to only be six months long have actually gone longer in length. The forbearance agreement on this one is a year, and everybody's suggesting that at the end of the year - the documents suggest that at the end of the year - they'll be sitting down to enter another forbearance agreement. So where the banks used to think of restructurings about a short period of time, now they're thinking of a much longer period of time, which says to me they've decided that they're going to support the companies. It's actually been great though, because we've been able to make all kinds of operational changes and working capital changes. It's been really interesting to see how these restructurings move forward.
You know, once you have the banks all on side, there's a great opportunity for companies to fix up a lot of things that they've had problems with. We've made significant reductions in the working capital and used that to repay the debt. We've closed down a couple parts of the operations that were losing money. So I'm thinking that the company will actually be in good shape after the end of the year. May not be back on side with the covenants because of the high leverage, but it will be in significantly better shape than it was at the start of this recession.
Helen: That's great Dave, good to hear a positive story in these challenging economic times. Are you finding that banks are becoming more lenient or more willing to work with their clients when they break, or come near hitting their covenants?
Dave: I think it's partially a function of the management team, partially a function of the banks' view on the industries. I mean, there are some industries where it just doesn't make sense for the bank to support them. They don't see anything but a continuous security erosion. And if that's the case, then they are actually exercising their rights in realizing on their security. But I think for a lot of companies the banks are being quite supportive right now, believing that if they hunker down with their own clients, and ride this out, they will still have these clients around after the recession's over. And a lot of them will be in better shape than they were before they started.
Helen: And any hints or advice on how to get your bank on side, how to work with your banker?
Dave: I think that the best way to get your lender on side is to show them that you get it. That you understand the situation that you're in. That you've got realistic projections, realistic forecasts, and that you've got a plan to deal with it. And instead of delivering up problems, you go into the bank and you say here's a problem, and here's a solution.
Helen: Are you finding clients are reluctant to deal with that, reluctant to recognize that this economy outlook isn't what it was before?
Dave: Oh yeah, yeah. I mean, they've got to be hit with several months of continuous decline in demand before they really come to grips with how bad the problem is for them. But we've been in this recession for long enough, or in this downturn period for long enough, that it's starting to sink in. And now companies, I'm finding, are much more willing and able to move forward with a restructuring plan and move forward with trying to cut a deal with their lenders in these bad times.
Helen: Dave, is there anything you can do to help on the strategy side before a company hits the wall with its bank covenants and its financing?
Dave: Yeah, I mean to a certain degree, you can avoid some defaults by changing the way you operate. I'm working with a company right now and one of the things we're doing is cutting out the non performing parts of the business. So we're actually closing down a couple of joint ventures. So it may mean that you have a short term breach on an earnings covenant, but what you can do is you can show the bank that you've addressed it and that you'll be back on side. The other thing is creating liquidity. I think right now a lot of the banks are used to covenant breaches, or they're going to get used to covenant breaches as the fourth quarter results are tabled, but at least if you can show the bank that you're not continually bumping up against your operating line, that you've got decent liquidity, that it's easier for them to support. One of the ways you do that is by selling off or reducing your working capital; sell off some non-core assets and try and create some additional liquidity for yourselves.
You know the other thing that a lot of companies need to do is look at forward contracts, joint venture partnership agreements that they've got, all those sorts of things and figure out what they can do to best position themselves. So I think it's a big question with a myriad of answers to it. There are heaps of things that you can do to better your position before you go in and talk to your lenders. Again, one of the things I would say though, is a lot of companies have not gotten to the point where they're realistic about what they see going forward; they're still talking about increases in demand, and this current environment could be with us for a little while, no one knows.
Dean: So any company going in to their lender with a hockey stick kind of forecast probably shoots their credibility down as soon as they walk through the door.
Dave: Yeah, absolutely. The banks are looking for credibility. What they want to know is that the management team understands the situation; that they get it, and they're prepared to deal with it. And, you know when you have management teams who've always been focused on optimism, sales and marketing, sometimes that's not what you get.
Helen: Dave, what would you be —- what's the right time for a company to be taking action? When should they be calling you in to help them?
Dave: Whether it's with us, or whether they've got the resources to do it internally, but I think everybody should be taking action right now, I mean there's very few companies that have been insulated from this. Whether they're going to breach their covenants or not, they still need to do whatever they can to stem the losses, and better manage their working capital. So I would say everybody needs to do this right now. If you do know that you have a covenant breach, there is a lot of merit, if you don't have the resources internally, in hiring somebody from the outside to help you position yourself with the lenders, make sure you've thought about all the strategic alternatives that are available to you, and help with the implementation. Implementing a restructuring plan that is a big departure from what a company has done historically takes a lot of work and a lot of thinking through, and so a lot of companies are engaging people to help them actually think through their implementation plans, whether that's closing down plants, or just doing something internally.
Dean: So Dave, I guess listening to your answer there, it seems like the PwC restructuring strategy is really to get involved a lot earlier, and I'm assuming that by getting involved earlier, it leads to more positive outcomes on the other side.
Dave: That's what we're looking for. There's been a significant shift in thinking here, especially with the problems that we've got, to try and help companies stay away from significant accidents and significant problems. The earlier you start on that, the better off you're going to be.
Dean: And I guess a term that's kind of picked up interest over the last few years is what they call a CRO, a Chief Restructuring Officer. And you talk about companies restructuring; making hard decisions — what role would a CRO play in that?
Dave: Well it's interesting. Every time the bank sees a management team that they don't think gets it, that's talking about the hockey stick recovery on demand, or not being prepared to deal with - to make the hard decisions and implement them, the concept of a Chief Restructuring Officer comes up. There are not a lot of Chief Restructuring Officers in Canada; most of the good ones are quite busy right now. But a Chief Restructuring Officer is somebody who's been through this before. They can make the hard decisions, and has no emotional attachment.
A good Chief Restructuring Officer also has a very good understanding of what the banks what, and what the banks are looking for and can sort of bridge that gap between differences of opinion. There is a big role for Chief Restructuring Officers, I'm just not sure that there's enough of them available. There's a lot of people out there that will put up their hand and say "I'm a Chief Restructuring Officer, I've been through a restructuring," but there really aren't that many out there.
Dean: So if we could clone them, we'd really have a good business model, wouldn't we?
Dean: Well we're almost out of time, Dave. With your few remaining moments, is there one piece of advice you'd like to leave our listening audience with?
Dave: Yeah, be realistic and be proactive.
Helen: Great advice, Dave. One last question: how are you helping your clients manage through these turbulent times?
Dave: You know, our role has become very much a hand-holder. Taking companies who have never had to deal with these kinds of issues and helping shepherd them through it. That is probably the biggest role that we're taking on right now, or the most significant role that we're taking on right now. We've been helping a lot of companies sort of work their way through issues on restructurings that they've never had to work through before, and we're helping them make the difficult decision.
One of the biggest benefits that we provide to the company is our credibility. You've got a practice that's full of people who've been through lots of restructuring, lots of insolvencies, who have very tight, good relationships with the banks, and understand how they think. We also have good access to capital markets, although there's not a lot of liquidity today, hopefully it won't be that long before there is some liquidity again. We have an all encompassing approach to restructuring, so we can handle the performance improvement side, we can handle the new money side, and we can handle managing the relationships with the banks, and helping the company implement a restructuring plan. It's a very broad approach to restructurings in the way we think about them, and we've had great success in the last little while.
Dean: Thank you Dave for your simple, honest and practical approach to restructuring in a down economy.
Voice over: Tune in next week for another episode of Strategy Talks. This episode — "How Will a Recession Affect the Value of My Business?" — will feature Ken Goodwin, a Partner in the Dispute Analysis and Valuations group at PwC. Ken will talk about valuations, and how your business might be valued differently in a tight economy. Here's a sneak preview of what Ken has to say.
Ken: You know, valuation is a matter of judgment, and as you put it, two corporate finance professionals or two evaluators are going to have a different opinion. I think what we try to bring to the table is a level of pragmatism - let's look at the facts, let's see what evidence is out there, and we have to make a decision based on the evidence that is there.
Voice over: Learn more about how PricewaterhouseCoopers, and in particular the PwC Restructuring and Distress Strategy group, can help your business restructure in these challenging times. Visit the PwC Managing in a Downturn webpage at pwc.com/ca/managinginadownturn.
Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, thank you for listening.
Helen: And I'm Helen Mallovy Hicks. We hope you'll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at pwc.com/ca/managinginadownturn.
The information in this podcast is provided with the understanding that the authors and publishes are not herein engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009, PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network. Each of which is a separate and independent legal entity.