Gloomy economic forecasts and a looming debt wall for FY17, bubbles within segments of the property and construction markets, higher banking capital to cover risk and an emphasis on safe harbour reforms for directors will see more corporate restructurings in the coming year. We consider here how plans are developed and how to judge their success.
Setting the scene
Companies are increasingly stripping away costs, reducing workforces, limiting the hours or changing the rosters of workforces and renegotiating downwards the pricing in supplier and contractor arrangements. The combination of pessimistic economic prospects, greater uncertainty about lending and the need for companies to have more equity, means that market players are drawing up restructuring plans and thinking about how they are going to implement them.
There are important factors at play: the willingness of financiers to back boards and management with transparent plans for the repair of balance sheets and profitability, the rise of alternative capital, secondary market trading, some modern challenges in security enforcements and the recent sanctions imposed on Kleenmaid directors for insolvent trading.
Each of these factors, together with proposed legislative changes to provide a "safe harbour" defence, encourage turnaround planning, and focus on saving an enterprise from an unplanned insolvency event. A good board will have early recognition systems to identify looming liquidity events, financial stresses in the business, sensitivity checks on macro changes in the business environment and a plan in place to sell assets, raise capital, change debt and supplier arrangements and generally right size costs to meet falling revenues.
Obviously events will dictate the precise issues a business will need to deal with, so the following is necessarily very high-level. The stages can be concurrent, or ordered differently, to meet the specific needs of the company under examination.
Stage One: Recognition
Distress has many progenitors. It may arise from factors as diverse as a breakdown in workforce trust leading to industrial action, a product failure or securitiesbased litigation claim, automations and disrupted markets, changing consumer patterns (including from offshore buyers), changed regulatory settings or sovereign risk, debt overburdens or looming maturities, debt accelerations brought about by market, interest coverage or other covenant breaches or just oldfashioned management incompetence.
The problem needs to be recognised so that it can be cauterised and eventually form part of the repair within the plan.
Stage Two: Stabilisation and transparency
The foundations for any successful turnaround will be:
- determining whether the business is insolvent, suffering a liquidity event or possibly has artificial imbalances capable of being resolved by accounting treatments (for example, subordinating intercompany positions to re-classify current liabilities, rebalancing foreign exchange treatments, or reconsidering aggressive depreciation strategies). Generally, imbalances will have been identified by the business before the engagement of the restructuring adviser, in which case liquidity and solvency measures will be the first lens to be applied over the business;
- assessing the short-term viability of loss-making businesses and developing a plan for dealing with the workforce, supply, trade creditor and other issues likely to arise;
- identifying immediate funding needs and investigating receivables financing, asset financing, shareholder and subordinated loans, employee priority funding and alternative business funding or capital raising programs. Many special situations funds known to restructuring advisers will be willing to assist businesses with bridging finance to help execute a restructuring plan;
- assessing management credibility and competence to undertake both a business as usual program and a concurrent turnaround business program; and
- assessing key stakeholder support and establishing transparent future information flows to financiers (existing and new), key suppliers, workforce representatives, regulators and other key parties necessary to the successful implementation of a restructuring plan.
Stage Three: Negotiation and profitability
Once the business is stabilised, the more interesting stage of the restructure can begin. It will involve, at least, these steps:
- creating financial controls - three way forecasting, quality of on the ground information inputs (asset values, asset quality, inventory controls etc) - and a robust reporting model able to disclose meaningful information to stakeholders and the board;
- making operational improvements to bring down costs, and restore efficiencies and quality of product. Often third party industry specialists can provide both the optimisation work and also give stakeholders comfort that management is genuinely trying to improve operations. This approach was very successfully undertaken by Lynas Corporation when it engaged industry experts to significantly increase production rates. Even with low rare earths pricing, meeting production targets helped Lynas come to an arrangement with its financial counterparties;
- restructuring the balance sheet to right size debt loads (or maturity profiles), divesting non-core and uncommercial assets, bringing forward tax revenue rights or raising capital. In more sophisticated models, there may be an interchange between balance sheet growth and profitability, as better equipment is acquired to improve profitability; and
- addressing structural issues, either using the moratorium of a formal administration, the consensual and court approvals of a scheme of arrangement or simply a series of bilateral agreements between the company and its stakeholders (and, in some cases, the engagement with a third party in a control transaction). Each structural change will involve a different process and deliver differing outcomes to equity, depending once more on where the value breaks inside the enterprise.
Stage Four: Implementation
No plan succeeds as a piece of paper. The restructuring adviser will build metrics to measure the effectiveness of the plan implementation across the business, reporting on successes (and inevitable failures) to the board and stakeholders. A robust model will allow for adjustments as necessary, for example to regain customer or supplier or even workforce trust.
We use the word "trust" advisedly, for the simple reason that few plans survive unless communications and strategic development are matched by an understood common and shared purpose message. For that message to be understood and accepted, a cultural change in the enterprise is often required, which in turn fosters a belief in the messaging that the business has a restored value and focus. Sometimes this messaging is assisted with branding, other times with evidence of cultural change to address any behavioral issues within the (near) failed enterprise.
This form of trust rebuild will form a major part of the turnaround plan and may run for many years after the restructuring advisers have left the building. Often this will just be the first in a series of cultural changes. Sometimes many years must pass until the restructure can be called a success.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.