Posted: 03 Sep, 2019
Executives from Gordon Brothers offer tips for recovery in this complicated global environment.
As our economies become more and more global, we have entered a new era of cross-border transaction structuring. International lending and liquidation are becoming more prevalent and lucrative. Liquidation strategies are scoped across oceans and continents to maximize recovery values. As lenders, this is an important moment, where creative thinking about values and exit strategies can uncover a whole new realm of possibility to put capital to work. But in order to do so, it’s critical to understand the dynamics at play and how to recover in this complex, global environment when necessary to do so.
In 2019 the overall global economy continues to grow, despite a slow-down from advanced economies, trade skirmishes between the US and China, looming European trade calamities theorized from a no deal Brexit, and an increase in nationalism and populism in many countries. Within this tumultuous economic environment, how do lenders recover on assets within and across international borders with a reasonable degree of confidence? How do investors mitigate inherent risk in such ventures while finding the proverbial diamond in the rough? The answer can be found in another question: how do you capitalize on accelerating mining activity halfway across the world to recover on idle equipment sitting in the Amazonian rainforest?
To execute a deal like this one, investors may face a multitude of logistical pit-falls, jurisdictional headaches, legal road-blocks, and operational quagmires. But it is possible, increasingly common, and at times quite rewarding. However it requires the alignment of a number of factors to realize untapped value. Below we detail the necessary conditions that can make complex, cross-border asset recovery a valuable opportunity, as well as the appropriate strategies to successfully underwrite and recover on industrial equipment assets.
In-Market Asset Recovery Limitations
Buying assets, whether abroad or domestically, and transporting them to a seller is not ideal, especially when those assets require disassembly and reassembly. Typically, sellers inspect and purchase assets in situ and incur any transportation costs themselves. Asset relocation strategies are generally only pursued by owners that fear a future competitive threat from selling assets in-market. Disassembly and transportation processes intrinsically lower an asset’s value, so are only outweighed by mitigating a competitive risk, or outsized rewards from selling abroad. This second scenario is increasingly common today. With continued globalization, we are able to widen the scope of investment, and divergences in economic conditions and sale prospects are increasingly apparent, and often promising.
For example, in the Amazonian equipment deal, a perfect storm of economic conditions shaped the exit strategy. In the run-up to the 2014 FIFA World Cup football (soccer) competition and the 2016 Summer Olympics, Brazil embarked on a monumental building and spending spree. Just a few years later, the country is now left with unfinished projects, vacant stadiums in remote locations, large deficits, and a surplus of construction equipment. A deep recession has resulted from the overspending. This recession is largely unique to Brazil amongst other large, developing countries. With dwindling public investment, many of Brazil’s large construction contracts have run dry, forcing many construction companies to suspend or abandon operations and mothball equipment. The country has a surplus of heavy equipment with limited prospects of large infrastructure projects to prompt operators to resume operations or capital to fuel purchasing. There is a very limited domestic market for many of these assets, and a lack of liquidity for those operators who are in need of equipment.
Opportunities in Foreign Markets
On the other side of the world, in a vastly different domestic economy, Australia’s mining market is growing. In the remote region of Western Australia, Australia’s mining sector has played a significant role in fueling China’s economic engine. Mineral exports comprise 35 percent of Australia’s economy, and Australia has become the world’s largest exporter of iron ore and coal. But Australia’s equipment supply has not recovered from the contraction that followed the latest decline in mining only a few years ago. After a mining downturn driven by depressed commodity prices and the completion of numerous infrastructure projects, the Australian mining and construction industry is enjoying a resurgence driven by government spending and rebounding commodity prices. In Western Australia this growth is highlighted by gold and lithium, the latter promoted by the rise in acceptance of electric vehicles. Additional major project investment in iron ore by BHP and Rio Tinto has further fueled economic stimulus in the region.
A lender looking to recover assets significant to mining and road construction today will find a market hungry for used equipment all but unavailable in Australia. This divergence in equipment demand held the key to recovering on the idle equipment from Brazil, unlocking significantly more value for the seller by transferring them to the buoyant Australian mining market.
While the stars aligned favorably for this transaction, similar scenarios are far more common today and in the recent past than many investors may appreciate. As business chases favorable manufacturing conditions to new markets, demand for equipment goes with it. For example, as the North American paper and printing industry wanes, used assets can achieve strong sale prices in regions where the industry is growing, such as China. The same goes for textile manufacturing assets, which were sold out of the US into Asia in the 1980s and 1990s, and construction assets being transferred out of the UK following the global financial crisis and sold in Australia, which was relatively unaffected by the financial collapse. As new countries become developed and grow at different rates, manufacturing, and the equipment assets required to support it, move into those countries, supporting robust used equipment prices.
The Promise of Change
International markets are in constant flux, perhaps never more so than today. Looking ahead, there are many existing factors that may drive divergences in asset recovery opportunities. Eurozone economic trends are slowing, with imports growing and exports falling. Italy has entered recession; Greece has never fully recovered from its economic collapse in 2008; France is roiled in political protests; and all of Europe is holding its breath over the ominous effects of an extended Brexit negotiation. In China, economic growth is likely to continue slowing as a result of multiple Chinese companies defaulting on domestic renminbi loans and bonds, as well as difficulties from US tariffs.
The impact of all these factors is yet to be seen. As shown by Australia’s persistent growth following the global financial collapse, some markets may prosper and serve as favorable recovery environments for used equipment assets. On the other hand, pervasive uncertainty may buoy demand for domestic used equipment as companies hesitate to commit to expensive new investment and instead take a wait-and-see approach supported by less costly, used assets. While the recovery strategies will vary and inevitably grow in complexity, it is important to keep watch on how asset values are trending in the lead up to whatever is next so investors are not caught flat-footed. As lenders continue to underwrite cross-border asset-based loans, the following exit strategies and considerations can serve as a guide to ensure maximum coverage and more predictable recoveries if and when distress strikes.
Mitigating Risk When Importing and Exporting Assets
There are a plethora of conditions and variables when attempting to buy, transport, and sell assets across multiple nations and geographical locales. From afar, the process appears daunting, an intricate orchestration that could succumb to any number of legal or logistical hang-ups. Amongst all these considerations, first is the question of viability: is it worth it?
Modelling the costs and recoveries requires particular expertise with respect to the actual methodology to relocate the assets, and understanding the selling market well enough that there are no surprises. In some case, scrapping or writing-off assets that are unsaleable locally may be the best course of action if the cost to transport them is too high and the likely recoveries too low. Appraisers should assess whether the demand for imported assets can hold up against similar domestic assets. Transactions of this kind can also take much longer than a domestic sale, so understanding the likely direction of values near and medium term is equally critical. Finally, lenders should understand the actual costs to disassemble, export, import, and reassemble the assets. Without the proper cost-benefit analysis, the risks might be too high; that is an important question to have answered as part of the diligence, underwriting and monitoring processes.
Essential to successfully executing the international transfer of assets is a fundamental understanding of the political and business climate of the countries in which the transfer will take place. There is no better way to attain this understanding than to rely on trusted local partners with on-the-ground contacts in-country. Local connections and trust can make or break a deal once the wheels are in motion. While many domestic-only providers may have the local connections needed to facilitate in-country, they are often limited when it comes to the other side of the equation—selling the assets out of market. The ideal partner or assortment of partners requires deep expertise and relationships at each point in the transaction stage and in every market involved.
Insurance and Guarantees
In addition to creating and promoting trusted local partnerships, businesses should take sensible security measures to ensure the proper transfer of assets once officially exported and received at the port of landing. In countries where purchasing the assets outright is required, the process of paying and then receiving goods can be a complex one, fraught with legal risks and numerous tax considerations. Additionally, making sure the assets meet the conditions and regulations upon arrival at the destination is crucial to keep unexpected costs to a minimum. Investors should rely on insurance policies or contract with vendors that can guarantee the exchange of goods or the delivery of the services necessary for successful import.
Market-Specific Legal Expertise
Immense effort is needed in analyzing transaction structures, especially when importing or exporting assets. Across countries where common law is in practice, such as the US, UK, Australia, Hong Kong, India, Canada, Israel, New Zealand, Ireland, and South Africa, transaction structuring is often more straightforward. Operating as agents of the seller and refined auction processes make this process fairly smooth in countries like the US and the UK. Issues of transferring titles and transaction structuring take on a new level of complexity across differing legal systems, however. Countries where civil law is practiced include Brazil, China, Denmark, France, Germany, Italy, Mexico, Russia, Spain and Sweden. When approaching cross-border deals, it is important to engage attorneys that specialize in the local legal system. Developing a workable structure is half the battle.
Additionally, many countries have government imposed limitations or regulations on particular assets that need proper indemnification before they can be imported or exported. For example, importing machinery and equipment into Australia is regulated by strict biosecurity laws that help to protect indigenous plants and wildlife. These laws help to keep potentially harmful soil, seeds, plants, and animals out of Australia and require equipment to undergo a rigorous cleaning process before it can be imported. Such considerations require coordination with various domestic governmental agencies. Additionally, many materials are regulated internationally by NATO or European Union countries because of their dual-use status. These materials are civilian assets, such as lab equipment or products made with specialty metals and alloys, which may also have military or weapon applications, and therefore have export restrictions or bans. All of these considerations require lenders to consult specialized legal counsel when looking to recover and or transport assets internationally.
Recovering assets in the manner described above is not routine for lenders, but recognizing opportunities to structure loans and ensure asset coverage in creative ways can yield unique profits. Lenders who find themselves in the midst of underwriting against or recovering on cross-border equipment assets should monitor logistical and economic trends globally. A golden opportunity may lapse because of uncertainties in the chain of delivery, or a lack of clarity on emerging recovery trends across different markets. When attempting to recover or lend against assets under complex, global conditions, creativity, due diligence, and strong partnerships are the key to success.
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