TMA Round Table Meeting - in conjunction with BREAL Zeta and Gateley Legal

Gateley Legal’s Offices, King Street, Manchester, M2 4WU

Date: 9 November 2022

FLYING IN A PERFECT STORM - THE NORTH WEST OUTLOOK FOR 2023

A look ahead to the upcoming market developments, challenges and opportunities for the turnaround market in the North West.

At the table 

Stuart Tait – Gateley [Tait]

Annabel Todd – BREAL Zeta [Todd]

Michael Magnay – Alvarez & Marsal [Magnay]

Frank Ofonagoro – Quantuma [Ofonagoro]

Tom Weedall – Blazehill [Weedall]

Chris Hall – Hilco Global [Hall]

Sean Powell – Secure Trust Bank [Powell]

Charles Shepherd – Barclays [Shepherd]

Bill Dixon – ME [Dixon]

Tom Jack – Endless [Jack]

Navigating The Challenges Ahead

[Todd] Today, management teams face a particularly challenging set of circumstances which they will not have experienced before. As businesses emerged from the pandemic with a distinctly more positive outlook, they were hit by an array of unprecedented factors, from spiralling inflation in fuel and energy costs to rising interest rates and falling demand. Now we see that consumers are trading down everything they buy – in food and discretionary spending. So you’ve got businesses trying to react to falling demand, but they’ve also got soaring wage inflation pressures. For management teams, it has been a tough couple of years, with fantastic support, but now there isn’t going to be that follow-on.

[Jack] Businesses have been hit with massive price increases, raw materials, labour shortages, and changes to consumer buying behaviour and have been caught cold. So, what is their contingency plan? Do they have enough headroom and liquidity to manage through the next hurdle, as there may not be another?

The Risk Of Stalling Through Inertia

(Ofonagoro] Many management teams are finding forecasting extremely difficult based on the past few years’ performances, if not nigh on impossible. We've found that where businesses have gone down the distressed line, there has been some inertia in their management teams. There’s a lot of waiting to see whether there will be another potential re-financing, as opposed to the management team acting proactively to future-proof the business while they still have time. We’re seeing quite a lot of instances where people are saying, “you’ve made some really good points, but I’ll go away and think about it for another few months before taking action”. 

[Tait] Corporates are either seeking avoidance, rather like an ostrich with its head in the sand or, even if they are slightly more open to forecasting, the directors are not in the right mindset to look for solutions and plan a route forward. I expected that we would be getting more company-side engagement at this point, but our flow is very much on the lender side on security reviews and light touch planning at the moment in readiness for when things do develop.

[Magnay] The inaction from management teams is probably forgivable, isn’t it? For the past 2 or 3 years, every business has had endless government support packages, they have had HMRC, landlords and creditors unable to take any enforcement action, so they have been able to bury their heads in the sand with no consequences. Even though it’s a relatively short time, people have probably got used to that environment and are now thinking, ‘we know we’ve got a problem but if we just sit here long enough there is a decent chance that somebody will come along and prop us up again”. The potential for widespread business failures across the economy over the next few years looks unpalatable to a government with an election coming up in 2 years. 

The counter to what I said earlier is that, in reality, there are now greater consequences than ever of sitting and doing nothing. For the last 15 years, with no inflation, low-interest rates, etc there have been no unlimited consequences for not acting. Now, with interest rates ticking up and with inflation running at say 10%, there is a genuine cost of sitting on your hands and doing nothing. 

[Tait] Restructuring is downside mitigation. People see the cost, but they don’t always see the upside at first because it’s reduced downside, so that can sometimes be a barrier to businesses engaging with advisors.

[Ofonagoro] Going back to the inertia point, being able or knowing where to go to seek advice, including your financial stakeholders is important. It’s just being aware that the owner-manager who for the past 40 or 50 years has been used to coming up with the answers themselves, cannot always be expected to go and seek help proactively. However, there are far too many headwinds and challenges not to try and change that mindset and encourage business owners to go ahead and seek advice.

Managing Shorter Runways

[Hall] We’ve noticed over the past 12 months or so that runways are getting smaller and shorter, so now is the time for management to be on the front foot in planning for these kinds of situations.

[Todd] In the past week, I’ve had three transactions that have come in direct where the incumbent banks are fairly aware of how deep the issues are. However, it feels as if the last people the companies are talking to are the banks and their lenders. They are trying to sort out HMRC, they are trying to sort out the creditors, but they’re not engaging so when these issues do come to light, there’s little or no runway. With a lot of deals, we’re now seeing very specific numbers in terms of the availability required as well as asset classes that wouldn’t necessarily have been mentioned in that security in the past, such as intellectual property.

[Tait] On the company side everything is coming in too late. If you’re doing a first directors’ duties call, where there is already a winding-up petition from HMRC, it’s a very different conversation. You might look at an exit plan and consider that it will take six months. Now we’re looking at situations where everything’s been pulled, and you have probably got one or two months at best to start to manage the situation.

The Pivotal Role of the Co-Pilot

[Dixon] It would be better if we got to companies earlier in the curve. What I’ve found interesting in the last few years, I’ve got 2 clients now where I’ve completed the work with them, and they’ve asked me to stay on. They want me to listen, attend board meetings, be a sounding board and give an alternative view, and they might give me a call to ask how we should attack this. So you have got these companies saying, “I appreciate the value of the way someone else thinks now and I am going to keep that going.” So, it’s a way, as a profession that we can promote a kind of non-exec role, to the extent that they have somebody who’s there who can challenge management, give independent views and watch out for things on the horizon.

[Weedall] Time, liquidity, lack of asset cover and capability of the management team are all key issues. As a lender, I often think it would be good to get more hands-on in the business and maybe put an interim in or somebody to be our eyes and ears because there is a lack of expertise or experience from management to navigate through the issues they are facing.

[Todd] We’ve found that in terms of management, it’s not just necessarily the financial interim that is required or a bolstering of the finance. It’s C-suite in general because I think management teams being pulled in every direction on a board of three people, is no longer viable. They need to have that additional capacity to get a grasp of what is going on. And I think to your point, more and more wanting to keep people in there as your eyes and ears to bolster that team.

[Jack] Our mantra is that you sleep a lot better at night when you know you’ve got a good management team and that is the case. You know if a business doesn’t have the right team leading it, somebody needs to help that team. It might be a chair or a sponsor that can make those decisions or it’s a TMA turnaround or restructuring person with experience who says right – we need to sort this out. Having good networks of turnaround directors who can support lending, PE or corporate situations is important because the options are fewer and if time is constricted then the options are dramatically reduced. Management doesn’t have the experience to navigate through. 

[Magnay] You’re also assessing the capability of management not just to run the business on a business-as-usual basis but with a view to what you think the next 2 or 3 years look like and whether they’ve got the skills to get through that tough period.

New Dynamics For The Headwinds Of Change

HMRC

[Dixon] National policy is that it was going to take 3-6 years to recover from Covid for businesses because that is what the government has guaranteed debt for, but HMRC is saying that 6 months is enough and that has got to be fundamentally changed. That said, the market is reacting in my world. I am seeing that creditors are doing what they can to support businesses by offering deferment repayments.

[Tait] The HMRC point interests me as there is such a disconnect in terms of policy. We saw it in early Summer when there was such a massive ratcheting up. I sense that HMRC was starting to feel that it was being treated as a mezzanine lender and needed to make a point. It feels like they have pressed the accelerator too hard and there is at least one round of good businesses that have been hit with winding up petitions who may not dig out of that. There is this sense of need for the government to make examples to try and re-base the position to not allow everyone to get away with it. That is fine as long as there is the bandwidth within those departments to work out those situations and make commercially rational decisions and that is not necessarily forthcoming. I hope that we’ll see some more balance coming through the government position and government debt enforcement that won’t be quite so draconian.

[Magnay] There is a realistic prospect of a cull of all those zombies that we’ve been talking about for the past 10 or 15 years, with interest rates, with higher leveraged businesses obviously but even in the SME spaces as well. The reality is there are a lot of really poor, inefficient businesses that have just been surviving through the benign economic conditions we’ve had for the past 15 years. The government can’t continue to prop up these businesses any longer, can it? Global factors are driving inflation and interest rates beyond the government’s control and it’s the interest rates in my view which will kill a lot of these zombies.

Credit Insurance

[Dixon] There’s a liquidity crisis through stealth coming up, which a lot of companies don’t realise. You’ve got companies now whose credit ratings are going down, credit insurance is being removed both on a company and a sector basis and at the same time, the prices are going through the roof. So how are they going to get the working capital to run their businesses when the cost of living is costing £1.5m and they only have £500k credit limits? I think credit insurers in particular are getting very aggressive, they are going to have the Triple A debt books and next year I think that’s all they’re going to have for the premium. For one of my clients, I’ve said, “You’ve got to shrink your business, it’s too big for the credit you can get from the market, you’ve got to come back and bring your turnover down by 25-30% so you will be able to live in this world.” I don’t think that has hit people yet.

[Todd] The wider issue with credit insurers is the blanket decision across a sector. So it can just fall away in one press of a button and businesses simply don’t know they haven’t got visibility over where their insurance sits.

[Tait] Everything becomes very binary. There’s no nuance involved but I suppose that has to be the case as people don’t necessarily have the bandwidth to consider the implications of every single variation.

[Ofonagoro] There are still quite a few self-help remedies that management teams can employ. Sometimes provisions will take the credit rating into account. If it has fallen, then the level of deposit they’re going to ask for will be higher. So what are the drivers of credit rating? It can be things as simple as filing your accounts on time, which can result in a tangible impact on cash performance.

Crown preference

[Hall] The re-introduction of Crown preference sucks so much liquidity out of small floating charge deals where that used to be a very good source of availability on refinancing – that has pretty much gone now. 

[Magnay] Crown preference has completely changed the stakeholder. We’ve seen it on a couple of insolvencies, where we’ve been sat with the lender saying, if you want us to take an appointment here then we need some kind of funding in place as we’re just not sure what the realisations are going to be for various reasons. On both occasions, not unreasonably, the lender has come back and said, “Am I going to get a penny out of this administration?” And the answer on both occasions was “no”.

Stock overhang

(Todd) One of the other massive challenges that businesses have had to face up to very quickly is a huge stock overhang. As demand has dropped, from the other side of the equation, demand has fallen away and businesses have been left with enormous inventory overhangs that need knowledgeable operational skills to be able to negotiate with the supply chain, manage intake differently and plan for what next year is going to look like. 

[Magnay] The point you make about stock is spot on. In at least two instances, we’ve seen that the value of stock is eroding, whether you’re talking about retail, selling last season’s stock to flip through the wrong season or holding it for 12 months. We’re working with a steel stockholder who decided to go out and buy steel due to global supply chain disruption. Demand has tightened, they have bought too much, and the value of steel has since come down materially.

Shifting demographic
(Todd) When you consider that an increasing number of over-fifties are exiting the workforce, it’s a segment that has the greatest amount of experience. Their businesses traded through the last financial crisis, so they know what needs to be done. However, if the business starts to go through a period of stress in this cycle, then the temptation for them might be to retire early or go part-time. So it’s important that businesses focus on making sure they retain that experience, especially through difficult times. 

Preparing for a Steep Descent

[Todd] When you look through our book, there are several businesses that have reported record years. There’s a striking a disconnect between their financial results and what’s happening in the news. But there is always the underlying concern that for some businesses going into 2023, the external issues we’ve mentioned will have an impact on their businesses. With interest rates increasing problems may start to crystallise. In Q3 the banks as a whole were provisioning for losses across the board so they are anticipating that these may increase.

The Fear of Conceding Control

[Hall] I think one of the problems for a business owner is the fear of giving up control of that business to an advisor. They may think “Once I’ve done that, my destiny is out of my hands” and I think that is very difficult but once you’re on board with a client and they begin to trust you, that’s when they can see the value.

[Ofonagoro] The way I try to redress these things is as you start to go down the demise curve, the more you run the risk of losing the agenda. It then becomes the lender’s agenda, it becomes the creditor’s agenda, and it sometimes goes back to being a cost agenda, particularly if trying to leverage, for example. The way we frame it is you’re not giving control to us; actually we’re trying to help you regain control of the agenda to take charge of your destiny.

Preparing the Flight Path Ahead

[Magnay] What’s interesting for me as a restructuring advisor and an IP is that if we look over the next 2-3 years, I suspect we all expect it’s going to be a pretty rough 2 or 3 years and that there is going to be material uptick in insolvency and restructuring as a consequence of that. That’s interesting for us if the liquidity remains in the markets, so you have solutions to deliver. 

From a UK economic perspective, if we do have a period of reckoning for a few years then that should hopefully lead to a more efficient, more effective, more productive economy coming out the other side of this. Painful as it might be the next few years, long term it should be for the better. 

[Tait] I can’t see any way that the market shouldn’t develop quite rapidly now. If, as stakeholders, we can encourage directors to think as much as they can, even if they don’t have a complete answer, then that’s where we’ll have the best opportunities to add value in restructurings when the storm breaks.

[Dixon] The next few years are going to be a different type of turnaround world. Businesses will probably be more heavily geared when they come out of this because that is the way they’re going to get through this. 

(Todd)  There’s no doubt that we are going to have to come up with creative solutions to work with businesses that have never gone through what they’re about to experience. That said, in the next couple of years there should also be significant opportunities for those businesses that have the liquidity and the resources, particularly in terms of funding strategic bolt-on acquisitions. 

What we try to talk to management about, is that dynamic of bringing more to the table than just cash, it’s an investment for future growth. While there’s a temptation for businesses to hunker down, I’d like to see management teams looking beyond the short term to the medium term. The concern otherwise is that key areas such as ESG go on the back burner as companies tighten. In a few years, the danger is that this is going to start feeding through to the supply chain. So there are areas where businesses can look to invest sensibly, whilst maintaining liquidity to see them through the downturn.

The good businesses, those that are leading in their sub-sectors, will always be able to access capital. However, there are big differences between businesses that are trading ok, those not growing the way they want to and those that are under pressure and becoming more stressed and in need of TMA help.

TMA members are ideally placed to help management teams in these situations, having a breadth and depth of experience in dealing with complex challenges and uncertainty. It’s about getting our sleeves rolled up to help those businesses navigate through the downturn and thinking creatively and collectively about providing solutions and being able to access the relevant skills and expertise from the TMA network.