Description
During this information in regard to buying an underperforming company in the balkans.
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Buying an Underperforming Company in The Balkans
By Hugh C. Larratt-Smith, MBA
For the past 20 years, companies in The Balkans have not been on the radar screen of
most private equity groups.
It’s not that The Balkans lack comparative advantages. The
wage rates in the region are up to 75% less than Western
European nations. Education levels are high and the
workforce is relatively skilled. Many professionals and
middle managers have proficiency in numerous languages
– it is not uncommon to meet people who speak three to six
languages. The Balkans is within 1,000 KM of 170 million
consumers. Transportation links are good. Two of the four
Balkans nations, Slovenia and Croatia, are in the European
Union. Serbia is targeting to join the E.U. in 2020.
What has held back private equity groups is the historic
opacity of corporate laws, particularly bankruptcy legislation.
In many countries in Southern Europe, the legacy corporate
insolvency regimes have impeded the restructuring of firms.
Many countries have provided excessive protection to
existing shareholders, and have failed to provide adequate
rights for creditors. Often times the SME has become
completely uncompetitive by the time creditors get a voice.
As we all know, time is the enemy when a SME is failing.
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But things are changing. For example, Slovenia has drafted
an amendment to the insolvency law to bring the insolvency
regime into line with international best practices. The
overarching goal is to facilitate the restructuring of viable
SMEs.
A key feature of the amendment is the compulsory settlement procedure with the
absolute priority rule which prevents existing owners from blocking the restructuring
process. If the equity in the debtor is zero, then the SME can become a candidate for
sale or investment by a financial or strategic player.
In addition to legal reform, Slovenia privatizing a number of state owned companies.
Many of these companies will be of interest to private equity groups.
In Serbia, up to 180 state owned companies are scheduled for privatization in 2014.
Indications are that the companies will be shepherded through pre-packaged
bankruptcies to cleanse the balance sheets before the sale process.
Many SMEs in Slovenia, Croatia, Serbia and Montenegro have inherent strengths. From
the early 1990’s to the onset of the global financial crisis, numerous medium sized
companies in the region established a record of growth that few other EU regions
matched. However, when the crisis hit, economic growth virtually collapsed. Demand in
Europe, which accounts for the majority of exports, fell sharply and remains weak.
Business financing decreased significantly. Many SMEs were unable to reduce their
cost structures in lockstep with the decline in revenues, resulting in excessive borrowing
to finance losses.
However, many of the attributes that made the region so attractive prior to the crisis
remain intact.
The Balkans have a number of “broken wing” companies with problems that are clearly
identifiable, can be remedied and are attractive candidates for fresh equity capital.
Some are “good income statement, bad balance sheet” companies. Others have been
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unable to finance new production lines, new products or geographic expansion, so their
growth has been hindered.
What Are Distressed Investors Looking For?
Many people approach Trimingham, saying that they want to buy a troubled company.
When we show them a troubled company to buy, they look at the financial statements
and exclaim “Wait a minute – the company is losing money – why would I buy a loser?”
But smart buyers know how to look through the existing situation and glean the real
value.
There are three types of distressed investors: 1) wealthy individuals; 2) strategic
players; and 3) private equity and hedge funds.
Wealthy individuals usually invest in companies that are in their comfort zone. Often,
wealthy investors are entrepreneurs who own or have sold their companies. They invest
in distressed companies that are in similar industries or market niches that match their
experience. They will rarely stray outside their comfort zone. For example, if the
entrepreneur was successful in the dairy sector, the chances are he/she will invest in
dairy opportunities. The odds of that wealthy person investing in a troubled systems
integration company are low.
Strategic investors typically invest in a distressed company when it is insolvent and
being liquidated. Most strategic buyers are uncomfortable buying a going concern with
lurking liabilities, but will do so if this is what it takes to protect the assets that they are
buying. Often, strategic buyers are interested in brand names, patents, copyrights,
product knowledge, customer lists, key employees, manufacturing technology and cost
information.
Private equity and hedge fund investors want to buy or invest in troubled companies
with clearly identifiable problems. These Financial Buyers/Investors look for profit
margin improvement that is achievable, realistic and sustainable through price
increases, product positioning and re-launches, product line rationalization, marketing
and advertising initiatives, productivity gains, improvement in materials and supply chain
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cost management, headcount reductions, and other reductions in Sales, General and
Administrative expenses.
One of the common themes of turnaround financing is simplifying and focusing the
business. Financial Buyers/Investors want a company where the path to profitability is
understandable, such as eliminating unprofitable lines of business, facilities, customers
or products. In some cases, the company’s revenue may drop 20% to 40%, but if
unprofitable business is eliminated, then the decrease in revenues is welcomed.
Some private equity groups have invested on a sectoral basis in The Balkans, such as
telecom. If a private equity group is comfortable with the sector such as power
generation or airport management, this may mitigate other risks which may be present
in the deal.
Global buyout firm Kohlberg Kravis Roberts and Mid Europa Partners are two large
buyout funds with an appetite for The Balkans. KKR has agreed to buy SBB Telemach,
a telecommunications company based in the former Yugoslavia, from central Europe-
focused Mid Europa Partners in a deal worth approximately €1 billion. Mid Europa
Partners is a private equity group with a geographic focus on Central and Eastern
Europe and Turkey. They have recently raised a new buyout fund.
Private equity groups that focus on smaller transactions – typically for SMEs – will likely
follow in the jet-stream of the larger buyout groups. Private equity groups that are
actively investing growth stories in The Balkans include NCH Advisors with offices in
Croatia, Montenegro, Albania and Greece; MPE in Slovenia and Argo Capital
Management in Mayfair. GSO Capital – Blackstone in Berkeley Square recently
financed the acquisition of a Slovenian pigment company by an Austrian strategic player
– combined EBITDA is estimated to be in the EUR 40 million range. “SMEs with hair on
them” – read: underperforming companies - are more difficult to finance, but are
attracting the attention of some Middle East, Russian, Austrian and London special
situation funds.
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EBRD is providing senior and mezzanine debt, as well as non-control equity financing in
the range of EUR 2 million to EUR 100 million to SMEs in Slovenia, Croatia, Bulgaria,
Serbia, Romania, Albania and Montenegro. Through its affiliated funds – the EUR 265
ABM CEECAT Recovery Fund and the EUR 90 million EMSA fund – EBRD is investing
through all layers of the capital structure.
Are We Merely Moving the Deckchairs Around the Titanic?
Financial Buyers/Investors try to avoid companies with significant operating losses that
are dying from 1,000 cuts. When sizing up a turnaround, investors need to determine if
the projected cash flows are realistic and achievable. They need to know that if the
company has a broken wing, it can heal over time. It’s no good investing in a turnaround
where the capital structure gets re - jigged, but the operating metrics of the company
are unchanged. We call that “moving the deckchairs around the Titanic.”
A key criteria for Financial Buyers/Investors is that all unprofitable activity can be
eliminated from the company over some reasonable period of time. Most Financial
Buyers/Investors think a company has turned the corner when there’s six to nine month
stability in monthly EBITDA.
A turnaround needs a path to profitability that’s understandable. For example, “SKU
proliferation” is a common problem with companies that are deteriorating – products
with too many colors, size, and features, with the result that inventories balloon. SKU
proliferation is often a sign that the sales department of a company or customers have
too much power. A company that has scrubbed its SKU count with a hard wire brush
has reduced its chances of becoming road-kill. Sizeable decreases in a company’s
revenue may result, but also signal a return to growth if unprofitable business is culled.
In fact, many companies experienced 20% to 50% decreases in revenues during the
credit crunch, and now are looking at 2-5% growth for the foreseeable future. The
positive side to lower revenues is lower working capital requirements.
Financial Buyers/Investors typically look hard at the collateral to gauge their downside in
case they have to liquidate, but good collateral is no substitute for a solid turnaround
plan. In many legacy insolvency regimes, enforcement and recovery of collateral can be
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plagued by delays and deficiencies inherent in local court procedures, and once
recovered invariably the expected values have not been realized. Auction procedures
in emerging markets and the SEE region in particular restrict minimum bid price
reductions in auction to 10% or 20%, requiring multiple tenders to finally attract a buyer
at the right price.
A turnaround company needs a written and detailed turnaround plan that includes
timelines, deliverables and responsibility for implementation. Managing a company with
no turnaround plan is like driving across country without a map. For lenders who are
financing the turnaround, it’s not enough to simply review the plan. The lender has to
aggressively track the implementation. An undisciplined turnaround is like “putting
makeup on a corpse.”
Financial Buyers/Investors in turnaround companies want to be comfortable that the
management team won’t repeat the same mistakes that got them into trouble in the first
place. They need to see that the issues that caused the problems – material input costs,
union issues, product quality – have been dealt with realistically in the turnaround plan.
In many underperforming companies, the incumbent management does not fully
appreciate how quickly the downward spiral can accelerate. Consequently, they are less
likely to take the drastic steps needed to salvage the company. A typical statement by
management is “we can’t do those cost cuts – they’re too close to the bone”. Once the
management team is behind the curve in cost cuts, it can be difficult to regain control of
the situation. Like a bicycle going full-speed, things were very smooth when the
economy and the company were expanding at a rapid clip. When things slow down, it
can get quite wobbly.
Many “growth” companies get into trouble because they haven’t cut back on head office
overheads, new product development or other ‘growth’ elements of their cost structure.
Some Financial Buyers/Investors find themselves confronted by tough choices –
management is saying that aggressive marketing spending is needed to grow sales, yet
Financial Buyers/Investors often look at ‘soft’ CAPEX as a potential black-hole for
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liquidity. In some instances, the company’s business model has changed dramatically,
and all spending needs to be completely re-evaluated.
A complex capital structure in a troubled company can muddy the waters to the point
where management becomes ineffective. In some larger private equity deals,
participants in the capital structure are fighting each other while management tries to
play one side against the other. Or there are those instances where management gets
so distracted trying to please each participant in the capital structure that they take their
eye off the ball from a day-to-day management perspective. Or they become deer-in-
the-headlights, afraid to make decisions with business risk because they are afraid of
displeasing the party that ultimately gains control.
Another difficulty of buying or investing in a troubled company is when the legacy owner
is still in place. There are many instances where the legacy owner is now threatening to
walk with the customer relationships if the Financial Buyers/Investors play hardball.
Distressed service companies can be tough since valuable customer relationships often
stretch back years. These relationships can be very difficult to transition, particularly
when legacy owners sense that their career with the company may be nearing an end.
Often when a turnaround professional walks through the door for the first time at a
company, he is confronted with iterations of the turnaround plan that are too numerous
to comprehend. The management team has produced countless financial forecasts, and
wonders why the lenders have lost faith.
A critical tactic is to put a stake in the ground with a plan that has contingencies built in,
and gives a modicum of wiggle room. It’s better to under promise and over deliver.
When the economy is in a slow-growth mode, a surprise on the downside is more likely
than a surprise on the upside. You don’t have the wind at your back the same way you
do in a growth economy.
From the moment a turnaround professional meets the company, usually the lender(s)
are blamed as a root cause of the problems. “We’re a good company where bad things
have happened to us” is a common refrain from management. In some of the cases
we’ve seen with some larger companies who have a syndicate of lenders, certain legal
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professionals have deliberately stoked the animosity amongst the lending syndicate, or
between the borrower and its lenders. They needed to be the smartest guys in the
room. Stoking the animosity gooses the professional fees in a hurry. They exploit the
fact that some balance sheets seem deliberately designed to keep lenders and
investors at bay by complex corporate organizations and collateral structures.
One of the hallmarks of a successful turnaround is developing a common front with the
lenders as quickly as possible. If there’s a cashflow or collateral “waterfall”, shoot for
consensus on exactly where the water is flowing. A Colorado River type dispute you
don’t need.
Turnaround lenders need a written and detailed turnaround plan that assigns
responsibility for implementation and includes hurdles, dates, and deliverables. They
want to see contingencies built into the plan. Turnaround lenders lose confidence in the
company’s ability to execute a turnaround when the turnaround plan is constantly re-
written.
Turnarounds can be like riding a mechanical bull blindfolded…
Turnarounds can be like riding a mechanical bull blindfolded – you know it’s going to
move, but you don’t know where, so you need to brace yourself.
A key element in managing through a turnaround is accurate and timely key
performance indicators (“KPI’s” in the lingo of the turnaround profession). In a
manufacturing turnaround, KPI’s can include scrap levels, rework hours, overtime
hours, material variances and late shipments. In a transportation turnaround, typical
KPI’s can include revenue-per-mile revenues, cost-per-mile, number of waybills, and
number of pickups. In a retailer, typical KPI’s can include pedestrian counts, shrinkage,
sales patterns and product velocity. Companies that are turning the corner generally hit
their KPI targets consistently.
Many lenders and investors will evaluate the success of the turnaround process by
assessing gross margin as opposed to, say, EBITDA. They strongly believe gross
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margin demonstrates the company’s long-term ability to generate a profit while EBITDA
merely demonstrates the company’s ability to generate short-term cash flow. A positive
EBITDA coupled with an industry based sub-standard gross margin is a strong
indication the problem has only been masked, if addressed at all.
Another clear sign that a company is turning the corner is reduced turnover within
management ranks. When a company is in the crisis stage, many of the “A” team
managers in a company have departed, usually out of frustration with the problems
leading up to the crisis. Or the “A” players don’t want their career tarnished with a
bankruptcy filing. Headhunters often keep tabs on companies that are known to be
struggling, and poach key talent as the company hits the wall. However, once a
company stabilizes, it can become an attractive place to work again.
We all know that many corporate leaders are proactive in making the necessary
changes for an organization to survive, but real change is typically resisted. Companies,
once saved, can easily drift back into the old ways of doing things. A company that has
turned the corner doesn’t exhibit this type of management dysfunction.
Companies that have turned the corner often show an improved new product pipeline –
this pipeline has usually been starved for new products, since product development is
one of the first items to be cut when a company starts to sink beneath the waves. As a
company turns, improved liquidity can prime the pump for new product launches, such
as increased attendance at trade shows, advertising and co-promotions. Lenders are
often reluctant to fund new product development. A key role of the turnaround
professional is to transparently develop a solid justification for new product development
expenditures.
Companies that are turning the corner usually show improved service levels – more
orders are shipped on time, on spec. One of the typical signs of a company that is
headed for the ditch is that shipments to customers are often late, incomplete or are not
up to customer specifications. As the company reaches the inflection point in a
turnaround, service levels should be close to 100%.
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In summary, here are three key take-aways:
“Broken capital structures” and excessive leverage. Financial Buyers/Investors want to
purchase the fulcrum security in a distressed company. The fulcrum security can be the
senior, second lien, mezzanine, trade or bond debts. In rare instances, investors will
buy a lawsuit against a company or tax liens to gain control.
Identifiable and cost - effective legal and regulatory path to recapitalization. Since
Financial Buyers/Investors will need to fund legal, accounting and turnaround consultant
expenses, they want a clear path to closing a transaction.
“Companies dying from 1,000 cuts”. Financial Buyers/Investors are not interested in
companies suffering from chronic underinvestment, including marketing, sales, capital
equipment, human resources and management information systems. In many
instances, these companies have lost many of their key employees.
The Big Picture
As international investors search for yield, Slovenia and the other CEE/SEE countries
are appearing on their radar screens. Many of the most important factors and attributes
which drove the striking growth of The Balkans prior to the crisis remain in place. By
building on these strengths to update and refine their growth models, SMEs in The
Balkans can become more globally competitive and resume strong growth. The
advantages and resources of the countries need to be used in new ways to restore pre-
crisis growth rates.
For example, according to The World Bank’s Doing Business Index, Slovenia has risen
from 63 to 35. Slovenia has reduced the time to start a business from 60 days to six, cut
the time to register a property by two-thirds and reduced corporate taxes by more than
10%. On The World Bank’s Government Effectiveness Index, Slovenia is the best
performer at 1.02, compared with the CEE average of .57
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Insolvency procedures have been significantly improved in some countries in CEE and
SEE regions, but continue to take time and are prone to heightened regulatory risk and
unpredictable outcomes. Since the crisis, enormous attention has been placed on the
adoption of new less formal consensual resolution procedures and the use of
prepackaged plan to help accelerate resolution outcomes, while placing much of the
control back into the hands of the real stakeholders. Examples include Croatia,
Slovenia, Montenegro, Romania and Serbia. These new systems work better than the
old one and complement turnaround strategies.
The Balkan’s legacy of allowing excessive protection to existing shareholders and not
providing adequate rights for creditors is changing. As legislators embrace the
importance of revitalizing SMEs with fresh capital, foreign direct investment will bring
new vigor to the economies and prevent the silent enemy of brain drain of the new
generation.
About the Author
Hugh Larratt-Smith, MBA, is a Managing Director with Trimingham, a CRO and
Financial Advisory firm. He is managing Trimingham’s CRO practice in The
Balkans, and is leading the formation of the Slovenian Chapter of TMA in 2014. He
can be reached at [email protected]
doc_101441653.pdf
During this information in regard to buying an underperforming company in the balkans.
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Buying an Underperforming Company in The Balkans
By Hugh C. Larratt-Smith, MBA
For the past 20 years, companies in The Balkans have not been on the radar screen of
most private equity groups.
It’s not that The Balkans lack comparative advantages. The
wage rates in the region are up to 75% less than Western
European nations. Education levels are high and the
workforce is relatively skilled. Many professionals and
middle managers have proficiency in numerous languages
– it is not uncommon to meet people who speak three to six
languages. The Balkans is within 1,000 KM of 170 million
consumers. Transportation links are good. Two of the four
Balkans nations, Slovenia and Croatia, are in the European
Union. Serbia is targeting to join the E.U. in 2020.
What has held back private equity groups is the historic
opacity of corporate laws, particularly bankruptcy legislation.
In many countries in Southern Europe, the legacy corporate
insolvency regimes have impeded the restructuring of firms.
Many countries have provided excessive protection to
existing shareholders, and have failed to provide adequate
rights for creditors. Often times the SME has become
completely uncompetitive by the time creditors get a voice.
As we all know, time is the enemy when a SME is failing.
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2
But things are changing. For example, Slovenia has drafted
an amendment to the insolvency law to bring the insolvency
regime into line with international best practices. The
overarching goal is to facilitate the restructuring of viable
SMEs.
A key feature of the amendment is the compulsory settlement procedure with the
absolute priority rule which prevents existing owners from blocking the restructuring
process. If the equity in the debtor is zero, then the SME can become a candidate for
sale or investment by a financial or strategic player.
In addition to legal reform, Slovenia privatizing a number of state owned companies.
Many of these companies will be of interest to private equity groups.
In Serbia, up to 180 state owned companies are scheduled for privatization in 2014.
Indications are that the companies will be shepherded through pre-packaged
bankruptcies to cleanse the balance sheets before the sale process.
Many SMEs in Slovenia, Croatia, Serbia and Montenegro have inherent strengths. From
the early 1990’s to the onset of the global financial crisis, numerous medium sized
companies in the region established a record of growth that few other EU regions
matched. However, when the crisis hit, economic growth virtually collapsed. Demand in
Europe, which accounts for the majority of exports, fell sharply and remains weak.
Business financing decreased significantly. Many SMEs were unable to reduce their
cost structures in lockstep with the decline in revenues, resulting in excessive borrowing
to finance losses.
However, many of the attributes that made the region so attractive prior to the crisis
remain intact.
The Balkans have a number of “broken wing” companies with problems that are clearly
identifiable, can be remedied and are attractive candidates for fresh equity capital.
Some are “good income statement, bad balance sheet” companies. Others have been
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unable to finance new production lines, new products or geographic expansion, so their
growth has been hindered.
What Are Distressed Investors Looking For?
Many people approach Trimingham, saying that they want to buy a troubled company.
When we show them a troubled company to buy, they look at the financial statements
and exclaim “Wait a minute – the company is losing money – why would I buy a loser?”
But smart buyers know how to look through the existing situation and glean the real
value.
There are three types of distressed investors: 1) wealthy individuals; 2) strategic
players; and 3) private equity and hedge funds.
Wealthy individuals usually invest in companies that are in their comfort zone. Often,
wealthy investors are entrepreneurs who own or have sold their companies. They invest
in distressed companies that are in similar industries or market niches that match their
experience. They will rarely stray outside their comfort zone. For example, if the
entrepreneur was successful in the dairy sector, the chances are he/she will invest in
dairy opportunities. The odds of that wealthy person investing in a troubled systems
integration company are low.
Strategic investors typically invest in a distressed company when it is insolvent and
being liquidated. Most strategic buyers are uncomfortable buying a going concern with
lurking liabilities, but will do so if this is what it takes to protect the assets that they are
buying. Often, strategic buyers are interested in brand names, patents, copyrights,
product knowledge, customer lists, key employees, manufacturing technology and cost
information.
Private equity and hedge fund investors want to buy or invest in troubled companies
with clearly identifiable problems. These Financial Buyers/Investors look for profit
margin improvement that is achievable, realistic and sustainable through price
increases, product positioning and re-launches, product line rationalization, marketing
and advertising initiatives, productivity gains, improvement in materials and supply chain
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4
cost management, headcount reductions, and other reductions in Sales, General and
Administrative expenses.
One of the common themes of turnaround financing is simplifying and focusing the
business. Financial Buyers/Investors want a company where the path to profitability is
understandable, such as eliminating unprofitable lines of business, facilities, customers
or products. In some cases, the company’s revenue may drop 20% to 40%, but if
unprofitable business is eliminated, then the decrease in revenues is welcomed.
Some private equity groups have invested on a sectoral basis in The Balkans, such as
telecom. If a private equity group is comfortable with the sector such as power
generation or airport management, this may mitigate other risks which may be present
in the deal.
Global buyout firm Kohlberg Kravis Roberts and Mid Europa Partners are two large
buyout funds with an appetite for The Balkans. KKR has agreed to buy SBB Telemach,
a telecommunications company based in the former Yugoslavia, from central Europe-
focused Mid Europa Partners in a deal worth approximately €1 billion. Mid Europa
Partners is a private equity group with a geographic focus on Central and Eastern
Europe and Turkey. They have recently raised a new buyout fund.
Private equity groups that focus on smaller transactions – typically for SMEs – will likely
follow in the jet-stream of the larger buyout groups. Private equity groups that are
actively investing growth stories in The Balkans include NCH Advisors with offices in
Croatia, Montenegro, Albania and Greece; MPE in Slovenia and Argo Capital
Management in Mayfair. GSO Capital – Blackstone in Berkeley Square recently
financed the acquisition of a Slovenian pigment company by an Austrian strategic player
– combined EBITDA is estimated to be in the EUR 40 million range. “SMEs with hair on
them” – read: underperforming companies - are more difficult to finance, but are
attracting the attention of some Middle East, Russian, Austrian and London special
situation funds.
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EBRD is providing senior and mezzanine debt, as well as non-control equity financing in
the range of EUR 2 million to EUR 100 million to SMEs in Slovenia, Croatia, Bulgaria,
Serbia, Romania, Albania and Montenegro. Through its affiliated funds – the EUR 265
ABM CEECAT Recovery Fund and the EUR 90 million EMSA fund – EBRD is investing
through all layers of the capital structure.
Are We Merely Moving the Deckchairs Around the Titanic?
Financial Buyers/Investors try to avoid companies with significant operating losses that
are dying from 1,000 cuts. When sizing up a turnaround, investors need to determine if
the projected cash flows are realistic and achievable. They need to know that if the
company has a broken wing, it can heal over time. It’s no good investing in a turnaround
where the capital structure gets re - jigged, but the operating metrics of the company
are unchanged. We call that “moving the deckchairs around the Titanic.”
A key criteria for Financial Buyers/Investors is that all unprofitable activity can be
eliminated from the company over some reasonable period of time. Most Financial
Buyers/Investors think a company has turned the corner when there’s six to nine month
stability in monthly EBITDA.
A turnaround needs a path to profitability that’s understandable. For example, “SKU
proliferation” is a common problem with companies that are deteriorating – products
with too many colors, size, and features, with the result that inventories balloon. SKU
proliferation is often a sign that the sales department of a company or customers have
too much power. A company that has scrubbed its SKU count with a hard wire brush
has reduced its chances of becoming road-kill. Sizeable decreases in a company’s
revenue may result, but also signal a return to growth if unprofitable business is culled.
In fact, many companies experienced 20% to 50% decreases in revenues during the
credit crunch, and now are looking at 2-5% growth for the foreseeable future. The
positive side to lower revenues is lower working capital requirements.
Financial Buyers/Investors typically look hard at the collateral to gauge their downside in
case they have to liquidate, but good collateral is no substitute for a solid turnaround
plan. In many legacy insolvency regimes, enforcement and recovery of collateral can be
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6
plagued by delays and deficiencies inherent in local court procedures, and once
recovered invariably the expected values have not been realized. Auction procedures
in emerging markets and the SEE region in particular restrict minimum bid price
reductions in auction to 10% or 20%, requiring multiple tenders to finally attract a buyer
at the right price.
A turnaround company needs a written and detailed turnaround plan that includes
timelines, deliverables and responsibility for implementation. Managing a company with
no turnaround plan is like driving across country without a map. For lenders who are
financing the turnaround, it’s not enough to simply review the plan. The lender has to
aggressively track the implementation. An undisciplined turnaround is like “putting
makeup on a corpse.”
Financial Buyers/Investors in turnaround companies want to be comfortable that the
management team won’t repeat the same mistakes that got them into trouble in the first
place. They need to see that the issues that caused the problems – material input costs,
union issues, product quality – have been dealt with realistically in the turnaround plan.
In many underperforming companies, the incumbent management does not fully
appreciate how quickly the downward spiral can accelerate. Consequently, they are less
likely to take the drastic steps needed to salvage the company. A typical statement by
management is “we can’t do those cost cuts – they’re too close to the bone”. Once the
management team is behind the curve in cost cuts, it can be difficult to regain control of
the situation. Like a bicycle going full-speed, things were very smooth when the
economy and the company were expanding at a rapid clip. When things slow down, it
can get quite wobbly.
Many “growth” companies get into trouble because they haven’t cut back on head office
overheads, new product development or other ‘growth’ elements of their cost structure.
Some Financial Buyers/Investors find themselves confronted by tough choices –
management is saying that aggressive marketing spending is needed to grow sales, yet
Financial Buyers/Investors often look at ‘soft’ CAPEX as a potential black-hole for
7
7
liquidity. In some instances, the company’s business model has changed dramatically,
and all spending needs to be completely re-evaluated.
A complex capital structure in a troubled company can muddy the waters to the point
where management becomes ineffective. In some larger private equity deals,
participants in the capital structure are fighting each other while management tries to
play one side against the other. Or there are those instances where management gets
so distracted trying to please each participant in the capital structure that they take their
eye off the ball from a day-to-day management perspective. Or they become deer-in-
the-headlights, afraid to make decisions with business risk because they are afraid of
displeasing the party that ultimately gains control.
Another difficulty of buying or investing in a troubled company is when the legacy owner
is still in place. There are many instances where the legacy owner is now threatening to
walk with the customer relationships if the Financial Buyers/Investors play hardball.
Distressed service companies can be tough since valuable customer relationships often
stretch back years. These relationships can be very difficult to transition, particularly
when legacy owners sense that their career with the company may be nearing an end.
Often when a turnaround professional walks through the door for the first time at a
company, he is confronted with iterations of the turnaround plan that are too numerous
to comprehend. The management team has produced countless financial forecasts, and
wonders why the lenders have lost faith.
A critical tactic is to put a stake in the ground with a plan that has contingencies built in,
and gives a modicum of wiggle room. It’s better to under promise and over deliver.
When the economy is in a slow-growth mode, a surprise on the downside is more likely
than a surprise on the upside. You don’t have the wind at your back the same way you
do in a growth economy.
From the moment a turnaround professional meets the company, usually the lender(s)
are blamed as a root cause of the problems. “We’re a good company where bad things
have happened to us” is a common refrain from management. In some of the cases
we’ve seen with some larger companies who have a syndicate of lenders, certain legal
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professionals have deliberately stoked the animosity amongst the lending syndicate, or
between the borrower and its lenders. They needed to be the smartest guys in the
room. Stoking the animosity gooses the professional fees in a hurry. They exploit the
fact that some balance sheets seem deliberately designed to keep lenders and
investors at bay by complex corporate organizations and collateral structures.
One of the hallmarks of a successful turnaround is developing a common front with the
lenders as quickly as possible. If there’s a cashflow or collateral “waterfall”, shoot for
consensus on exactly where the water is flowing. A Colorado River type dispute you
don’t need.
Turnaround lenders need a written and detailed turnaround plan that assigns
responsibility for implementation and includes hurdles, dates, and deliverables. They
want to see contingencies built into the plan. Turnaround lenders lose confidence in the
company’s ability to execute a turnaround when the turnaround plan is constantly re-
written.
Turnarounds can be like riding a mechanical bull blindfolded…
Turnarounds can be like riding a mechanical bull blindfolded – you know it’s going to
move, but you don’t know where, so you need to brace yourself.
A key element in managing through a turnaround is accurate and timely key
performance indicators (“KPI’s” in the lingo of the turnaround profession). In a
manufacturing turnaround, KPI’s can include scrap levels, rework hours, overtime
hours, material variances and late shipments. In a transportation turnaround, typical
KPI’s can include revenue-per-mile revenues, cost-per-mile, number of waybills, and
number of pickups. In a retailer, typical KPI’s can include pedestrian counts, shrinkage,
sales patterns and product velocity. Companies that are turning the corner generally hit
their KPI targets consistently.
Many lenders and investors will evaluate the success of the turnaround process by
assessing gross margin as opposed to, say, EBITDA. They strongly believe gross
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margin demonstrates the company’s long-term ability to generate a profit while EBITDA
merely demonstrates the company’s ability to generate short-term cash flow. A positive
EBITDA coupled with an industry based sub-standard gross margin is a strong
indication the problem has only been masked, if addressed at all.
Another clear sign that a company is turning the corner is reduced turnover within
management ranks. When a company is in the crisis stage, many of the “A” team
managers in a company have departed, usually out of frustration with the problems
leading up to the crisis. Or the “A” players don’t want their career tarnished with a
bankruptcy filing. Headhunters often keep tabs on companies that are known to be
struggling, and poach key talent as the company hits the wall. However, once a
company stabilizes, it can become an attractive place to work again.
We all know that many corporate leaders are proactive in making the necessary
changes for an organization to survive, but real change is typically resisted. Companies,
once saved, can easily drift back into the old ways of doing things. A company that has
turned the corner doesn’t exhibit this type of management dysfunction.
Companies that have turned the corner often show an improved new product pipeline –
this pipeline has usually been starved for new products, since product development is
one of the first items to be cut when a company starts to sink beneath the waves. As a
company turns, improved liquidity can prime the pump for new product launches, such
as increased attendance at trade shows, advertising and co-promotions. Lenders are
often reluctant to fund new product development. A key role of the turnaround
professional is to transparently develop a solid justification for new product development
expenditures.
Companies that are turning the corner usually show improved service levels – more
orders are shipped on time, on spec. One of the typical signs of a company that is
headed for the ditch is that shipments to customers are often late, incomplete or are not
up to customer specifications. As the company reaches the inflection point in a
turnaround, service levels should be close to 100%.
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In summary, here are three key take-aways:
“Broken capital structures” and excessive leverage. Financial Buyers/Investors want to
purchase the fulcrum security in a distressed company. The fulcrum security can be the
senior, second lien, mezzanine, trade or bond debts. In rare instances, investors will
buy a lawsuit against a company or tax liens to gain control.
Identifiable and cost - effective legal and regulatory path to recapitalization. Since
Financial Buyers/Investors will need to fund legal, accounting and turnaround consultant
expenses, they want a clear path to closing a transaction.
“Companies dying from 1,000 cuts”. Financial Buyers/Investors are not interested in
companies suffering from chronic underinvestment, including marketing, sales, capital
equipment, human resources and management information systems. In many
instances, these companies have lost many of their key employees.
The Big Picture
As international investors search for yield, Slovenia and the other CEE/SEE countries
are appearing on their radar screens. Many of the most important factors and attributes
which drove the striking growth of The Balkans prior to the crisis remain in place. By
building on these strengths to update and refine their growth models, SMEs in The
Balkans can become more globally competitive and resume strong growth. The
advantages and resources of the countries need to be used in new ways to restore pre-
crisis growth rates.
For example, according to The World Bank’s Doing Business Index, Slovenia has risen
from 63 to 35. Slovenia has reduced the time to start a business from 60 days to six, cut
the time to register a property by two-thirds and reduced corporate taxes by more than
10%. On The World Bank’s Government Effectiveness Index, Slovenia is the best
performer at 1.02, compared with the CEE average of .57
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Insolvency procedures have been significantly improved in some countries in CEE and
SEE regions, but continue to take time and are prone to heightened regulatory risk and
unpredictable outcomes. Since the crisis, enormous attention has been placed on the
adoption of new less formal consensual resolution procedures and the use of
prepackaged plan to help accelerate resolution outcomes, while placing much of the
control back into the hands of the real stakeholders. Examples include Croatia,
Slovenia, Montenegro, Romania and Serbia. These new systems work better than the
old one and complement turnaround strategies.
The Balkan’s legacy of allowing excessive protection to existing shareholders and not
providing adequate rights for creditors is changing. As legislators embrace the
importance of revitalizing SMEs with fresh capital, foreign direct investment will bring
new vigor to the economies and prevent the silent enemy of brain drain of the new
generation.
About the Author
Hugh Larratt-Smith, MBA, is a Managing Director with Trimingham, a CRO and
Financial Advisory firm. He is managing Trimingham’s CRO practice in The
Balkans, and is leading the formation of the Slovenian Chapter of TMA in 2014. He
can be reached at [email protected]
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