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Keeping value in your firm

Early preparation can help stop a business falling into administration and alternatives can be found

Whatever the state of the market now, in many construction sub-sectors it is likely to get worse. Management teams can optimise their position, and that of their distressed companies by preparing early and accepting the realities of the value diminution which will continue.

Corporate valuations have fallen significantly since the highs of mid-2007. But where

the existing shareholders’ proportional ownership of a business is diminished due to the need to raise outside capital or convert debt to equity is equally attractive for shareholders.

If companies are left to crash into administration, the value destruction is considerable. But if management correctly reads the path on which their company

is set, action can be taken to ensure an orderly re-organisation to keep the business as intact as possible and prepare for the upturn.

The first line of defence is inevitably internal and operational. The key challenge for management here is to assess the rate of diminution of demand and to restructure overheads accordingly.

However, companies are missing opportunities in terms of external parties, including

capital providers but also potential joint venture partners, merger partners, acquisition targets and acquirers.

Talking to your bank

Typically, companies spend more resources managing client relationships than in managing those with their banks.

But companies should prioritise dealings with their capital providers. It is important to have the bank understand your financial figures, current and projected, but also for you to understand your bank’s processes.

For example, do you know whether existing relationship managers would remain in place through the process of covenant breaches, or would this move to an individual at the bank who you have never met before and who does not know your business?

Who is the decision-maker at the bank when it comes to negotiation for increases in credit lines, payment holidays, debt for equity swaps or debt purchases?

It is also important to understand the parameters in which your bank will operate. The bank itself may not know them, but any indication is better than none.

Take, for example, a company which is projecting a shortfall in its debt repayments. A natural next step is to look at potential equity providers to re-capitalise the company. Under these circumstances equity providers would be unlikely to fund a business without a reduction in debt levels.

In many cases this discussion has not been possible as banks have been unable to negotiate in an orderly fashion.

Banks could work harder to ensure that early negotiations can be held in a considered, low pressure environment so as to avoid wholesale destruction in value.

Strategic alternatives

The key to optimising your position in discussions with incumbent banks is to create alternatives. These typically look to the generation of capital, either organically or from outside sources.

Outside equity capital is available, as specialist distressed, and increasingly mainstream private equity firms stalk the market for recovery plays. Debt capital is currently very scarce except in the case of very solid asset backing.

But there are cases of equity providers prepared to fund both debt and equity in deals on the basis of being able to re-finance at a later date, but this is not a preferred route. It is possible for external capital to enter the picture before insolvency (perhaps involving a voluntary write-off or conversion of debt on the part of incumbent banks), or after insolvency as part of an emergence from administration.

Another alternative is to arrange the purchase of your company’s debt by a third party. This may be combined with a further equity funding. Incumbent equity holders are likely to be diluted, however the introduction of a new capital provider can dramatically turn around management priorities from fire-fighting to strategising for the future.

As is the case at any time in the cycle, a constructive dialogue with capital providers is essential for long-term value creation. If an orderly sale of a company’s debt can occur, this can protect value.

One of the key problems of investment in or purchases of distressed companies is the lack of due diligence and/or warranty protection – in other words, greater risk.

But there are products, such as warranty insurance, which can protect purchasers of distressed debt, which means debt bought below face value. In selling debt, the banks do not wish to be left with residual liabilities and often the target company in question could not support a contingent liability.

Again, these transactions, albeit distressed, can only occur if management is well-prepared in advance and if banks are able to negotiate sensibly rather than taking impossible positions.

Adrian Pritchard works in mergers & acquisitions at Nash Fitzwilliams www.nashfitzwilliams.com

Mergers and acquisitions

Mergers and acquisitionsAn effective way of creating capital is for competitors to merge and exploit cost and revenue synergies.

Many of these are obvious to management teams; however one area which is becoming topical is solvency of suppliers.

Construction companies will lose orders if they appear risky to their customers. One clear synergy of a merger is to remove this concern and so increase customer confidence.

Through mergers, companies have the chance to participate in (rather than be a victim of) the inevitable capacity reduction.

Mergers do involve dilution of equity and, perhaps as difficult, the initiation of discussions between parties often long regarded as mortal enemies. However, current conditions could mean that these alternatives get significant attention.

If an alternative is prepared in advance, it may be possible to access outside capital to further strengthen the merged entity.

While in the short run synergies may be exploited, in the long run a formidable presence can be established within a subsector.

This can create significant long-term shareholder value, particularly as markets recover and it should in part compensate for the equity dilution suffered on the merger.