Founder: Turnaround Talk
As we read in The Bible, Jericho was a city that was famed for its impenetrable walls. This created one of the civilisations that proved to be a major power in the Middle East at the time and a major rival to the Israeli expansion in the region.
Building a culture of a strong foundation is a sure-fire way to guarantee future sustainability. On 7 April, Deloitte released the results of its 2022 Restructuring Survey where some interesting industry insights were highlighted.
One of the overarching themes at the recently held results presentation of the 2022 Deloitte Restructuring Survey is that the Covid-19 Pandemic – and the change that it introduced into the market – came as a shock to the system. Companies have never experienced this level of disruption before, and many are contemplating their next step as they negotiate a significantly different future than the one that they were expecting.
As with any survey, there are many more themes that try to unpack the current status quo or trends that are driving the industry going forward. Below are some of the more important industry drivers that Deloitte feels are pertinent to the industry.
A crash of grey rhinos
The survey points out that Michele Wucker coined the term “grey rhinos” for high impact risks people should see coming but invariably ignore until it is too late, like reacting to a rhino aiming its horn in their direction and preparing to charge. In her 2016 book The Gray Rhino, she cautioned that “the frequency of pandemics warns of a much bigger global health threat to come: it’s not a matter of if but when”. As the world recovers from the last grey rhino charge, and with the next one already with us, it seems a fitting time to ask for respondent views on what risks they see on the horizon.
Survey respondents across Africa are most concerned about local risks: political uncertainty, the emigration of talent and sovereign debt crises featured prominently across jurisdictions. Global risks that keep leaders in advanced economies awake at night – climate change, geopolitical tension, and digital inequality – are less of a concern for Africa. This could partly be due to Africa having enjoyed relative shelter from the worst financial and health effects of the global financial crisis and Covid-19 pandemic respectively.
Source: Deloitte
The survey adds that more likely is that for businesses leaders in Africa, political and economic uncertainty are more pressing priorities. By 2024, developing countries (excluding China) are expected to be 5.5% behind pre-pandemic GDP, while advanced economies are forecast to be 0.9% ahead. While the focus on immediate risks that loom large for Africa is understandable, recent events in Ukraine show that business leaders should not lose sight of global risks that could have an impact on the continent. With that said, increasing divergence between developing economies in Africa and advanced economies elsewhere brings local risks to the fore, and our survey respondents believe that these will play out over extended timeframes.
These risks will become more frequent, and arrive simultaneously – a crash of grey rhinos. For companies, this means operating in a highly uncertain environment which requires resilience and agility. For lenders and restructuring professionals, this means that clients that look like winners in one season can quickly become distressed in the next.
A stitch in time: measuring distress
The survey points out that, in a world of frequent grey rhino events and consistent uncertainty, new winners and losers will emerge across regions, countries, social classes and sectors, as well as between peers within sectors. The pandemic was devastating for sectors highly reliant on nine-to-five office workers – real estate, automotive and transport – while sectors such as technology and telecoms benefitted from work-from-home trends.
While its duration is uncertain, the war in Ukraine will shift trends again as consumers feel the impact of fuel and food inflation; retailers that were reaping the rewards of pent-up demand six months ago may show signs of stress later this year. Meanwhile, gold and Platinum Group Metals (PGM) producers that were in the doldrums in 2020 are likely to ride ever-higher commodity prices.
The survey adds that, in this environment, where winners can become losers alarmingly quickly, the proactive tracking of indicators of financial stress is critically important for boards, management teams, lenders, and other financial stakeholders.
A key question posed to survey respondents was which metrics they consider to be the most effective indicators of financial stress. The top answer was declining operational/ free cash flow; 85% of respondents across Africa included this in their top five, and the remaining top metrics were trading or cash flow related.
Professionals in the restructuring industry will not be surprised by this finding: cash is the lifeblood of business and close cash flow tracking and management are critically important as signs of stress appear.
The survey points out that, while respondents across geographies and roles broadly agree on which are the most important indicators of financial stress, views diverge on how often these are tracked by management teams.
Our C-Suite respondents believe that they regularly track revenue, profitability, cash flow and working capital, but acknowledge that debt ratios are less of a priority. Lenders’ perception, however, is almost diametrically opposed: they believe that cash flow and balance sheet metrics are tracked less often than headline-making revenue and share price indicators.
C-Suite respondents across Africa prefer to manage stress and distress in-house. We frequently see management’s preferred course of action when distress triggers materialise; in-house corrective actions are in shades of teal while external actions are in shades of grey. It is telling that even for trigger events that would almost certainly require external input at some stage – withdrawal of facilities, forecast insufficient cash flow for debt service, covenant breach forecast within the next 12 months – our C-Suite respondents’ instinct is to monitor trading, take action as a management team and consult with the board.
When external support is required, our C-Suite respondents identified legal counsel as their first port of call, followed by financial advisors and then lenders. Auditors are by some distance the last to the party.
The survey believes that the combination of factors discussed in this section – management teams placing less focus on tracking key cash-focused indicators of financial stress, and their reticence to alert external stakeholders of the warning signs – make surprises the new normal. Long-ignored grey rhino risks will suddenly rear their heads and financial stakeholders will discover their true impact on companies when it is almost too late.
Source: Deloitte
This, in turn, will result in an uptick in distressed financial restructurings where time and optionality are limited. And survey respondents agree: 84% of restructuring lawyers, lenders and practitioners are optimistic about growth in restructuring activity over the next 12 months, and 62% believe that business rescue can be improved by providing BRPs with more time to assess rescue options, whether before or during business rescue.
The rise of distressed M&A
The survey points out that In the last year, the rise of distressed M&A (especially when used as an exit strategy) has become evident. BRPs were the stakeholders that indicated that distressed M&A played a greater part in their portfolios compared to any other stakeholder. Commercial banks, possibly given the trust issues of business rescue, also expect greater distressed M&A activity in their portfolios with 31% of commercial banks indicating that more than 25% of their portfolios undertook distressed M&A in the past year, which is expected to rise to 38% over the next year.
The C-Suite clearly see the opportunity that distressed M&A will bring (Figure 5.3) as there is an expectation that competition will increase for distressed assets. Those deals in more accommodative jurisdictions should be more successful than others as regulatory risk remains, in their opinion, the greatest challenge.
The survey adds that distressed M&A can, and often does, go hand-in-hand with business rescue. When the lawyers were asked to make one recommendation to improve business rescue legislation, the ability to conclude a ‘pre-pack’ business rescue was ranked in the top three options behind establishing a dedicated commercial court (perhaps no surprise for a legal audience!) and almost equal with clarity regarding the ranking of PCF.
Ultimately, one could argue that a transaction in business rescue through a distressed M&A would achieve both objectives of business rescue. Not only would one rescue the business and provide opportunity for continued trade for creditors, but also ensure that creditors achieve a better result than in liquidation through the distribution of proceeds to the pre-commencement creditors.
Innovative thinking
There is one more theme – a crisis of trust – which is discussed in a separate editorial as it needs a bit more interrogation and questioning.
When faced with the prospect of the Jericho problem, the Israelites had to think out of the box to come up with a solution. BRPS and Turnaround Professionals are faced with similar problems and are equally required to employ innovative thinking. This will be discussed in later editorials.
