The State of the Industry

After a busy 2020, 2021 proved to be a significant year for the business rescue industry.

What is the state of the industry? This was discussed in the recently published 2021 Deloitte South Africa Restructuring Industry Survey. Below are the key findings from the survey. Over the next few weeks, we will focus on the contents from the survey in greater detail.

What does the future of the restructuring industry hold post Covid-19?
Given the Covid-19 pandemic and its effect on various businesses and industries, South Africa continues to confront a deteriorating economic climate, resulting in increasing numbers of distressed businesses.

The aim of this report is to give an overall view of the restructuring industry and to obtain a deeper understanding of how the informal restructuring and business rescue (BR) industries are expected to unfold post Covid-19.

A cross-section of restructuring professionals in South Africa was surveyed to obtain a better understanding of the current state of the industry following the Covid-19 pandemic, and what their expectations are for the next 12 months.

Key findings
Some of the key themes that emerged from the survey are:

• Protecting the business and preservation of employment are still ranked as the top priorities of a restructuring process;
• On the back of increased activity experienced by respondents in the past 12 months, 88% of respondents are expecting
• increased activity levels in the restructuring industry over the next 12 months;
• Availability of post-commencement finance (PCF) is still considered an important requirement for a successful BR process;
• Informal restructuring solutions are preferred over formal solutions, largely due to greater success rates and cost effectiveness;
• The unfavourable stigma attached to companies in BR is a challenge to the success of a formal restructuring process;
• Early identification of financial distress is still ranked as the most important element to be improved in local restructuring;
• The appointment of a chief restructuring officer (CRO) is not common in South Africa, with CROs deemed to be difficult to find;
• Nonetheless, 77% of respondents believe that the CRO role will be more important in the future;
• Respondents anticipate increased demand for distressed funding as one of the key financing trends over the next 12
• months; and
• Customer relationship management (CRM) tools, big data, cloud as well as AI and machine learning are some of the technologies expected to have transformational impact on the restructuring process in the coming years.

Prior to the COVID-19 outbreak, South Africa had been grappling with lethargic growth rates, job losses, structural challenges, a sizable fiscal deficit, and an expanding debt-to-GDP ratio. The pandemic and the lockdown restrictions imposed to control the spread of the virus have exacerbated this already dire economic state.

The South African economy’s response to Covid-19
Economic growth is estimated to have contracted by -7.2% in 2020, given the shock to output in 2020 on account of lockdown restrictions. This severely impacted households and businesses in the first half of that year. Indeed, 2.2 million jobs were lost in Q2 2020 and although employment recovered by 900 000 workers in the last two quarters of 2020, many jobs lost in 2020 are unlikely to return.

South Africa’s gross debt-to-GDP reached 63.3% in 2019/20 and is expected to surge to 80.3% in 2020/21, owing to the government’s fiscal stimulus measures and declining tax revenues.

The Covid-19 pandemic has disrupted businesses and industries across the country. According to respondents, sectors that have been most affected by the pandemic and lockdown restrictions are the hotel and leisure, retail, real estate and construction sectors.

While many sectors have been severely impacted by the pandemic, there are sectors which have benefited from the pandemic, such as online businesses. Respondents identified the telco, media and technology (TMT), agriculture, financial services and resources (e.g. mining) sectors as those least affected by the Covid-19 pandemic.

Given the severe economic contraction, and uncertainty regarding the path of the virus, the vaccine rollout programme and the timeframe of economic recovery, some economic sectors will certainly take longer to rebound, increasing the need for turnaround and restructuring services. Respondents believe that the hotels and leisure, retail and commercial real estate sectors will continue to suffer in 2021.

Apart from the travel and lockdown restrictions imposed, South Africa has prioritised its response to the health crisis by aiming to save as many lives as possible and supporting people and businesses that are most affected. The South African government has introduced fiscal and monetary measures in an effort to boost economic activity and curb the spread of the virus. A Covid-19 support package of R500 billion was budgeted to cater for, amongst others, tax and payments relief, protecting jobs through wage support, and funding small businesses in distress.

Unsuccessful
While these government responses have been welcomed, 88% of respondents do not believe that the government’s fiscal and monetary measures have been successful in curtailing the impact of the Covid-19 pandemic, particularly on businesses. Some respondents believe that government has been more proactive in communication, planning and creating policies, while implementation has been less effective. As a result, most respondents feel that government has not handled the fallout from the pandemic well. Instead, respondents believe that financial institutions have supported South Africa’s economy through the pandemic and have handled the Covid-19 pandemic best.

Financial institutions were the first port of call for corporates struggling with the effects of the pandemic, and 27% of respondents indicated that a request to waive covenant breaches and obtain capital and interest holidays was the most common action taken by companies in an attempt to bolster their balance sheets and preserve liquidity. Unfortunately, this is not a sustainable solution to generating liquidity as the obligation to make payment against debt facilities remains and future repayments are likely to be higher because of the deferrals. It is clear that financial institutions have taken a pragmatic view and waived events of default to avoid systemic failure and widespread insolvency.

Rationalising operating costs and deferring nonessential and major capex were also cited as common actions taken by companies. However, these measures are regarded as ‘quick fixes’ rather than sustainable measures to improve the balance sheet. Working capital optimisation is an example of a more sustainable measure to improve cash flow, although with longer timelines for implementation. The long-term strategic consequence of the delayed or cancelled capex programmes is unknown.

Economic growth is forecast to recover to 3.3% in 2021 and then moderate to 2.2% in 2022. However, there are many threats to these figures. The overall uncertainty around global conditions, the vaccine rollout, the path of the virus, electricity supply risks, ongoing weak business and consumer confidence, and other structural weaknesses challenge the country’s chance of a sustainable economic recovery. In addition, government continues to battle balancing risks emerging from growing debt burdens attached to public spending and spending on infrastructure investments with those from prematurely withdrawing fiscal support.

Dependent growth
Short-term growth is highly dependent on the vaccine rollout to prevent future waves of infections and a resulting return to ‘normal’ economic activity, stabilising the fiscus, and implementing a complex set of reforms to alleviate constraints to growth.

The key focus should be on addressing the country’s structural weaknesses by building business confidence, lowering the cost of doing business, stabilising electricity supply and public finances, as well as stimulating private sector investment.