DealMakers AFRICA Q2 2020
One Size Does Not Fit All - restructuring for uncertain times
by Edmund Higenbottam and Brett Roberts
A combination of factors is challenging the economic sustainability of businesses, large and small, across Africa. Globally, the COVID-19 crisis and associated lockdowns have had the effect of “calling the end of a long bull market” that has run since the credit crisis of 2008. In most African markets, however, the bull market had already ended some years before the pandemic. Instead, in Africa, the pandemic has compounded previously existing difficulties, such as weaker commodity prices, sovereign credit challenges, volatile exchange rates and uncertain public policy regimes. Despite some differences, there are many commonalities among the issues facing a wide range of companies across all sectors. From an investment perspective, investors have taken an increasingly “risk-off” approach to Africa in recent years that has only accelerated during the crisis, adding refinancing risk to the multitude of risk factors already at play.
While pervasive in influence, these challenges are impacting companies differently, depending on their strength heading into the crisis, as well as their business models and sectoral exposures. For the strongest performers - “top quartile” companies - the crisis is causing challenges that are primarily short-term in nature, including constrained cash flow and reduced profits. For bottom quartile companies, tough conditions have exacerbated bad debt positions, product deficiencies, operational inefficiencies and/or balance-sheet weakness that now threaten their viability. A common theme across the board is a focus on maximizing efficiency, which in many cases means salary cuts, especially for more senior staff.
Even for top quartile performers, short-term challenges specifically relating to the Covid-lockdowns may necessitate negotiations with creditors, to relax covenants and defer principal payments. Many of these companies were growing strongly before the crisis.
However, a few months of impaired revenues can wipe out an entire year’s profits, leaving such companies in need of external equity to grow in the post-crisis period. For some of these top companies, the crisis presents opportunities to implement new growth strategies, restart capex programs or even pursue opportunistic acquisitions. For equity investors, there may be opportunities to gain exposure to companies and projects that previously had been sufficiently capitalised through internal means.
For companies in the middle quartiles (the second and third quartiles, on either side of the median), discussions with creditors are often critically important, and may require more formal forbearance agreements. In some stress cases, the ability even to service interest – let alone principal – is in jeopardy. Perhaps equally important, the crisis is a catalyst to address critical strategic questions, which probably should have been considered more seriously before the crisis (Similar questions also should be posed regarding the various business lines within companies). Should multinational groups sell or close down their operations in weaker performing countries to focus on stronger markets? Do companies postpone or progress previously allocated capital expenditure or asset programs like plant openings? Does the company have the right skills in senior and middle management? What is the right capital structure and funding mix going forward? Is the company too dependent on one type of funding source?
Many companies in the bottom quartile were already facing “going concern challenges” pre-crisis. Many of these will therefore need to consider significant asset sales or a full-blown sale of the company, if possible, to salvage value for stakeholders. In order to buy time for such sales, unpalatable decisions by creditors may be required, such as debt-for-equity swaps or write-downs.
Coordination among creditors – as well as a responsible approach to negotiations – can be incredibly helpful in achieving the best possible outcomes. Without communication among creditors, a distressed situation can quickly evolve into a classic “prisoner’s dilemma.”
One key for all companies is to act early: completing a renegotiation with creditors takes time, especially if the arrangement is tied to one or more of the other corporate moves discussed above. “Running down the clock” reduces room for manoeuvring, and hence, negotiating power. Furthermore, a realistic and analytical approach to the problems is crucial. Are the challenges actually a solvency problem as much as a liquidity problem? What is the most realistic pathway to return to a normal course of activity, and what (and how realistic) are the assumptions on which this pathway depends? An external advisor can accelerate the identification of the key issues, as well as the overall decision-making process.
Furthermore, negotiations that straddle different sponsors, shareholders, creditors of different types or seniority – and perhaps new investors – can be complex to manage. A clear strategy that is analytically “watertight”, vis-à-vis the company’s fundamental financial position, as well as clear tactics for the paths of the negotiations – group by group – are equally important. Verdant Capital is currently advising companies across several countries and regions in Africa – top quartile, middle quartiles and bottom quartile – to address all of these challenges and opportunities.
Higenbottam is Managing Director and Roberts a Director of Verdant Capital. Verdant Capital is a leading specialist financial advisory firm that operates across Africa.