As countries across Europe prepare for phase two of the coronavirus pandemic, with lockdown measures set to be gradually lifted and economic support measures being implemented, the restructuring community is prepping up as well for what will likely be a long and busy restructuring cycle. While the panic mode that dominated the market at the onset of the crisis seems to have faded, uncertainty on how to deal with such an unprecedented event is here to stay for the foreseeable future.
“The premise we must take is that nobody really has any idea how to deal with this unique situation. If we take the 2008 crisis as a reference point, in fact, by comparison to the damage the virus is now wreaking on economies, 2008 seems almost a sideshow,” commented Andrew Wilkinson, Senior European Partner at law firm Weil Gotshal & Manges, participating in a live webinar hosted by Debtwire in partnership with Datasite on challenges and outlook in restructuring for 2Q20 and beyond, last week.
“We are two months into this crisis in EMEA and we are seeing various stages as we prepare for a full restructuring cycle,” pointed out Merlin Piscitelli, Chief Revenue Officer for the EMEA region at Datasite. “The traditional M&A market and exit options have been dropping, while with companies that were already in trouble or maybe had six months before running into trouble, the crisis [has accelerated the process]. These are also early days of liquidity crunch as people assess balance sheets and short-term capital needs, with various funding options – rights issues, high yield bonds, private placements, etc. Finally, strategic reviews of businesses across all sectors [are being undertaken] to assess how healthy they are.”
“In the case of companies with pre-existing operational issues, those have now been uncovered, forcing owners and management teams to address them faster than they might have otherwise,” added William Jenkins, Managing Director at Alvarez & Marsal. “Then you have companies with a catastrophic issue, where revenues have basically stopped or markedly declined – travel, casual dining, entertainment industries. But the most interesting part is the way this crisis is sweeping through consumer-focused companies, as consumer demand and confidence have been badly hit and there won't be a light switch moment, but rather a prolonged recovery. In this context, consumer finance businesses are particularly interesting, as they relied on getting money out of the door and on collections.”
All actions taken so far – both by governments and individual companies – have been aimed at one key thing: weathering the storm and buying time.
“The governments have been implementing several measures, including direct/indirect borrowing support, tax deferral, changes to insolvency regimes. None of it is going to restore economy: they are designated to buy time, keeping companies alive and employing people,” Wilkinson pointed out. “The restructuring path ahead will be different [from before]. To do a restructuring you need a business plan, numbers for this year and next to do your sensitivities and then build up a capital structure. But it is very difficult to have those building blocks now.”
In addition to that, management teams have mostly focused on the day-to-day operations so far, pushing any meaningful balance sheet conversation to a later stage, Jenkins added. “CFOs have been looking to draw down on their revolvers, which was absolutely the right thing to do, and worrying about their balance sheets later. When they have these conversations with stakeholders, what are they going to present given that no one knows how the coronavirus crisis will unfold and last for, and what shape the recovery will take?”
“Revolver drawings are happening all over the place, and ultimately that is what they are for at the moment, alongside borrowers looking into some other debt capacity under their existing documentation,” concurred James Slessenger, European Managing Director of Xtract Research, a Debtwire sister company. “What the capital structure will look like at the end of this is something that none can say now.”
While investors have been concerned at the start of the crisis that companies' EBITDA could be artificially inflated by adding back lost revenues as exceptional, non-recurrent items, there haven't been any such cases to date. However, borrowers have been looking at some other ways under the documentation to avoid using actual 2020 EBITDA numbers.
“In the US, Mednax has got its lenders' approval to use the average last eight quarters EBITDA to end 2019 as a proxy for this year EBITDA, while Marriott International, which has agreed a covenant holiday for this year, will use 1Q21 EBITDA and annualise it when covenants apply again next year,” noted Slessenger. “In general, there is quite a long runway before hitting a hard default. For the first quarter of this year, you are still buoyed by three quarters of last year; 2Q20 will be when the covenant ratio headroom will start being eroded . But even then, as a lender, why would you start enforcing when asset value is mostly impaired?”
As balance sheet rework processes are overall being pushed away, the exceptions to this trend are companies that have liquidity needs and are unable to access government-backed funding. “Those are the current restructuring candidates, and it is a growing list,” Wilkinson commented.
European governments have also been proactive by introducing changes to the insolvency regimes in a bid to promote restructurings and keep companies out of insolvency. The UK government, for instance, has changed its approach towards companies at risk of insolvency markedly.
“A few years ago, on the back of some high profile companies collapsing such as BHS and Carillion, the UK government took a tough stance against management. That has changed now, and the [priority] is to make sure companies don't go bust,” Wilkinson said. “Additionally, up until the crisis, there wasn't a compelling need for super senior funding [in insolvency situations], but it is now essential to put that in place, in order to move the burden of funding away from the government and towards the private sector, where it should be.”
As much as government support is key and unavoidable at present, it simultaneously raises questions over which companies should actually benefit from it, and what its long-term consequences will be. However, what a sustainable capital structure will look like post-coronavirus might mean something quite different from before.
“Governments' view of what a zombie is, has likely no resemblance to what zombie meant before. Any company that employs a reasonable number of people and would employ them after the crisis is a company that the government will want to support,” Wilkinson pointed out. “That said, government assistance will complicate the task of restoring normality when we come out of this, and will be a major challenge for the [restructuring] industry collectively."
This article was originally published by Mergermarket on May 1, 2020; it has been republished with permission.