The Current Situation and K2’s Recommendations for the Autumn Budget Statement

Calls for measures in next week’s Autumn Budget Statement to stimulate the economy are growing louder by the day.

Sadly, the news has been unrelentingly gloomy since October, when Public Sector jobs cuts showed a reduction of 110,000 between March and June, the rate of cuts five times higher than the OBR’s prediction, while job creation in the private sector was only 41,000.

On 14 November, the CBI’s latest employment trends survey found that 47% of employers were relatively optimistic, predicting their workforces would be larger in a year while 19% predicted they would be smaller, a positive balance of +28%.

But then, on 16 November against the background of the Eurozone debt crisis, the Bank of England revised down its growth estimate to stagnation until mid-2012 and only 1% growth for the year as a whole.

The ONS unemployment and employment figures on 19 November showed unemployment at its highest ever total of 2.63 million. From July to September a record 305,000 employees had gone from the economy and in the same period 100,000 people became self employed making a record high total of 4.09 million.

Are these people with a burning ambition to start their own business or have they simply given up on the increasingly fruitless search for employment and set themselves up as freelance sub-contractors or consultants?

As lending conditions continued to tighten, particularly for the country’s SMEs, Project Merlin again undershot its target and companies continued to pay down debt rather than investing.

By 20 November, the CBI, too, had had a rethink, reporting that firms were now reviewing investment plans after a “sharp fall” in confidence with 70% of senior business leaders now less optimistic about the future and two out of five freezing recruitment or laying off staff.

This does not suggest that the private sector is either in the position or the mood to create the additional employment that the government hoped would mop up the public sector job losses.

While not wishing to contribute further to the doom and gloom, it is difficult to find anything positive to say about the current picture and therefore this post adds to the growing calls for a “plan A-plus”  to stimulate some growth. What business desperately needs is some stability to restore confidence.

Our wish list includes measures to encourage small businesses to build capacity for growth by making it easier for them to employ and train people. Initiatives such as a NIC holiday for new employees, or young employees, training grants and relaxing termination obligations will make it easier for employers to justify taking on staff.

We also need measures to encourage export, particularly to areas outside the Eurozone, such as export trade credit, marketing support, trade delegations and export tax credits.

Finally small businesses need to be able to fund their investment in growth via a level of credit easing. The Government initiative of demanding that banks make loans to SMES under Merlin, while at the same time requiring them to reduce risk, is a farce. There are a number of possible initiatives but the Enterprise Finance Guarantee scheme hasn’t worked and the Small Firms Loan Guarantee Scheme (SFLGS) that it replaced did work. We advocate a reintroduction of the SFLGS.

Times are Tough for Commercial Landlords

Commercial landlords are coming under pressure from all sides in the current economic climate.

The plight of those landlords in the retail sector has perhaps been the most widely publicised as more and more empty shops appear on the High Streets where retailers have either ceased trading or moved out of expensive and badly performing outlets.

The problem for landlords is the double pressure of receiving no rent for their empty properties while still being liable for paying expensive business rates, calculated at approximately 40% of estimated annual rental value, a considerable burden.

Recently Dixons, owner of Currys and PC World, revealed that it had agreed with some of its landlords, to pay rent of just £1 a year in exchange for Dixons continuing to pay the business rates. Dixons is not the only retailer with business rate only deals with landlords.

Problems are not only in retail, however. Many commercial landlords are struggling as their tenants downsize, restructure or go out of business altogether, leaving empty industrial and office units for whom new tenants are hard to find. They still have to service their own loans as well as securing their empty premises and paying rates.

Added to this is the change in attitude among lenders towards property companies. Property loans are generally provided by banks who are now asking for much more equity and much better tenant covenants with evidence of a secure income when considering new or renewal of commercial mortgages. Banks themselves are already overloaded with vacant and distressed property assets.

The confluence of pressure is leaving many commercial landlords completely boxed in and adding to the problem is the amount of commercial property on the market.

A related issue is the number of businesses that cannot be sold because of an existing lease obligation. Buyers often want to downsize and therefore are seeking to renegotiate lease terms before purchasing the business.

There are formal and informal restructuring options that can be used to help commercial landlords who are dealing with vacant and loss-making properties but restructuring property portfolios is a complex process and every single situation is different.  This is a situation that requires the knowledge and skill of an experienced restructuring adviser.

Falling Confidence Among SMEs Supports Evidence of a Long L-Shaped Recession

Recently released insolvency figures show relatively little change year on year, suggesting that the debate about whether the recession would be a V-, U-, W-, or an L-shape Is now over.

It is four years since the economy collapsed and the evidence is piling up that it is flatlining. Whatever the technical definition for coming out of recession may be (ie two successive quarters of growth), a growth of 0.2% for the UK economy means it continues to bump along the bottom of an L-shaped economic decline, whether it is called a recession or not.

Had the recent decline followed the pattern of previous ones the numbers of insolvent companies would by now be climbing noticeably, as they are generally held to do when an economy is on the road to recovery.

However, the latest CBI quarterly survey shows a sharp decline in confidence among small and medium sized businesses, reporting flat domestic orders in Q3 and export orders down by 8%. They expected domestic orders to fall by another 4% in the final quarter, no growth in exports and were indicating intentions of reducing their stock holdings – hardly suggestive of any optimism there.

Perhaps the most interesting feature of the just released quarterly insolvency figures is the noticeable increase in the number of Company Voluntary Arrangements (CVAs) relative to the numbers of companies in Administration as going concern formal insolvency procedures. Compared to the same quarter last year, CVAs rose by 29.6%, while Administrations rose by only 6.3% perhaps reflecting the adverse publicity over the use of Pre-Pack Administrations.

Many commentators are predicting a lot of insolvencies lining up for the end of Q4. Since a rise in insolvencies traditionally indicates the emergence from recession, perversely, this suggests that they are being optimistic rather than pessimistic.

But if the economy doesn’t recover and there is a rise in corporate insolvencies, this will be truly damaging for the UK. There is a huge difference between insolvency to restructure a business to prepare it for growth and insolvency to close it down.

Continuing low interest rates and no discernible evidence of banks or other creditors really piling on the pressure, nor any sign of the restructuring that normally indicates the bottom of a recession, plus the plummeting confidence of the country’s SMEs, suggest that the economy will bump along the bottom Japanese-style for the foreseeable future at best or will decline further at worst.

The Roller-coaster That is Magazine Publishing

The magazine publishing industry has been on a roller coaster ride for many years as print advertising revenues have plummeted, driven partly by a shift to online advertising but more recently by the drop in marketing budgets during the ongoing economic crisis.

This year alone, Sky has discontinued all its magazine titles, each of which had a circulation of £4 million. BBC Worldwide has sold 34 titles to a private equity company. Future UK closed eight titles in July, citing a decline in revenues particularly in the US, and the UK-based B to B publisher Schofield closed its US operation completely, allegedly because the US division’s bank withdrew its finance.

Publishers have been suffering from a triple whammy, of diminished advertising revenue, increased newsprint and ink costs, while simultaneously trying to service residual debt taken on during the good times. 

Yet some publishers remain up beat. London-based B to B publisher Centaur Media has announced that it will double the size of the business in three years by focusing on buying up exciting new businesses, paid-for subscription services and events. Centaur restructured into three divisions in June and says that by 2014 it will double its revenue, the proportion of money it makes from online media and its operating margins. It also plans to reduce its reliance on advertising and shrink the contribution of printed media from 43 percent to 16 percent.

The question is whether it will succeed. We know of one publishing company currently going through a restructure that had been growing over the last two years.  It has a defined circulation B to B market with publications funded by advertising revenue. However, despite its current profitability it is carrying huge liabilities built up over two years of loss making while the business was growing. The sad fact is that this publishing company was undercapitalised and as a result its suppliers have funded its growth and are now exposed as unsecured creditors.

The raises the issue of growing liabilities in an industry where revenue is declining and supplier costs are rising. The potential for a publishing house to drag a lot of suppliers down with it is huge. Restructuring such companies is also difficult since cutting editorial costs has an impact on quality and relevance to readers.

Clearly the industry will need to be much more innovative if it is to survive and prosper. One obvious tactic, as illustrated by Centaur, is to shift some titles to being online only.  Others are making some online sections accessible by subscription only and charging for special reports and in-depth industry information. Other innovations could include experimenting with outsourcing writing overseas, outsourcing sub editing and page make up and printing abroad.

Readex, which regularly surveys attitudes among B to B readers recently reported that 74% wished to carry on using print versions of the titles they read so there is plainly life in the B to B publication market. Professionals will always need to keep up to date with their industry’s developments and the activities of competitors.

Nevertheless, the print side of the industry is likely to decline. Publishers will need to be more innovative and change their business model, most likely embracing alternative media that does not rely on printing and physical distribution.

A cynical view of the European bailout

The European President Herman Van Rompuy has finally emerged from wherever he’s been hiding to comment on the European bailout fund: “The leverage could be up to one trillion under certain assumptions about market conditions and investors’ responsiveness in view of economic policies”.

Isn’t it reassuring to know that politital leaders have a grip on the problem.

Meanwhile markets rise with relief that 17 eurozone member countries agree that China will bail out Europe.

Now that Greek debt will be written down, when will Italy, Portugal, Spain, Ireland, France and Belgium make their demands for their own write down?

 

Politicians and Retailers are Still in Denial as they Focus on Window Dressing

Once again retailers have blamed the weather for stagnant sales, only this time it was a couple of weeks of unexpected sunshine in September rather than the three weeks of snow that were blamed for dire pre-Christmas sales last year.

Both politicians and retailers are still in denial about the High Street. Most initiatives are aimed at stimulating consumer spending whether discounting or sales, talking up the recovery and promoting spending or window dressing by Mary “Queen of Shops” Portas.

The fact is that consumers in the UK are undergoing a huge change in their approach to consumption and credit. They are spending less on unnecessary goods and this in turn is having an adverse impact on retailers.

Over the last thirty years our excessive consumption has driven the UK economy, creating the illusion of growth while all the time we became ever more dependent on the retail sector. Our consumption based growth was fuelled by ever more debt, not just personal debt but national debt, creating an ever increasing huge balance of payments deficit. This combined debt, consumer, corporate and national borrowings, represents 466% of UK GDP.

However the debt has to be repaid, and we have finally faced up to this harsh reality, paying back a net £200 million in September according to the British Bankers Association.

Companies like JJB Sports, Jane Norman, TJ Hughes, Walmsley and Alexon with its 990 shops all recently joined a growing list of struggling companies going bust, while the Home Retail Group, owners of Argos and Homebase, has reported pre-tax profits down 72%.

We need to challenge the notion that all these high street retailers should survive. If we are going to consume less, can we sustain the current number of retailers?

In addition to adjusting their UK retail business models some, including Debenhams and Argos, are focusing on international expansion.

As turnaround specialists we are arguing that we need a vision, we need export oriented manufacturers and services to effect a transformation if we are to become a producer economy with a balance of payments surplus.

Construction in Crisis – Time for a Reconstruction?

The ongoing economic crisis continues to take its toll on the construction industry with the sad news that a high profile company that was more than 100 years old has gone into administration.

KPMG have been appointed as administrators of London-based Holloway White Allom, which recently completed a refurbishment of the Victoria & Albert Museum, for which it won a conservation award.

The company, founded in 1882, was known for high profile contracts including the refurbishment of the Bank of England in the 1930s, the construction of Admiralty Buildings on Horse Guards Parade, of the Old Bailey in the early 1900s and the fountains in Trafalgar Square.

Although the company was undergoing a turnaround and restructure, following a cash injection earlier in the year from private equity firm Privet Capital, it is understood that it was forced into administration by late payment for one large project.

This latest high profile casualty comes as the construction industry faces increasing pressure. ONS figures show that output on public housing was down by 5.3% and on other public projects by 7.5% during the three months to August 2011 compared with Q3 last year, and accountancy firm Deloitte reports that the number of property and construction companies that went into administration in Q3 2011 rose by 11% to 117 compared to 105 in the same period last year.

However, some sectors of the industry are faring better than others.  Bellway, for example, this week posted a 50% annual increase in pre-tax profits, smaller construction companies focusing on repair and refurbishment are also surviving well and commercial construction activity has increased for the 19th month in a row.

Those companies that took steps to restructure their business to focus on what is likely to survive in a declining market and to deal with indebtedness early in the recession have done well. 

This suggests that those companies with a bad debt or over-indebtedness due to historical loans should consider restructuring their businesses before they run out of cash. It is not too late for them, but they are likely to require a restructuring adviser to help them.

Businesses Should Pay Down Debt and Beware Offers That Seem Too Good to be True

Many businesses are overburdened with debt and desperate for ways to deal with pressure from banks, HMRC and other creditors. All too often they are prepared to pay off old debt by taking on new debt which leaves them vulnerable to unscrupulous lenders.

Prior to 2008, interest-only loans and overdrafts were a common method of funding, and were reliant on being able to renew facilities or refinancing.

Like many interest-only loans, an overdraft is renewed, normally on an annual basis, but it is also repayable on demand. What happens when the bank doesn’t want to renew the overdraft facility?  With the economic climate continuing to be volatile and uncertain and banks under intense pressure to improve their own balance sheets, they are increasingly insisting on converting overdrafts to repayment loans and interest-only finance is disappearing.

This has created a vacuum for alternative sources of funding to enter the market where distinguishing between the credible salesman and the ‘snake oil’ salesman can be very difficult. Desperate businesses are desperate often try to borrow money and become more vulnerable to what at first sight seem to be lenders that can offer them alternative funding solutions that the banks cannot.

Generally the advice is to beware, as the recent eight-year prison sentence handed to “Lord” Eddie Davenport illustrates.  The charges related to a conspiracy to defraud, deception and money laundering, also referred to as “advanced fees fraud”. 

The court found Davenport and two others guilty in September. Meanwhile a large number of businesses had paid tens of thousands of pounds for due diligence and deposit fees for loans that never materialised and left victims even deeper in debt. The case only became reportable in October, when restrictions were lifted.

Many businesses just want to survive and are trading with no plan or in some cases no prospect for repaying debt. In such instances they should be considering options for improving their balance sheet by reducing debt. Options might include swapping debt for equity, or debt forgiveness by creditors or setting up a CVA (Company Voluntary Arrangement).

Leadership, Restructuring and the Eurozone

The Germans and other northern members have benefited from the Euro effectively fixing the exchange rate that has made it easy and relatively cheap for them to sell their cars etc to southern members to whom they lent money to buy their cars. This is very similar to the banks lending money to customers who spent it.

The issue then is who takes responsibility for the debt and managing the Eurozone fallout. Do lenders write off debt, or do they lend more such as via Eurobonds or Quantitive Easing (QE) with terms that impose huge penalties. This latter route is similar to the reparations that planted the seeds of the second world war, a subject that has recently been put on the table. Or do lenders defer payments that allow for a fudge whereby loans are repaid over an extended period that effectively allows inflation to devalue the loans.

The UK has opted for the fudge route and will avoid banks defaulting through QE, low interest rates and using inflation to reduce the cost of repaying debt. While most borrowers will benefit, those with assets, savings and reserves will see them devalued while the debt overhang is cleared. Although this is regarded by many as a mistake, we saw in 2007 and 2008 what happens when banks default and are right to avoid bank defaults.

Europe however has yet to find a solution whether it is by managing southern member defaults, or providing more loans to avoid default. The problem facing European leaders is that they need to be strong and stand up to their electorates if the lessons of history are to be applied.

While European leaders find their backbone, in UK our political leaders are looking decisive, a tribute to both Darling and Osborne. Inspite of the decisions taken it will still take a long time to clear the debt overhang with a floating exchange rate and inflation to reduce debt and low interest rates to smooth the way.

Most UK companies that have undergone restructuring have much stronger balance sheets and are building reserves ready to take advantage of the Eurozone fallout. However there are still many more UK companies, that like many European members, have weak balance sheets and continue to struggle while they and their lenders put off the inevitible restructuring.

Winding Up Petitions

269 Company Winding Up Petitions are due to be heard in the High Court this coming Monday, 19th September where the list is still dominated by HMRC petitions.

None of the Companies listed are well known and unusually there are no football clubs listed however one with the name Three Merry Lads Ltd sounds like an interesting business.

Since introducing our handholding service for directors dealing with a Winding Up Petition, it is unusual for K2 not to have anyone to take along on Monday. We like to take directors to the High Court in London several weeks before their company’s Petition is heard so they know what to expect, but we continue to be surprised that so many reject the offer of this free service.

If you know anyone dealing with a Winding Up Petition or have a client who would like to come along to the Companies Winding Up Court on Monday or indeed any Monday do get in touch, call over the weekend if you want to join us on Monday 19th.

We love it whan a petition is dismissed following approval of a CVA.