Banks, Lenders & Investors Finance Turnaround

Can zombie and critically distressed businesses be resurrected from near-death?

zombie and critically distressed businesses - can they be rescued?More than one in ten (11%) UK businesses is a zombie business at the start of 2019, according to the Business Distress Index produced by the insolvency and restructuring trade body R3.
The figure rises to 16% of businesses in the North East, according to the Newcastle Chronicle, and the state of many more UK businesses is graphically illustrated by research from Begbies Traynor’s most recent Red Flag Alert, which showed that the number of businesses in “critical” distress leapt by a quarter to 2,200 in the fourth quarter of 2018 while those in “significant” distress remained roughly flat year-on-year at 481,000.
A zombie business is generally defined as one that is only able to pay the interest on its debts, not repay the principal debt.
As such, economists argue, these businesses act as a drag on investment, productivity and the economy, because they do not have the available capital to invest in new operations, products, or services, while the investment tied up in them is denied to other, nimbler companies.
Also, it is argued, many of them are only surviving because of the continuation of the very low interest rates that Central banks put in place in the wake of the 2008 Crash. Indeed, the BIS (Bank for International Settlements), the umbrella organisation for global central banks, has argued that the steep increase in the numbers of zombie companies has been “one of the dangerous by-products” of persistent low interest rates.
Is there any point in trying to rescue zombie and critically distressed businesses?
Inevitably all this supports the doom and gloom merchants who are predicting an imminent recession exacerbated by Brexit uncertainty, a decline in globalisation and ongoing trade wars.
Ric Traynor, executive Chairman of Begbies Traynor, suggests that in today’s world businesses need to be able to change direction quickly.
“Far too many companies have been caught out by an unwillingness to rapidly evolve and adapt to the new climate we are in,” he says.
We would argue that before such businesses throw in the towel completely it is worth getting help from a turnaround and restructuring adviser.
They will conduct a thorough and in-depth review of the state of the businesses and identify its weaknesses and strengths and may be able to offer solutions, some of which may involve radical restructuring and reorganisation to fundamentally change the business.
This may involve slimming down the business to a core activity that is profitable in a way that justifies investment in a new strategy that becomes the foundation for future growth.
We have some Guides that might help here such as a Guide to Productivity Improvement. Do look up our library of Guides at:

Banks, Lenders & Investors Finance General

Is there a link between unethical personal behaviour and corporate behaviour?

infidelity and corporate behaviourCan and should investors expect the corporate behaviour of CEOs to be ethical if their behaviour in private is less so?
Releasing the names of those people who had registered their interest in having an extra marital affair following a hack of the Ashley Madison data base caused much vicarious interest. While it no doubt embarrassed those who were exposed and possibly excited some divorce lawyers, it raised the question as to whether someone who deceives their marital partner is more likely to deceive their business or their business partners and shareholders.
It prompted research in the USA by authors John Griffin, Samuel Kruger and Gonzalo Maturana, who then published their work Do personal ethics influence Corporate ethics?
They had cross matched some of the names revealed with corporate information available from Lexis Nexis and other sources, and against the US’ Financial Industry Regulatory Authority’s BrokerCheck and the results revealed a correlation between those financial advisers exposed for marital infidelity and those with a record of serious misconduct revealing that they were twice as likely to have committed an offence.
A similar correlation was revealed when they checked revealed names for chief executives and chief financial officers.

Is ethical behaviour the same whatever the context?

The authors argued that there is plenty of research that shows that the behaviour of CEOs influences others in a company: “other employees perform better if they think the top management is trustworthy and ethical”.
I recall being asked by owners of a nightclub in Greek Street to investigate its lack of profits with view to improving them. I quickly discovered that significant amounts of cash were disappearing from the tills. It turned out that the owners were popping in to take cash, the managers knowing this were also taking cash and so were the staff. Everyone was at it and it was clear that the business was morally and culturally bankrupt with no one interested in it being successful. Theft had become part of the culture where knowledge that others were stealing made it OK. I closed it down and sold the premises on the grounds that a cultural transformation was required based on changing all staff and the behaviour of the owners.
There is a debate to be had about whether some behaviour is acceptable in the corporate context that would not be acceptable in private or social life.
Businesses are largely results and profit-driven and these days investors expect results in a much shorter time than they would have in the past. While outright cheating, deception or breaking the law would not be condoned, aggressive pursuit of corporate goals is arguably a much greyer area.
According to the website ethical “Research suggests that people’s moral compasses are malleable and that various factors influence them. People do differ in their levels of personal integrity, but everyone is susceptible to environmental influences.”
It argues that the behaviour of leaders can therefore have a critical influence on the behaviour of those they are leading. My example of the nightclub supports this.
It makes sense, therefore, that leaders should demonstrate a balance between a focus on outcomes and goals and the means by which they are achieved and that it is important to also focus on people’s efforts to improve and to reward them.
There is also the argument that if a business is receiving bad publicity for the way in which it treats customers and addresses their customer complaints such that it is perceived to be entirely profit-driven and paying scant attention to the quality of service then ultimately the business will be damaged.
So logically, if such behaviour is damaging the bottom line, then the return to investors will also be damaged, and it therefore makes sense for investors to pay attention to the ethics of CEOs both in their private and their corporate behaviour.

Banks, Lenders & Investors Cash Flow & Forecasting Finance General

December Sector focus – are residential care homes viable businesses?

care homes resident and carerThere have been question marks over the financial viability and sustainability of private residential care homes for the elderly since the collapse of Southern Cross in 2011.
At the time it was the largest provider of private residential care homes in the UK and for the first ten years of its existence had been deemed a financial success.
The company was set up in 1996 by a businessman named John Moreton following Government changes to the care home system, resulting in financial cutbacks alongside the imposition of higher standards, which pushed many small independent, essentially family-run, providers out of business.
By 2002 Southern Cross had 140 sites and attracted venture capital interest from WestLB, and two years later, from US private equity firm Blackstone, which bought the business for £162 million.
It continued with acquisitions until the 2008 Financial Crisis, whereupon it became unable to pay a debt deadline of £43 million, its share values plummeted and it began selling assets to pay its debts.
It is a familiar story, but it does not seem to have diminished the appetite of private equity to invest in the care home sector.
However, there have long been concerns about its viability, the most recent in November 2018 being a warning from the regulator the CQC (Care Quality Commission) that Allied Healthcare, the UK’s current largest provider, owned by German private equity investor Aurelius, could cease operating within weeks, again because of loan repayments falling due.

Sustainability problems for the private residential care homes sector

Care homes’ income comes from a combination of self-supporting residents who pay a average of £830 per week for their accommodation and care and from local authority-funded residents, whose maximum payments are considerably below the required cost.
At the moment there are over 400,000 care home beds in England but a lack of public sector care home provision has led to warnings that there will be a shortfall of some 28,000 beds by 2025, according to AMA Research published in its The Care Homes Construction Report, which found that the majority of developers were concentrating on building in areas with a high concentration of potential self-funded residents.
In November 2017 the CMA (Competition and Markets Authority) warned that the sector was on the verge of collapse largely because there was a £1 billion shortfall in costs due to local authorities being unable to meet the actual costs of care provision.
Its analysis of the sector’s financial viability found that the industry was at a “tipping point” and that it had come across instances where local authority-focused care home providers were exiting the local authority segment and that some providers had handed back care home contracts to local authorities.
It concluded that providers have generated most of their profits, in aggregate and on a per resident basis, from non-local authority funded residents, where self-funded residents have made a higher contribution towards fixed costs and common costs such as overheads and that providers have been loss-making in economic terms, i.e. returns below the cost of capital, on local authority funded residents.
It also concluded that many providers were carrying unsustainable levels of debt.
In February 2018 the CQC introduced a new financial viability test on new care providers. It should be remembered that the CQC is responsible for vetting standards of provision and quality of care in care homes and rating them accordingly. Where improvements are required this will mean additional expense for the owners.
Given that investors in private equity and venture capital require a significant return on their money, and in recent times have been less than patient about waiting to get it, all this would suggest that the current model for financing care homes is not viable and significant changes are needed to the model of care provision for the elderly, both local authority-funded and self-funded.

Banks, Lenders & Investors Business Development & Marketing Cash Flow & Forecasting Finance Insolvency

Is fear for the future the explanation for a rising numbers of insolvencies?

does fear for the future rule your business decisions?The increased number of insolvencies, largely due to CVLs (Creditors Voluntary Liquidations) between July and September this year is a worrying, but hardly a surprising, trend.
There has been a gradual upward trajectory in insolvencies for much of 2018 but it seems to be accelerating. The latest figures, for Q3, show an increase of 8.9% on the previous quarter and an increase of 19.3% compared with Q3 in 2017. CVLs make up the bulk of the quarter’s insolvencies at 71.6% of the total, that is 3,083 out of 4,308 and the highest number of quarterly CVLs since January to March (Q1) 2012.
As for much of the year the construction industry had the highest number of insolvencies in the 12 months ending Q3 2018, followed by the wholesale and retail trade and the repair of vehicles industrial grouping.
For some time now, it has been clear that businesses have been holding back on investment for growth given the climate of uncertainty that the economy has been in for two years now, and yes, many cite the lack of clarity over the outcome of the Brexit negotiations as their reason for holding off.
My regular readers know that I believe no SME business can afford to stand still without risking eventual failure and that in difficult times I advise focusing relentlessly on cash flow as well as a regular review of margins and Management Accounts.
Nevertheless, it is understandable that there is little confidence in the future after two years of tedium, and, some would argue, incompetence in the negotiations and it may be that the rising insolvencies are a sign of businesses – and creditors – running out of patience or room for manoeuvre.

The signs for the future are not good

In the last week the CBI (Confederation of British Industry) quarterly survey has revealed that smaller British manufacturers expect their output to dip for the first time in seven years during the next three months. It found that order books are struggling as Brexit approaches, with firms reining in their investment plans as a result. Optimism about export prospects for the year ahead is also at its the weakest level since April 2009.
Lloyds Bank’s monthly barometer of business confidence has also shown a marked slide particularly among smaller SMEs and the net positivity balance had fallen by 9% to -7%.
While the latest IHS/Markit purchasing managers’ index (PMI) for the construction industry improved to 53.2 in October a slowdown in housebuilding across the UK and in new orders is weighing heavily on construction, proof, if any were needed, that in this sector particularly survival depends on growth.
On top of this has come the news that two European suppliers of car parts, Schaeffler and Michelin, announced plans to close UK factories, although both deny this has anything to do with Brexit. Instead they cite dwindling demand for smaller tyres.
As reported in the Evening Standard yesterday, research by Populous World has predicted that around 12,450 smaller businesses in London and the South East may go under if there is a no deal Brexit, with the figure at 7,900 failures even with a deal.
As if that were not enough, there will be more pressure on struggling businesses following the restoration of HMRC to preferential creditor status in last week’s Budget, albeit that this is restricted to recovery of unpaid PAYE, CIS and VAT as the taxes collected by businesses on behalf of HMRC.
Given all the above and that HMRC has become increasingly aggressive in seizing assets and in litigating to recover money owed and, as calculated by Pinsent Masons, that the average length of cases of unresolved tax battles going through the courts is now 39 months, it is perhaps no surprise that creditors are running out of patience and CVLs are climbing rapidly.
Many lenders, creditors and even shareholders would appear to be pursuing a strategy of ‘better some cash now rather than waiting for more later’. Is there a real fear of worse to come?

Banks, Lenders & Investors Finance General

Is Buy-to-Let property still a good investment?

Buy-to-Let residential property focusThe Buy-to-Let residential property sector is the focus of this month’s sector blog.
For several months now, the rate of growth of UK house prices has been slowing down, although this has been somewhat skewed by significant reductions in London and the South-east of England.
There is no doubt that the UK still faces a housing shortage, particularly for affordable homes, with purchase prices still way beyond the means of many potential buyers. In theory this should preserve demand for privately rented homes given that almost everywhere in the country there are lengthy waiting lists for council housing.
However, there have been a number of measures and announcements in the last couple of years that may signal that becoming a Buy-to-Let landlord is no longer such an attractive proposition, especially for private landlords, rather than for property owning businesses.
Landlords are subject to a number of taxes including stamp duty, a one-off tax on the purchase of a property valued above £125,000. In fairness this applies to all buyers and the amount payable goes up in stages depending on the purchase price. So, the duty payable is £3,750 on the first £125,000, £6,249.95 on prices from £125,001 to £250,000 as examples. Stamp duty for second homes now also attracts a 3% surcharge.
But private landlords must also pay tax on their rental income and the summer budget of 2015 changed the amount of tax relief available on the interest on buy-to-let mortgages, which since April 2017 can now only be claimed at the basic, 20%, level of tax, regardless of whether the landlord is paying this or the higher rate of income tax. The same budget also abolished the “wear and tear” tax relief with effect from 2016, which allowed landlords to claim tax relief of 10% on rental income.
On selling a property a landlord must also pay capital gains tax, but only if they sell at a profit. However, they can deduct some expenses incurred in buying, selling or improving the property.
This build-up of pressure on private landlords over the last couple of years, has, according to a report from the Intermediary Mortgage Lenders Association’s (IMLA), resulted in a reduction in new investment in the Buy-to-Let sector from £25 billion in 2015 to just £5 billion in 2017.
In October this year, the Residential Landlords Association (RLA) called on the Government to force Buy-to-Let mortgage lenders not to refuse mortgages to landlords where a tenant is a benefit claimant. RLA research found that “two-thirds of lenders representing 90% of the buy-to-let market did not allow properties to be rented out to those in receipt of housing benefit”.
Looking further ahead, private landlords may eventually find demand for rental properties reducing in view of the Prime Minister’s announcement at the Tory Party conference in October that the cap on local authority borrowing to finance council-house building would be removed.
However, this week, an article in the Independent newspaper revealed that more than half of local authorities in England, many of them in areas of greatest need for new homes, would be unable to take advantage of this because they did not have the right type of accounts, known as housing revenue accounts (HRAs).
This, and a feared slowdown in new builds by Housing Associations, has led to the Office for Budget Responsibility (OBR) predicting that the result would be fewer than 9,000 new homes over the next five and a half years, rather than the 10,000 a year predicted by the Government.
The future for the private Buy-to-Let sector is therefore less certain than it was. Despite the pressure on landlords, those who see property as a long-term income investment will benefit from the demand providing their borrowings and maintenance costs are minimal. A change of government might of course change all this.

Banks, Lenders & Investors Finance General

Predatory investors behaving like unscrupulous bankers

leopard with prey - a predatory investor?Ten years after the lending culture that resulted in the 2008 Great Depression it seems that the behaviour of some investors is no less predatory and unscrupulous than those of bankers 10 years ago.
Recently FanDuel, a fantasy sports site, was sold by its Private Equity investors to Paddy Power Betfair for $465 million. So far so good. However, despite the sale price the ordinary shareholders got absolutely nothing.
The background to the investment is that the business was regarded a Unicorn company (a privately-held start-up valued at more than $1 billion) with it having more than 6 million daily customers in America.
Two Private Equity investors, KKK and Shamrock Capital, provided funds, based on a valuation of at least $1 billion. However, I am sure that the actual investment was based on a mix of debt and equity with a tight agreement that included a drag-along provision that was binding on all shareholders and allowed them to force through the sale of 100% of the shares at the reduced valuation.
I speculate that despite investing in the equity at the higher valuation, the amount of equity was minimal and in any case the agreements provided for the shares having a preferential status and I am also sure provided for an uplift on the equity that ranked ahead of ordinary shareholders.
I am also sure that much of the investment was debt that will have ranked ahead of shareholders. Given the sophistication of the Private Equity investors I am sure they did well out of their pref. share uplift, fees and interest on the debt, albeit at the expense of the founders and other shareholders who will have created the $465 million value for which the company was sold.
Not surprisingly, the former owners and the ordinary shareholders are considering legal action on the grounds that the sale undervalued the business in the USA and ignored a US Supreme Court decision to relax sports gambling laws there. I don’t however believe they will be successful in pursuing a claim since I am sure that the Private Equity investors will have covered all the bases legally.
In my view this is similar to the ruthless, unethical behaviour that characterised lenders’ attitudes at the height of the lending crisis that led to the 2008 Great Recession.
The defence of such behaviour is that it is legal and one of ‘buyer beware’. Perhaps the ordinary shareholders should pursue their advisers who are culpable for leaving their clients so exposed to ruthless and unscrupulous investors.
Doubtless private equity companies, like banks, would argue that it is their job to maximise returns for themselves and their investors by whatever means, albeit within the law. However, the ethics of their behaviour and their reputation for fair dealing ought to be a concern if they are not to become regarded in the same way as bankers.

Banks, Lenders & Investors Cash Flow & Forecasting Finance General

The current state of the UK commercial property sector

an unusual angle on commercial propertyThe UK’s commercial property sector covers everything from retail units to warehousing, office blocks to industrial units and it is no surprise that some sectors are performing better than others.
Across the commercial property sector, UK prime commercial property rental values increased 0.7% in Q2 2018, according to CBRE’s latest Prime Rent and Yield Monitor. It found that the Industrial sector was the top performer for the 7th quarter in a row with a 2.1% increase in prime rents. CBRE is the world’s largest commercial property services and investment company.
Clearly, a major concern for the commercial sector is the dramatic decline in demand for retail space in the light of the plethora of retail failures over the past two years. This has been attributed largely to the shift by consumers to online shopping, but also to the 2017 business rate revaluation that some argued had a disproportionate impact on smaller retailers although I think it has affected all non-domestic rate payers.
The most recent quarterly survey by RICS (the Royal Institute of Chartered Surveyors) also reports: “results show the downturn across the retail sector intensifying, with stores in secondary locations displaying particularly negative rental and capital value projections.”
While the demand for renting retail shopping units may have plummeted, however, demand for warehousing has soared – attributed largely to this shift to online shopping but also to the surge in popularity of the discount supermarkets such as Aldi and Lidl.
Here, CBRE reports that there has been a “near doubling in demand for warehouse space over the past 10 years” from 130 million sq ft in the previous decade to 235 million sq ft today. This is a mixture of both leased and purchased space. This is not uniform across the UK, depending as it does on efficient road and rail infrastructure and the East Midlands counties of Northamptonshire, Leicestershire and Derbyshire have benefited the most.
The BBC reported recently that “construction is under way of 11 mammoth units at the East Midlands Gateway, which is poised to host names such as Amazon, Shop Direct and Nestlé, as well as creating 7,000 new jobs”.
When it comes to office properties, again there has been some regional variation albeit that overall office prime rents increased 0.6% in Q2, up from 0.4% in Q1 2018, again according to CBRE.
However, Central London Office prime rents decreased slightly in Q2 thanks to a fall of -0.1% in the West End. By contrast South East and Eastern rents increased 1.1% and 0.9% respectively. Suburban London Offices also reported a 1.2% increase.
One interesting development is that some specialist office commercial property companies have been capitalising on the trend for flexible offices on short-term, flexible leases, in one case earning a 48% net rent premium on its flexible leases when compared with traditional lease deals.
It is perhaps surprising in the aftermath of the Brexit vote that as mentioned earlier has been the demand for industrial premises, which RICS’ survey says “continues to attract solid demand from both occupiers and investors”.
CBRE, too, reports that Industrial property continues to outperform all other commercial sectors and, as with office space, there is a regional variation in demand with the strongest rental growth in this sector in the North West, where rental values in Q2 increased by 5.9%.
Clearly, therefore, anyone interested in investing in commercial property would be well advised to pick their sector carefully and keep an eye on the shifting trends as the UK gets closer to the date for leaving the EU in March next year.

Banks, Lenders & Investors Business Development & Marketing Finance General

Short termism still dominates shareholder and investor behaviour

short termism is rational when there's no light at the end of the tunnelThose who follow my blogs will know that I have criticised investors and shareholders for the short termism that has dominated their behaviour and thinking for many years.
It is a mindset that was highlighted in 2015 by Bank of England economists Andrew Haldane and Richard Davies, who argued that corporate and investor impatience was on the increase. Little has changed since then.
The emphasis has been on maximum return for investors’ money as soon as possible, and has also dictated high levels of CEO remuneration, but, as I have previously argued, these are not helpful for businesses that want to be around in the medium and longer term, after non-shareholding executives have moved on.
This particularly affects businesses’ ability to invest in R & D and in planning for growth and forces them to focus on immediate profits to pay dividends, which may not necessarily be in the best interests of their sustainability in the future.
As Haldane said in a BBC interview “companies risk “eating themselves” as shareholders and management were gripped by a form of short-termism.

Is short termism a reasonable position because of Brexit uncertainty?

Since the UK decision in 2016 to leave the EU, the ongoing Brexit negotiations have added an extra layer of uncertainty to business forward planning.
According to the CBI, in the year or so since the Brexit decision, businesses have been seen higher import costs, falling financial markets, weakening consumer spending and ongoing uncertainty. Its January 2018 economic review reported: “This is clearly hitting plans for capital spending in the year ahead, with around 40 per cent of businesses citing a negative impact from Brexit on their investment plans.”
In December last year the Daily Mail’s online publication This is Money, also told a similar story: “Investors have pulled nearly £4.3 billion from UK funds over the past 18 months.”
Immediately after last year’s election, the IoD (Institute of Directors) also reported a 34% reduction in confidence in the economy among its members.
“It is hard to overstate what a dramatic impact the current political uncertainty is having on business leaders, and the consequences could – if not addressed immediately – be disastrous for the UK economy,” said Stephen Martin, director general of the IoD said at the time.
In the face of rising political volatility and uncertainty about growth, both globally and nationally, it is difficult for institutional investors to know what to do for the best.
It pains me to say it, but in the light of all this, short termism among shareholders and investors may be a rational strategy, despite the longer-term consequences for businesses. At least until we can see light at the end of the tunnel.

Cash Flow & Forecasting Finance Insolvency Rescue, Restructuring & Recovery Turnaround

Investing in a struggling business – is it ever worthwhile?

the uphill battle to save a struggling businessWhile many people are attracted by the low cost of buying a struggling business where they believe they can do better – and reap the rewards – there is always the risk they are deceiving themselves or being over-optimistic.
It may be that there is a demand for its product or service but if a business is struggling, it is struggling for a reason.
So, it is important for the potential buyer to look closely and with care at why the business is in trouble and to ask themselves whether they honestly have the knowledge, skills, stamina and enough finances to be able to bear the loss if a turnaround should prove unsuccessful.
While a degree of self-confidence is important, confronting the reality of the situation is even more so.

Are there issues the struggling business is hiding?

When reviewing the circumstances of a struggling business a degree of scepticism is likely to be needed.
There may have been problems that can be remedied, such as poor management, poor organisation, a lack of funding or lack of financial control.
On the other hand, there may no longer be a market for the product or service, such as when technology has changed as has been the case with the transition from cameras using film to digital photography, or it may be too competitive such as the van delivery market, or the company’s reputation is severely damaged. Often the mountain is too steep to climb and it may be better to walk away.
Are the directors being honest about what has been happening? Are the suppliers who may also be angry creditors likely to be supportive of a restructure attempt? How many employees will have to be retained by the new owner under the TUPE rules and will this place an excessive burden on costs going forward? Will clients stay with you or even come back?
The answers to these questions, and many more, are crucial when considering buying a struggling business.

Are there better options?

If they would be useful to your existing business it may be better to buy the assets of a struggling business, which will be handled by valuers and surveyors.
In this way buying the database of a struggling business may be a more cost-effective way of increasing the customer base of an existing business than marketing to entirely new customers.
It may be safer to pay more for a profitable business with growth potential where the reason for sale is clear such as someone wanting to retire.
There is always a case of “caveat emptor” (buyer beware) so this route isn’t for the feint hearted and you can afford to make costly mistakes.
Get it right and the spoils can be huge, but you are warned.

Banks, Lenders & Investors Cash Flow & Forecasting Finance General

Is short term investment damaging future business prosperity?

For many years, the UK economy has depended heavily on consumer spending and on property speculation.
This may have led investors, even pension funds that require steady returns over many years, to focus too heavily on short term investment and gain and, therefore, on quarterly or annual reports and results thus undermining their willingness to wait for future returns.
However, the creative infrastructure that led to such inventions as the steam engine depended not only on “lightbulb” moments but also on people who were educated, skilled and above all had the time to think slowly and in depth.
Recently the Bank of England’s Chief Economist, Andy Haldane, has been worrying that the development of the internet has also undermined the ability to think slowly and in depth and thus the patience needed for business innovation and progress.
If UK businesses, from SMEs to large corporations, are to remain at the forefront of innovation they will need continued investment in the best brains, in research and development and in a decent infrastructure and that means investors willing to be patient for the long haul.
Is it time that more emphasis was put on education, training, employee development and perhaps even public investment in longer term projects to emphasise the importance of sustained effort and patience?