SPECIAL REPORT: One Size Does Not Fit All – Restructuring for Uncertain Times, from Verdant Capital
This sponsored content was written by Edmund Higenbottam and Patrick Ball, who serve, respectively, as the Managing Director and a Director of Verdant Capital. Verdant Capital is a leading specialist financial advisory firm that operates across Africa.
A combination of factors is challenging the economic sustainability of financial institutions and other 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 traditional banks, microfinance institutions and operating companies. From an investment perspective, investors have taken an increasingly “risk-off” approach to Africa in recent years that only has 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.
For top quartile performers, short-term challenges may necessitate negotiations with creditors to relax covenants and defer principal payments. Many of these companies were growing strongly before the crisis, principally through the reinvestment of retained earnings. 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 or even pursue opportunistic acquisitions. For equity investors, there may be opportunities to gain exposure to companies that previously had been sufficiently capitalized through internal means.
For companies in the middle quartiles (the second and third quartiles, on either side of the median), discussions with creditors are critically important and typically 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? Is the risk model for key credit products still “fit for purpose”? Does the institution 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 lender?
Many institutions 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 creditors. 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. One example of this is the memorandum of understanding (described on page one of this newspaper) agreed to last month by many of the largest microfinance investment vehicles (MIVs). This memo provides a framework for investors to work together to resolve issues arising from the crisis, creating win-win outcomes for creditors and borrowers. Without communication among creditors, a distressed situation can quickly evolve into a classic “prisoner’s dilemma.” One complication is that many microfinance institutions now have a broader range of creditors than just MIVs – including development banks, local banks and bondholders – each of which has very different frames of reference. Multiple levels of seniority (or worse, ambiguous or disputed levels of seniority) can exacerbate challenges significantly.
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 maneuvering 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 financial institutions and companies in Africa – top quartile, middle quartiles and bottom quartile – to address all of these challenges and opportunities.