The economic impact of COVID-19 will affect Australian businesses across all industries, as a range of temporary government measures delay inevitable restructurings and insolvencies, according to a new report from MinterEllison called Distressed Debt and Special Situations – succeeding in uncertain times, published in conjunction with Debtwire Asia Pacific.
Mid-market enterprises are considered to be more vulnerable to exposure and find it harder to secure financing. However non-bank lenders may offer an alternative pathway to secure funding. MinterEllison partner, Ron Forster, is concerned that many companies are still in survival mode due to the coronavirus and not looking further ahead: “Companies need to adopt a medium-term outlook to their financing, which requires putting in place restructuring plans today to prepare for financial problems that they anticipate arising in a few months’ time.”
This involves exploring all sources of finance, including hybrids, as they look to restructure their balance sheet, convert debt to equity, and where possible, sell assets. They may also want to explore raising equity among shareholders or converting shareholder loans to equity.
"If companies don't plan beyond the immediate crisis, they may suddenly face repayments that they won't be able to meet. This will inevitably lead to default, and their options to restructure will fall away. Distressed companies need to move – and the sooner the better – to anticipate breaches of covenants and repayment challenges," said Forster.
Numerous opportunities – including refinancings, recapitalisations and those around distressed debt could arise. According to Debtwire intelligence and research, numerous early stage discussions between companies and funds for potential private-debt deals have already commenced. However, these deals may be stalled until travel restrictions are lifted and fund managers and their teams can complete ground-level due diligence.
As cash flows are hit, opportunities ahead for the private debt space could be found in refinancing deals for mid-market companies, as banks become more conservative or slower to provide rescue capital compared to credit funds. Recapitalisation needs among these firms and businesses of all sizes are also expected in the coming months when there is a clearer picture on the scale of the pandemic and its impact.
While parts of Australia have started reopening, ongoing restrictions in others provide an uneven economic landscape. It is, therefore, impossible to predict when a true return to normality will happen. More importantly, it may be too soon to start assessing the real impact. Through the remainder of the year, we will likely get a truer picture of how much the pandemic has impacted business’ bottom lines.
For some companies, it may require a small amount of capital to breathe new life into the balance sheet. For others, full restructuring will be required. “In order to receive funding companies will need to demonstrate that they have a viable business plan for the future, and that growth that is both realistic and promising. Business owners may also need to recalibrate their business to attract funding,” said Forster.
Depending on how the next few months unfold, opportunities may present themselves to debt funds and special situation investors as more companies require equity. Even so, competition in this space demands fast action. The ability to move quickly on these opportunities, as always, will be dependent on having the right team in place and the right intelligence to assess sectors in distress.
Key trends and considerations for debt funds
- Restructurings are getting faster. All parties involved aim to accelerate the process and complete the turnaround as quickly as possible to minimise the disruption to the business and for employees. Assets are going to be exposed to the market over much shorter timeframes, and identifying preferred bidders, closing the process and transacting with the most likely buyer is likely to take place in a shorter period of time than previously used to. Debt funds that are able to engage in a faster process both in terms of completion of due diligence and clearing all approvals to invest are likely to be exposed to more opportunities.
- Having an unsecured position is risky. Ideally, a lender wants to be in a position to move into restructuring with a secured debt position. This will allow the lender to have greater influence in the process and outcome.
- When buying into a syndicate, debt funds should understand the perspective of majority lenders. Ideally, they would join the process with other like-minded investors, so they have the ability to block competing proposals.
- Debt funds should consider restructuring and turnaround opportunities well before external administrators are considered. This ensures the best chance of success. Competition and interloper risk can increase when external administrators are appointed because they have to run a formal process.
- Understanding regulatory frameworks and the government support in key Australian industries is critical. In particular, sectors impacted by COVID-19 have a range of changing requirements and incentives, and funds will want to take advantage of them. There are also a range of tax considerations, ASX and Corporations Act rules and FIRB rules, which are critical factors in shaping how to inject capital into distressed companies.
- Remember regional differences across Australia. Federal and different state and territory laws will often need to be factored in. A thorough understanding of this will expedite the process, avert breaches and non-compliance and provide a better outcome to the whole restructuring or turnaround.