Business failures and distress are part and parcel of a capitalist economy, and those businesses that survive and thrive are generally adaptable and agile in reacting to changing circumstances.
While it may be stating the obvious that there are more distressed businesses during times of crisis, what is pertinent for these companies is understanding the ingredients necessary for survival and regeneration. In this series of Rethinking Economics articles, the proponents discuss the macroeconomic issues and what business leaders should do at the microeconomic level. While the microeconomic issues will be the focus in this article, we will also touch upon the macroeconomic issues.
Applying what we do know at a macroeconomic level
Economic crises differ in respect of source, severity and duration but there are common threads. Unlike conventional articles on restructuring, the macro issues are addressed first because at the microeconomic level, a successful restructuring is substantially dependent on macroeconomic conditions. The three macroeconomic factors that are discussed are interrelated and policymakers must never lose sight of these issues but ensure that they are addressed continually during the crisis.
An adequate policy response during a crisis should address social and political stability, liquidity in the banking system (including broader monetary policy), and aggregate demand (fiscal policy). These factors will be discussed in greater depth in further articles but suffice to say that businesses should recognise that macroeconomic conditions are critical for a successful restructuring.
More importantly, what businesses cannot afford now is to be paralysed by the deteriorating macroeconomic conditions and take a do-nothing approach or give up as conditions worsen. The success of an economic recovery is dependent on both the actions of the government in having the right policy response and execution as well as the private sector’s resilience and capability in restructuring its businesses. Both are inextricable.
What we do know at the microeconomic level
We had alluded that restructuring is crucial to rescue distressed companies and reduce widespread loss of jobs and the collapse of businesses. In fact, all stakeholders, including creditor banks, benefit from restructuring and this assertion is supported by comprehensive analysis from Danaharta that clearly shows that borrower-driven restructuring provides the best results, even for creditors and not just the promoters and employees.
Sage 3, a firm with a RM20 billion track record in restructuring, can affirm that the above analysis we produced nearly 15 years ago is still valid and applicable today (see table).
The above may not be obvious to the uninitiated and the following explanation is instructive. A receiver or liquidator cannot manage the business the way the entrepreneur or business promoter can as the latter would have the mindset, ambition, business network, industry knowledge and experience to leverage off to turn around the distressed businesses.
Moreover, liquidation drives down business value, as recovery to stakeholders is on a break-up basis since assets are likely to be sold piecemeal owing to possibly varying security charges.
On the other hand, corporate debt restructuring prevents destruction of intangible values such as skills, know-how and experience gained and accumulated over many years of operation. If these troubled companies are to be liquidated and cease to exist, these intangible values, which are highly valuable to our economy, will be lost as well. During the Asian financial crisis (AFC), Tun Daim Zainuddin, the then minister of finance, reportedly told Danaharta that borrowers must not only be given a chance to restructure but also a fighting chance in times of crisis.
What we do know on delivering successful restructuring
In this section, we set out the following points:
• The mindset;
• The right team;
• Sustaining the business as a going concern;
• The first-mover advantage;
• The restructuring process; and
• The desired result
At times of crisis, adopting the right mindset is crucial for businesses that face financial distress because of external factors beyond their control. Business leaders need to accept the “new reality” fast and quickly build consensus among senior management and the board of directors as effective decisions can be made swiftly when the whole team is clear on the overarching goal of the business.
Acceptance enables leaders to think critically and diagnostically about the current circumstances. On acceptance, a paradigm shift in the mindset occurs, which allows leaders to ask tough questions, conduct an honest assessment and develop an action plan. Therefore, business leaders must not dwell in denial over the predicament the company is in, otherwise these tough questions and answers will not surface and it would be difficult to get off the block and the first-mover advantage would have been lost.
The first step after acceptance is for management to conduct an honest assessment of the business and develop a business plan calibrated to the new normal. Part of the honest assessment is early realisation of “what you know and what you don’t know”. Normally, this is best addressed by consulting specialist advisers who are objective, credible and as passionate as promoters and owners are about the business. During these volatile times, it is also important to be open to third-party views, acknowledging that we cannot know everything.
The right team
The right team would include board members, the CEO and CFO so that they can meet regularly and quickly make decisions — which shall be accepted by the full board. In putting the team together, careful consideration should be given to the characteristics that are required during these challenging times. Some of the characteristics are grit (not to be disheartened in the darkest hour), ability to make decisions without full information (business instinct and acumen), ability to make tough decisions, being committed to the fight for survival, being realistic, optimistic, innovative and resourceful and inspiring confidence and putting stakeholders at ease.
Furthermore, when assembling the team, companies should consider whether they can benefit from having advisers who are specialists in this area of restructuring as they have the experience in managing distress issues and are capable of providing a robust and honest assessment of a business plan and guiding the business over the long period ahead. These specialists must be an integral part of the team and not just be a sounding board but actually deliver critical components of the restructuring.
Sustaining the business as a going concern
For the team, the first step is to stabilise the business to maximise the likelihood of remaining as a going concern.
The business must not be overwhelmed by the numerous issues that will surface and that must be addressed effectively, including disruption in supply chains, letters of demand and tightening of credit terms by trade creditors. It is also impossible to foresee all problems, hence there must be acceptance that not all issues can be solved and some need to be put on the back burner. For issues that cannot be resolved immediately, communicate and explain the business situation to the various stakeholders. Giving them the silent treatment will only aggravate the situation.
Cash flow is king; managing this is critical, therefore a pragmatic approach and timely information are a must. If debtors cannot pay in full, partial payments can help with the liquidity position of the company. Similarly, creditors should be prioritisd based on how replaceable they are and how critical they are in sustaining the business. In respect of timely information, the cash book should be updated daily and projections continually updated — a rolling forecast.
A key consideration for distressed businesses is whether they should adopt a strategy of being the first mover in respect of restructuring. There are actually a few cogent reasons that businesses should consider in adopting such a strategy, which will be explained below.
The mood with stakeholders — whether creditors, government, bankers, shareholders or regulators — currently is to favour restructuring, and thus it is best to strike while the iron is hot. Furthermore, Bank Negara Malaysia recently announced that there will be a relaxation in stage transfer and impairment rules, encouraging banks to restructure. When the economy returns to normalcy and the MFRS 9 impairment rules are reinstated, no doubt restructuring will be even more challenging.
Similarly, if restructuring can be accomplished before April 2021, listed companies are exempted from certain requirements under PN17 and having a regularisation plan approved. Finally, statutory notice of demand in respect of winding-up has been increased from 21 days to six months with a clear intention to provide distressed companies with much-needed breathing room to recover from the economic strain.
In times of crisis, restructuring resources will certainly be thin and these may include critical agencies such as the Corporate Debt Restructuring Committee (CDRC) and Small Debt Resolution Committee (SDRC), which will face a deluge of cases. Similarly, the best restructuring specialists with a track record and significant experience are limited, and their services will be in high demand just as tehy were during the AFC. If businesses wish to secure the “A Team” for the restructuring of their companies, they certainly need to move first.
From a value perspective, at the initial stages of distress, there is far less destruction, and therefore, there are usually more options available and a wider pool of investors willing to invest new money in the distressed companies. However, if the businesses delay their restructuring, there will be a greater destruction in the value of these companies, making raising new money near impossible.
Early discussion with potential investors has no downside as expectations can be understood and the basis of the rescue can be conveyed to all stakeholders early on. However, on this point, there is another school of thought which says that investors are unwilling to wait out the lengthy debt settlement process and will only assess the investment opportunity once a debt settlement has been struck and viability assured.
Most importantly, being the first mover demonstrates that business leaders are not in denial and are being proactive in searching for resolutions. Certainly, any reasonable stakeholder will appreciate this.
The process of restructuring
The process of a corporate debt restructuring can be broken down into three main phases, which are origination, negotiation and execution.
In the origination phase, the viability of the distressed company and the level of the sustainable debt it can carry must be established using business plans based on realistic assumptions. In this connection, the value of the business on a going-concern basis post-restructuring, along with its liquidation value, is determined upfront. Additionally, it is also critical that an analysis of creditors involved is done so that there is clarity on issues such as priority and security cover, which will guide the origination of a debt settlement proposal. Typically, it is at this stage that legal expert counsel is required to advise on the various interests and rights of each stakeholder. Lastly, when originating the debt settlement or regularisation plan, it is important that the scheme has the least number of moving parts to avoid possible roadblocks during implementation.
Part of the origination phase is also to determine which restructuring options to pursue, that is, whether through a formal route such as Section 366 of the Companies Act 2016, the informal forums of CDRC or SDRC, or a combination of both formal and informal routes.
While there are several options available in Malaysia, including judicial management (JM) or voluntary schemes, the lack of success in JM, loss of control by the entrepreneur and board, the limitation in respect of application to listed companies, and secured creditors’ ability to scuttle the plan would be cogent reasons to seek other approaches. The rule of thumb is that legal approaches (including Restraining Order vide Section 368 without support of bank creditors) should be a last resort and a consensus-based restructuring approach is preferred as it does not cause confrontation and entrenched positions, which are destructive.
However, consensus is normally challenging because of the borrower’s poor/disadvantaged position to negotiate with the creditors on a bilateral basis. This is why leading practitioners in restructuring opt for the CDRC/SDRC approach and have been able to achieve a considerable amount of success — the right mix of protection provided by the standstill and consensus-based approach.
The desired result
Business leaders need to appreciate that this is a golden opportunity to restructure. We alluded earlier to a host of initiatives by the government and regulators to enable such restructuring within a window. However, it is not enough to merely restructure but to ensure that the restructuring is done correctly and that the business is set on the right track and not become what is known as a “zombie company”.
The desired result is for well-restructured companies to be able to weather the storm brought on by the crisis. This is because compared with other companies in the industry, they are equipped with stronger balance sheets post-restructuring (lower debt level), which will provide them with the additional capacity to absorb the shocks.
In contrast, there are companies that have undergone restructuring but remain laggards. For example, some of those in which restructuring had been completed in recent years were starting to experience distress pre-pandemic and this will certainly be exacerbated by the crisis. Their debt levels remain unsustainable as reflected by poor DSCR and gearing ratio. The rule of thumb is for DSCR to improve above 1.75 times and gearing ratio to well below one, but this will vary with industry benchmarks.
In a poorly executed restructuring, businesses’ debt levels remain unreasonably high post-restructuring in relation to the borrower’s cash-generating ability — an unsustainable proposition. Additionally, a poor restructuring exercise would result in the book value of debt and equity that is not commensurate with the post-restructuring enterprise value — impeding new capital injection, which is eventually required for the business to grow.
What we can conclude
The Chinese word for “crisis” in Mandarin consists of two characters, with one representing “danger” and the other, “opportunity”. If these characters are translated literally, it can be mean “problems are opportunities in disguise” because some of the greatest innovations and changes come during times of crisis.
World War II, mankind’s worst crisis, was also a period of great innovations, such as the development of radar, antibiotics, synthetic rubber, jet engines and liquid fuel rockets and the releasing of the power of the atom. In the aftermath of WWII, there were changes on the social and political fronts as well, for example, the acceleration of independence for countries under colonial rule, the formation of world bodies and the implementation of social safety nets (addressing the issues of the Great Depression).
We already sense that there will be profound changes in the world as a result of this pandemic, all of which provide unimaginable opportunities. For businesses, this is the chance to put things right and position themselves to seize numerous opportunities — relating to the way society works, learns and trains, enjoys leisure, protects itself, communicates and manufactures goods — as well as in shorter supply chains with the possible shift of manufacturing away from China. For the underdogs, this is certainly a once-in-a-lifetime opportunity for a more level playing field for resources, especially human capital and acquisition opportunities.
We are just about to embark on the initial phase of a severe economic slowdown with the government and businesses facing what appears to be an endless string of imponderables, which raises the question, “Where do we start?” To answer this question, I dare say, without a shadow of doubt, requires the right mindset and team.
Datuk Mohd Anwar Yahya is a partner and an executive director at Sage 3, a boutique corporate finance advisory, and currently serves on the boards of directors of several Malaysian public and private corporations. He has over 25 years of experience in public policy, corporate finance and strategy at a Big Four accounting firm.