How do you match 2008 debt levels with 2010 cash flows? Jeff Eisenberg, IRN's finance correspondent, finds some of the answers in the recent restructurings of rental companies Neff Rental and HUNE.
"One lawyer with his briefcase can steal more than a hundred men with guns." Mario Puzo, the Godfather.
Almost everywhere in the world, rental company finances are under more pressure than ever, especially from their banks, investors, and other creditors. Companies that planned their cash flow, and added debt, during the boom years are facing unprecedented challenges trying to match 2008 debt with 2010 cash flow. It's like everyone is waking up after the biggest party ever...with a huge hangover.
Many companies now find themselves with unsustainable levels of debt. There are alternatives to company bankruptcy, including restructuring, using formal or informal agreements. But if companies thought the rules and practicalities for restructuring were straightforward in the past, things are very unclear in 2010. And for various reasons, the future is unpredictable - rental companies need to be aware that restructuring can be a minefield.
The terms restructuring, rescheduling and refinancing are often used in confusing ways. The clearest definition of restructuring has to involve eliminating some or all of a company's debt, including possibly converting it to equity or share capital. If the company has a "payment holiday", or some time with no payments or reduced payments, and the payments are moved further into the future, this is more accurately described as a rescheduling.
And a refinancing is when one bank or finance company replaces another, especially without any default or conflict with the original bank.
Often the rental company has no choice but to restructure, if its debt level is too high, and the company can not make payments on time, either to the bank or suppliers. Or, the company may have a funding line with covenants, which are financial ratios or benchmarks that have to be met, and the bank may force a restructure. Creditors including suppliers and leasing companies may force a company into liquidation or restructure if they are not paid on time.
The rental company may also make itself much more valuable using a pre-arranged restructuring, although this must be approached with much caution (more later). The shareholders may lose some or all of their shares, or be required to put in more cash.
The bank will accept restructuring of its customers if it is forced to, or if it finds its position is made better by the restructure. A few examples will be discussed below.
Restructuring by negotiation or by Chapter 11
Almost all countries have a statutory framework and practices for restructuring. In the US, Title 11 of the US (Bankruptcy) Code has two Chapters - Chapters 7 and 11 - that are often referred to in other countries. Chapter 7 details the procedures to liquidate a company (that is, how to close it, sell the assets, and decide who gets the proceeds.)
Chapter 11 deals with how companies can restructure, with protection for the company and its assets while it reorganises, under the supervision of the courts. The protection and court supervision means that for a period of time, leasing companies can not take their machines back, and creditors can not even take the company to court to recover payments, seize assets, etc, allowing the company to keep trading.
How to choose between liquidating a company, and restructuring it? This is usually the result of a proposal by the company management, which is subject to a vote by creditors, under the supervision of either a court or a court approved accountant or lawyer, depending on the country. In some countries, however, preserving jobs can be as important as protecting creditors.
The basic negotiation keys are:
• Are the bank and other creditors better off accepting the plan of the management rather than the threat of liquidation?
• Could another equity investor provide a better restructuring plan? Is the amount of equity negotiable?
• Is the management's restructuring plan better than a long administration? (This is a particularly sensitive question in Southern Europe where a company can be in administration for quite a few years, with courts sometimes prioritising employment rather than debt repayment.)
• How much power does the court or bankruptcy administrator have?
• Is the negotiation better via a court-approved "Chapter 11" procedure, or done by private negotiation, or a mix, like the pre-arranged Neff Rental solution?
Remember, this is 2010, and nothing works along a standard formula, like it may have before the credit crisis and the current downturn.
The two last visible rental company restructurings were Neff Rental Inc. in the US, and Hune Rental S.L.U. in Spain. Both companies had very rapid growth, by acquisition and organically, with several changes of investors. Neff went to the stock market in the US, and then back to private ownership; HUNE stayed in the hands of venture capitalists.
HUNE's planned restructuring will take its debt from €500 million down by around €200 million. The company and its stakeholders are negotiating everything without a "concurso" (creditors meeting), from the point when Advent, the venture capitalist that held the most shares, sold them to management, to when Banesto (its largest bank) agreed to turn its debt into equity. Not all details have yet been made public.
Why would Advent and Banesto do this? For Advent, defending their position via lawyers and bankruptcy courts must have looked like good money after bad, so far easier to just walk away. Never underestimate how much money can be spent with advisors and lawyers: the Neff disclosure documents estimated a good deal over $1million.
After Advent wrote off its shares, Banesto clearly had more room to manoeuvre. For banks in Spain, where the ‘Chapter 11' process (that's what it's called, even though it's not actually Chapter 11 of the Spanish legislation) can mean a company will stay in administration for years, the conventional wisdom is to try to avoid letting the court supervised administrator gain control of the company.
Because HUNE did not have a concurso, there was no interruption to the business, including to payments to suppliers, employees, and taxes. So, for HUNE, from December 2009, when the article in Cotizalia declared ‘Advent throws in the towel', and sold its shares to management for €1, to when Banesto took control around the end of May, the process may be nearly over in a relatively short time.
In the US, Neff filed its Chapter 11 petition in May of this year. It had US$609 million of debt, which will be reduced by $400m. The second lien debt holders (those debtors second in the queue to receive payment) were originally proposed to get 3% of their money back, while trade creditors will get 1%.
In the US, ‘debtor in possession' finance is easier to raise than in most countries, and GE happily announced $175 million for Neff. This is used to pay salaries, rent and suppliers (remember, parts and fuel suppliers who have just lost 99% of their balances might want cash up front this time).
The Chapter 11 restructuring was reported as "pre-arranged", but part of this procedure was an "auction", where Wayzata Investment Partners had to agree to pay around 24% of the second lien debt holders to "buy" most of the equity.
In the US, the Chapter 11 process is seen as more predictable and transparent than in many countries, so while the lawyers and advisors may get more money out of the transaction than the trade creditors, their fees are still a relatively small percentage of the $400m debt that was lifted from the company's shoulders.
Neither one of these two examples of restructure was very surprising. The US process, relatively efficiently run transparently through the courts, means that Neff will, after the next hearings in September, be able to keep moving forward. The HUNE example was done in a typically southern European informal style, avoiding the unpredictable and slow court supervised Spanish bankruptcy system, with the added benefit of less interruption.
More interesting is that so many other rental companies around the world have similar levels of debt, and we have seen so very little restructuring activity. The banks in many countries are letting rental companies walk along like ‘zombies' with debt levels that could not be repaid in decades at current cash flow levels.
And the equipment acquired with that debt is getting older all the time: the banks are simply postponing the inevitable, to avoid crystallising their losses. What rental companies must worry about is a slight recovery, where used equipment values, particularly at auction, come up to the level where banks will see that they may be better off forcing the rental companies to liquidate rather than to restructure.
The Author: Jeff Eisenberg has spent 14 years in the rental industry. He started and led Genie Financial Services in Europe, providing finance for large and small rental companies all over the world. Since 2000 he has held senior positions in a number of European rental companies, as well as running his own consultancy for rental companies, financial institutions and equipment manufacturers. In July 2008 he joined Netherlands based Riwal working specifically with acquisitions.
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