The dynamics of a growing sector

  • 01 Sep 2002
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The number of players involved in European corporate finance advisory has increased sharply over the past couple of years. From the influx of boutiques specialising in certain areas of restructuring to the rolling out of dedicated restructuring teams at the universal banks, corporates are faced with more choice than ever before.

On the large field of corporate advisory, it can be hard to identify all the players and work out in which positions they play. Where, for example, do the capabilities of traditional corporate finance advisors and investment banks end and more formalised restructuring advice begin?

After all, although the reorganisation of certain water companies in the UK sector was a restructuring, it has little in common with what specialist practitioners in the US - and, increasingly, the UK - would regard as genuine restructurings. Those are generally situations involving companies that have defaulted on their debt (or are about to do so) and have either entered into bankruptcy proceedings or are standing perilously close to them.

The common theme in restructurings of this kind is that they are complicated by the interests of a broad swathe of investors ranging from bank creditors to high yield bond investors.

That is why they call for a very special set of skills, believes Richard Stables, head of Lazard's European restructuring group, which has been closely involved in virtually every large restructuring in Europe over the last year or so to have arisen as a result of clear corporate distress.

In broad terms, bankers say that in the European market restructuring advice provided by banks can come from any combination of three sources: specialist niche players, or boutiques; investment banks; and commercial banks.

Over and above those sources of advice, the majority of the large restructuring situations in Europe will typically also call on the services of one or more of the leading accountancy firms as well as legal counsel from the restructuring practices of law firms. Given that separate teams are needed to advise debtors and creditors alike, that can (and does) mean that in the larger restructurings formidable armies of heavyweight advisers can be assembled on either side, carving up formidable fees between them.

A league of advisers

In the case of Marconi, for example, Lazard and Morgan Stanley (from the banking community), Allen & Overy (on the legal side), the accountants Deloitte & Touche and the restructuring specialists Talbot Hughes advised the company. Its 27 creditor banks, meanwhile, drew their advice from PricewaterhouseCoopers and Clifford Chance, while the bondholders were guided by Greenhill on the banking side and Bingham Dana from a legal standpoint. In total, it is estimated that between them these firms will walk away with fees worth about $80m.

That may sound like a fairly equal division of labour, although the specialist restructuring houses within the banking community argue that they lead the way in providing the independent advice on dealing with a disparate corpus of stakeholders.

Says Lazard's Stables: "We can add real value in situations where companies have borrowed money from a huge syndicate of banks and where they have also raised money in the high yield market, as recapitalising such entities is complex, often with many opposing moving parts."

He believes there is a crude but very clear correlation between the expansion of the high yield market - which will always have its defaulters - and the need for the services of specialist restructuring practitioners such as Lazard.

Stables says that Lazard owes much of its strength and presence in the European restructuring market, in which it has been actively involved since the summer of 2001, to its independence. As an advisory focused business with no balance sheet to speak of, Lazard has none of the conflicts of interest that inevitably arise from lending to a company or arranging bond or equity issues for the corporate sector. That conflict is enshrined in US legislation, under which in most cases investment banks are prohibited from providing restructuring advice to companies that have filed for bankruptcy, to avoid their advising a company to which they had provided an investment banking service.

As a result, says Stables, in the US market many other major league investment banks will generally walk away from a potential restructuring advisory mandate, leaving the field clear for the specialist firms. Or they will spin off their restructuring practices into separate groups that are no longer conflicted. That is precisely what happened at Dresdner Kleinwort Wasserstein, where the clear conflicts of interest in the US led to a restructuring of the restructurers, and its respected in-house practitioners, Ken Buckfire and Martin Lewis, moving across to join Henry Miller, who had managed his own restructuring boutique in New York since 1991.

European freedom

In Europe, the pure investment banks - thus far - remain unencumbered by legal bars to being involved as restructuring advisers and, on the surface, appear to be very involved in the process, acting, for example, as consultants in asset disposal programmes.

In practice, however, these houses have taken little if any part in advising companies' bondholders or creditors in the major restructurings that have been taking place in Europe due to their inherent conflicts.

Certainly, many of the investment banks appear to be playing down their role as advisers to restructuring situations in Europe. All those approached by EuroWeek either declined to comment or explained that they had no dedicated restructuring teams, and that those individuals involved in the process were generally mainstream debt capital market or corporate finance staff involved on a temporary basis in helping companies in difficulty or distress.

In contrast to homegrown Lazard, another of the boutique firms to make impressive inroads into the European market for advice in large scale restructurings is US-born Greenhill & Co, which was set up in January 1996 by Bob Greenhill, former vice chairman and president of Morgan Stanley, and now has offices in London and Frankfurt. Then, its principle raison d'etre was the provision of strategic M&A advice, and David Wyles, a managing director in Greenhill's London office, says that the firm has advised on over $200bn of M&A deals since it was established.

Clearly, given the current state of the global economic environment, that dealflow has thinned in recent months, but as Wyles says, the skill sets involved in advising on restructuring are very closely related to those involved in M&A consulting.

That gives a boutique player like Greenhill a built-in hedge that is close to perfect - allowing it to capitalise on M&A booms during economic upswings and surges in distressed-related restructurings when the macro-economic environment is less buoyant.

Like Stables at Lazard, Wyles insists that the trump card for a house like Greenhill is its independence. "On the restructuring side people are seeing very clearly that the big bulge bracket players have obvious conflicts of interest," he says. "Our clients know that we are giving an independent view and that we are not always going to be also trying to earn money on the equity or the debt side or through corporate broking. On the M&A side, some of the most valuable advice we have provided to companies is where we have advised them not to do a transaction."

Other boutique players from the US are also acknowledging the opportunities that are arising in the European market. For example, Houlihan Lokey Howard & Zukin (HLHZ), which lays claim to being the largest dedicated restructuring practice in the world, originally focused on Europe through an agreement with Close Brothers in the UK, but in June officially opened its standalone office in London. John Reynolds, managing director of HLHZ's London office, says that his group had already worked - on behalf or creditors and debtors - on a number of successful European transactions long before the opening of the London office, such as the restructuring of Ashanti Goldfields.

"But clearly there will be much more restructuring to come, and we believe that you need to have a transatlantic presence to be able to work effectively on the increasing number of restructurings that have an international dimension to them," says Reynolds.

"For example, we are currently working on behalf of the unsecured creditors of NRG, which is a US independent power producer with about a third of its business overseas. For situations like that, an international perspective is essential."

Local partners

Some of the smaller US boutiques, however, have restricted their involvement in the European market to being present only through local affiliations. One good example is Peter J Solomon Company, which is predominantly an M&A boutique established 13 years ago but which has now fully integrated its restructuring practice with its M&A operation.

In Europe, the firm has an affiliation with Clinvest (the investment banking arm of Crédit Lyonnais) which, according to Brad Dietz, a managing director at Peter J Solomon's New York office, allows it to identify European companies that may have an eye on buying into troubled or distressed assets in the US. Conversely, it also allows it to advise US companies contemplating doing the same in Europe, "so it's really a two-way street across the Atlantic," says Dietz.

Not all of the US boutiques agree that the European market will be sufficiently fertile for them to justify channelling the necessary resources into establishing dedicated European-based operations.

At Blackstone in New York, for example, Arthur Newman, who has headed the company's restructuring practice since 1991, is dubious about Europe's potential and its suitability as a region for Blackstone to expand into. "We have thought about the European market but we have not yet made any plans to expand on the other side of the pond," he says. "We have an office in London focusing on private equity and we are aware that other US restructuring practices are opening up in London. But we are just not sure that there are going to be that many opportunities in Europe. Of course there have been a number of big restructurings in the telecoms sector but that particular bus may now be behind us."

The other deterrent to a US firm like Blackstone establishing a London presence, says Newman, is the difference in the legislative environment. "Until recently I had firmly believed that trying to be a restructuring adviser under the UK Companies Act was almost pointless," he says. "Either a company gets sold off or more often than not the banks step in and appoint a liquidator and that's that. I understand that there have been some changes in the UK law that might make the legal environment there a little more amenable for companies as opposed to lenders, but quite frankly we have more than enough business to keep us busy in the US, where we also have this lovely law called Chapter 11."

Institutional presence

The apparent independence of the boutiques that are setting up shop in London and elsewhere need not mean that the European restructuring market is closed to others, for a number of reasons. The first of these is that European legislation has not yet followed in the footprints of its US counterpart and prevented institutions with investment banking relationships from advising those same clients in the event of distress and restructuring.

That has allowed some European banks to take up the challenge of building and maintaining dedicated restructuring departments of their own with, they insist, solid Chinese walls constructed between them and their broader corporate finance franchises.

Of the European banks that have established restructuring teams, it is generally accepted that those at UBS Warburg and, to a lesser degree, Deutsche Bank and Credit Suisse First Boston lead the way. The UBS Warburg division is led in Europe by Carsten ten Brink, whose team of about 35 people work exclusively on corporate restructuring, an effort that was recently rewarded when the bank was appointed to advise the bondholders in the restructuring of NTL and Telewest.

That, says ten Brink, was a new departure for UBS Warburg, which had traditionally advised on the debtor rather than the creditor side, although he also points out that there are a range of objectives that are common to advisers on both sides of the table.

"Whether we are advising bondholders or the company itself or even strategic partners, the bottom line is generally the same," he says. "That is to create a sensible and sustainable business plan, and, on the basis of that plan, to assess what the appropriate capital structure of the company needs to be." As part of the NTL restructuring, that exercise also involved injecting new capital into the company. "Obviously converting debt into equity gets rid of debt that the company can't service and therefore saves interest payments," says ten Brink. "But it doesn't bring in any new money, so assessing the liquidity position of the company is another essential advisory function."

In the case of NTL, the bondholders recognised that they could better safeguard the company's future - and therefore their own investment - by injecting $500m of new debt into the reconstructed firm.

A second reason why it is misleading to assume that the so-called boutiques are the domineering players in the restructuring market is that to do so overlooks the vast majority of restructuring exercises that do not necessarily involve rescue-style debt for equity swaps.

"A lot of the situations we get involved in as a firm never really hit the light of day as restructurings," says ten Brink. "If you can organise an asset sale, or advise on a rights issue, or on a refinancing that smoothes out the maturities of a company's bonds, the likelihood is that you will have solved a large part of a company's debt problem long before people start to worry about the structure of its balance sheet. To some extent, I regard what we do here as bankruptcy protection."

That explains why ten Brink, like most bankers involved in the restructuring industry, carries business cards that announce him as an investment banker rather than as a restructuring expert.

The same is true of the large US commercial-cum-investment banks that are active in the European market. For example, at JP Morgan in London, Stephen Eichenberger is head of the European restructuring group, but his business card announces him as managing director of debt capital markets, precisely because the definition of corporate restructuring is such a moveable feast.

"To my mind," he explains, "restructuring means that companies are doing new things to change previous strategies or to undo things that were done in the past. That may be because the market's perception of the company's value has changed, or it may be because they are under some form of duress from the market - caused either by a fall in its stock price or because creditors, bondholders or ratings agencies are exerting pressure on a company to reduce its debt.

"Whatever the cause, and whether it is self-inflicted or not, the common thread is that these companies are having to make some changes in the way they manage and finance their business."

Much of the time, Eichenberger adds, that means that companies need help with their liquidity positions. "Often liquidity problems have arisen because borrowers have bunched all their maturities together, or relied too much on short term facilities, looking at the world through rose-coloured glasses and assuming that banks are going to continue to provide them with 364 day money on very favourable terms," he says.

"The assumption was often made that even if those short term facilities could not be rolled over, companies would always have the bond, equity or convertible market to turn to instead. Nowadays, many are waking up to find that one or more of those markets are closed to them, not necessarily as a result of anything they may have done, but just because market fundamentals have changed."

In other words, restructuring is often a remedial service for good companies with bad balance sheets. It is also a service which, for the companies themselves, is much more valuable if it is provided early, with prevention infinitely preferable to cure.

"We try to impress upon companies that although the CP market might look cheap, the belief that the capital market will always be available as a refinancing vehicle is dangerous and unhealthy," says Eichenberger. "Many companies have recognised that although it might cost another 50bp or 100bp to term out their debt, it is a price worth paying if markets close down."

Cherry picking

Eichenberger himself draws his experience from the US market, where he began advising companies on debt restructuring and work-outs in the early 1980s, but the sheer diversity of skill sets that are required to advise on the process in the European market means that he runs what he describes as a "virtual group", cherry-picking, as and when required, from elsewhere within the JP Morgan group.

"It makes very little sense to hire a large number of people who are focused exclusively on restructuring when we have all the necessary expertise within the group," Eichenberger explains.

Of JP Morgan's competitors in Europe, Citigroup also has this broad range of products at the disposal of its corporate customer base, which, says Steve Din, managing director of Citigroup's European investment bank and head of its restructurings group, makes it ideally suited to provide support for companies in need of restructuring assistance.

"Companies considering a capital restructuring will likely seek a combination of first, advice; second, liquidity; and third, capital," he says. "Of course the boutiques are very good at providing that element of advice and there is no shortage of work for them in the current economic environment. But a firm like Citigroup can provide all three elements. Above all we are able to provide them exactly when they need it."

As a good example of the sort of situation in which Citigroup has brought together these three elements, Din cites industrial IT firm ABB, for which Citigroup has recently helped to provide equity-linked, loan and bond financing as a way of supporting the company's target of reducing its net debt by some $1.5bn this year.

That process has involved renegotiating a $3bn loan, issuing a $968m convertible and, in May, raising $750m through a dual Eurosterling bond led by Barclays Capital, Citigroup/SSSB and CSFB.

All three transactions, says Eirik Winter, managing director at SSSB, are interlinked. "The advantage we have, and we have seen this with US and European companies, is that we can provide help across the whole of the capital structure," he says.

"The first step is normally some kind of amendment of their loan agreements, which might mean waivers on covenants to give them some breathing space and make sure they can meet their immediate liquidity requirements. The next step is to look at the whole range of solutions that are available to the company, which might mean everything from divestments to different capital market transactions, be they equity, equity-linked or bond issues. We offer our advice as objectively as we can - not pushing any product, but modelling the solution to fit the need of the company. Obviously there is nothing we can do about depressed economies or about asbestos claims, but we can certainly help with immediate liquidity-related and capital structure problems."

Fair enough. But those who advise on corporate restructurings from outside the banking world still express reservations about the conflicts of interest that they perceive will inevitably arise when banks provide transaction-related advice.

At Stern Stewart in New York, for example, senior vice president of the corporate finance advisory practice Martin Ellis mentions investment banks' tendency to recommend equity-based products as a restructuring solution as a clear example of this dilemma.

"Many of the investment banks are advising companies that they should issue equity to maintain a bond rating, even when companies clearly have the capacity to take on more debt," he says. "But I think that issuing equity at a discount in today's market sends a very negative signal to investors. From the standpoint of an investor I certainly wouldn't want to see management issuing equity at a discount just to maintain a bond rating, because doing so isn't going to change the profitability of the firm.

"The only reason I can see for investment banks advising companies to issue equity is that fees in that market are relatively high - which is attractive for the banks when nothing much else is going on in the market."

It is not difficult to see why restructuring specialists are suspicious of bankers focusing on the transaction-related elements of balance sheet and capital structure reorganisation.

They say that one of the essential roles they play in any given restructuring is the provision of advice relating to the shape and strategy of the company after an equity-debt conversion or other transformation of the capital structure.

Life support

The first objective of the specialist advisers is to act as a life-support machine, ensuring that the business can continue to function on a day-to-day basis.

"The first goal is to help stabilise the company. If it is going to be successfully restructured the first priority must be to make certain that it can keep its staff and its customers and keep the business alive," says Wyles at Greenhill. "Once you have stabilised the business the next objective is to design and develop a business plan that is going to maximise the total value pool for stakeholders. That may involve selling some businesses off, or downsizing them to a level at which they are able to function profitably."

That process is an essential prerequisite to the construction of a more appropriate and durable capital structure. "Until you have identified the core of your business and the operational restructuring that needs to be arranged around that core it is pointless trying to devise a capital structure that is appropriate for the business," Wyles adds.

Another theme that bankers say is common to most if not all restructurings is the imperative for the company to keep a very watchful eye on its cash position. "What you tend to find is that most companies that find themselves in a restructuring position have lost control of their cash," says Wyles.

"So one of the first things you try to do in a restructuring is to help companies come to terms with managing in an environment in which cash is recognised as being the life-blood of the business. That means knowing exactly where your cash is, and knowing that every time you negotiate a contract you are absolutely certain what the impact is going to be on your cash balance. So the sort of questions we would need to ask are: are you investing your cash wisely? Is your capital expenditure appropriate? Are you focused on managing and delivering cash?"

Those tenets may be glaringly obvious enough to a healthy FTSE-100 company, but restructuring experts say that an amazing number of companies tend to overlook them in their pursuit of growth. At KPMG in London, partner Shaun O'Callaghan agrees that cash considerations should be paramount for companies that are being restructured.

It is part of a more general move that these companies have to make which takes them back to basics.

"Three or four years ago there seemed to be no emphasis on cashflow and profit whatsoever," he says. "If you mentioned cashflow and profit you were written off as some form of Luddite. The belief that spread through boardrooms and capital markets was that businesses should be run for sales and Ebitda and in this wonderful world capital expenditure was seen as being free. In the companies I have visited where we are trying to pick up the pieces, right from the chief executive down to the secretary everybody seemed to believe that capex was free.

"Going forward one of the things we need to work very hard on with companies is the move to a cash, profit, sales mentality." *

  • 01 Sep 2002

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