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Working Capital Management

Working Capital Management often represents the most substantial performance improvement opportunities available to a company.  While optimizing levels of accounts receivable, inventory, and accounts payable will not show improvement on a P&L, the reality is that the cash flow generated from working capital management represents a lower cost source of funding than additional debt or equity, and as such robust working capital management generally conveys a strategic advantage over less disciplined competitors.

1) Size of the Opportunity.  A recent survey of 1,000 major U.S. companies found a potential cumulative cash flow improvement of $1 trillion through working capital management.

2) Early Warning System.  Careful attention to working capital sensitizes companies to subtle changes in their operations (slow-paying customers, falling demand for key items, trouble in the supply chain, etc.), and so gives attentive managers advance notice that something may be wrong.

3) Maximizing Value.  Strong working capital management is a discipline that is hard to develop, and easy to lose.  For those companies that stay focused, though, the increase in enterprise value can be substantial.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.

 

Fisker Automotive: A Beautiful Mess

This article originally appeared in Business Insider

How can anybody learn anything from an artwork when the piece of art only reflects the vanity of the artist and not reality?

― Lou Reed

Fisker Automotive recently filed for chapter 11 bankruptcy protection and announced plans to sell itself to recently formed holding company Hybrid Technology, following that company’s purchase of a defaulted Fisker loan from the U.S. Energy Department.  Of the startup automakers granted loans by the Energy Department, Fisker Automotive was approved for the largest amount ($529 million).  Tesla Automotive has repaid the $465 million in loans it received.  Though it received approval for a $529 million loan, Fisker received only $192 million (the company repaid only $53 million of that total).

Co-founded by Ashton Martin designer Henrik Fisker, Fisker Automotive set out to create something beautiful and lucrative.  By all accounts the company was wildly successful at the former, and shockingly unsuccessful at the latter. Fisker Atlantic

The Fisker Atlantic

Privco Chief Executive Sam Hamadeh summed up the challenges of an aesthetically driven company with too much capital and too little discipline when he noted the Fisker was at one point spending $900,000 per vehicle produced, and then selling those vehicles for $70,000.

Hamadeh went on to note:

Fisker Automotive may well go down as the most tragic venture capital-backed debacle in recent history,” Hamadeh said in a statement. “The sheer scale of investment capital and government loan money — over $1.3 billion in all — was squandered so rapidly and with so little to show for it that the wreckage is breathtaking. Bankruptcy will be the end of Fisker, but for the taxpayers, venture capital firms, individual investors, and Fisker’s suppliers, it will all be too little too late.

The writing has been on the wall for some time regarding Fisker.  The company laid off 75% of its staff in April as it sought to preserve its dwindling cash and assess its options.  At the time of its announcement, Fisker, which had raised an estimated $1.3 billion from investors, had cash on hand of less than $30 million.

In the end, the company failed to produce the most beautiful of all outcomes for investors: a return.

The Demise of a Bad Deal

This post originally appeared in Business Insider

Victory has a thousand fathers, but defeat is an orphan.

– John F. Kennedy

Things seemed so simple in 2007. Energy company TXU looked like a sure-thing. Demand for energy was climbing. The company’s robust profitability suggested an ability to service a substantial debt burden. Throw in some operational efficiencies and TXU had the appearance of a golden opportunity for some of the biggest PE firms in the U.S. to ride increasing energy demands to riches.

It has not worked out quite that way. Following its purchase in 2007 in a $48 billion buyout, the company, now renamed Energy Future Holdings had its profitability crushed by the unset of large scale fracking and the accompanying collapse in natural gas prices. Arguably good management and savvy financial engineering are the only reasons that the day of reckoning has been put off as long as it has. Natural gas hedges minimized the pain in the early years after the buyout. And on the balance sheet side there have been several distressed exchanges and refinancings in specific tranches of the company’s $43.6 billion debt structure. But there is only so much that good management and creative financial engineering can do when faced with an investment thesis that has been proven false, and market expectations are that a bankruptcy filing is imminent.

Losses happen in investing, but it is interesting to see in this case the maneuverings of savvy investors on all sides.
• PE firms KKR and TPG Capital contributed $3.5 billion in equity to the original deal
• Goldman Sachs Capital Partners contributed $1.5 billion in equity
• $3.3 billion of equity was contributed by clients of KKR, TPG and Goldman, as well as Lehman Brothers, Citigroup and Morgan Stanley
• Investor Apollo Management Group, Oaktree Capital Group and Centerbridge Partners have taken considerable stakes in various tranches of the company’s debt, positioning themselves for an eventual ownership stake following a restructuring

Recent news suggests that that $8.3 billion equity commitment may, post-restructuring, shrink to an ownership stake of less than 3 percent. The pain is not limited to the equity in this deal, though. Moody’s recently reported that due to the sheer size and complexity of Energy Future Holdings’ restructuring, it would likely result in lowered recoveries across the capital structure.

With $270 million in interest payments due November 1, one of the largest non-financial bankruptcies in U.S. history is likely about to be filed. A successful chapter 11 reorganization will allow a way forward for the over-indebted company, but will be a black eye for investors floored by the punch they did not see coming.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. He can be reached at 312-505-7238 or at david@acm-partners.com.

Eike Batista

This article originally appeared in Business Insider

How flattering to the pride of man to think that the stars on their courses watch over him, and typify, by their movements and aspects, the joys or the sorrows that await him! He, in less proportion to the universe than the all-but invisible insects that feed in myriads on a summer’s leaf are to this great globe itself, fondly imagines that eternal worlds were chiefly created to prognosticate his fate.

–          Extraordinary Popular Delusions and the Madness of Crowds

Eike Battista is not having a good year.  In fact, it might be fair to say that the Brazilian entrepreneur is having perhaps one of the most horrendous years of wealth destruction on record.  In little more than a year Batista’s fortune has plummeted by over $30 billion, his support among Brazilian politicians has evaporated, and his creditors have gone from enthusiastically backing his endeavors to nervously eyeing their collateral.

For those unfamiliar with the new poster boy for emerging markets euphoria gone horribly wrong, look no further than the recent Bloomberg Businessweek article by authors Juan Pablo Spinetto, Peter Millard, and Ken Wells.  Their reporting details all the usual elements in these situations, with a few interesting wrinkles:

  • The Batista empire benefited from a compelling story that investors desperately wanted to believe.  With a network of companies focused on natural resources and based in Brazil, Batista had a need for capital at exactly the point in time when institutional investors were looking for investment opportunities emerging markets.
  • OGX, an energy exploration and production company founded by Batista in 2007, bid aggressively (in some cases offering bids double that of its competitors) for offshore oil leases.
  • Batitsa had the dangerous combination of being a famously hands-off manager who was nevertheless relentlessly optimistic about his ventures.  Over time his direct reports came to avoid bringing him bad news, which may have only speeded the decline of Batista’s empire.

The focus of Eike Batista these days is on preserving some value, as he struggles to restructure the debt of his various companies.  News that mining company MMX had reached an agreement to sell a controlling stake in a Brazilian iron-ore port sent the stock up 8 percent for the day, though investors have still suffered a 76 percent decline in 2013.  This marks only the latest in a series of transactions aimed at preserving something of the Batista empire, though the heavy debt burden of these companies suggests that preserving any equity value may be a lost cause (see articles here and here).

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.

The Distressed Market to Come

This article also appeared in Business Insider

“The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane.” – Marcus Aurelius

We have commented before on the difficult position commercial and industry (“C&I”) lenders found themselves in at the end of the 2008-9 recession.  The economic recovery was tepid at best, and growth prospects for small and mid-sized companies were poor.  Nonetheless, with banks and commercial finance companies having recovered, there was eagerness to lend.  The simple dynamics of supply and demand manifested themselves, and over time lending standards have loosened, and some of the troublesome practices of years ago, such as PIK toggles, have made a comeback.

There is now increasing evidence that middle market companies are struggling with under-performance, signaling an increase in the default rate in coming months.  This prompted us to think through just what restructurings will look like during the next recession.

We start with the current crop of asset based loans made since 2011:

  • Deal Trends: Average deal size is up nearly 140% since 2011, as lenders gravitate to the companies that have an appetite for loans: private equity backed companies and larger private companies seeking growth through industry consolidation, international expansion, or both.

exhibit_ABL Deal Trends

  • Deals by Size: Though deals over $250MM accounted for approximately 75% of ABL commitments since 2011, there is still an important portfolio management component to the loans that have been extended.  More than 500 loans with a commitment size below $25MM were made in the ten quarter period assessed (Q1-11 – Q2-13).

exhibit_ABL Deals by Size

  • Deal Statistics: Deals below $50MM were nearly 60% by number but less than 6% by amount committed.

exhibit_ABL Statistics

Conclusion

As the C&I market has skewed toward larger deals in the wake of the recession, the outline of the restructuring market for the next recession has begun to come into focus.  Increasing exposure to larger deals (there is considerable evidence, anecdotal and otherwise, that lenders are seeking to raise their hold limits on syndicated deals) will create an uncomfortable dynamic in which the failure of some deals will be too painful to contemplate, suggesting drawn-out turnarounds as an approach to increase enterprise value and bailout lenders unable to take severe haircuts on large exposures.  On the smaller side of the market, we believe that the move toward distressed M&A as a means of credit risk transfer will continue, as lenders address the portfolio management challenges of troubled credits by insisting on a quick sale, rather than backing a more time-intensive turnaround process.


Private Equity: A New Approach

This article originally appeared in Business Insider

July 20, 2011

By David Johnson, ACM Partners

The markets have opened up enough that deals are getting done, but challenges remain for private equity investors looking down the road and asking the obvious question: how to generate attractive returns in this environment?  Increasingly the answer has been a heightened focus on operations.

This pivot from the traditional (though somewhat dated) view of private equity as being an industry composed of senior deal makers and junior model monkeys has been driven by a number of developments:

  • The diffusion of key deal-making skills has eliminated any competitive advantage based on deal-making / financial engineering acumen (at least in mature private equity markets).
  • As Adley Bowen at Pitch Book has noted, there are currently 4,500 private equity portfolio companies.  Many of those companies are not alone in their niche but find themselves competing against other well-funded private equity portfolio companies.
  • The recession of 2008-9 forced many private equity firms to implement significant operational changes in their portfolio companies.  This trying experience instilled an appreciation for the centrality of an operations focus in an entire generation of private equity professionals.

Private equity firms are managing this dynamic in different ways.  Larger firms such as KKR have developed in-house units, as KKR has done with Capstone.  Across the PE spectrum the role of operating partner has become increasingly common.  And of course advisors are often relied on to either provide this core competency or supplement private equity firms’ in-house resources.

In the face of low-growth in developed economies the impact of boring but impactful initiatives such as book of business analyses, centralized purchasing, increased IT infrastructure, etc. has shown itself to be a significant driver of value.  Growth stories are more exciting, and it is always nice when the blocking and tackling of performance improvement can be combined with a return to growth, but sometimes that is not possible.

At the end of the day, style points matter less in investing than returns, and returns generated from making portfolio companies leaner still count.

The Never-Ending IP Struggle

This article originally appeared in Business Insider

July 14, 2011

By David Johnson, ACM Partners

Disney is releasing another Winnie the Pooh movie, and the occasion made me think of the peculiar intellectual property fight that has been raging over Pooh for some time.  The story of control over Winnie the Pooh and the other lovable characters that populate the Hundred Acre Wood is fascinating in its byzantine complexity.  To summarize:

  • The characters were created in the 1920’s by A.A. Milne.  Copyright protections at the time lasted for an initial period of 28 years and a renewal period of 28 years.
  • In 1930 Milne and Stephen Slesinger entered into a contract granting Slesinger merchandising and other rights in exchange for royalties.  Slesinger created a company, Stephen Slesinger Inc. (“SSI”) and assigned those rights to the new entity.
  • SSI was extraordinarily energetic with their IP, creating the first Pooh doll, board game, puzzle, radio broadcast, animation and motion picture.  By November 1931 Winnie the Pooh was a $50 million business, providing an eye popping return on Slesinger’s $1000 upfront payment to Milne (Milne also received 66% of subsequent income).
  • Milne died in 1956, with rights to Winnie the Pooh transferred to his wife, Dorothy.  Upon Dorothy’s death rights were transferred to the Pooh Properties Trust.
  • Disney acquired the rights to Winnie the Pooh from SSI in 1961.
  • An amendment of the 1976 Copyright Act granted an additional 19 years of protection.
  • Disney negotiated a revised deal with the Pooh Properties Trust in 1983 in order to prevent a feared contract termination.
  • In 1998 the Copyright Act was amended again to provide an additional 20 years of protection.
  • In 2002, with Disney embroiled in litigation with SSI over claims that it had systematically underpaid royalties due SSI for years, Clare Milne sought to terminate the 1930 agreement.
  • In 2006 the U.S. Supreme Court declined to grant a writ of certiorari, leaving the heir of A.A. Milne with no recourse.

It has been a long and winding road for a bear of very little brain.  Something to think about as the new movie helps create and enhance the enthusiasm of another generation of fans.

The Base of the Pyramid

This article originally appeared in Business Insider and TMA Midwest Blog

January 21, 2011

By David Johnson, ACM Partners

There is a palpable sense of impatience in the business press when discussing our tepid recovery.  People are anxious to start up the music and resume the party and are seemingly resentful of those who point out that however much we might wish to be done with the Great Recession it is not done with us.

One area that has been receiving too little attention is the wide divergence in outlook between large (national and multi-national) companies and those in the middle market (here defined as companies with less than 500 employees; the two sides of that divide having an approximately equal number of U.S. employees as of 2008).  Companies in the S&P 500 are enjoying historically high levels of profitability (often driven by robust sales to emerging market countries) and sitting on a veritable mountain of cash.  Meanwhile, middle market companies are hard pressed to find growth domestically and many lack the financial and managerial strength necessary to exploit growth opportunities in emerging markets.

The divergence between the upper and middle markets is not limited to growth prospects:

  • Operations: Larger companies have aggressively taken advantage of globalization to remake their organizations in the past 15 years.  They have seized on labor force arbitrage opportunities, remade their supply chains and outsourced non-core business functions.  Companies in the middle market are woefully behind the curve, and as a result have both higher costs and lower operational flexibility.  Taking full advantage of globalization to remake operations is not solely a matter of finding the lowest cost.  Issues such as order lead times, strength of native labor pool, legal environment, etc must be taken into account as well.
  • Commodities: While commodity prices received considerable attention in 2011 the reality is that broad macro factor point to upward-trending prices and considerable volatility as the new normal.  For middle market companies this will necessitate considerable effort to preserve gross margins, in particular the adoption of hedging strategies and a revamped approach to purchasing.
  • Systems: All the buzz around Big Data tends to obscure the fact that many companies have yet to implement ‘small data” initiatives such as KPI dashboards and other simple yet highly effective business intelligence tools.  I have been on numerous client engagements at companies with sales up to $1 billion that have lacked the ability to identify their most profitable product or sales channel.

The opportunities inherent in the U.S. middle market are enormous, but many of the bullish pronouncements in the general business press ignore the challenges these companies face.  Many are considerably behind their larger competitors in enjoying the fruits of globalization.  The path to profitability and growth for this sector of the economy will be a focus on basics.  Rationalizing SKUs, firing bas customers, identifying and increasing investment in high-return sales channels and shutting under-performing locations/divisions are the kind of unsexy blocking and tackling operations that will drive middle market profitability through the current decade.