jan van der walt ceo: turnaround solutions deputy ceo: turnaround management association –...
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Jan van der WaltCEO: Turnaround SolutionsDeputy CEO: Turnaround Management Association – Southern Africa6 September 2006
Implications of new business rescue legislation for private equity in South Africa
Private Equity World Africa 2006
Turnaround solutions for underperforming and distressed
businesses
The premier professional community dedicated to corporate renewal and
turnaround management
Implications of new business rescue legislation for private equity in South Africa:
Business rescue
New business rescue legislation
Implications for distressed portfolio companies
Implications for distressed situation investment opportunities
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Management-led
correction
Informal creditor workout
Business rescue Liquidation
Failure
Underperforming company
Turnaround – stabilised, funded
and fixed
Highest success rate
High success rate
Low success rate Failure
Failure Failure
Time
Informal processes Formal processes
Cost/Success rate
High success rate High failure rate
Low cost High cost
Power of directors and management
High None
Distressed company
Debts worked out and possible turnaround
Rescued – sold/funded or turned around
Dissolved
If sold/funded but not yet turned around
If worked out but not yet turned around
Timeline of financial distress:
As a troubled business moves along the timeline, costs increase, but the success rate and management power decrease
This is due to change with the introduction of new business
rescue legislation.
Low success rate: Compared to 75% for workout
More information to follow
Compared to the (low) international norm, South Africa has an even lower business rescue success rate due to its antiquated insolvency legislation
In essence, failed workouts presently go straight into liquidation
Business rescue
BUSINESS RESCUE
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Business rescue has a number of objectives and benefits
The purpose of business rescue is to preserve the going concern value of a distressed firm, that is or is going insolvent but potentially viable, through:
– Refinancing/financial restructuring, or
– Turnaround (including refinancing/financial restructuring), or
– Keeping it afloat and selling it as a going concern (for turnaround/refinancing by the buyer)
A firm that enters business rescue and emerges intact may satisfy creditors' claims more effectively than a firm that is liquidated
Business rescue is meant to allow a distressed firm to:– Satisfy claims of creditors– Continue in the economic stream i.e. source of business for other companies– Preserve jobs and create employment – Pay taxes
However, SA’s business present antiquated business rescue legislation does not achieve these benefits
BUSINESS RESCUE
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Business rescue, however, is not a silver bullet for distressed companies - as illustrated by overseas statistics
High cost: Direct costs represent 24% of book value on entering business rescue (Nachtman et al,
1999) but still less expensive than liquidation (the move towards pre-packaged from free-fall business rescue will reduce costs though)
Low success rate – the USA experience: Baker Smith, President of Morris-Anderson: "Since over 85% of businesses never
successfully emerge with a confirmed plan of reorganization, the cure must be worse than the illness. Most companies die in Chapter 11. Unless a company’s underlying problems are addressed with a turnaround plan or sale, Chapter 11 can’t ultimately save them."
Many firms increase their investment expenditures only by very little in the first two years after a debt restructuring (James 1995)
In each of the first five years after emerging from business rescue, between 35 percent and 41 percent of all firms have negative operating income (Hotchkiss 1995)
More than 75 percent of firms that complete debt restructurings emerge with a leverage ratio that is higher than industry median and most are still significantly more highly leveraged than before the onset of financial distress (Gilson 1997)
Furthermore, between one quarter and one third of all distressed firms re-enter financial distress within a few years after completing a debt restructuring (Hotchkiss 1995 and Gilson 1997)
BUSINESS RESCUE
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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The success rate of business rescue is low because (1) it is wrongly deemed to be a measure of last resort and (2) has too little emphasis on turnaround
Why a low success rate? Formal business rescue is expensive:
– To save costs, management-led correction and informal credit workout are still attempted when formal business rescue should already be taking place
Stigma of bankruptcy:– In countries with a legacy of English law like SA, business rescue carries the stigma of
bankruptcy, leading to loss of prestige, staff and customers
– This is in contrast to Chapter 11 in the USA where bankruptcy carries less of a stigma
Resistance of directors and management:– Less so with Chapter 11 in the USA where directors and managers remain in charge (DIP or
debtor-in-possession principle)
– But more so in non-Chapter 11 jurisdictions since directors and management lose control
BUSINESS RESCUE
As a result of the 3 points above, a business tends to be too deep in the Failing Zone of the Z-Score by the time that business rescue is triggered (example of Z-Score to
follow).
Focus on “restructuring” instead of “turnaround inclusive of restructuring”
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Apart from new business rescue legislation, we identified a number of key success factors for business rescue in South Africa
BUSINESS RESCUE
Business rescue key success factorsAvoid the need for business rescue
Avoid formal business rescue by educating business in timeous and effective reaction to early warning signals of distress
Expedite business rescue if the need cannot be avoided
A stronger legal deterrent to directors trading under insolvent conditions (in new Companies Act?)
Avoid “free-fall” business rescue - don’t start looking at solutions only once insolvent
Instead, use “pre-packaged” business rescue:– Timeously devise a turnaround plan inclusive of financial restructuring and
then invoke business rescue before real financial distress has set in– This hybrid takes the form of the informal creditor workout with its low costs,
but invokes business rescue to achieve the protection offered by the latter.
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Business rescue key success factors … (2)
BUSINESS RESCUE
Business rescue key success factorsDon’t attempt to rescue a lost case
The purpose of business rescue is to avoid making a Type 1 error
Type 1 error = to liquidate businesses that should be rescued
Conversely, Type 2 error refers to attempting to rescue businesses that should be liquidated
Cost of Type 2 error = cost associated with the unsuccessful rescue attempt plus the cost of subsequent liquidation
These first 3 points can be illustrated by means of the timeline of financial distress table on the next slide.
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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The timeline of financial distress illustrates how remedial processes are applied during different stages
The stages and processes in the timeline of financial distress:
Informal Processes Insolvency ProcessesEmerging problems
Acute and worsening problems Insolvency but possible viability
Insolvency and unlikely viability
Management-led correction Informal creditor workout
Business rescue Liquidation
Pre-packaged Free-fall
No creditor and legal issues since the financial situation is not yet critical
Critical financial situation but no creditor pressure, due to support from benevolent shareholders ( e.g. distressed government organisations, SOEs and companies with financial support from holding companies)
Informal agreement between management and creditors (banks) to reduce indebtedness
Terms of workout agreement dictates agenda
Present: none Present: judicial management and Section 311 Compromise of Creditors
Very low success rate
Realisation of the distressed company's assets and the distribution of proceeds to its creditors
Future: Invoked when not yet insolvent
Higher success rate than free-fall
Future: Invoked once insolvent
Lower success rate than pre-packaged
Management retains the initiative and controls the turnaround agenda
Banks hold the power
Court-driven – inflexible and expensive
The timeline of financial distress is adapted and extended from Matthias Kahl, “Economic distress, financial distress, and dynamic liquidation”, Journal of Finance 62 (February 2002) pp.135-168Used by the G10’s Contact Group on the Legal and Institutional Underpinnings of the International Financial System to describe insolvency arrangements and contract enforceability
BUSINESS RESCUE
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Business rescue key success factors … (3)
BUSINESS RESCUE
Business rescue key success factorsTurnaround, not mere restructuring
Financial restructuring alone is OK if EBITDA/operating profit is positive, but losses are incurred due to the interest burden
But businesses with strategic, organisational and operational challenges require more than restructuring to survive
If distressed businesses are not stabilised and the underlying causes of distress are not fixed through turnaround action, the business will not survive restructuring
Business can in legal terms be “rescued” by selling it – but that still leaves turnaround to the buyer
Unless the business is fixed, "business rescue" postpones the inevitable.
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Business rescue key success factors … (4)
BUSINESS RESCUE
Business rescue key success factorsTurnaround finance
Need for a stronger turnaround private equity industry in South Africa that:
– Not only invests in underperforming businesses and businesses requiring financial restructuring …
– … but also invests in distressed businesses too
New business rescue legislation will stimulate the market for distressed situation private equity
Business rescue cannot happen without a cheque book.
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
Business rescue key success factors … (5)
BUSINESS RESCUE
Business rescue key success factorsOrganised industry
Turnaround Management Association - Southern Africa:– Promotion of the turnaround and business rescue industries
– Information exchange, networking, education and raising the standards of turnaround across both the informal and formal sectors
Education Education of industry and government through TMA-SA
Educational conferences like this one today
Certified Turnaround Professional (CTP) qualification:– TMA-SA’s future programme to educate turnaround practitioners
– Exam on (1) turnaround management (2) financial, managerial and tax accounting (3) law
– Proven track record and experience
133 The Trails, 127 Linden Rd. Sandown 2196, Sandton
Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
Business rescue key success factors … (6)
BUSINESS RESCUE
Business rescue key success factorsBusiness rescue scorecard
The success rate of business rescue overseas is low
There will, as done in 2004, be much hype from government and in the press, creating false expectations about the prospects for business rescue in SA
We therefore call for a scorecard to measure and the track the success of all business rescue attempts under new legislation:
– Number and turnover of businesses that survive business rescue– Percentage of jobs retained as a result of business rescue– Claimholder recovery rate as a result of business rescue– Cost of business rescue– Restructuring, turnaround or sale
Business rescue
New business rescue legislation
Implications for distressed portfolio companies
Implications for distressed situation investment opportunities
Implications of new business rescue legislation for private equity in South Africa:
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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The drafting of new business rescue legislation in South Africa has had a rocky start, and is not finalised
2004: The Department of Justice announced new business rescue legislation to replace judicial management which has been in existence since 1926:
– Draft legislation prepared by Daly Inc. and the Banking Council of South Africa
– Involved changes to existing insolvency legislation to be implemented within a year
2004: The Department of Trade and Industry launched its own initiative:
– Business rescue legislation to be incorporated into the Unified Insolvency Bill of Professor David Burdette of the Centre for Advanced Corporate and Insolvency Law (CACIL)
– Involved new insolvency legislation
2005: After convergence between government departments, the dti announced new business rescue legislation as part of the new Companies Act (Chapter 6):
– Oct 2005: Creditor-friendly proposal by Professor David Burdette based on the UNCITRAL Legislative Guide and aligned with SA insolvency legislation
– June 2006: Latest version by new authors – reportedly a debtor-friendly “mix of judicial management, Chapter 11 and other” – compatible with SA insolvency legislation and Uncitral guidelines?
BUSINESS RESCUE LEGISLATION
Next? What? When?
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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New business rescue legislation will provide more protection and time for a troubled company to rearrange its affairs and survive
Could be debtor-friendly rather than creditor-friendly
Protection and more time: A moratorium on the rights of claimants and legal proceedings against the
company:– No interest, capital, creditor payments….
– Moratorium will overcome two of the weaknesses of the informal creditor workout:• It represents cram-down of dissenting minority creditors who cannot derail the process any more
• Banks don’t face the problem of free-riding other creditors any more
Ringfencing and ranking as to preference of creditors' interests:– Post-commencement finance ranks highest (but in free-fall business rescue it is unlikely that
there will be any unencumbered assets)
No time limit on the duration of business rescue as long as it is working
Opens the door for pre-packaged business rescue
BUSINESS RESCUE LEGISLATION
Business rescue
New business rescue legislation
Implications for distressed portfolio companies
Implications for distressed situation investment opportunities
Implications of new business rescue legislation for private equity in South Africa:
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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Private equity firms will have more scope to rescue their distressed investee companies, but will lose control
Positive implications of new business rescue legislation: Will buy more time for restructuring, turnaround or sale:
– Through a moratorium on the rights of claimants and legal proceedings against the company
Could be debtor-friendly
Pre-packaged business rescue …– … before real financial distress has set in, will increase the chance of turnaround success, or
a successful sale at value
Negative implications of new business rescue legislation: Loss of control to the 3rd party appointed to conduct business rescue
Challenge to private equity firms with troubled portfolio companies: Overcoming the stigma of bankruptcy
IMPLICATIONS FOR DISTRESSED PORTFOLIO COMPANIES
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
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We expect workouts to be replaced by pre-packaged business rescue to some extent
R400m T/O listed company
Z-Score graph reflects history up to 2002, and thereafter the turnaround plan inclusive of debt repayment schedule agreed with bank (informal creditor workout)
Share price was R0-35 in 2002
Company not insolvent
Turnaround plan attracted R20m private equity investment at R1-20/share (not reflected in Z-Score)
Share price increased to R2-00 within months
Company adhered to bank debt repayment schedule
2006: forecast problems realised, share price dropped, bottom 5% of its sector on stock exchangeIn this example the turnaround, although successful, would have
been easier and less risky if it was conducted in terms of pre-packed business rescue.
IMPLICATIONS FOR DISTRESSED PORTFOLIO COMPANIES
Example: Turnaround under workout conditions:
Business rescue
New business rescue legislation
Implications for distressed portfolio companies
Implications for distressed situation investment opportunities
Implications of new business rescue legislation for private equity in South Africa:
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
New business rescue legislation will stimulate the market for distressed situation/turnaround investment
Private equity financing stages:
Opportunity in SA
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT OPPORTUNITIES
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Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
In overseas markets within modern business rescue jurisdictions, turnaround private equity lies in the middle of the risk continuum
Private equity risk/return profiles:
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT OPPORTUNITIES
New business rescue legislation will decrease the current risk of turnaround private equity in South Africa to be on par with the international norm.
South Africa to move leftward towards the norm
233 The Trails, 127 Linden Rd. Sandown 2196, Sandton
Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
Private equity firms will have more time to evaluate a larger number of deals, but the competition will increase
Positive implications of new business rescue legislation: More time to conduct due diligences than before:
– Especially if pre-packaged
Less investment risk than before– Better due diligences
– More stability before investing
All other things being equal, a higher number of salvageable distressed situations will be available to private equity firms
Negative implications of new business rescue legislation: More competitive deal flow situation for private equity firms …
Higher prices – more difficult to find bargains …
… because distressed businesses will have more time to find investors
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT OPPORTUNITIES
What does the turnaround private equity market look like at present?
243 The Trails, 127 Linden Rd. Sandown 2196, Sandton
Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
The market for turnaround private equity has substantially decreased over the past decade, but there are signs of an impending upturn
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT OPPORTUNITIES
Compulsory company liquidations per month:
The market for turnaround private equity is expected to increase in 2007.
After reaching its lowest point in 24 years, June 2006 saw the prime rate increased by 0,5%, expectations of further interest rate hikes, and rising inflation expectations
Another 0,5% increase in the prime rate to 11,5% was announced in August, and the same increase is expected for October 2006
Internationally, a big rise in companies facing serious financial difficulty is being reported as the global credit booms seems to be coming to an end
Business rescue
253 The Trails, 127 Linden Rd. Sandown 2196, Sandton
Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
Questions ?
Turnaround Solutions is a turnaround management firm advising and managing underperforming and distressed
businesses
Corporate Renewal Solutions is a business transformation and strategy-driven management
consulting firm
TAS and CRS is a division of Corprenewal, a black-owned management consulting firm
Cell phone: 082 853 1414
Land line: 011 477 4414
Fax: 086 510 6184
TAS web site:
TAS email:
www.turnaround-sa.com
CRS web site: www.corprenewal.co.za
CRS email: [email protected]
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Turnaround Management Association – Southern Africa
Tel.: 011 964 2895
Fax: 011 748 2809
Web site: www.tma-sa.com
Email: [email protected]
Jan van der Walt
263 The Trails, 127 Linden Rd. Sandown 2196, Sandton
Private Equity World Africa 2006 Implications of new business rescue legislation for private equity in South Africa
Cell: 082 853 1414Phone: 011 477 4414Fax: 086 510 6184
Resume of Jan van der Walt
As CEO of Corprenewal, Jan van der Walt has 26 years' experience in turnaround management
In his career he served as both senior accountable executive, and in advisory positions in the public sector and in the private sector with clients as large as R5bn turnover
He has wide experience in devising and implementing leadership, strategy, financial, organisational and operational solutions in turnarounds
Jan is an active presenter at conferences, publisher of turnaround articles and web sites, and guest lecturing in turnaround management at business schools
In 2004 he initiated the Task Group for Organising the Turnaround and Business Rescue Industries, which included 100 representatives from various stakeholder groups in industry
The Task Group spawned:– ABASA - Association of Business Administrators of South Africa - a proposed business rescue regulatory body in terms of
future new business rescue legislation. Jan serves on the Interim Executive of ABASA as Treasurer.– Turnaround Management Association - Southern Africa, the establishment of which Jan initiated and concluded as a
founder member. Jan serves as Deputy CEO as well as on the International Committee of TMA International.
Qualifications– MBA (Stanford Business School), where he studied with a Fulbright Scholarship and specialised in strategy– Honours B.Sc. in Operations Research (University of South Africa)– B.Sc. Industrial Engineering degree (cum laude) (University of Pretoria)
Personal web page: www.turnaround-sa.com/team/jan van der walt.asp