The coronavirus pandemic has left some financial professionals busier than others. M-III Partners, a transaction advisory and turnaround firm that works with PE clients in special situations, is one of them. PE Hub recently spoke with Colin Adams, a managing director at the firm, about the state of the economy amid covid-19 and the actions investors should take to support their portfolio.
You’ve been doing special situations advisory work your entire career, including throughout the financial crisis. How is this time around different?
It’s fair to say that in the past four days I have seen things that I have never seen in my 20-year career.
One of our more junior colleagues recently asked me, “You must have seen defaults get called all the time on Debtor in Possession (DIP) loans?” And I said “No. I have never seen this happen in 20 years.”
Similarly, I have been working on a private equity sponsored deal where the existing lenders and the sponsor are in agreement about making a transaction happen, and nevertheless, uncertainties are preventing a closing.
MAE and MAC clauses are not only being discussed, they are being used. How many times in my career have I actually seen MAE or MAC get called? Quite literally zero until last week, and that includes the financial crisis, where there were threats about it, but it never really happened. This week I’ve seen it called twice in the last two days. And people are not worried about it — they are calling it with impunity, because there is a global pandemic going on and the world has changed.
What do you think can be a ‘fix’ or a ‘stimulus’ for the economy and for the private equity community right now, versus 2008?
I think the financial crisis in 2008 was ultimately a supply of money problem — liquidity dried up. You had businesses that were otherwise doing all right when the crisis struck and still had the prospect to be okay, but financing dried up, and when that happened, there were all these knock-on effects, such as people losing their jobs and demand drying up. The way to solve the problem in 2008 was capital. The people that had capital were able to step in and say: “You haven’t had a source of money, but I’ve got money; I am the savior,” and those people did very well. And they were able to use capital or the pricing mechanism to bring the demand back.
Contrast this to the present day where demand has dried up completely. For example, when the government says you have to shut down your restaurant, then there is no demand to come eat because your restaurant can’t be open.
Because this is a demand issue, I don’t think that the fix is throwing dollars (certainly not fixed income dollars) at the problems. I don’t know how you bring the demand back. Whether it’s a restaurant, a hotel, a cruise ship — lowering the price of the hotel room, giving out two-for-one dinner offers, making the cruise half as expensive – none of those things for the next three, six or maybe nine months are going to stimulate people to buy those services or buy those goods.
So if you are a PE sponsor or equity investor, what you have to realize is that unlike 2008 — which was really a lack of debt capital problem — here it is an equity capital problem. There is a long-term drying up of demand. So the dollars that are needed are long-term equity dollars that are going to get the benefit of the return in the future. And you need new dollars that do not require regular interest payments like the fixed income dollars do.
What advice are you giving PE-backed portfolio companies seeing demand for their services or products dry up?
PE firms and their portfolio companies should be thinking about three critical things: liquidity, liquidity, and liquidity. How much liquidity do I have in the business? How do I get more liquidity in the business? What are my options to stay liquid?
Most of what we are doing now is helping our existing clients manage though the acute shock that is covid-19. We are helping people to think through what are the strategies and tactics that can be employed to weather the storm and also to come out on the other side of this pandemic in a stronger position, ready to take advantage of what hopefully will be a fairly healthy economic rebound once people’s health is back.
A lot of what we are thinking about with our PE and portfolio company clients is what can you do to generate liquidity so that you can weather the storm and what can you have defensively to protect your clients and your business.
Our approach to this is a comprehensive review of sources of liquidity, both external and internal.
External is really going through a review of all the resources that are available to a company and to a sponsor. Do you have the ability to access incremental liquidity under a revolver? Do you have untapped lines that are available to you? Are there unencumbered assets that could be pledged to existing or new lenders to generate incremental liquidity?
The internal review is all about how is your business set today from a cash efficiency and maximization perspective? Are you being as efficient as possible in the way in which cash is moving through the system of your business? Are you collecting receivables quickly enough? Are there parts of your operations, purchasing, supply chain, where — given the disruption that is taking place — you can find ways to be cutting better deals for the near term and the longer term to reduce the cost of supply into your business? And, similarly, do you have the appropriate inventory level for the demand shrink that we are all projecting? All of that internal thinking is ultimately a way to unlock cash from the business itself.
And therefore, if you’ve done it right, we are going to create some liquidity from all those external sources. We are going to squeeze the sponge of internal efficiency to create some additional liquidity there. If you put those two together, that’s supposed to give us 90 days-plus to weather this storm and be super successful when things come back.
You mentioned hospitality. Are there any other industries you see being hit harder than others?
It’s impacting everybody. We are absolutely seeing this across business services, which is having an impact on telecoms, especially in the telephony and telecom service providers. You are absolutely seeing it in retail too as people are staying home and not going out. You are seeing it in oil and gas, energy services, because there is less demand for oil. And all of the service providers to all of these businesses. If you are a software company that does primarily restaurant point of sale systems, or retail services, that can have an impact on you. Because if your client is suffering a demand decline, you are going to suffer a demand decline. No one is immune right now from the demand decline that we are seeing.
Do you see a cost opportunity for sponsor acquisitions during this time?
For PE sponsors that are looking to acquire more companies, I think it’s a very robust time, it’s a rich time to do that. As long as when they buy the company they understand that they are going to be equity financing a period of low demand, which will eventually come back when this is all over.
Action Item: Write Colin Adams at firstname.lastname@example.org.