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Lara Gibson

9Questions is our Q&A series featuring key decision-makers in the leveraged finance and distressed debt world — get in touch if you know who we should be talking to!

For our first ever distressed 9Questions 9fin’s Lara Gibson interviewed Paul Kirkbright, head of Alvarez & Marsal’s EMEA Financial Restructuring Advisory, to discuss the current environment.

1. Given macro headwinds, which include the war in Ukraine, inflationary pressures and rising interest rates, do you think there will (finally) be a wave of restructurings?

I suppose I should start by saying we probably redefined our definition of “restructuring” when we were coming off the back of the lowest level of new restructuring activity that those of us who have been around for a long time can recall in our whole careers. Everyone I speak to of my vintage says the same thing; we’ve never seen anything like it. That being said, the cocktail of macro factors we have going on like the Ukrainian situation, inflation, labor shortages, supply chain issues will most likely trigger an uptick in restructuring opportunities.

In addition to this, we’re coming off the back of the pandemic period where a number of deals were perhaps done in haste and not based on entirely realistic numbers. I think as well that the upcoming situations will certainly test the appetite of investors to follow their money in challenging situations.  Private equity has been enjoying a particularly good run and there are questions around how willing they will be to follow the money and how willing private credit will be to give breathing room to borrowers who are struggling to service their debt obligations.

2. Which sectors do you think are most likely to fall into distress due to macro pressures?

That’s the $64 million question. The macro issues we are facing are so diverse that they transcend a massive range of sectors. In the past we had clear-cut examples like the oil price collapse of 2014/15 and the dot-com bubble burst where it was easy to pinpoint which companies would be affected. In today’s world, 99% of businesses will be affected by ongoing issues like inflation, supply chain issues and wage rises.

One sector where we will see lots of casualties will be the consumer demand sector. Hospitality, cinema, gyms and non-food retail are likely to be affected if there is a recession. If borrowing rates continue to rise, there will be a big knock on effect in the property market and construction-related businesses such as steel and concrete providers [who] will be massively affected. The steep rise in raw material costs, supply chain issues and wage costs will affect a wide range of manufacturers and we will likely see a number of these facing distress later this year.

3. What’s the opportunity set like in distressed situations right now? We’ve already seen companies directly exposed to Ukraine and Russia coming under pressure, what other knock-on effects are expected in Western Europe?

Recently there has been a noticeable pickup in activity, I would say the last two or three months there has been more pitching activity, more discussions with borrowers, stakeholder groups and lenders around issues that they are getting concerned about. There are obviously a number of companies with exposure to Russia who are working with distressed advisors and on the Western European side we are more or less seeing the typical ‘run of the mill’ restructuring candidates who are a mainstay of our world.

The majority of opportunities we are seeing are those caused by weaker management teams and generally poor operational execution. There are also a number of companies who were able to easily access capital markets or government support during the first phase of Covid-19 and are now starting to face liquidity issues. Another trend we’re starting to see is companies which have been unable to navigate the rampant pace of technological change which occurred during the Covid lockdowns and are now being pushed out of their respective markets.

4. How is A&M positioned to take advantage of these opportunities? What is your strategy and how would you differentiate yourself from other advisory firms such as PJT, Houlihan Lokey and Moelis?

Our breadth of offering across the restructuring spectrum really positions us as one of the only one-stop shops that can combine financial advisory capabilities to match any investment bank with the full range of services you need to deliver the most complex transactions. Services such as valuations, tax, operational improvement capabilities, contingency planning and insolvency capabilities to ensure any transaction can get done.

We also can combine this with chief restructuring officer specialists that have really deep industry expertise for running businesses in C-suite roles and this gives us a really different perspective into the strategic commercial and operational issues that are causing all of the liquidity stress. We also have the most comprehensive geographical coverage amongst any of our peers.

We’ve started to double down on our range of offerings in the past two years. We also have scaled our operations in the last two years and doubled our headcount in this period. We opened new offices, launched new operations and started new services such as portfolio advisory and special situations M&A.

We’re also looking to invest more in our headcount and will aim to grow another 50% or more during the next three-years across major regions to build the strength and depth everywhere we need it. In a quiet market right now, we’re tactically repositioning to make the most of future opportunities.

5. Quite a few companies, most recently Missguided, were unable to withstand supply chain issues? Do you see this as a key issue for companies?

The fragility of global supply chains has really been exposed during the Covid-19 crisis, Brexit, challenges in the shipping industry and now the Russian invasion of Ukraine. Many companies are now fighting to build resilience into their supply chains and they’re rushing to bring production closer to home.

Previously it was in vogue for fashion companies to manufacture stock in East Asia to increase margins and now that pendulum has really swung back and retailers are opting for factories much closer to home in countries like Turkey.

A number of manufacturers including auto companies are choosing to build up a larger supply of stock to avoid any potential disruption in the assembly process. This of course leads to additional cost infrastructure and additional working capital needs.

6. Private credit continues to grow and grow as an asset class, do you think it will play a larger role in restructurings/distressed situations, and how will it alter negotiating dynamics?

Undoubtedly the growth of private credit funds as an asset class means that they are going to play an increased role in restructuring dynamics as they’re so deeply embedded in the financing. Due to the staggering volume of capital private credit funds raised in recent years, which they need to deploy, they are increasingly investing in more stretched transactions and will find themselves in distressed situations. Many of these funds are off-shoots of CLO or special situations funds anyway and will have the capability to navigate distress.

Lots of these lenders put in place unitranche structures and this will greatly simplify restructurings as it will reduce the number of stakeholders around the table, which by any measure is the most complicating factor in restructuring negotiation dynamics.

Also it’s worth pointing out that during the Global Financial Crisis of 2008, the majority of special situations funds had their capital pulled out by worried LPs and missed out on the opportunity of a lifetime. Next time around, this is unlikely to happen and private funds will be able to sweep up ripe distressed opportunities.

7. How will sponsor-owned credits look to navigate the potential upcoming distressed waive? Generally speaking, will they prefer to inject capital or seek external funding?

There’s no simple answer to this question because it very much depends on the dynamics of the individual sponsor and where a particular asset sits in the fund. In general they will prefer to seek external funding if possible and injecting capital tends to be the less desirable option.

We have seen some unusual behavior from sponsors where they’ve shown themselves willing to throw the keys on the table and walk away when further support is needed. This can be helpful as it can facilitate lenders taking over the business or it allows a court process to happen more easily. On the other hand, it is also unhelpful to remove one option from the table quite early and reduces the amount of turnaround options a distressed company has.

With the typical private equity-owned, private debt funded companies we have seen a lack of meaningful covenants put in place during the past five years and this often means the restructuring starts later due to the absence of triggers. In these circumstances it really tests the sponsors appetite to inject equity into the business in crisis. Often they opt to hand over the keys if they can not secure additional external funding to avoid injecting significant amounts of capital.

8. What impacts do you see emerging from the difficult financing environment for LevFin?

We are seeing that the power balance is moving a little bit more in favour of lenders and we are seeing some aspects of the market where lenders don’t want to play in. The super senior RCF part of the market is one such example. Due to the yield and the terms it is really not that attractive for lenders to expose themselves to these structures. Even though they’re arguably the safest part of the structure, why would lenders even expose themselves to limited risk for almost no reward?

As a sort of spring against that, I think there’s still huge amounts of liquidity in the market. In the past 12 to 18 months we’ve started to see sponsors put in a bigger proportion of equity versus debt as valuations got stretched and I think sponsors will need to continue doing this to attract lenders.

9. Lots of credits are trading in the 80’s or below -  do you think this is because they are pricing in upcoming distress - or is this just a repricing of risk?

You can probably account for certainly things in the nineties, maybe even in the top end of the eighties not being distressed just reflecting the current state of the market. I think the debt markets in general are a poor indicator of true value from a distressed perspective.  When we get inside the market, mis-pricing of the debt is actually quite serious. I'm always very cautious to put too much store on whether it's yield distress or just they've got it wrong.

Logically from a purist perspective if the senior debt is significantly below par, the second lien should be much more severely impaired, arguably should have no value.

Ultimately, pricing is a poor reflection of distress and to determine whether a business is in trouble you need to look under the hood of the business and consider whether it has a right to exist.

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9Questions - Paul Kirkbright, Alvarez & Marsal

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