Middle corporate New Zealand has historically struggled to attract the banking sector support that it deserves. It has usually played 'third fiddle' to the flashy violins from the rural and housing sectors, in terms of access to capital.
In the decade to June 2011, agriculture debt expanded 3.4 times. Prior to 2008, farmers were quite secure in the knowledge that if the first bank said no, then the next bank would likely be down the driveway quick smart.
No longer. Farmers are so busy deleveraging they’re back among the woodwinds in the capital orchestra pit. Lending to the rural sector is likely to remain subdued in the short term because of new Reserve Bank requirements, called a capital overlay, forcing banks to retain more equity for every dollar they lend.
Meanwhile, residential is relatively flat but hangs on to its second fiddle status.
What business leaders now need to realise is that banks’ priorities for asset allocation have been completely turned on their head and the lenders are now focussing their attention on middle corporate New Zealand.
Middle market takes a bow
Middle market companies now have first violin status, for the first time in a decade, he says. This presents a competitive advantage to companies that are prepared to take a strategic and flexible approach to their funding needs.
There is a 12-to-18 month window to favourable debt conditions. We’ve noticed ANZ’s marketing campaign saying it’s got $3 billion available to lend to businesses. Funding is available and we estimate there’s probably more than $10 billion in general allocation across the major banks.
Not that this means a licence for the banks to be loose with credit. But businesses can take advantage now and lock
in arrangements to achieve long-term strategic goals
In the middle market, owners and executives typically straddle the different aspects driving company performance, more so than senior executives in large corporates. They are closer to the action and are able to see how this tallies with future trends and organisational strategy.
The marriage of long-term funding arrangements to three-and-five year strategic plans is often absent. This is a critical strategic avenue that is too often overlooked, he adds.
Be pro-active not reactive
By the time the economy has picked up and everything’s going 4%, 5% growth, everybody will need credit. But it will also be a time when the banks can be more selective about to whom they extend credit. Today’s environment is more of a 'buyers’ market' and KPMG has noticed a definite upturn in inquiries about capital structures and debt management.
We want Directors in middle market boardrooms to see that they have opportunities to review their debt situation and capital structure in a way that will help them drive their businesses more effectively and give them more flexibility to grow. Good governance should incorporate adaptable funding strategies that are firmly wedded to the business strategy.
Look beyond the initial business strategy. People think that acquisition is a driver of debt, and that’s often true. But capital expenditure, research and development, working capital management and entry to new markets can also be timely opportunities to review funding strategies.
More attractive to third parties
Integrating funding arrangements with overall strategy will also make businesses more attractive to potential third party investors, such as private equity. They’re quite selective and bring a rigorous approach to their analysis.
Private equity examines scores of companies each year but invest in only a few – and a sophisticated funding strategy could be the vital element in persuading third party investors to come on board.
Here are two examples of what can be achieved in the present environment.
A medium-size company with shareholder interests of over $30m that was seeking a $10m facility. They had gone to their transactional banker, who said no, yet when we looked at it, we said that this business should at least have a modest debt facility. We came in and assessed the business and the important thing was to rearrange the security. We repaid some shareholder loans, rearranged the securities, did some long-term forecasting and presented the business in the proper light. Its debt facility was approved.
Singapore-based Olam International - a very large business by New Zealand standards but it an exemplar of how to maintain financial and strategic flexibility. Because Olam is a world leader in terms of market disclosure, its strategy is easy to analyse. They’ve continued to raise capital, even during the global financial crisis. They bought back convertible notes, which had been issued with an option to convert to equity at a later date, when they became mispriced – they made a $20m profit.
They’ve got a clear strategy and that gives them the confidence to raise capital ahead of the game. They mix up the sources: short term, medium and long term, as long as 10 years. So you’ve got a mix of maturities and sources and they’ve matched their balance sheet to those sources – for instance, they’ve got US$2.4 billion fixed assets and are funding that with US$2.2 billion equity because they know it is permanent capital. Whereas, working capital is funded through matching maturities.
Should the market turn or an opportunity arise, Olam can access cash from uncommitted funding lines, short term debtors and receivables and inventory.
It’s a copybook case study and a superb example of someone doing it ahead of the curve. While New Zealand middle market companies can’t replicate Olam’s strategy in its entirety because they don’t have access to long-term debt or public bonds, they can learn from the Singaporean masters using capital to develop strategy and achieve a competitive advantage.
Charles Widdicombe - Associate Director, KPMG Corporate Finance.