Businesses are having to make hard decisions

CIARAN RYAN: These are trying times for businesses across the country. We know GDP contracted a whopping 51% in the second quarter of this year and 2.2 million jobs have been lost. As financial results start to trickle through, we’re getting a sense of the damage inflicted by the lockdown, and it’s not pretty. Businesses are having to make hard decisions, such as whether to apply to their banks for additional borrowings or try to trade their way out of the crisis. There’s hardly a business in the country that has not agonised over how to survive the next 12 months. Some need cash to cover working capital, others need capital to purchase machinery.

Joining us to explore this subject is Marc Rosen, head of deal structuring at Investec. Hi Marc. From where you sit, just give us a sense of what impact the lockdown has had on earnings during the crisis and what businesses are likely to endure.

MARC ROSEN: Hi Ciaran, thanks for having me on your show. Ciaran, I think you’ve summed it up quite purposely. A lot of businesses have been absolutely decimated by this crisis. I think if you look specifically at the mid-market space, what nobody could have ever anticipated was a complete shutdown where you turn off the taps and turnover kind of dropped to levels of zero. And I don’t think South Africa or even the world had any understanding of how quickly or how short an amount of time was available for businesses to navigate from calling it built-up equity in those businesses or available cash to be able to navigate through that, and cover costs in a period where they’re not being able to generate any sales revenue.

And I think what we’ve seen is that was kind of the first part of the Covid scenario which everyone had to grapple with. A fight for survival. We had this what we’d call almost a glut in the system – that there was nothing that could actually happen. You had customers who couldn’t pay you, and that obviously, in turn, led to this kind of lack of cash availability, which would mean ultimately you couldn’t pay employees. There were landlords that couldn’t be paid, and ultimately creditors and suppliers weren’t being paid in the normal course. So the system kind of broke down and ultimately froze and went to nothing.

So what we’ve seen since then is this has led to businesses having to understand what that meant and having to repurpose. Some of them had to look to raise equity to put into the business to allow them to just continue. Some businesses probably were those businesses that were trading marginally before the situation and Covid occurred. I think those businesses are the ones that have probably not been able to survive thereafter.

But what we’ve also seen is resilience in a lot of South African businesses, which has been quite surprising, even to us – to see those very good operators in their industry just realise what they have to do to effectively stop the bleeding and turn things around. And that really did take a form of more of an idea of rationalisation and understanding of how to alleviate costs within my cost base where, if I return to a new normal, which is no longer at a 100% trading level that I realised before, but maybe at a 60 to 80% trading level, how can my business be nimble enough to actually continue?

And what we’ve seen is beyond just continue. Some businesses are even starting to thrive, because they understand and they’ve had to self-assess, take a look back at themselves and understand how much of these additional costs or overheads they are carrying are actually unnecessary. In trimming that fat, it’s made them a lot more nimble and with the ability for them to trade at probably higher profitability levels, even on the back of reduced turnover.

I think what you’ve also then seen as a final point is while these businesses are now surviving, the good operators are those that are also now seeing spouts of opportunity in a very, very depressed environment. And that I think comes at such – [in some cases] to the unfortunate event in terms of a loss of a competitor. You’ve seen that happen significantly across the board.

But I think your customer base and just how you supply, so the change in innovation, the ability to take on this virtual kind of sales platform, has also allowed certain businesses to find their way through to a customer base which was very hard to come by in a scenario where you had a lockdown and no physical presence where you couldn’t trade face to face.

CIARAN RYAN: I think every business in the country has confronted this crisis in fairly innovative ways, and it’s forced them to develop a Plan B and a Plan C. And I think one of the things that has happened is that views on debt have changed. Debt doesn’t always have to be seen as a negative but rather can be used to release working capital or improve cash flow. So I guess the big question borrowers are having to answer is whether they’ll have sufficient revenue to cover additional borrowings – assuming that they do borrow – in 12, 18 months. Now, what kind of discussions are you having with clients around this issue?

MARC ROSEN: I think having sufficient cash to allow you to trade is going to be critical going forward. And part of that self-reflection I alluded to was that South Africa generally is quite a conservative lending environment. Business operators have lived through times when interest rates were 25%; they’ve been burnt by those types of historical events. And there is a conservativeness around debt, traditionally. So people need to understand the right type of debt and the right type of funding can be incredibly positive for your business, but debt for the sake of debt – you can’t plug a hole where you’ve got eroded earnings and you need to provide debt to fill that hole.

So what we understand when we are speaking to business operators is how we can assess how your business actually works from start to finish. At what point in your working-capital cycle can we provide that assistance, that provision of money that allows you to trade and to run your business?

And what I mean by that is, if we look across a working-capital cycle, be it funding to assist in the purchasing of raw materials or products that they’re going effectively [to] look to distribute, whether it be funding on a facility where we allow for the release of working capital that’s tied up into your debtors – so the receipts from your customers waiting to occur – or, finally, if it’s just purely the provision, as you alluded to earlier in your intro, around the purchase of capital assets required in order to either deliver your product or actually manufacture your product.

So it really becomes an understanding that that debt needs to provide that platform for growth. It needs to provide the platform that, for every rand that you’re putting into a business, you are using that money into the creation or for the fulfilment of additional sales and turnover.

And I think that comes from different points. Predominantly it allows you to pay for the goods that you need to put into the system and allows you to buy in your stock, it allows you to buy your materials. But it also allows you to provide terms to your customers to also give them that relief – that they can pay you in a little more of an easier time period – because your customer is under pressure as well. So it just allows you to expand on that cycle from your use of cash into the cash received from your customers, and it gives you that relief to allow you to trade more efficiently.

CIARAN RYAN: An interesting thing about South African businesses is that many of them have deleveraged quite extensively over the last five or seven years. So their balance sheets are in pretty good order, as things stand. I guess this means they now have the capacity to take on additional borrowing without incurring too much risk. Would you agree with that viewpoint?

MARC ROSEN: I do. But I think what’s changed in the Covid landscape is a debt provided traditionally would look at your historical financial information, and that becomes a proxy to understand the capacity for borrowing. I think what Covid has done is, if I look at the last 12 months, your balance sheets to a large extent have been wrecked. Your trading profitability doesn’t represent the true consistency of the business, because you’ve got this massive fluctuation. So I think, specifically from the Investec perspective, it kind of lends itself to our theme and our approach that we need to back individuals and we need to back the right business owners and business managers and management teams, in terms of understanding that these are the right operators that can come out of this environment. And looking at the last 12 months is not going to paint that picture.

And that’s why it goes a little bit further. I think the lines between debt and equity in that sense have blurred a little bit since Covid. To be able to look purely at historical financial information you’re going to get a bit stuck with the Covid noise that now sits in the system.

But, to your point, those businesses have built up retained earnings and built up strength in their balance sheets. A lot of the time that net asset value on the balance sheet is reflected in the form of either stock on hand, debtors in the business, or capital assets. And what we look to do is to look to those assets and look to release cash tied up in them for the business to put into use, so that they could be more productive and look to drive a bit forward.

CIARAN RYAN: Okay. So businesses need to look at how they fund their growth, which means the right type of lending – the right amount at the right time. Is that correct?

MARC ROSEN: Absolutely. And I think it’s very important – the right type of funding is critical. If you look at some of the products Investec for Business offers on a trade finance perspective, trade finance is traditionally used to purchase stock, and it allows you additional time periods, so effectively you are settling your current creditor and it’s giving extended periods of time to effectively pay back the bank.

That time delay is allowing you to, instead of tying that cash up and paying for goods at a point in time, if you take an additional 30 to 90 days of additional trading terms, in those 30 to 90 days you are allowing yourself time to beneficiate those materials, be it a raw-material conversion process or even if you’re just a pure distributor. It gives you that time to hold that stock and to distribute it into the market.

I think that’s already explaining that there is a short-term requirement in businesses that trade finance addresses. But if you consider that against long-term debt, which is provided into the system and has this amortisation profile where you’re required to pay back quarterly, regardless of how you’re trading, you kind of start getting to an inflexion point where if you start hitting that growth cycle, instead of funding the purchases of stock, and applying that into your inventory cycle, and then paying it back as you receive cash from your customers, you may be forced to repay the debt without having that validity, and you might be taking on additional debt that you don’t need necessarily at that point in time.

I think further to that, we then go to match alongside that with borrowing those facilities, where we look to fund against debtors books, where we look to say [that] against the debtors’ book we’ll provide a certain level of curing. And that allows you to access that funding as and when those invoices are raised to your customers on a portfolio view. When looking at that again, matching that with your trade finance, you are using the debt as and when you need it.

Now what’s critical in understanding the right top of debt at the tight time is that the nature of these facilities leads towards the cyclical nature of how business trades. You are funding the purchase of stock, you are funding the sale of that stock, and you’re bridging that tiny mismatch between with cash coming in. So providing that ability to have the liquidity for a business to use at any point in time allows them to trade. And if you’re having that capacity, sometimes you just don’t have the ability to buy the stock or to give your customer’s terms – which leads to non-productive income.

CIARAN RYAN: So I guess the message for businesses is they don’t necessarily have to be scared of debt, that there are types of debt, different types of debt, that are available which will match their timescales and their predicted revenue flows.

Final question here, Marc: are you optimistic that we will look back on this Covid crisis as a blip on the radar, or do you think it’s going to be something more significant? Is this a fundamental change in the way that we’re doing business going forward?

MARC ROSEN: I think it’s a difficult question, and I think it may be too soon to answer that really confidently. I think what probably will happen in my opinion, going forward, is that the nature of the lockdown scenario has been unprecedented, and when we look back in a few years’ time, people will always question whether an economic lockdown should have occurred. And that continuous debate around the protection of lives in a crisis like this versus the protection of lives, linked to the loss of jobs that have occurred. And the loss of business from this will always be where the debate will occur. I think it was an impossible decision for any country to make because you are doomed if you do and you’re doomed if you don’t, regardless.

Having said that, I do think what makes it difficult for South Africa is the fact that we were already in a very difficult economic environment to begin with, and what’s happening now is this has a compounding effect. And I think that will lead to certain businesses that just will never recover and are lost to the system. That can be kind of understood right now by the loss of jobs that you mentioned in your intro, again, saying around there are 2.2 million jobs that probably won’t come back in the same form as what they were.

That being said, I think it’s also led to a change in mindset, and I think for these businesses that have managed to come through this and have been able to realise that there is a way to trade in a different way, potentially looking at a different market, whether it’s internationalising your product, given the digital changes and your engagement with customers around the world – speaking to a customer internationally or in South Africa on a virtual conference call or whatever it may be – there’s no difference. I think that’s expanded the horizons of international trade. And, as I also mentioned, the nimbleness that is now being understood by those good operators means that they are probably trading a lot more profitably than they were, even with the higher turnover levels that they had previously.

So, in answering your question – and I feel like I haven’t really given you the answer – I think it’s 50/50. I think we’ll see, unfortunately, a loss of business that will never be recovered. And hopefully, that will be replaced by those great operators that grow their businesses. And, as their businesses grow, they can absorb those lost jobs into a recovered industry that they find themselves in. It’s an inflection point everyone’s facing right now. I think we need our South African environment to also turn, to answer that question. We need to see the drive into infrastructure projects. We need to see that drive into those areas which create those jobs. And we need to see the ability for certainty in terms of legislation and the ability to trade, to allow these businesses to perform and focus on their strategy, and then they’d use whatever forms of funding that they need to assist in driving that vision and that growth.

I still think South Africa is incredibly lucky with the ability for entrepreneurs to access a market. And I think the ability to grow into this economy is always there because we’ve got a relatively low base to grow into. And I think that will always allow the hopefulness and the optimism that South Africa can recover from this ultimately. It might take a little bit longer than we’d like.

CIARAN RYAN: Okay, Marc. Thanks very much for that. We’re going to leave it at that. That was Marc Rosen, head of deal structuring at Investec.

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