Operational Turnaround –Focus on Working Capital and Supply Chain-lecture by Igor Zax at LBS

Operational Turnaround –Focus on Working
Capital and Supply Chain
Igor Zax, CFA, Sloan Fellow (LBS)
Managing Director- Tenzor Ltd
© Tenzor Ltd 2009-2012
www.tenzor.co.uk
1

Strategic Value Drivers
 Buying “Cheap”
– Typically driven by distressed seller
– Timing is critical
– Limited due diligence
 Navigating Insolvency process
– Loan to earn
– Pre-Packs
– Winning capital structure battles
– Heavy reliance on legal process
www.tenzor.co.uk
2

Strategic Value Drivers
 Efficient Liquidation
– Sum of parts is more than the whole
– Individual assets are valuable but buyers are not
interested in the whole
– “Bodies in the cupboard”
 Operational Improvements
– Management Change
– Integration/Synergy
– Specialist Turnaround Strategies
www.tenzor.co.uk
3

Why Turnaround?
 Insolvency may be an efficient solution if there are
substantial assets in the business (based on actual
liquidation value) and they can be easily secured.
 Otherwise, one needs to keep the company as going
concern as the best way to recover- and this is not only
lender’s decision.
 To do so, one needs to answer why the company exists and
how is it linked to its environment.
 Bank lender makes a one-off decision to lend-supply chain
partners making their decisions (including granting credit)
every time
www.tenzor.co.uk
4

Five “C” of Turnaround
 Control
– Creditors seek to control assets and decision making
 Capability
– The team (existent, new or interim) need to be capable for the task
 Credibility
– Turnaround plan and the team need to have credibility with all
stakeholders
 Clarity
– What is the company’s core business, how it fits with the industry
structure and does the business model match it
 Co-operation
– Lending group are not the only stakeholders. Ongoing support
from suppliers, customers, distributors and others are vital for
survival © Tenzor Ltd 2009-2012
www.tenzor.co.uk
5

Steps for Distressed
Turnaround
 Diagnostic – “post deal” due diligence
 Fixing the team
– Loyalty
– Competence
– Communication
 Re-defining the business
 Process optimisation
www.tenzor.co.uk
6

Operational Due Diligence-key
part of M&A deal
www.tenzor.co.uk
7
Accounting
Legal
Target
ODD-Multi Dimensional PictureJust one side?
We need not only answer “what” but “why” and
“what does this mean?”

Operational Due Diligence-
core questions to answer
 Re-construct the link between the numbers and physical
process
– Get the access outside of “professional seller”!
– Do not limit your conversation to finance people- they talk about
numbers, not the business
– Speak to sales, procurement, manufacturing- and reconcile what
you hear to what you see in the numbers
– Understand external environment- suppliers, customers,
distributors- they may tell you a lot of things you would not hear
from the company
– Visit the warehouse and manufacturing and ask few simple
questions
www.tenzor.co.uk
8

Practical Example- What Can
you find in a warehouse
www.tenzor.co.uk
9
 What Do you see in Warehouse?
– Two similar boards (one of which is PCB and one is assembled) are on the
warehouse shelf
 What do you see in Accounts?
– Working Capital problems
 What do you see in Manufacturing:
– Delays, quality issues
 What do you see in Customer Service
– Quality Issues
PCB PCBA

Question to ask – Why? And
Is there a link?
 The company is buying printed circuit board from a small
supplier with advance payment
 They have no way to properly do QC before assembly
 They send the board for assembly to another far away
provider
 When they finally got the board back, they find not all of
them pass testing. Complex process to find out whose fault
(from the two suppliers) it is.
 What we discovered – WRONG SUPPLY CHAIN causing
the problem
www.tenzor.co.uk
10

Industry structure and Supply
Chain
 Global industry structures changed massively
 Platform companies "Produces nowhere but sells
everywhere... know where the clients are and what they
want and where the producers are. Platform companies
then simply organise the ordering by the clients and the
delivery by the producers (and the placing of their logo on
the product just before delivery).“- GaveKal
 Integrated and collaborative supply chains.
 Contract manufacturing, outsourcing, muli-tier distribution
 Changed structures are often ignored by analysts
www.tenzor.co.uk
11

Supply Chain- Distribution of
Risk and Reward
www.tenzor.co.uk
Component
Manufacturers
Contract
Manufacturers
Component
Distributors
OEM Distributors VARs
Customers!
• Understanding the supply chain is core to determining the future
of the company.
• How is wealth and risk distributed?
• What is outsourced to whom? Who does financing- is the
company a bank? Should it be?
• Is the issue overall health of the chain, distribution of rewards and
risks at particular layer or just company specific issues?
• Who can “shortcut” the chain and what would be consequences?
• Who is going to loose the most if company disappear and what
can they contribute to rescue?
12

Working Capital- Good
Starting Point
 Most of the problems of companies manifest themselves in
working capital (A/R, Inventories, A/P)
 Aged debtor list and its analyses vs. sales
– Are receivables real?
– Is ageing real ?
– Why payments are late – disputes vs. credit?
– Are sales real?
– What happened prior to sale?
 Sale is converting inventory to A/R showing a profit. Did it
– Push the problem next level?
– Chanel overstocking?
– Produce uncollectable A/R
– Is there actual end user demand?
www.tenzor.co.uk
13

Working Capital Analyses –
cont.
 Analysing late payments allows to uncover issues with quality,
logistics, systems, etc. –credit management is the best source of
information about the company issues
 A/P
– Short terms – why terms are not offered?
 May be wrong supplier, no insurance cover, bad history?
– Long terms –are these sustainable?
– Overdues- would these be tolerated?
– Key question – are suppliers still supplying or they already
or about to stop?
– May be significant cash outflow post acquisition.
www.tenzor.co.uk
14

Working Capital Analyses-
cont
 Inventory
– Clear distinction between finished goods, components and work in
progress
– Obsolescence
– Components for wrong models? They may be perfectly good but perfectly
useless
– Is there a process for managing inventories?
 Overreliance on ratios- these are just averages
– “Good” DSO may be a mixture of prepayments and massive overdue
– “Good” DIO may be a large pile of useless stuff and a massive shortage
of needed inventories
– “Good” DPO may be a mixture of pre-paid suppliers and the ones who
already stop supply and looking for legal action
www.tenzor.co.uk
15

CAPEX/ Development Costs
 EBITDA focus creates a strong incentive to under invest
 Company can run on close to zero CAPEX and even
maintenance for a while – but this would mean massive cost in
the future
 Cutting R&D improves short term profitability but negatively
affects future cash flows.
 Cutting people improves profitability but in many business this
is the main asset.
 Particularly relevant for industry buyers- often overestimating
own ability to develop/support
www.tenzor.co.uk
16

Processes
 Assets are not enough –there should be a process for business to
run
 If one thinks of outsourcing (either manufacturing or service)
one needs to have a n efficient process in the first place
 Efficient and well documented process can be “portable”- i.e.
Moved to different location etc. If the “process” is based on a
“fire fighting” skills it is not only inefficient, but not “portable”
 One needs to understand what they are buying – “whole
business” or its part (for example sales team or R&D capability)
 If part of the business is not needed, what would it cost to
liquidate and would this adversely affect the “desired” part.
www.tenzor.co.uk
17

Working Capital Management
 Loosing supplier credit is the major risk-do not provoke by late
payment (but try to negotiate longer terms) and keep good
communication. No supplier’s support-no deal.
 Receivables are major asset- they need to be managed properly
and financed were appropriate. Both quality and financibility of
receivable book may be key in pre-deal due-diligence.
 Manage inventories-but understand that many optimisation
models assume risk free counterparties.
 Analyse the product mix not only from profitability standpoint,
but also working capital effect –and go out of products you can
not afford
 If the company is not right place for financing and risk, find one
in the supply chain who can take it
www.tenzor.co.uk
18

Redesigning the Model -
Distribution example
Supplier Distributor
purchase
Sell
Payment
Provides:
Marketing/Sales
Logistics
Service
Working Capital
Finance?
Risk mitigation???
Risks:
Distributor credit risk
This risk may be highly
concentrated
Customer credit risk (if
distributor has little capital)
Product liability (any case)
Credit Insurance?
Factoring?
Securitisation?
What credit limit?
Diversified risk?
Low concentrations?
Single vs. multi tier?
How do you finance
receivables in EM?
www.tenzor.co.uk
19

Distribution example
Supplier
Distributor-
now agent?
Sell
Provides:
Marketing/Sales
Logistics
Service
Collections?
Performance risk
mitigation?
Credit Insurance-
easier to obtain?
Invoice discounting?
Factoring?
We are in Europe!
Diversified risk?
Low concentrations?
Single vs. multi tier?
No need to finance in
EM?
Low working
capital needs!
www.tenzor.co.uk
20

Why Do You Need Working
Capital-Business Model?
 Working Capital needs are related to structure, not
necessarily value added
 Supplier’s upmost concern now is risk
 Learn the core lesson from banking crisis- the fact that you
transferred risk on paper DOES NOT mean you transferred
it if counterparty is or becomes week
 Variety of legal structures to mitigate risk, while reduce
working capital needs
 Similar models can be applied to contract manufacturing,
printing, material processing, etc.
www.tenzor.co.uk
21

Example-Printing
www.tenzor.co.uk
22
Component
Supplier Assembler OEM
• What business the assembler is in?
•What worries the component supplier?
•What worries the OEM?
•What worries banks/factoring company/credit insurer?
•Would acquisition resolve any of these?
• Is there alternative model?
•Whom do you need to speak about what?
•When would the “original” structure work best?

Rise of ABL
 Cash flow lending was the main trend in the past. Today,
EBITDA is much more volatile- not only reducing
multiples, but also making cash flow lending unavailable
in many areas.
 Lending against assets becoming more used, especially
where the value can be clearly determined.
 Illiquid and long term assets are difficult to lend against-
shorter term is easier.
 “New Financial Engineering”- how to reduce the risk in
transactions
 Unlike cash flow lending, ABL often needs understanding
of operations © Tenzor Ltd 2009-2012
www.tenzor.co.uk
23

Credit Insurance and Receivables Financing
 In Europe, credit insurance is extremely important (domestic and export)
 The supplier may not be the one making decisions
 If cover is withdrawn, company can try to negotiate with insurer (to restore cover)
and/or supplier (to continue sell uninsured) IF debt is current
 If the payments are overdue, supplier may not supply or risk the claim not being
paid...
 Receivable financing is underutilised by suppliers-they paid for taking off the risk
but did not use the financing available!
Trade Receivables % Insured % Financed
Europe 35 5
UK 30 6
US 5 4
www.tenzor.co.uk
24

Supply Chain and Turnaround
Financing
 The supplier (even a highly distressed) is a lender,
providing next step in the chain (distributor, manufacturer,
end user etc.) with credit through payment terms
(sometimes they are the only or main source of credit).
 Buyer of the goods can effectively provide money to the
seller through reduced payment terms without taking risk
(providing supplier fulfilled the contract).
 This may provide a workable alternative to DIP (Debtor in
Possession) financing, allowing in some cases to provide
funds to distressed company without being affected by
possible bankruptcy procedures
www.tenzor.co.uk
25

Practical Implications for Companies
in Emerging Markets
 Setting up oversees distribution entities is currently
seen mainly from tax planning perspective
 Setting an oversees distribution/operation entity
(with transparent operations and reasonable
capitalisation) may create significant financing
opportunity as:
– The company will have access to efficient receivable
financing
– The company will effectively lend to the EM one
through short payment terms without joining queue of
creditors © Tenzor Ltd 2009-2012
www.tenzor.co.uk
26

Examples of possible deal
structures
 EM Company (high margin/low liquidity) buying
a low margin/high volume distributor
– Lower price-higher margin at distributor level
– Distributor has access to WC finance-some times even
for sales back to EM
– Short payment terms- resolving liquidity issue
 Buying distressed EM exporting Company
– Very difficult to refinance locally
– Invest at distributor level-refinance through payment
terms
www.tenzor.co.uk
27

Why Vertical Integration?
 Recent years show a global trend to “platformisation”
 This was driven by lower transaction costs, supply chain coordination
and general low risk environment
 This is changing now, as risk is again high on the agenda, and
transaction costs are up
 Deals start coming small and very large
 Cost of acquiring supply chain partner may be lower than switching cost
 Resolving of concentration problem- getting away from excessive
dependencies.
 A lot of supply chain optimisation techniques designed for a “risk free”
world
 In a risky world it is cheaper to have a solution within a firm- the very
reason firms exist (Richard Coase, Nobel price in economics 1991)
www.tenzor.co.uk
28

Supply Chain-its importance to
creditors and turnaround investors
 Company’s working capital needs depends from business model-
and this can be changed (meaning less money needed to support
the turnaround)
 Instead of distressed financing of troubled company, one can often
finance healthy one (such as its distributor) with the same net effect
but different cost and risk
 One needs to be aware of cross border differences- for example
there are more solutions for financing sales to Emerging Markets
from the West than for domestic financing within Emerging
Markets.
 Sick companies in healthy chains have much higher chances of
survival than in sick chains.
www.tenzor.co.uk
29

Vertical Integration- Working
Capital Implications
 Buying a week player up the chain- moving from concentrated
non- financeable receivables book to diversified
 Merged company can finance receivables- target on its own find it
difficult because of operational risks.
 Inventories – can be managed down on elimination of bullwhip
effect and reduction of safety stock to cover supply risks
 Payables. If target facing withdraw of lines from suppliers or credit
insurance, restoring of these can provide immediate working
capital boost.
 Conclusion: Working Capital may change tremendously in a
successful acquisition, providing cash boost instead to cash drain to
acquirer
www.tenzor.co.uk
30

Thank You and Good Luck!
 Igor Zax, CFA, Sloan Fellow (London
Business School)
 Managing Director, Tenzor Ltd. (London)
 Tel: +447775708426
 E-Mail: igor.zax@tenzor.co.uk
 Web site: www.tenzor.co.uk
www.tenzor.co.uk
31

Operational Turnaround –Focus on Working Capital and Supply Chain-lecture by Igor Zax at LBS

Recommended

Recommended

More Related Content

Viewers also liked

Viewers also liked (12)

Similar to Operational Turnaround –Focus on Working Capital and Supply Chain-lecture by Igor Zax at LBS

Similar to Operational Turnaround –Focus on Working Capital and Supply Chain-lecture by Igor Zax at LBS (20)

More from Igor Zax (Zaks)

More from Igor Zax (Zaks) (16)

Recently uploaded

Recently uploaded (20)

Operational Turnaround –Focus on Working Capital and Supply Chain-lecture by Igor Zax at LBS