eNews November 12, 2015

Industries to Watch: Beware of Acquisitions and Mergers

The announcement of an upcoming auction of one company and the widening expectations of a Chapter 11 filing for another from the energy sector underscore the importance of creditors continually scrutinizing companies engaged in an acquisition or merger, even if dealing with the stronger of the parties involved.

The Monday earnings report from Arch Coal Inc. shows losses of about $2 billion. This only added to the growing chorus of analysts predicting that a bankruptcy filing is imminent since the Oct. 27 downgrade of Arch’s senior secured revolving credit facility and secured term loan by Fitch Ratings. Fitch also noted that a “substantial portion of domestic coal production is in restructuring.” Meanwhile, the bankruptcy court handling the case of industry contemporary Walter Energy, which filed for Chapter 11 protection in July, has set a January auction for the heavily indebted company. Although the coal industry’s escalating struggles (muted market demand, increased regulation, etc.) have been well publicized, the companies both share another important similarity: They each acquired a struggling competitor in 2011 (Arch bought International Coal Group; Walter took on Western Coal Corp.). Neither was able to turn those assets into profitability; each essentially took on a long-term financial albatross that continues to haunt financial stability.

The issue is not coal- or energy-specific either—it can apply to any industry, but notably ones that are facing long-term headwinds. “Many times, companies buy other, distressed companies and may overleverage themselves in the process,” said Bruce Nathan, Esq., partner at Lowenstein Sandler LLP. “If they took on a lot of debt in the process, particularly secured debt, their financial performance can be impacted. Combine that with the depth of the problems of the business they’re buying and, likely, the adversity facing the industry they’re in, and that is a recipe for a future bankruptcy.”

Although rarely discussed in credit circles, the potential solvency problems created by the acquisition or merger for the buying and/or stronger party are not a new issue. It was at the heart of a creditor lawsuit brought against directors involved in the late 2007 buyout of Lyondell Chemical Co. by Basell AF and the Lyondell bankruptcy filing that followed just more than a year later. Creditors argued that directors who approved the merger should not have done so and, in the process, increased the risk to existing creditors, all without seeking their approval or input, according to the Harvard Law School Forum on Corporate Governance and Financial Regulation. The case still has not been fully resolved, according to Nathan. Notably, the merged LyondellBasell Industries N.V. does continue to operate.

Creditors should take note of these developments and certainly resist any urge to give a company the benefit of the doubt just because it looked healthy enough to force a merger or acquisition. Investigate how much leveraged debt was taken on, how much of a company’s own equity was used to facilitate the move and what ongoing trends may be increasing risk. “Don’t assume everything is automatically going to be hunky-dory post-acquisition” said Nathan. “You have to look under the hood.”


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Getting the Most Out of Marginal Accounts Requires Diligence

As many credit professionals know, not every account pays on time. That doesn’t mean, however, that there’s not a legitimate place for late payers in a business’s portfolio.

These types of accounts, known as marginal accounts, help fill gaps in “revenue shortfalls when a company or particular industry is seeing a drop in sales,” said Toni Drake, CCE, president of TRM Financial Services and the new instructor of the Principles of Business Credit class at NACM-National headquarters and NACM’s upcoming 120th Credit Congress & Expo in Las Vegas. “For instance, in the oil and gas service sector, companies are scrambling for sales, so the marginal customer becomes a way to achieve acceptable revenue levels.”

Drake considers marginal accounts as those companies that do pay, but usually past set terms. “This is the customer that the credit professional very often refers to as ‘high maintenance.’ Much time and effort is spent in managing the account, as well as interacting with the customer,” she said. “The marginal customer is most certainly a higher risk customer; but if handled correctly, it can become one of your most loyal customers.”

Businesses can charge such customers prices “that align with their pay habits and risk, so utilized correctly, they can help maintain profit levels,” Drake noted. “Usually companies with inherently higher profit margins, such as services companies, would find marginal accounts more attractive.” However, companies with very low profit margins must be careful with a marginal customer, she cautioned.

Drake suggests being extra diligent with credit investigations and credit reviews. “The credit professional has to be on the front lines making sure that the marginal customer does not become a distressed customer with a danger of bad debt losses.” Departments within a company must work together to make sure that they stay on top of a marginal customer, she added. “And certainly, make sure that the profit margins made on the marginal customer warrant the time spent and risk of selling the customer.”

She suggests using the following best practices when working with marginal accounts:

  • Be sure to review the creditworthiness of the marginal customer often, both nonfinancial reviews and financial reviews.
  • Stay in close contact with the customer, making sure that the customer stays within the parameters set for it.
  • And of course, always look at the customer from the perspective of the Five Cs of Credit (Character, Capacity, Capital, Collateral and Conditions), making sure that they continue to perform adequately in all areas.

- Diana Mota, NACM associate editor



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Adhering to Policies, Procedures Improves Collections

Closing gaps in recordkeeping and consistency in credit and collection procedures help eliminate some of the biggest obstacles to collection, according to a new survey by the International Association of Commercial Collectors (IACC), “What I Wish My Clients Knew, What I Wish They Told Me.” Commercial collection professionals belonging to IACC took the survey in October to identify actions they should or should not take to ease both in-house and third-party collections.

Nearly 37% of respondents chose missing records as the greatest barrier to successful debt collection. Missing information unnecessarily raises questions about whether the balance placed for collection is wrong and allows debtors to prolong the collection cycle, one survey taker said. About a third, however, identified the hiring of multiple collectors to pursue the same debt as the biggest roadblock. The double-teaming usually is not intentional and is often tied to gaps in recordkeeping, IACC noted.

Slightly more than half of the respondents (51%) said creating and adhering to a credit and collections procedure were the most important steps clients could take to clean up receivables. The survey also ranked “use your agency at the appropriate age of delinquency” as the most important piece of advice collections professionals would give. Most companies’ invoices allow a 30-day payment term, IACC said. “Typically, companies make no collection contact until between 31 and 40 days, and do not issue a final demand until between 90 and 120 days have passed. Policies often say at that point, the company will turn an account over to a third-party collector, but they often don’t.” One collections manager suggests sending accounts to collection at 60 days, if they’re not paid.

On Nov. 18, Robert Bernstein, Esq., and Kirk Burkley, Esq., of Bernstein-Burkley PC, will speak on this topic during NACM’s webinar “How Smart Credit Policies Improve Collection and Litigation Results.” The veteran attorneys will discuss the following:

  • The problems with current understandings of credit policy
  • The factors that impact collections
  • The key components of responsible, effective credit
  • Tactics for preparation, assessing, implementing and defending your credit
  • Where to start

- Diana Mota, NACM associate editor


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Catalan Resolution Unlikely to Impact Business in Spain

Credit managers doing business in Spain may have been surprised by the Catalonia parliament’s vote on Monday to adopt a resolution supporting its independence from the country. However, some credit managers based in Spain characterize the recent move mostly as a lot of noise that will likely fade in the coming months.

“Credit managers are facing a moment of uncertainty, but are confident that the water will return to its basin soon,” said Luis Carmona, international manager for Informa in Madrid. “There [are] some cautions to investing in [Catalonia] and some projects are on hold; nevertheless, it will be temporary.”

For some time, the northeastern region of Catalonia has threatened secession from Spain. Through this recent declaration, the pro-independence party hopes it can break away within 18 months. However, Spain’s prime minister has said the Spanish government will appeal the motion.

“The whole process is unconstitutional, consequently illegal, and it is only backed up by 48% of the voting citizens,” explained Carmona, who added that the party system does allow Catalonia to have a majority in the regional parliament with 48% of the votes. “However, the last elections were only regional regular elections, never a legal referendum with the connivance of the whole country and the central government.”

The Catalonia parliament, Carmona said, has taken advantage of an inactive central government. He believes, however, that the controversy will end soon through Spain’s constitutional court. “Most companies are seeing a future after the elections [on Dec. 20], in which [the] new central government will change a few things. The new intentional vote surveys give the independent Catalans less votes than in September. A clear constitution reform might be needed.”

In terms of credit, the Catalonia parliament has given serious thought to restructuring its finances. It currently holds around 26% of Spain’s total deficit, and the debt is supported mainly by the national government and national banks, Carmona noted. He believes if a split ever comes to fruition, which remains a long shot, Catalonia “will be in serious trouble” if it tries to refinance its debt.



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Overall Business Activity Outlook Low, Yet Current Data Show Growth

Optimism regarding future activity and corporate profits in the global service sector fell to a six-year low, according to the Markit Global Business Outlook Survey. Meanwhile, business confidence in the four BRIC (Brazil, Russia, India and China) economies also dropped in the manufacturing and service sectors.

“Worldwide business confidence is at the lowest ebb since the global financial crisis, dragged down by optimism slipping further to six-year lows in both China and India,” said Chris Williamson, chief economist at the international research firm. “The mood among U.S. firms also remains one of the lowest seen over the past six years, and gloomier readings were seen in both the U.K. and eurozone.”

Business bullishness in the United States did increase modestly in the survey, which measures the expectations of 6,400 companies for the year ahead. However, hiring intentions fell to one of its weakest levels since 2009. Despite an increase in U.S. firms reporting a more aggressive upswing in prices, the outlook for profits also dropped.

In the eurozone, Italy was one of the only major countries to show a positive outlook on business in the short term, while Germany and Spain reached new lows. In Japan, future business activity optimism increased, but it remained relatively aligned with the average seen over the past few years. “The failure of business confidence to show material improvements in the eurozone and Japan will meanwhile disappoint policy makers, given the amount of central bank stimulus already in place, and ups the chance of further policy action,” Williamson added.

Current data from Markit’s Purchasing Mangers’ Index, however, shows strong growth in October in the global service sector. The health care and financial sectors were its main drivers, while growth also registered in consumer goods and services, tourism and recreation, and food and beverages. The metals and mining industry, however, continued on a nine-month decline, recording falling output in October. “This contrasted with an overall rise in basic materials production, which reflected growth in the forestry and paper products, and chemicals sectors,” the report states.


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