Just a little over a month ago, in our Being Proactive: What’s Your Plan B report, we laid out a scenario that, at the time, was hypothetical. A macroeconomic downturn unexpectedly changes a company’s financial condition. Liquidity concerns emerge and refinancing debt becomes more challenging; a company finds itself in a “special situation” in which it cannot service its debt.
What was hypothetical then is reality today as companies across multiple industries bear the brunt of the COVID-19 crisis. Many companies that previously were financially healthy are facing challenges – for some, escalating distress raises questions about whether they can continue operating as a going concern.
In this context, now is time for swift and decisive assessment and action. Companies must “take their temperature” and diagnose their financial health in the wake of the COVID-19 outbreak. Even the $2 trillion federal stimulus is not a panacea. For some companies, this “cure” could make their fiscal ills even worse.
During a crisis, there is no fault or judgment. One competitor is not favored over another. Weathering the storm and emerging weaker, without addressing the underlying economics, will only postpone the inevitable.
At Cowen, we have deep expertise in all aspects of special situations and restructuring – combined with industry expertise. We have guided clients through crises before, most notably 2007-2008, with an array of solutions that will likely be much the same as those deployed today. Equally important, we work across the entire firm to bring the full weight of Cowen’s investment banking, research, sales and trading insights to every situation. For our clients, this approach means greater options and opportunities. As advisors, we are eager to work closely with companies that acknowledge the severity of their situation and genuinely desire to face their problems head on.
Triaging Balance Sheets and Portfolios
The scope and magnitude of the COVID-19 crisis makes it urgent for companies to assess their liquidity and debt service and establish a new base case to reflect the current economic climate, as well as several downside scenarios.
Companies fall into three general categories:
- Challenged, But Not Distressed. A company faces a liquidity concern or loan covenant breach, but not potential insolvency. The primary objective for companies in this category is allying fears and developing strategies for negotiating with lenders for an extension, covenant relief, or even incremental, short-term capital. If existing lenders are unwilling to extend further capital or provide waivers, the focus shifts to identifying “rescue financing” to buy much needed time for implementing a more complete set of solutions. However, “one-off” deals with multiple creditors, which fail to address the breadth of the problem, will likely create ill-will. Negotiations must be undertaken with transparency and trust.
- Distressed, Resulting from the Current Crisis. A company’s underlying business is sound but has been directly and seriously impacted by COVID-19. Of primary importance for these companies is understanding that hoping the crisis will end quickly, and that circumstances will return to normal, rarely works. A realistic assessment of alternatives will sharpen the focus on what is required for the company to survive.Now is the time to address the problem.
- Previously Distressed. Companies with challenges prior to the COVID-19 outbreak may have been previously unwillingly to address them. Now is an opportune time to act. Don’t waste a good crisis! During macroeconomic uncertainty, businesses face less stigma and reputational risk when considering bankruptcy or out-of-court restructuring. Virtually all businesses experience challenges in times like these; therefore, it is easier to have conversations around addressing difficult problems and finding solutions.
An increase in the number of bankruptcies is likely. Those that do pursue this course of action should be aware that:
- First movers tend to have an advantage over those that enter the process later. Those who move first will likely establish precedent. This applies to both the bankruptcy court and to what banks and other constituents are willing to do, such as relief from landlords, vendors, and creditors. Once a template for bankruptcy gets carved, subsequent companies could lose options as the involved parties may be more reluctant to grant as much leeway as they did initially. Bankruptcies at least in the short term will likely involve consensual restructuring, with a potential sale of the business later when the market stabilizes. Currently, the pursuit of asset sales may be less common because many of the “best buyers” are, themselves, facing challenges.
- Given the projected increase in the number of bankruptcies, judges will likely lose patience with those who do not have a well laid-out plan. This makes it imperative to work with advisors who have deep experience in bankruptcies to develop a detailed plan.
A Fluid, Fast-Changing Environment
The massive federal stimulus plan presents two issues for businesses. The first is whether they are eligible for relief and in what capacity. The second issue, for those that are eligible, is whether to accept this funding, given the restrictions that would be placed on them. Cowen has published a definitive guide to the CARES Act for small and mid-size companies.
Accepting stimulus money should be weighed carefully, as it will result in less flexibility and more restrictions. It’s crucial to consult with experts to determine whether stimulus funding will be sufficient for solving problems and avoiding further financial restructuring. It may be more advantageous in the long run to pursue other options.
A crisis calls for decisive and courageous actions. Companies that face their problems with candor and transparency will be far more likely to avail themselves to a broad array of solutions to get them through the crisis – and beyond.
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