As credit conditions for industry begin to improve, companies and financial institutions still need to perform an intricate dance to access the capital that businesses need to grow. TM finds that pricing precision, transparency and diversity of finance mechanisms are the themes for accessing capital in a new, more austere era where private sector growth is so important.
With less cash in the economy and tighter criteria applied to both lending and equity finance, how will companies fund themselves in the post-recession economy? Post-credit crunch, the constant theme has been higher costs of capital. But EEF’s November Credit Survey says that in the past quarter, the proportion of companies reporting an increase in interest rates and fees on both new and existing credit facilities has continued on a downward trend. The percentage of companies seeing costs fall remains static, however.
Necessity is the mother of invention and the recession has not only caused companies to exercise tighter financial management than before 2008, but has spawned some novel sources of finance. In 2009 the Labour government launched the Enterprise Finance Guarantee scheme. This is aimed at small and medium sized firms (SMEs) with no credit history or collateral, where the government is the guarantor for loans of between £10,000 and £1m taken from three months to 10 years. Initially take-up was subdued but it has since proved popular, where a total of £1.1bn has been tapped. Royal Bank of Scotland and NatWest alone have drawn loans worth more than £450m from the fund and in October the EFG was extended by a further four years with another £2bn.
Banks have been active in trying to lend money to manufacturers. RBS launched a £1bn special fund for manufacturers in July 2009. Again initial take-up was slow, reflecting companies’ natural aversion to borrowing of any kind after the crunch – RBS cannot disclose lending details, but the fund has helped several companies, while falling short of being fully tapped. In late July, International Innovative Technologies in Newcastle was the first UK company to receive funding from a corporate sukuk, a bond that complies with Sharia law arranged by private equity company Millenium Partners. And companies including King of Shaves and Ecotricity have raised money through privately placed bonds, with a fixed rate and term, issued to customers and ‘supporters’.
At a roundtable debate hosted by international business advisors BDO LLP in October, finance directors and financial advisors examined options for corporate finance open to UK companies in 2011.
Adversity and opportunity
BDO and their guests discussed several serious challenges to business at this important stage of the recovery, which sits between a potential golden age of opportunity – the low carbon economy, a weak pound, a strong manufacturing base in sectors like aerospace, defence and pharmaceuticals, innovative start-ups – and a possible double-dip recession.
Central to the health of the economy and the liquidity available for corporate finance are the pending public sector cuts. John Nicholas, a director of actuator and gearbox manufacturer Rotork, felt that the magnitude of the public sector squeeze will be very big, predicting civil unrest and potentially strikes in the winter. This was prescient, given that it pre-dated the November student demonstrations in London. BDO’s Jamie Austin, a corporate finance specialist, highlighted that the UK faces the near term challenge of managing foreign competition, the higher cost of all forms of capital and the lack of time for the private sector to soak up 490,000 redundant public sector workers over the next five years.
“We have a country that is relying on Dragon’s Den-type entrepreneurs coming out of the regions where the cuts will be greatest, a banking environment that is still pretty tough really, and an equity capital market where the bar has been raised. It’s a tough equation to reconcile,” he said.
The problem is regionally disproportionate, where some regions more reliant on the public sector, such as the North East, will struggle more than others to plug the gap. “The Government has talked a little about cuts, a little about growth but not really about its own role in driving and supporting growth,” said Lee Hopley, EEF’s chief economist. “The Growth Review will give a clearer picture on how the private sector will be able to fill the public sector gap.” [The Growth Review is now published. One key message is that companies are being asked to contribute to the Review by holding government departments to account – see TM.com for more information].
David Blackwood, finance director of chemicals group Yule Catto & Co, said that bank lending has been available right through the downturn; it is just a question of the price you are willing to pay, and the banking sector has moved the bar on credit quality and conditions. “Capital is a commodity – so it’s cyclical like any other commodity business. At ICI I briefly sat on five and seven-year loans priced at 13bps over Libor. Recently it would have been three year loans at 200 bps over Libor. It is a cycle, and as more competition returns, this cycle will reverse, like any commodity business.” While banks were willing to lend in 2009 and 2010, and indeed they did, with LloydsTSB having provided £35bn of corporate to November 2010, many large companies preferred to avoid borrowing at any cost, finding the cost unappealing or unaffordable.
Meanwhile small companies often found the bank loan terms incompatible with their needs. Ian Gold of the British Turned Parts Manufacturers Association told TM in July that in his members’ experience, banks were often not willing to lend for ordinary working capital purposes, only for a business plan that demonstrated growth. Many small engineering firms just needed a loan to ‘get going again’. This has perpetuated a negative view of banks in 2009/10 across much of the engineering sector.
Options for big companies
Given this distrust, Ian Plunkett, audit partner in Manufacturing and Industrial Markets at BDO, said: “We have to make sure the political, not just the economic, environment is right to get banks lending in the market again, as left to their own devices banks are currently in the business of risk averse lending and re-building balance sheets to improve capital ratios.” David Blackwood added that the last 18 months has exposed the difficulty banks have in finessing their societal function to both fund and facilitate capitalism and the economy, while also being capitalist entities whose chief purpose, as they see it, is to make profit.
“We may find that more companies will maintain more cash balances alongside other forms of term funding, rather than rely heavily on undrawn bank facilities for liquidity cover. If this was to become a trend then banks will ultimately have more lending capacity – which may stimulate more competitive pricing.” A private sector that funds itself more, internally, without a reduced need for banks or government may sound like a post-credit crunch utopia to some CEOs.
But Ewan Lloyd-Baker, CEO of Specialist Energy Group plc, says that it’s counter-productive to avoid working with banks and the state. “The cost of capital and access to capital is still a big issue for UK companies competing in a global market place. While for a company like our subsidiary, Hayward Tyler, we are able to compete globally based on the strength of our IP and the quality and reliability of our products the export opportunities could be enhanced given a more supportive funding environment, particularly given the significant state involvement in some of our domestic banks.
“Those businesses operating in countries which receive direct state backed finance or export led support will often have a lower cost of capital and/or greater access to capital thus giving them a competitive edge in winning and funding new business. If the government is serious about its stated intention to support export led manufacturing it must make that support tangible to enable a more level playing field.”
Equity capital markets
Companies need to access finance for growth.
Mergers and acquisitions for mid-caps and larger companies dried up in 2010.
If M&A activity is a barometer of recovery, Roger Lambert, chairman of corporate broking at financial advisory firm Collins Stewart, says it’s hard to tell where the recovery is, with newspapers reporting conflicting stories on the state of M&A transactions (in October the Daily Telegraph reported that there was £1.7bn of UK M&A deals in the pipeline, against the FT reporting a fall in M&A activity as a result of a lack of business confidence).
Rights issues have been thin on the ground this year but funds are available if the issuer, the buyer and broker can agree terms. Like David Blackwood, Lambert says that money is there, but with a paradigm shift in pricing and participants’ expectations compared with pre-2008. “In 2009, investment banks were very clever at building confidence against a shaky backdrop. If someone had mispriced a rights issue and the thing had failed, you’d have been back to square one – like snakes and ladders.” “Rights issues are priced differently now. A 30% to 40% discount to the theoretical ex-rights price (TERP) is now the standard – at that price everybody tends to say ‘of course we’ll come in’. When I started work, one-for-fours were often done at a 13% discount on the TERP. Try to get someone to underwrite that now and the OFT would say ‘how much’? But that’s what you’d probably pay.” Raising capital through an initial public offering (IPO) is also available but again companies need to be prepared to price sensitively. Collins Stewart was involved in the IPO of AZ Materials, whose products go into the manufacture of integrated circuit boards and flat screen displays. “It’s got a fantastic record, about 30% margins, huge growth and its management was very effective in the downturn,” he says. “The [investor] book was 50% full on day one. Why? It is a great business and the bookrunners advised the owners not to be too greedy on price. Compare that to New Look [retail] last year coming to the market at a premium to Next – totally unrealistic. For a successful IPO today you leave a little on the table.”
Money is there, then, but the bar has been raised to access it. And as jurisdictions like Singapore subsidise foreign businesses for setting up, what hope does UK plc have with a cash-strapped government more interested in a Happy Index than the Purchasing Managers Index? Don’t despair, says John Fulford, president of Dytecna, an engineering and through-life support company serving defence and commercial clients. “Go anywhere in the world in my sector and people want products manufactured in the UK. We [the UK] are the centre of excellence, and I’m amazed to hear so much talk about manufacturing in China. At any global aerospace conference, people want to do business with Britain because of our manufacturing capability, innovation, processes and lean manufacturing techniques – other countries are crying out for this expertise.” Peter George of Clinigen Group, suppliers of unlicensed and specialist medicines, agrees: “The British often win international prizes for chemistry – Brits and British institutions are leading the way here. For new carbon technologies, like the use carbon for power transmission, as well as pharmaceuticals, the global IP is here.
In my business I see that a UK plc commands a high degree of kudos and trust and is a good company to partner with, particularly in Asia and in Commonwealth countries. This is important and an area we should exploit going forward.” Funding for growth If access to finance was the key theme for manufacturing in 2009/2010, 2011 is all about growth. Manufacturing’s recovery through 2010 was impressive – according to EEF, while the UK economy has grown by about 1.2% since the January 2009 recession nadir, manufacturing output grew by 4%. And several manufacturing sub-sectors are in robust shape. A report by EEF and RBS, The shape of British Industry, says that the key to ensuring future growth in UK industry appears to be the size of companies (see page 16). Large manufacturers – those with >250 employees – drive collaboration in the sector, make investments benefiting entire industries and have the scale to invest in new opportunities. They can more easily sustain supply chains, while attracting new investment, and influence policymakers.
With evidence that credit conditions are improving (EEF) as banks and financial institutions keen to secure business have at least stopped increasing fees, the range of types of finance widening to include small bond schemes and even sukuks, and a government that is talking up the importance of growth, the climate seems to be getting better for manufacturers looking for finance.
With thanks to Ian Plunkett and Jamie Austin at BDO, Lee Hopley at EEF and all the participants, and apologies to those whose comments were not used.