As everyone knows, China’s rapid economic growth has caught the world’s attention.
In this high-growth environment, many businesses have achieved tremendous success, allowing inherent problems to go unnoticed. However, problems are beginning to surface as the nation starts to come to terms with situations that are a legacy of the easy credit that was made available by the government to counter the global financial crisis in 2009-2010.
Many believe that the economy as a whole is poised to enter a phase of adjustment. In such circumstances, many companies could benefit from restructuring to help them weather the storm.
Surviving the adjustment period
In recent months, the central government has implemented credit tightening measures to battle rising inflation. As the economy starts to deal with issues including high corporate debt levels, restructuring could provide a valuable tool to help businesses manoeuvre through the adjustment period.
As new money is no longer easy to obtain, many companies are starting to experience difficulties in managing their working capital. This is especially evident in, but is by no means limited to, industries which directly or indirectly serve or supply the real estate development market.
When it comes to the optimization of working capital, most Chinese businesses have a long way to go before matching international best practice. Companies that invest in improving management and working capital efficiency will gain an advantage in China’s slowing growth cycle, not least because they will be the ones most attractive to whatever providers of capital may be available.
Another area that Chinese companies need to address in the adjustment period is capital efficiency. Many Chinese businesses tend to use short-term debt to finance their operations, and rely on annual and even periodical renewal. This tendency became even more pronounced immediately after the global financial crisis, when companies took advantage of easy credit that the banks were extending at the government’s behest. Now that interest rates are on the steady rise, many companies would be better served by exploring refinancing options from alternative funding sources.
However, most companies do not have the experience or the network to tap into these alternative sources, and could benefit from approaching restructuring professionals who have wide exposure to alternative funding sources and refinancing solutions, such as distressed funds, private equity firms or other non-banking institutions.
Many smaller companies have felt the squeeze of the credit crunch and some have been pushed to distress or even bankruptcy. While failed businesses present a gloomy picture, they also represent an opportunity for stronger companies to acquire ready-made capacity by buying these failed businesses, either in or out of bankruptcy.
Distressed sales on the rise
The acquisition of businesses in distress is a relatively new concept in the PRC. However, as with many new concepts, the Chinese market is quick to learn, and some businesses are starting to adopt a strategy that includes distressed acquisitions.
Recently, we have witnessed companies showing interest in buying businesses out of bankruptcy. In such circumstances, a buyer may have the opportunity to choose which liabilities to assume and which to reject, and thus achieve better value for their money.
A recent case can serve as one example of this trend. A European company with a Chinese electroplating operation went out of business. As part of the global wind-down process, it was necessary to dispose of the Chinese electroplating operation. During the parent company’s financial difficulties, the Chinese operation had gone through a period of poor management and had lost a significant proportion of its workforce, who left in light of the obvious difficulties being experienced by the business.
At first glance, the situation was dire and the business was destined for a liquidation of assets.
However, liquidating assets piecemeal would not have generated the most value for the creditors and investors. Not only would the liquidation value of the assets have been low, but there might have been tax liabilities on the few assets, such as the land, that could possibly have generated reasonable proceeds.
As there appeared to be a few positive elements to the situation, KPMG explored the possibility of a distressed sale of the business as a going concern.
First, the company was located in a town in which competitors had set up electroplating operations and could be interested in expanding.
Second, the company’s production lines were relatively new and were well maintained despite the financial difficulties.
Third, most of the current and former employees were from the local area and had strong ties to the original owner, who considered it possible to rally some of them and rehire a lean team to resume partial operations.
Compared with a normal merger or acquisition process, a distressed sale is much less predictable.
While a distressed situation tends to turn off most ordinary buyers, the right strategic buyer or an experienced financial buyer of distressed assets may be able to act quickly to seize the opportunity for a bargain. Such buyers are likely to be experienced in restructuring the company’s balance sheet and may have access to a wide network of industry players and funding sources.
Due to the relatively tight time frame requested by the creditors in this case, executing the sale quickly was paramount. Marketing efforts were directed to the local competitors and their parent companies, and quickly generated interest. The terms of a sale were agreed within a few weeks.
Restructuring in China is evolving. In the past, restructuring strategies have been limited by a still-developing legal system, unhelpful government intervention and a conservative banking culture, as well as a lack of experience of distressed investment and excess liquidity in the market.
As the country continues to develop, these hindrances to corporate restructuring appear likely to diminish further.
Kan Limin is the head of restructuring, northern region, at KPMG China