In just 18 months the words ‘credit crunch’ and ‘sub-prime loans’ have moved from being strange new additions to our vocabulary to the causes of the unprecedented financial crisis we have all watched unfolding on the news.
The stock market, private equity investors, credit insurers and, above all, banks have downed tools and turned inwards and away from their customers while their own houses are put in order.
Where does this leave engineering and technology companies that need capital, or the reassurances and support of credit insurers? How are new projects or developments to be funded or opportunities to be exploited? How are day-to-day events like funding of working capital to be dealt with? How has the world changed and how are financiers now looking at investment propositions?
Where bank finance used to be readily available at a rate of anything up to five times or even six times cash flow, this no longer applies (the parallel with the residential housing market is clear). Instead, bank finance may not be available or available at above a rate of twice cash flow. This change has been quite a recent development.
Private equity investors no longer routinely assume that opportunities to acquire businesses will be forthcoming or that banks will be willing to contribute to the finance package on such terms.
For the more attractive investment opportunities and the stronger and bolder private equity houses, the reaction is to provide 100 per cent of the finance package required for the deal to happen, instead of the 20 per cent that would have been possible 12 or 18 months ago. The private equity investor will aim to borrow the money that will allow it to make the returns it desires as and when ‘normal service’ is resumed by bankers, perhaps in another six to nine months.
Overall, there have been diminished levels of mergers and acquisitions activity for engineering companies. Larger-scale deals of £40m and above are a fraction of the value a year ago, and the same trend is clear for smaller deals and for the volumes of deals, especially in the most recent quarter.
But there are different shades of reaction for different sectors and sizes. Larger deals are more difficult and it is the smaller ones that are getting more oxygen; retail is an unloved sector but investment opportunities that offer a lender some security — asset-backed lending proposals — are more attractive. That means a company that manufactures or deals in physical goods and has inventories and trade receivables can make a much more attractive proposition than a retailer, whose stock is financed by its suppliers.
So what are the options for engineering companies? Statistics show that early-stage and expansion investments are the least affected of the private equity sectors of investment, so it is good to be small — or to be looking for small amounts of investment funding. But if private equity is still hard to come by — and for larger buy-outs this will continue to be the case for some time to come — alternative investors may be sought that will fill the gap.
Investors that are not conventional private equity firms, for example cash-rich industrial companies or high net worth private investors, have been tempted by the returns being made by private equity to invest on similar terms, and the opportunity for businesses needing investment funds will be there to be tapped.
But perhaps the biggest opportunity for a good-quality and cash-rich company is to make that leap and become an investor. Now is the time to find good-value opportunities.
Will the availability of finance return, as the government hopes, and will those good- value opportunities soon be gone? Or will we all be in for a longer and more difficult haul?
It is hard to say. The nature of the downturn is really quite unusual. I don’t think the government expected it to happen like this, nor does it know how to anticipate the next development — and the stock market certainly does not.
That said, on ‘normal’ terms the expectation would be for the storm to abate and for a return to GDP growth in the UK by next autumn.
But when will there be the semblance of normality in the markets again? That depends on the large-scale lenders getting back to business which, in turn, requires them to have access to market funding — perhaps in three, six or nine months.
It is difficult to say but the runes may be read in the gap that shows between Libor (the rate at which banks lend to each other) and the Bank of England base rate. When that closes and looks stable once more, we may see a return to something approaching business as usual.
Simon Keeling is joint chairman of corporate finance specialist Corbett Keeling