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Alternative sources of capital can help when traditional funding disappears.
Tim Burke, CFO Europe Magazine
September 3, 2008
Money's too tight to mention. The credit crunch has slowed the flow of funds from banks, the IPO market is moribund and shareholders are shunning all but the most worthy rights issues. What's a cash-strapped CFO to do?
The answer could be to turn to lesser-known funding channels. "Six months before the credit crunch, there was a tremendous amount of liquidity and people were able to raise money in traditional formats," says Martin Cooper, head of the large and major corporates division at Lloyds TSB Commercial Finance, a UK asset-based lender. "Post-credit crunch, that liquidity has gone away, and as a consequence people are looking for alternatives."
As the following examples show, CFOs searching for different ways of raising funds have a range of choices, some more exotic than others.
Asset-Based Lending: Taking Stock
Asset-based lending (ABL) isn't considered alternative by everyone. In the US, secured lending against the value of assets — such as plant or stock or raising money against outstanding invoices with a factoring firm — is a common source of financing. The industry in America is now worth more than $500 billion (€322 billion). In Europe, it is far less mature. Even in the UK, the most active market outside the US, the perception of factoring as a desperate last resort has dogged the industry.
This seems to be changing. Last summer, 16 asset-based lenders in the UK, ranging from arms of big banks to independent players, formed a committee to demonstrate that as a group of lenders, "we were able to support bigger-ticket [M&A] deals," says Paul Hancock, head of ABL at JPMorgan and co-chairman of the UK's Asset-Based Finance Association (ABFA). Given the slowdown in M&A, Hancock now foresees a rise in companies using ABL to refinance instead. In the first quarter of 2008, in fact, the ABFA estimates that British ABL firms lent a record £16 billion (€20 billion), and anecdotal evidence from industry practitioners indicates that ABL use in Germany, the Netherlands and other parts of Europe has been rising.
While it can be pricier for companies to raise cash using their assets instead of conventional borrowing, CFOs may like the idea of tapping a single funding package from one source that leverages against myriad assets. A recent ABL user is Borders UK, a private equity-backed UK bookshop chain spun off from its American parent. In February it set up a £23m funding line with Landsbanki Commercial Finance, secured against its inventory.
As for CFOs of other companies who are thinking about ABL, Cooper reckons, "they'd probably be surprised at how easy it is to put in place and how easy it is to operate an ABL facility." What's more, he says, "once they've actually got the facility in place — so long as they look after the assets — they're freed up to get on and manage their business."
144A: Thanks but No Thanks, SOX
Asset-based lending has been around for years, even if many CFOs have never had reason to consider it. Other funding channels have been more widely used, but are only now really coming to the fore. Take the 144A market, which offers companies a relatively painless way to tap certain American investors. The SEC introduced it through rule 144A in the early 1990s to allow qualified institutional buyers (QIBs) to invest in debt and equity from companies not registered with the SEC. The issuing companies experience lighter regulation and less disclosure, making it cheaper and faster than raising funds through an IPO.
A study by Thomson Reuters found that the value of equity raised on the 144A market by non-American companies rose to $5.5 billion in 2007, from $2.3 billion in 2003. (See "In the Money" at the end of this article.) The report's author, Simon Tse, calls the market "a major lifeline between the US capital market and non-US issuers."
Foreign companies continue to leave listed life in the US, with the cost of complying with Sarbanes-Oxley the primary culprit. (See "So Long, Farewell" at the end of this article.) "If you don't fancy Sarbanes-Oxley and you believe that 144A gets you most of the way there, that's where you'll pitch your tent," says Jonathan Roe, London-based co-head of equity capital markets at Dresdner Kleinwort. Furthermore, new trading platforms allow QIBs to trade securities more freely.
But the 144A market does have its drawbacks. Despite relatively low legal requirements, buyers still want a certain amount of disclosure, and that means advisory costs can be higher than when accessing European markets, says Bart Capeci, a capital markets partner in the London office of law firm Allen & Overy. But in the current climate, companies could be willing to pay a premium to connect with a new investor base.
"It's more difficult and more expensive to access the 144A market than the euro markets," Capeci explains. "So a lot of CFOs, all things being equal, would rather not. But in recent years all things haven't been quite so equal as they have in the past." An illustration of his point was the US debt market staying open last year a lot longer than European markets. "And if you want to raise a huge amount of money, the pricing tension that you will get from selling into the US with 144A can make a significant difference," Capeci says.
Equity Facilities: In the Tranches
Companies that are happy to place equity but less keen on the rigmarole and roadshows entailed might consider an equity facility with a single finance house. Instead of a company raising a set amount of capital through an equity offering, the financier agrees to provide the sum in tranches, taking shares in the company at the current market price whenever the company decides it needs fresh capital. For growth companies with a rising share price, that can be less dilutive than a single transaction.
The process was started in 2001 by Yorkville Advisors, which calls it a standby equity distribution agreement, or SEDA. Paul Strzelecki, who runs Yorkville's London office, refers to it as "management controlled mezzanine" — the company gets new funding when required, and if the board decides it needs the whole sum at once, the SEDA can be turned into a convertible debt facility. It benefits a company which knows it won't need all the money at once, Strzelecki adds, as it's not "collecting money, sticking it in the bank and earning less interest than the real value of its stock."
There's plenty of fine print for both sides to stick to. In the case of a SEDA, the company and Yorkville contractually agree that the financier will never short the stock, will only take the rough equivalent of a day's worth of liquidity in one tranche and — in most cases — will not hold so much of the stock that it has to be declared a significant investor. For its part, Yorkville makes money from small trades in the stock.
One company to have benefited from a SEDA is Viaggi Del Ventaglio, a €783m Italian tour operator. In September 2006 the company arranged a €70m SEDA with Yorkville to help it refinance as part of a group restructuring. Since then it's raised about €32m from the facility to finance growth and help it get a better grip on cash-flow management. It's working so far: for the year ended October 31st, the firm's Ebitda was €22m, up from €9.5m a year before.
Strzelecki believes the economic downturn is creating new opportunities for clever corporates, but he also knows that many companies are reliant on fresh funding to make the most of them. "Good companies make good plays, therefore they may need cash to do that," he says. "They may want to launch a new product, go to a new market, or acquire another company, which means they can reduce competition and buy it less expensively in this market than they would have done a couple of years ago."
But like all other forms of alternative funding, an equity facility is just one piece of the funding puzzle — CFOs shouldn't sideline their relationship banks just yet. "We're not an answer to all your prayers," admits Strzelecki. "You still need debt from banks, you still need equity from investors. We are another source of that portfolio."
Tim Burke is senior staff writer at CFO Europe.