This article is adapted from a presentation at the Turnaround Management Association’s 2019 Mid-America Regional Conference.
At our firm we frequently find ourselves involved in transactions where, after much effort, we believe that we’ve set a distressed U.S.-based company on a glide path for a restructuring or a sale, sometimes via Chapter 11, sometimes via an out-of-court process. Then, however, some overseas issue that we thought was minor in the overall picture sometimes pops and upsets that glide path, and the tail ends up wagging the dog on the way (hopefully) to a closing.
These international issues can significantly impact the transaction or even derail it from proceeding. This article describes three situations I was involved in that illustrate the need to perform more than a cursory examination of a deal’s international aspects.
Case 1: Automotive Stamping Supplier
This $2.5 billion OEM got into trouble with an over-expansion and resulting debt. The U.S. parent company filed for Chapter 11 bankruptcy, but not its overseas subsidiaries in Europe, Asia, Latin America, and Canada. It was undergoing what appeared to a straightforward restructuring with a substantial reduction of its manufacturing footprint and headcount.
I joined the company a few months after the filing. In my first week I learned one morning that its Korean subsidiary was suddenly about to run out of cash liquidity. It had recently grown rapidly, supplying stampings to both Hyundai and Kia Motors. Its continued operation was important to the valuation of the U.S. parent company in its Chapter 11 process.
Case 2: Heavy Truck Component Supplier
This company was a $300 million distressed OEM and aftermarket supplier with manufacturing plants in the United States, China, U.K., and Argentina. It managed to weather the 30% to 40% heavy-truck-market downturn during the 2008-2009 global financial crisis.
The private equity owner had now decided to sell the company, emphasizing its strong market positions domestically and in China, which generated the bulk of the company’s revenues.
Another straightforward sale. What could go wrong?
Well, as the company’s investment bankers started to send out teasers and CIM documents to strategic and financial buyer prospects, two overseas issues cropped up.
First, the company’s small Argentina subsidiary suddenly encountered a rapidly deteriorating local economic environment under the country’s left-wing government. Huge losses piled up within months, necessitating a $12 million equity infusion to continue operations.
However, the U.S. parent company and its PE owner did not have the liquidity to provide the funding. Also, the Argentine losses would seriously impact the private equity sale valuation.
Second, in the middle of the sale process, on the other side of the Atlantic, lawyers advised that an issue had cropped up regarding the U.K. subsidiary’s $10 million underfunded pension liability. The U.K. pensions regulator would prohibit the sale unless the shortfall was addressed and was empowered to compel the parent (and even the PE owner) to take responsibility. Again the was liquidity that was not available and the sale valuation was jeopardized.
Case 3: U.S. Consumer Products Manufacturer
A $500 million, profitable U.S. maker of iconic consumer products diversified outside of its core space, and tripled its size, by buying a $1 billion Hong Kong-based global supplier of consumer electronics from a European conglomerate. The result: a $1.5 billion company with two very different business segments.
However, the Hong Kong acquisition performed poorly and losses piled up. The parent’s debt grew to over $500 million and its bond rating fell to deep junk status at CCC –.
The breaking point came when $100 million in liquidity was abruptly withdrawn by three Chinese government export credit agencies, and the Hong Kong electronics subsidiary could no longer purchase products from Chinese suppliers to sell globally. Its revenues plummeted much faster than costs could be cut, and it received a negative valuation.
The puzzle to be solved: how to turn back the clock to shrink the group to the original core U.S. consumer products, jettison the badly hemorrhaging electronics acquisition, and ring-fence the overseas electronics liabilities from reaching back to the healthy U.S. parent company. The U.S. parent had also provided guarantees to lenders and creditors of the Hong Kong business in a complicated capital structure.
What Happened: Case 1
A few hours after learning of the cash crunch at the illiquid Korean automotive subsidiary, I flew from Detroit to Seoul. Upon arrival, we bought time by immediately stretching some supplier payables. We were able to make the payroll that day and avert disrupting product shipments to Hyundai and Kia.
Later that week, we met with Korean banks that agreed to increase their revolving loans. Medium term, we moved to more aggressive cash management practices and built into the weekly forecast a cushion to provide for unexpected delays in cash collections.
Because Hyundai and Kia were not impacted by the supplier’s cash crunch, they continued to award new contracts to the Korean subsidiary. The growing business decidedly helped with the U.S. parent’s valuation, and the company was subsequently purchased out of Chapter 11 in a 363 sale by a well-known private equity fund.
What Happened: Case 2
The small Argentina subsidiary’s rapidly escalating losses, need for $12 million in fresh equity that the U.S. parent could not provide, and the prospect of the government prolonging and deepening the country’s economic malaise resulted in a negative valuation for the Argentine unit, compared to the parent company’s overall valuation.
We believed that prospective buyers for the entire global group would be distracted by Argentina and insufficiently focus on the crown jewels in China and the United States. As a result, we reluctantly elected to place the Argentina business into insolvency liquidation in a “quiebra” process, the equivalent of Chapter 7.
Prospective buyers were advised that Argentina was no longer an issue to be considered. Before that happened, angry at the prospects of losing their jobs, 400 factory workers one evening temporarily held the local management and a few U.S. parent company people hostage at the plant site, with the threat of physical violence.
The standoff ended peacefully but with disappointment on all fronts that the plant was no longer viable in the foreseeable economic environment. The deep country-wide recession and emergency shipments of substitute products from the parent to Argentina provided enough buffer inventory and time to Argentine OEM customers to let them find alternative sourcing.
Simultaneously, across the ocean, a pensions consultant helped the company in difficult discussions with the U.K. Pensions Regulator. The company wanted to avoid placing the U.K. subsidiary into insolvency, which would have caused both the loss of employment for current workers and the full loss of benefits for the retired pensioners.
After protracted negotiations, the U.K. subsidiary and Pensions Regulator achieved a win-win accommodation. Having solved the two overseas situations, the company was finally sold to a strategic buyer.
What Happened: Case 3
Our objectives were to revert to the original U.S. business, jettison the overseas electronics business, and prevent the overseas liabilities from reaching the U.S parent.
To effectuate that, the parent company was placed into U.S. Chapter 11. On the same day as that bankruptcy filing, we not only placed the Hong Kong electronics company into Hong Kong insolvency proceedings, we did the same in 23 other jurisdictions in Europe, Asia, and Latin America.
Separate individual insolvency filings were made for the Hong Kong electronics company’s subsidiaries. This was done because of the complex capital structure, where the parent company had provided guarantees to certain creditors and lenders of the electronics company.
Complicating the insolvency process for the electronics group was the need to shut down its global cash management system, which pulled funds daily from 23 entities around the world and concentrated cash in the Hong Kong headquarters’ London bank account.
The typical large bank cash management systems don’t work in a bankruptcy-insolvency environment. The 23 legal entities would have been left with no cash on the day after the filings, as their cash would have been moved to the Hong Kong entity’s London bank account. Without cash the electronics group would not have been able to move forward with the 23 individual insolvency proceedings.
There was also a need to leave enough cash for law firms in 23 countries to protect the respective country entities’ directors. In the end, the core profitable US parent company emerged from US Chapter 11 six months later, and the $1 billion-plus electronics group disappeared. The clock had been turned back.
For any restructuring or sale, every potential issue, whether domestic and international, should be checked out. Nonetheless, seemingly minor overseas can get short shrift and, unfortunately, fixing them can end up taking a lot more attention, energy, and time than had been expected.
You can’t afford to exhale until the coast is absolutely clear on both the domestic and international front. The tail can and sometimes does wag the dog.
Benson Woo is a managing director at Alderney Advisors, a turnaround and restructuring advisory firm focused on the automotive industry. Alderney was the lead financial adviser for 15 global automakers in the largest vehicle recall in the industry’s history.