"A company can only mislead its financial stakeholders once and get away with it."

James Wheeler of PILOTpartners engages in discussion with Nigel Atkinson and David Wilton with BTG Mesirow Financial Consulting. BTG MFC focus on their relationships with and the needs of their private equity clients in the current marketplace.

James Wheeler: To start the ball rolling, gentlemen, can you briefly describe BTG Mesirow Financial Consulting's services to the private equity sector and perhaps predict the major issues facing private equity houses and their funds over the next six to twelve months?

Nigel Atkinson: On the corporate finance advisory side we offer a full range of acquisition support, portfolio enhancement and exit services. BTG Intelligence are a group of professionals who can effectively investigate financial crime and corporate security breaches, no matter the size, complexity or circumstances. As well as the usual strategic and tax due diligence offerings, uniquely through BTG Intelligence we are able to do due diligence on jurisdictions, entities and people. So, for example, if a private equity investor is looking to invest in the Ukraine, we can look behind the people who are going to be managing the business and the potential problems in that jurisdiction.

In the underperforming and distressed arena, we also assist with origination portfolio review, and undertake diagnostic reviews of investee companies. This can lead on to further advisory work on performance improvement or more likely stabilising the business whilst turnaround and financial restructuring plans are developed, led by ourselves. During this phase we would typically be involved in stakeholder management, particularly in handling the banks and other lenders on behalf of management and PE investors. Once a plan is agreed we would handle debt advisory and refinancing issues ourselves, but for operational turnaround implementation we would typically deploy members of our new 'BRITE' panel, which is run by PILOTpartners.

JW: You mentioned international capabilities just now. Do these services extend outside UK and Europe?

NA: Yes they do.

JW: How is that organised?

NA: That is organised through a variety of arrangements we have established over time. In the United States, we have a joint venture with Mesirow Financial Consulting. Mesirow is a full service consulting business with strong emphasis on restructuring and valuation work. We also operate the Begbies Global Network, which is a network of like-minded firms that work in our key service lines of corporate finance, restructuring and tax. These firms cover about a hundred jurisdictions across the world. And lastly, we have our own network of firms in the key offshore financial centres such as Cayman and the Channel Islands.

JW: You mentioned the new Interim Turnaround Directors' Panel to which you have given the rather attractive soubriquet of 'BRITE'...

NA: Yes, that stands for BTG Restructuring Independent Turnaround Executives...

JW: What do you and your colleagues hope to achieve with this panel?

NA: David will be able to add to my comments, but first, just focusing on private equity portfolios for now, it would be to provide support to investors and management. Initially with our diagnostic work in looking at troubled portfolio businesses and helping to find workable solutions, using people who have senior level, relevant industry expertise but also situational expertise in handling distressed circumstances, working out what is wrong and what needs to be done. Then, in conjunction with the client, the members of the BRITE panel could then work within the company or companies to effect a turnaround.

JW: David, you've long had experience of using independent executives and directors to support turnarounds. Could you give an example of how you see this being successful in private equity backed businesses and the likely outcome?

David Wilton: Yes. First of all, let's be clear that when working with private equity one of the key issues in providing advisory services and external turnaround managers is that the advisor and interim manager have to have agility. We have got to fit the team and the skills to the job in question. In my experience I am certain that when one creates a combination of turnaround professionals in terms of the people such as Nigel and myself, together with an external manager who's great at operations or has specific sector experience, one creates a small, effective sub-team that provides real stability. This means that first, the client gets the comfort that the project is working, and secondly, the target company also gets the advice and support it needs to get through a difficult time. I've seen that in the travel industry, in shipping, manufacturing, media, and finally in construction, believe it or not, which is unusual in private equity. It's the strength of the combination of experience... just as an example, something we are currently working on, where we've gone through a first phase, we've provided a team of corporate finance, valuation, tax and forensic people working together to come up with an outline solution and, whilst we were doing that, within the company, we had our turnaround director managing cash, short term profits and management. In my view, you can't have one without the other. One has to have a stable platform while one looks at the feasible solutions in an objective way. Of course, we then expect to go on into developing those solutions and implementing them.

JW: Looking ahead, do you think that private equity will be more able more readily to dispose of unloved or underperforming investments to generate at least some value or return, rather than leaving ownership in the hands of the banks which don't really want to own these assets themselves?

DW: I think inevitably there are impacts on IRRs, if you are going down that sort of route. If one has got a troubled company then one can always sell it off if there is a purchaser with cash to do a deal. The slightly worrying thing is that whereas every private equity investor knows the sort of IRR he should get in a benign economic environment, I think that sometimes they struggle to recognise the critical value change that they need to face up to in more troubled or stressed situations. There is inevitably going to be an impact on price. The purchaser will probably recognise what's going on and consequently delays decision-making, and that can prove quite costly. We see our role as ensuring these issues are minimised for our client so exit value is protected as far as possible.

There are several investment outcomes that may achieve this, but if I can just turn it on its head – from practical experience there are also situations where the bank may be feeling the stress and the way forward may be for the private equity house to buy the bank debt at a discount, where the fund permits, and retain the whole of the investment for disposal at a later date. But that, of course, depends on overall expectations of both stakeholders and the availability of funding. But it is not necessarily a one way street for private equity.

JW: Do you expect banks to have an appetite for that sort of deal in the current environment given that the next round of MBO refinancings will be coming through and their own balance sheets remain challenged?

DW: I have seen these sorts of deals suggested. I believe they have happened. If, for example, where a bank hasn't got great security in a service industry, then they may think long and hard about pushing the company down the insolvency route but nonetheless looking for an exit that is better than taking the immediate pain, by trying to realise the debt rather than their security.

NA: They will probably be advised by investigating accountants who are looking at some pretty harsh numbers. This is an area where we can work on the private equity side to help negotiate an attractive deal with the bank.

JW: But given the proximity with which all firms of accountants operate with the banks, what conflicts are likely to arise when you are acting for the investor and/or management?

DW: Let me put forward my simple but firmly held view: whilst I do act for banks from time to time, as a matter of generality I tend to work for the shareholders. If I am engaged by the shareholder, then that is my client, and therefore if the bank needs advice then it should get its own advice. The bank has plenty of suppliers of advice. I don't see any automatic conflict in advising different stakeholders but this can only last whilst their several interests are aligned. Generally I see myself as an advisor to shareholders and companies and do little marketing to bankers.

JW: That seems to put you in a strong position competitively.

DW: It does, if people know about it.

JW: Let's move on to broader issues about the effect of the Government pressing on with reducing public debt. It seems to me that a lot of businesses that were acquired by Private Equity within the last three to four years, particularly in the service sector, will have Government as their largest customer. I am thinking particularly of service industries. A whole new sector of the UK economy has built up in recent years to service government/quasi-government organisations and private equity has been very keen to invest in their good quality cash flows, stable customer bases etc. That now seems to me to be at risk. What thoughts do you have on how leveraged businesses with Government as their core customer can refocus their business plan and also how private equity portfolio directors should engage management teams in this debate?

DW: They should get an early feel for where they stand. Because in the past, suppliers to the public sector tend to have had more comfortable relationships with their customers than suppliers to the private sector and,therefore, have had a habit of closing their eyes and saying "Well, we'll be OK because it's XX health authority, XX police authority, XX local government authority. We've dealt with them for years and we've always looked after each other when things get tough..." and you know, almost always they have. However, circumstances have changed. One has only to note how government ministers have called in major suppliers to ask them to revisit contract terms. If they have not recognised the change, suppliers probably won't be in the frame of mind to have the right conversation about contract renewal and pricing with their principal in time. They should be asking themselves whether the business model still works with a 25%-40% reduction in customer spend and if it doesn't, what changes can be made to help it do so. The more time they have available to look at alternative markets or to reassess their terms of trade – because that it might be something that simple to keep them in the game – the better. It may well be that some of these contracts are not as much at risk as they think. For example, where a supplier to an NHS Trust that is being put together as part of an initiative to a PFI partner, the contract terms are probably fairly well protected because the basis on which a PFI contract is renegotiated is likely to be clearly written and a significant cut in government spending won't necessarily filter through to 40-year PFI contract.

NA: I think the first thing government departments will do is be seen to cut back on external advisors. You can always leak it back in later if the first cut is excessive...

DW: The 'Yes, Minister' approach to public finance...

JW: When you are talking to portfolio directors of private equity firms about transformation strategies – because invariably you are likely to be brought in to difficult rather than benign situations – what is your advice to the investor and then the management team when the business needs to improve their cash management and deal with the first breach of covenants in their history, probably the first time they've ever had a problem with their bankers? How do you start off that conversation?

DW: I always start off from the basis that if you are a borrower then you will only mislead your financial stakeholders once and get away with it. However, what you find is that a lot of management teams either fail to recognise the truth or they assume it is something they can cover up or defer action on for now. But once that element of trust between financial stakeholder and management has gone, then it is very, very difficult to rebuild, so the first pieces of advice to a client are to make sure that they have the information to hand, and to make sure what they are telling their stakeholders is something that can be justified later on down the road. For the private equity portfolio manager, it is almost the converse – make sure the information received is credible. If it's not clear, get it made clear. If you think it's contestable, contest it, because if you don't do it now then you will have to do it under more difficult circumstances a short time down the line.

JW: At PILOTpartners we have seen stronger activity levels amongst stress investors in the turnaround marketplace. Do you think that the time has now arrived for the small numbers of perhaps not very well known stress investors to pick up basically sound businesses or, increasingly, packaged portfolios from private equity houses or other institutions (such as the Coller acquisition of part of the BoSIF portfolio earlier this month) needing to redirect their attention and funds elsewhere? In other words, is the stress investor market the right place to turn to for private equity, so that pre-recession deal making and fund-raising can return to some semblance of normality?

NA: They are there; there are quite a few of them though the overall capacity may not be that massive. Up to now I don't think there have been that many big stress deals. I think private equity will have to talk to these guys more but the chances are they are not going to come out with much for it. Private equity will typically be out of the money in these sorts of deals.

JW: Yes, but better that than losing ownership to the bank...

NA: Well, they're either in the money or they're out of the money, but at least they may retain some interest in such a deal which they wouldn't if the bank appointed administrators.

DW: I think the issue you mustn't get away from is that you can't make a bad business good just by bringing a different sort of funding into it. The key issue is making sure that the business is a sound business by the process of developing the right strategy, getting the right management in there, getting the cash flow right. The more you can de-risk the business, the more likely you are, whatever the source of funds, to provide some return to the shareholders. The less that is done to put the business right then the higher the cost will be to fund it, which means that shareholders are far more likely to drop out of the money.

JW: Given the importance that bank debt has traditionally played in the leveraged MBO model and the lack of availability of debt funding over the past two years, what light can you throw on the mindset of the debt providers in the current environment towards private equity held businesses where the equity value has travelled south rather than north?

NA: To some extent it comes back to what David was saying before. Unless you can sort out the fundamental issues of the business – assuming you're already in a stressed situation – you're probably not going to get on very well with the bank and will end up with an unfavourable response, and not getting refinanced at all. As far as new deals are concerned, the sorts of multiples available are likely to be much lower than they have been in the past.

JW: At a simple level, say the business isn't distressed but just underperforming andleading to problems ahead. Are the banks more likely to talk to firms like yours about restructuring before they talk to the private equity investor? Are they going to feel more comfortable getting a feeling from advisors first than talking to private equity houses?

DW: When a bank passes a particular company to its distressed team, which is probably beyond what you are talking about, then there would be pretty quick and regular communication. I believe the banks are actually really good at that. However, before that point is reached then the banks tend not to have any communication with the shareholders; they communicate with the directors. You get all the usual sort of covenants in term sheets for timely management information and so on, which tends to define the nature of communication. This does not tend to link into strategy and future investment directly. The banks would, therefore, tend not to engage with shareholders unless there was a specific issue about raising significant new equity.

JW: Objectively, at what point is it best for Begbies Traynor Group to come in?

NA: Before the bank has visibility of problems but as early as possible I think. The first sight of a possible covenant breach would be the point at which portfolio managers should talk to us.

JW: How do you first become connected with a portfolio business in difficulty?

DW: It would tend to come either through the investors or it would come through the chairman or a non-executive director, somebody we have dealt with before or it might come through one of their other advisers such as their accountants or lawyers. This goes back to what I said earlier on – you only mislead your financial stakeholders once. What we get then is the chance to talk to the bank not about things will get better tomorrow" but "these are the issues, these are the risks, these are the actions taking place to deal with them and these are the changes that are being made and why", rather than have the bank then turn around and say "We're not happy you've got a covenant breach. We need to know what's going on. We're constantly being given budgets and financial projections which are not being met or we're not getting the information on time". We co-ordinate the issues so that there is a sound basis of information for rational businessmen to make rational decisions.

NA: Good information management... getting good information to the banks is obviously where we can help a lot but historically that hasn't happened very much. Private equity has tended to do it themselves. There has been a very long run where they've done very well for their funds and themselves without many problems; generally they felt they could manage these situations themselves. In the current environment of more widespread distress across portfolios and imminent refinancing requirements it is clearly not feasible or sensible for portfolio managers to follow the DIY route.

DW: Sometimes they assume that an advisor put in for the bank will somehow cover up the issues from their perspective. It is very difficult for advisors to ride two horses at once. The trouble is that the horses don't always run in parallel lines and trying to ride two horses has inevitable uncomfortable consequences...

JW: Er, quite... As this interview comes to a close, it strikes me, from the issues we have been discussing, that if your firm doesn't have a unique position in the market, it certainly holds an unusual position given that you are not an accountancy firm that does audit work or has a big management consultancy practice; you're very firmly in the restructuring, turnaround advisory marketplace. When you talk to private equity firms about portfolio businesses in difficulty, how do you make your pitch, given that they have access to every advisory firm in the country?

DW: One of our advantages is that we're a lot smaller in some ways than many of the international firms. As we said earlier, that brings agility. It means that we don't have a lot of the problems that larger firms' internal regulatory processes involve because we don't have issues around dividing our skill base into discrete teams. We're more easily able to bring in outside expertise as part of our team. If we need an expert such as a financial modeller or a senior level sector guru....

NA: Such as a member of the BRITE panel...

DW: Exactly... we can bring them into the team. It is far easier for us to do that...

We are also more easily able to share information with our clients. For example, we offer clients access to our extranet, so they don't necessarily have to wait for reports. They can also place documents at a site to which our team has access whatever their skill base or area of focus. Clients like to use the extranet and look things up quickly when they are ready to and not have to wait until things are published.

NA: And I think another important thing is the level of experience that we have in our team. We have partners with over 30 years' experience.

JW: Many thanks to both of you for your time contributing to Pilot's Log, and, for my part, for working with PILOTpartners to establish the new BRITE panel which I am sure will make all the difference when you are advising private equity firms about their options for change in the months ahead.

BTG Mesirow Financial Consulting is part of Begbies Traynor Group plc
32 Cornhill
London
EC3V 3BT

Nigel Atkinson
T. +44 (0)207 398 3755
E. nigel.atkinson@btgmfc.com
M. +44 (0)7785 310 169