At the time of writing, we are in the midst of the worst of the COVID-19 pandemic. The government has just decreed the closure of industrial activity until 9 April and the state of alarm implemented at least until 11 April. It is a scenario unprecedented in recent Spanish history and with a potentially severe economic impact.
It is also a global crisis that today has 40% of the world's population in quarantine. Borders, airports, rail and road transport restrictions, temporary closure of shops and businesses in all sectors have been closed.
It is a demand shock in the economy, which has led to a very significant downward adjustment in asset prices. The Spanish stock market has fallen by 22% during the month of March. Oil prices are at 18-year lows with the benchmark WTI at USD 20 per barrel and Brent at USD 23 per barrel. The VIX volatility index is today at 66.52 when it was at 18.84 in January. All economic indicators point to a scenario of global economic recession. In Spain, annualised GDP is expected to fall by 13%.
Against this backdrop, I reflect below on the possible strategies and alternatives in corporate financing for companies in Spain.
1Initial situation
Capital markets are very efficient and adjust asset valuations to future scenarios very quickly. The market capitalisation of listed companies has been significantly reduced. There is more volatility, higher risk and uncertainty in the execution of companies' future business plans. Reduced future business growth (lower sales) usually entails a reduction in EBITDA and Free Cash Flow. It also increases the risk premium and its impact on the cost of capital and the cost of debt. With these indicators, company valuations are reduced.
However, if the business model was solid before the crisis, it is advisable to make pragmatic and objective adjustments to guarantee the future liquidity of the companies and to be able to remain operational and profitable during the recession. In my opinion, we are facing a scenario of economic recovery in U, where it will be critical to overcome 2020 and adjust to a 2021 recession.
Financial management measures
In the scenario we are facing, companies' future business plans need to be rethought, being more conservative and with the ultimate objective of maximising the liquidity of the business. We must be very attentive to the management of working capital. working capital (Working Capital). In order to carry out their activity, companies need a set of current assets (raw materials, work in progress, finished products, receivables, cash). Companies need permanent levels of current assets. As they are permanent resources, their optimal financing should also be long-term, mainly through two channels: - financing from suppliers and other creditors arising from operating costs. - financing through permanent resources: equity and long-term borrowed funds. In essence, when the average payment period is shorter (days to pay) than the average collection period (days to collect) there is a positive cash cycle The need for external financing is necessary, as financing from the holding's creditors is not sufficient. To manage this cash cycle, companies can manage the following levers: - payment channels and terms (discounts for prompt payment) - stock management of both raw materials and finished products. Investments in working capital represent a risk-return choice. In times of crisis it is advisable to increase investment in working capital (conservative policy): Increasing stock levels and credit to customers. Liquidity is increased at the expense of profitability.
Other conservative capital investment management measures in fixed assets and shareholder remuneration policy. We are already seeing how companies are reducing their CAPEX investmentsThey are also rethinking their merger and acquisition strategies, as well as managing their shareholder remuneration policy. (reduction and/or cancellation of the dividend) y the cancellation of share buy-back programmes.
These conservative management measures are aimed at optimising and maximising liquidity. free cash flow. In times of crisis like the current one, the much revered principle of Cash is King applies more than ever.
3.- Financing Instruments
Companies in times of crisis have to adjust their optimal capital structure, the combination of debt + equity. This optimal value will depend a lot on the life cycle of the companies; it is not the same for a start-up, a growing company, or a company in its maturity period. As risk is reduced in the life cycle of companies, the different possibilities and alternative sources of financing increase.
In times of crisis, public capital markets suffer greatly from risk aversion, closing as a source of financing for many companies. IPOs and issues of high yield corporate bonds and promissory notes of high risk companies are very much affected and the market is almost closed. Bank financing and alternative financing are very important in this scenario.
First of all, it is advisable to turn to all possible sources of financing instrumented by the government for SMEs and the self-employed in its anti-crisis measures. Government guarantees for bank financing of SMEs. ICO loans, and the temporary support financing offered by Spanish banks.
2.- There is a wide variety of alternative financing available in the Spanish market.. According to ASCRI, there are some 4.5 billion euros available in Spain for Private Equity. We understand it also includes Venture Capital at all stages of financing rounds from seed to follow-on financing rounds. Funds have a need to invest this capital and I know they are still looking at deals.
3.- Debt funds. In recent years, debt funds have proliferated in Spain. They are very specialised sectoral funds that have been established to finance very specific sectors in Spain. Real Estate Funds, Logistics Funds, Hotel Funds, Renewable Energy Funds to name but a few. There is also an ecosystem of short-term funding funds. which allow the discounting of invoices and advance their financing.
They can be a complement to bank factoring.
In conclusion, my reflection is that we will come out of this crisis, and when we return to our routine in the post-COVID-19 reality, business management in times of recession will require conservative management criteria and financial flexibility. Diversification of funding sources and adjustment of business plans to the new scenario will allow companies to remain operational and profitable.
Carlos López Jall
Partner - Senior Advisor of Beka Finance