Shifting asset valuations and rising debt will fuel more corporate restructurings in 2017
By James Feltman
Posted: 11th July 2017 10:12What do Macy’s, Ericsson, and Deutsche Bankhave in common? They’ve all announced major restructuring plans in the last few months. While there are several macroeconomic trends fueling the restructuring environment, two trends have the staying power to influence both restructuring marketplace participants and market sectors for the next several years.
The first trend is a shift in the type of assets that drive value for a company. The new economy stars are intangible assets. Disruptive technologies, customer databases, and innovative software are fueling market value and overshadowing traditional brick-and-mortar assets.
Take Tesla, the electric car manufacturer, as an example. Tesla has a market capitalisation of $49 billion, which not only exceeds the market value of Ford Motor Company, but is also flirting with the market capitalisation of General Motors Corporation at $51 billion. An impressive feat given that Tesla is only 13 years old, has yet to report an annual profit, and has sold a fraction of cars compared to its competitors – 76,000 for Tesla versus more than six million for the Big 3 manufacturers.
Another example is Amazon, the e-commerce behemoth with a market capitalisation of $420 billion, nearly twice the value of Walmart, the world’s largest traditional retailer. What makes the Amazon story even more fascinating is that Amazon reported 2016 profits of $2.4 billion on sales of $136 billion – a profit margin of only 1.76% – while Walmart reported 2016 profits of $119 billion on sales of $482 billion, a profit margin of 24.6%.
How do you determine which assets are the most highly prized? Look no further than the restructuring marketplace. It’s an incredibly efficient arbiter in determining which assets are deemed the most valuable.
For example, in the retail industry, the continuing wave of restructuring proves that e-tailing is draining the profitability of traditional retailers at a pace requiring consolidation both in the number of stores in operation and between brands. Gross square footage has become a liability but brand names and licensing rights are retaining their value. In the gaming business, customer affinity databases and incentive programs, which are integral to their brand, are prized assets while values for second and tertiary operating locations have plummeted. In the airline industry, value is based on routes, customer loyalty programs, and passenger experience management including websites as a sales portal, landing rights, and airport slots.
Investors and lenders would be well advised to look past traditional forms of collateral and make sure they understand who holds the rights to the assets that ultimately drive business performance. Similarly, in this dynamic environment, management and boards should secure the appropriate advice to determine asset valuations.
The second trend shaping the restructuring marketplace is debt wave 2.0. The first debt wave occurred in 2008, and while there was concern that the marketplace could not absorb the amount of short-term debt coming due and naysayers predicted a landscape littered with defaults, no such thing occurred. But, will it be different this time around? Here are some sobering facts. The world is swimming in unprecedented levels of debt. The global debt-to-GDP ratio is at record highs in every sector including corporations, households, and governments. According to the Institute for International Finance, global debt now exceeds $215 trillion, representing 325 percent of global GDP. While developed countries accounted for the lion's share of global debt, emerging market debt issuances are taking place at astounding levels with approximately $179 billion in the first quarter of 2017. Given the relative instability of emerging market governments and corporations, there is growing concern that these countries will have difficulty repaying the bonds and loans due this year, creating a refinancing risk.
In the world’s two largest economies, China and the United States, the warning lights are starting to blink. In the United States, subprime car loan defaults are on the rise, student debt defaults are rising, and public pension debt exceeds the ability to meet payment obligations long term. Another possible canary in the coal mine: junk-bond rated companies have issued more than twice the level of debt in the first quarter of 2017 than in the same period last year.
Similarly, in China, the Organization for Economic Co-operation and Development (OECD) reports that the current level of corporate, government and individual debt exceeds GDP by 250 percent. Chinese companies have recently begun to pull back from large foreign financial commitments and bond defaults are rising. With its own debt burden to contend with, can the world continue to expect China to be the shock absorber for debt that no one else wants to hold?
So what else is different? For starters, the US Federal Reserve is beginning to deleverage its $4.2 trillion balance sheet. Secondly, the era of low to no cost borrowing will eventually end. We are already seeing the initial impact in the US as we adjust carrying costs to reflect the new level of government debt at the $20 trillion level. Spreads for premiums on high yield bonds over benchmark Treasury’s remain somewhat consistent with historical average (around 4%). This would indicate that the market has a continuing appetite for this product and willing to acquire more of it at current yields. This result is likely driven by the hunt for yield in an otherwise tight marketplace. It is a reasonable expectation that one should expect to see higher yield product coming to market in 2017. China now has its own debt burdens and Chinese companies have recently begun to pull back from large foreign financial commitments.
Time will tell, but debt wave 2.0 could end very differently this time around.
James (Jim) Feltman is a managing director for the Disputes and Investigations practice. His practice is focused on providing fiduciary, advisory consulting and expert witness testimony in the areas of insolvency, restructuring, money laundering, Ponzi schemes, asset tracing and recovery, accounting and financial statement reporting issues, causes of action against officers, directors and third parties, securities fraud, misrepresentation, and hedging and trading in complex securities schemes.
James can be contacted on +1 212 450 2854 or by email at James.Feltman@DuffandPhelps.com