Working through the gloom

Working through the gloom

The economy might be depressed, and lending might be way down from what it was. But BQ finds many Yorkshire dealmakers surprisingly sanguine about the future.

You know the current economic downturn must be a bad one when, asked about the prospects for making a deal in Yorkshire in 2012, even the region’s dealmakers – hitherto some of the most optimistic people you could come across – sound at best flat.

“Flat” is in fact exactly the adjective that James Cliffe, divisional director for relationship banking at Barclays, uses to describe dealmaking activity.

“This really is a slack period,” he continues. “Other regions have a higher level of activity, particularly the Eastern region and the North West. Yorkshire is finding it tough at the moment, although certain sectors are thriving.

“Agriculture, for example, is performing very strongly. But that makes me wonder whether the agriculture and food base which is traditionally strong in Yorkshire is not masking even lower levels of activity in other sectors.”

Others share the view that possibilities for making an exit or doing an acquisition in this market are subdued. Darren Forshaw, co-founder of Endless, is one of them.

The turnaround investor, which launched with great fanfare in 2006 and has already been through three rounds of successful fundraising, has made two significant investments this year: in online bathroom retailer bathstore.com, formerly owned by Wolseley, and in cinema visual effects business Cinesite, which worked on the Harry Potter films, among other things.

Both of these deals involved significant restructuring. “Cinesite was a good business that had been caught up in a massive US problem,” says Forshaw, the problem being that its previous owner, Kodak, had filed for bankruptcy protection in the USA.

“And bathstore.com had been operating without a management team, so we had to put in a new management team with a new chief executive.”

Nonetheless, the prognosis for those already in the Endless portfolio is less dramatic. “We see no light at the end of the tunnel,” says Forshaw, “and we are revising our business’s business plans to see the same for four of five years. They have to get used to the current lending scenario, and aim to grow on their own.”

There is a note of resignation here, as there is among many other dealmakers. But some of them think getting used to a more sombre market may be no bad thing in the long run. Mark Clephan, a director at Ernst & Young, says deals activity has been going up and down all year, although currently we are “bouncing along the bottom”.

“The ups and downs, however, make it difficult to read too much into the data,” he says, “as it can be skewed by just one big deal.” Even still, he does not find this an entirely dismal situation to be in.

“The market is way down from where it was five to six years ago,” he says. “But the worst thing we can do is compare the current market with 2007. That was a period when we had a glut of finance, and that stimulated behaviour.

“That market probably won’t come back for a period of time, and there are people out there who are probably wishing that it does not come back in that form at all. “The market is currently in equilibrium. Advisers know what they have to achieve.”

Such assessments are being made of course, as complaints continue to come in from many business groups about banks simply not lending enough, even now. Forshaw is at least sympathetic to the view that the banks could do more.

“I know that banks have to get themselves properly capitalised,” he says. “I can understand why they would not want to get back to the position they were in. But it is disingenuous to claim, as some of them do, that that lending is as it should be.

"Currently most banks are only offering loans lasting 12 to 18 months. How can you plan a business with that sort of offer?”

He is particularly scathing about Project Merlin, the project set up by the Government and the four major high street banks in an attempt, among other things, to boost lending to small businesses.

“Project Merlin was meant to be operating in growth markets and offering new lending,” he says, “but I wonder how much new lending is actually being done. To me they just seem to be offering new lending to existing customers.”

Not surprisingly, perhaps, Cliffe disagrees with such an assessment. “I see the levels of our debt and deposits on our balance sheet are both rising, and that has to mean that we are lending new money,” he says.

As far as small businesses are concerned, he points in particular to the National Loan Guarantee Scheme, which was launched in March this year.

This aims to make lending easier for small businesses by reducing the cost of loans by 1% and by the Government providing guarantees for unsecured borrowing. Cliffe claims that 60% of NLGS schemes so far lent out have been funded by Barclays.

Beneficiaries in Yorkshire include Freshways, an Asian supermarket based on an abandoned Tesco site in east Leeds which gained £13,500 to expand its premises; the Joe Cornish photographic gallery in Northallerton; and Kingfisher, a fish and chip shop in Crosshills which gained £10,000 to open a new restaurant.

More recently the Treasury has also launched the Funding for Lending (FFL) scheme, which again has been designed to increase lending by allowing UK banks and building societies to borrow from the Bank of England at cheaper rates for periods of up to four years.

In September Lloyds Banking Group was the first bank to take advantage of this scheme, drawing down £1bn which it said would be passed on to small businesses “in a matter of weeks”.

John Robson, regional director for Lloyds TSB Commercial in the North of England, said this lending was just the start.

“We are committed to helping Britain prosper by encouraging investment and supporting businesses and households with the best possible terms,” he said.

Lloyds also claimed that its lending to small businesses over the year has increased by 4%, at a time when net lending as a whole had fallen by the same amount.

Outside the government-backed schemes, Barclays conventional lending to businesses has included a loan to Thirsk-based solicitors Calder Meynell to help it open a new office, a loan to energy management firm Orchard Energy to help it move headquarters from Brighouse to bigger premises in Elland; and a loan to Panetti’s, a bistro in Bedale that first opened in 2001 and wanted to refurbish its premises.

Invoice finance specialists have been busy too. Bradford-based detergents and chemicals manufacturer was able to take a 50% stake in Warrington-based food hygiene company Klenzan for an undisclosed sum, thanks to funding provided by RBS Invoice Finance.

The same funder also provided a £35m working capital facility to Rullion Group, a recruitment company which is headquartered in Cheshire but has a major office in Leeds, to help its continued organic growth.

Yet Cliffe concedes that there remains a funding gap for start-ups and small companies with a turnover of £1m, even with partially public funded agencies such as Finance Yorkshire aiming to fill that gap.

“That area is not really where private equity houses operate any more, he says. “Finance Yorkshire is fine, but it needs to be part of a wider solution.” More ominously for some, he adds that the NLGS and FFL schemes have not made his bank change its attitude on the kind of businesses it will lend to. “We aim to provide cheaper funding to those we would lend to anyway,” he says.

“If we see a viable business that business will get lending. Nothing has changed.” The problem, as he sees it, for both large and small businesses, is that many business owners still think they are more or less duty bound to be loaned funds.

“There is a mismatch between debt and equity release,” he says. “In the past there were funders who were taking equity risks and expecting debt returns, but they got into a lot of trouble.

“Many of the propositions I see are more suited to equity transactions.” This is a sentiment that many corporate finance advisers broadly agree with.

Stuart Warriner, corporate finance partner for PricewaterhouseCoopers in Leeds, says: “We wouldn’t applaud banks if they built up a huge debt book again.”

He believes that for businesses with turnovers of over £5m banks are still willing to lend. “But they are not as eager as they used to be,” he says. “You have to understand their need for rigour.”

Christian Mayo (pictured above), corporate finance partner at KPMG, thinks banks were “probably lending too much before”, and like many observers he believes this has led to a great deal more caution in the market.

What is particularly, noticeable, however, is that this caution is not just on the part of the banks: borrowers are feeling cautious too.

“Companies now lack confidence to take on debt,” says Mayo, “even if you could still do much at the moment with a loan of just one to two times your EBITDA.”

This caution, it seems, even applies among companies who have already secured funding. Cliffe at Barclays claims that deals agreed by his bank that are “waiting to go” are currently at record levels, as companies are taking a more cautious approach to drawing down debt. All this caution means that the time taken to complete deals inevitably takes longer.

“People now do really full credit checks and due diligence,” says Warriner. “I would say now a deal can take five to six months to complete, whereas in the good times it might take four to five weeks.”

That isn’t necessarily a bad thing for corporate financiers, bankers and lawyers who charge fees according to hours worked.

But the extra caution among companies for doing any kinds of deal at all means that such advisers really have their work cut out for them.

“It used to be the case that you could just send around an information memorandum to get people interested in a deal,” says Mayo.

“Now you have to target buyers much more, and understand what they are after. The process is much, much more front-end loaded.”

But evidently some of this activity is paying off, because it would be wrong to say that no deals are being done. Stuart Warriner, for example, has done four major ones this year.

These included an MBO at dried food manufacturers Symingtons which provided an exit for Bridgepoint; advising Humberside Airport on its acquisition by Eastern Airways, selling Marks & Spencer suppliers Quantum Clothing to Japanese firm Itochu; and helping car parts distributor Andrew Page acquire south of England-based Camberley Auto Factors. Dealmakers note that the activity that is going on is heavily swayed towards corporate.

“The corporate client base in particular has been really active,” says Richard Hunt, a corporate partner at law firm Squire Sanders. “It has identified new targets, and has a very clear direction of activity.”

In fact, he thinks that this year so far has been promising, albeit quiet over the summer period during the Olympics.

Earlier this year he advised 2M, the holding company of Leeds-based Surfachem, on a £25m MBO and on a subsequent bolt-on acquisition.

There is more of a question mark over private equity houses’ activity, with the general consensus seeming to be that, because of banks withdrawing debt, their ability to do deals has been hampered because they cannot rely on the leverage they could take advantage of in the past, and in some cases are having to do all-equity investments to get the deal off the table. But even here there are some who are optimistic.

Ian Marwood from Grant Thornton, who is yet do a deal this year having finished 2011 with something of a bang, says it is just not in the nature of private equity houses to sit on their haunches.

“Doing deals is what gives them a reason for being,” he says. “If you are just looking after a portfolio then you are going to get edgy.”

That’s a sentiment echoed by Andy Ball, one of the founders of North Edge Capital, a new private equity house focused on the north which many dealmakers are expecting great things of in the future.

“If private equity people just sit on their desks and wait for deals to come in they are not going to get a lot of work done,” says Ball, who, like all of the senior management team at North Edge, used to work at LDC.

Although the North Edge fundraising – a global affair led by UBS – was only completed in July, and they have yet to make any investments, Ball says their goals are clear.

“Our model is that we strictly do not over-leverage,” he says. “We are only looking at two to three times earnings. At that level of multiple, debt is still available.”

He claims his team actually wants to seek out businesses that have potential challenges. Immediately after the credit crunch, initial claims that distressed sales would soon become dealmaker’s bread and butter seemed to be scotched as banks tended to hang onto what might be called “zombie” companies.

In the past 12 months here have been some, however – Clephan, for example, advised on the sale of defence supplier Astrum, which had gone into administration, back to its original owner William Cook.

And Dan Renton, a director at Deloitte, reckons many more such opportunities could soon arise. “Distressed sales died off in 2010, but bounced back in 2011-12,” he says.

“These are not bad businesses, just overleveraged, and corporates will buy them.” Endless, of course, has a track record in this area – although Renton now claims there are half a dozen such funds operating in the same market and looking over Endless’s shoulder. Forshaw insists that so far they have not lost deals to the newcomers, or vice versa. But there is a particular new kind of debt-only deal that Endless is particular keen on in the current market.

“There are many businesses out there controlled by syndicates of creditors which are paralysed by disagreements between the syndicate members on how to proceed,” he says.

“We are looking at some of these, aiming to buy someone out of that syndicate and take control by convincing everyone about the direction the business should follow.”

Still, there is no disguising the feeling among all of Yorkshire’s dealmakers that times remain tough. And will do so while the economy remains in the doldrums.

The only way out of that, they say, is for the Eurozone crisis to be resolved, and for some confidence to return to the housing and jobs market. And those are two factors that are well out of their control.