Radical Value Creation: Case Study of a Successful Middle Market Turnaround
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1 Abraxas Group www.abraxasgp.com Radical Value Creation Case Study of a Successful Middle Market Turnaround Date: June 28, 2016 David Johnson Interim Executive (CRO, COO, CFO) Restructuring and Turnaround Advisor
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Transcript of Radical Value Creation: Case Study of a Successful Middle Market Turnaround
1Abraxas Group
www.abraxasgp.com
Radical Value Creation
Case Study of a Successful Middle Market Turnaround
Date: June 28, 2016
David JohnsonInterim Executive (CRO, COO, CFO) Restructuring and Turnaround Advisor
“If you want something new, you have to stop doing
something old”
‒ Peter Drucker
Abraxas Group
www.abraxasgp.com2
• David Johnson is a career change agent who has served as interim manager or financial advisor on over $5 Billion of distressed middle market transactions.
• In his nearly 20 years as a change agent, David has served as an advisor, board member, interim manager, investor and operator at organizations ranging in size from pre-revenue startups to Fortune 500 organizations.
David Johnson
Abraxas Group
www.abraxasgp.com3
Email: [email protected]
Ph: 312-505-7238
Twitter: @TurnaroundDavid
Overview
• In the summer of 2015, a $160MM construction company was undergoing an accounting restatement, placing the company in default of loan covenants on $100MM of debt facilities.
• The company’s owner, a middle market private equity firm, appointed a new CEO in July 2015 with a mandate to lead a turnaround of the company.
• On July 31, David Johnson was retained to provide finance leadership in the turnaround, and shortly thereafter was named Interim CFO.
Abraxas Group
www.abraxasgp.com5
Company begins to miss financial targets, leadership fails to assess root causes and the decline continues
Downward Spiral
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Leadership sets increasingly aggressive targets, focus is on a single contract or quarter to turn things around
Decline becomes evident to outside stakeholders
Lenders press for a fire sale or liquidation process
Underperformance
Envelope Pushing
Severe Business Erosion
Fire Sale / Liquidation
Companies in distress tend to follow a similar pattern, the goal of any turnaround is to provide a sharp and
definitive break from the downward spiral
• The new leadership team had a number of challenges to deal with immediately:
– Capital structure (financial sponsor and lenders highly uncertain)
– Toxic relationships with key customers
– Communication breakdown with key material suppliers and subcontractors
– Plummeting morale
Challenges
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Hit the Ground Running
• August and September saw the new leadership team absorbed in a number of issues critical to the survival of the company:
– Lender Relationship. As a result of the company being in default of its loan covenants, lenders were insisting on formalizing a Debt Amendment Agreement. Absent support (even reluctant support) from lenders, the company would not be able to execute on a turnaround plan.
– Mending Fences. Confidence in the company was low, both internally and externally. Customers, vendors, and staff were confused, angry, and scared, sometimes all at once. Leadership needed to get out with a new story for why the turnaround could work.
– Building a Team. Prior management had lost all credibility, and by July senior leadership had been fired. The new leadership team was being assembled in real-time as the issues facing the company continued to multiply.
Abraxas Group
www.abraxasgp.com9
Lender Relationship
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Reporting Cadence Normal Course Workout
Quarterly Quarterly Covenant Compliance and Borrowing Base Certificate
N/A
Monthly Monthly financial results Covenant Compliance, Borrowing Base Certificate, Monthly financial results
Weekly N/A Rolling 13-week cash forecast, weekly variance analysis, general update
When a company is placed into workout by its lenders, the focus shifts from one of a collaborative partnership focused on growth to one of risk management and downside protection.
This is a shift from “grow together” to “get out whole”.
Companies in workout should never lose sight of this change.
Customers
• Key customers were losing faith in the company’s ability to execute
• Revenue was down, litigation expenses were up
• Customer complaints were not being addressed
Vendors Staff
• Critical Material Suppliers and Subcontractors were frightened that the company would fail
• Vendors were accelerating payment demands
• General managers were overwhelmed
• Inside the company, formal communication channels had broken down
• A sense of fear and resignation prevailed
• Rumors were everywhere, and morale was falling
Mending Fences
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Building a Team
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Position New to Company? New to Role
CEO Yes Yes
COO No Yes
CFO (Interim) Yes Yes
Vice President, HR No Yes (role expanded)
Head of Sales No Yes
Corporate Controller No Yes
General Managers (7) No Yes
The company’s leadership was remade beginning with the appointment of a new CEO in July 2015.
The leadership team, composed largely of existing staff elevated to leadership, were energized to drive the turnaround, and outperformed the expectations of all outside observers.
Now Prove It
• Entering Q4 (Oct – Dec), the company had addressed legacy issues, and bought some time with lenders.
• Nonetheless, the factors weighing against the company were considerable:
– Calendar. Q4 was going to be a make or break quarter for the company, but all were aware that Q4 was traditionally the weakest quarter of the year.
– Stakeholders. Relationships were at a fragile point in October 2015, with many inside and outside the company taking a “wait and see” approach to the turnaround.
– Liquidity. The company had a severely constrained liquidity position, and the agreement negotiated with lenders had provided only modest relief.
– Potential Fire Sale. Lenders had insisted on the retention of an investment banking firm to run a “dual track” (sale or refinance) process, with a deadline of a completed transaction by June 15, 2016.
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• The company rapidly began showing improvement in both revenue and gross margins.
• Revenue growth. Core customers reengaged after meeting with new leadership, leading to strong revenue increases.
• Gross margin expansion. A focus on costs allowed the company to execute “better, faster, cheaper”.
Performance Improvement
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128.4 126.1139.3
114.2 109.9 110.3 106.1112.8 108.0
Revenue Trends
Rev Baseline
148.7 164.6 166.6
176.9
154.7 138.2
150.5 140.2
179.9
Gross Margin Trends
GM % Baseline
(July 2015 = 100.0)
Customers
• Leadership focused on meeting with key customers, to apologize and reset expectations
• Workable releases increased, and the turnaround became a growth story
Vendors Staff
• Key vendors were contacted, and payment plans were negotiated where necessary
• As the company made good on its commitments, vendor relations quickly normalized
• Employees noted the common sense changes and they quickly bought in
• Sensible RIFs, clear communication, and savvy promotions signaled a break with the status quo
Rebuilding Trust
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• It was immediately clear that a substantial improvement in cash management would be necessary to fund the turnaround.
• Weekly cash reporting was initiated, and disbursement controls were implemented.
• Absent these improvements, the company would have had insufficient liquidity and a fire-sale would have been the only option.
Cash Management
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Cash Management (Cont.)
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82.187.5
78.888.1
94.5
70.8
58.8
78.5
64.5
Days Sales Outstanding
DSO Jul15 Value
(July 2015 = 100.0)
$9.2 $6.4
$7.9
$22.1
$9.8
$14.6
$24.3
$7.9 $10.0
Cash Flow Impact from Improved Collections
CF +/-
($ millions)
Special Projects
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Turnaround situations give rise to enormous workloads on the accounting and finance function.
At this company, there was the added handicap of a deficit of institutional knowledge (due to 100% turnover in the corporate finance function).
Project Name
Debt Amendment Agreement Negotiations
Development, Implement and Oversee Cash Management
Support Working Capital Field Exam
Support Fixed Asset Field Exam
Sales & Use Tax Analysis
2015 Audit
Five Year Forecast
2016 Operating Budget
Flash / Three Month Forecast Revamp
Backlog Analysis
Insurance Renewal
Misc. Policies & Controls
Month-End Close Process Revamp
New Accounting System Rollout
Sale/Refinance Process
Support of the Business
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Function Points of Contact Nature of Support
Strategy CEO Strategic plan development, change management
Capital Structure CEO, Financial Sponsor Scenario testing, forecasting
Operations COO Collections, vendor relations,capex priorities
Sales Head of Sales Market intelligence, reporting for licensing submissions
HR / Admin Vice President, HR Insurance submissions, IT issues
In addition to managing the one-time items tied directly to the turnaround of the company, as Interim CFO
David also had considerable responsibilities for supporting the business during his tenure.
Testing a Hostile Market
• In January 2016, with the high-yield market in the throes of a “risk off” spasm, the company’s investment banking firm contacted prospective capital providers.
• By this point the company had logged only one solid quarter of post-turnaround performance (Q4), and expectations were low.
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Dual-Track Process
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Through the diligence and connections of a well-respected investment banking firm, the company was able to reach out to a broad cross section of prospective capital providers.
The benefit of this approach, in addition to creating tension among multiple bidders, was in speaking with prospective investors with widely divergent risk tolerances.
For the 9-month period Aug15 – Apr16, the company saw a 76.8% YoY increase in EBITDA.
With each month of outperformance, the company’s value increased.
Robust Profit Recovery
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EBITDA (Aug 14 – Apr 15)
Change in GM ($)
Change in SG&A
All Other Changes
EBITDA (Aug 15 – Apr 16)
100.0
45.56.6
24.7 176.8
Values Common-sized with Aug14 – Apr15 EBITDA = 100
Sale
• Offers recognized value created in the turnaround, with substantial equity value for sponsor
• Immediate pay-off of lenders and realization of investment gain for sponsor
• Validation of new leadership team’s accomplishments
Refinance
• Offers allowed company to continue generating value for current sponsor
• Successful exit for incumbent lenders and responsible capital structure moving forward
• Opportunity for leadership team to continue to execute on 5-year plan
Optionality
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The company was able to refinance its entire capital structure, and beat the June 15, 2016 maturity date by one day.
New Capital Structure
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Sep15
Senior Debt
Jun16
Subordinated Debt
Keys to Turnaround Success
1) Runway. Diligent cash management allowed the company to fund normal operations through an intensive sale/refinancing process.
2) Performance. For the 9-month period of Aug15 – Apr16 the company saw the following YoY improvement:– Sales: 9.8% increase
– Gross Margin ($): 20.1% increase
– SG&A: 5.1% decrease
– EBITDA: 76.8% increase
3) Team. A cohesive team, encompassing staff, new leadership, as well as outside advisors, were able to work together, overcome constraints, and in the end drive considerable value creation.
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Bottom Line
• In July of 2015, most of the lenders to the company would have been happy to get out whole, implying no equity value for the company.
• In choosing the refinancing option, the company’s financial sponsor turned down offers that implied a doubling of enterprise value (>$70MM increase in equity value) over 11 months.
• Not only was radical value created, but all involved (new lenders, financial sponsor, leadership) were in agreement that the company had become a platform for further value creation in the years to come.
Abraxas Group
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Radical Value
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$0Equity Value in July 2015
>$70MMEquity Value Increase
11Months of Turnaround
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