Capital Markets in the COVID-era: key considerations for companies and their investors

by James Isola | 4th May 2020

How to keep shareholders informed during the pandemic? Will AGMs ever be the same again? When will distressed M&A start? And why is private equity sitting on the sidelines.. for now?  Maitland/AMO partner James Isola put these questions to Slaughter and May’s capital markets experts David Johnson and Christian Boney.

  1.  How to update shareholders in this environment?

Market rules and standards apply – even now.  The FCA is vigilant – it is contacting companies and their brokers when it sees share price moves/rumours to ask ‘is there something to announce?’. Companies need to provide timely information but avoid a running commentary. Initially, companies couldn’t quantify the impact on earnings and withdrew earnings guidance. Now we are seeing more details and whether they are tapping government schemes.  The focus is on liquidity so banking covenants and maturities are key.  Some companies have guided the market on cash burn rates.

  1. Companies have cut dividends. What about executive pay?

Many executives have voluntarily waived or deferred salary/bonus.  Companies are also wary of LTIP awards based on a very low share price – but most have gone ahead while pointing out the discretion most schemes have for scaling back if needed. But things are evolving. The Investment Association says that shareholders expect remuneration to reflect the experience of shareholders, employees and other stakeholders.

  1. We’ve heard all about ‘Going Concern’ opinions- why is ‘material uncertainty’ also a worry?

Many calendar year end reporters got their 2019 results signed off ahead of lock-down with no particular problem regarding ‘going concern’.  But now we are seeing issues with subsidiary accounts sign-off and will soon be into issues for companies with March year-ends.  The FRC and the FCA have suggested a delay to signing-off accounts, but this ignores reporting requirements in many debt instruments that will trigger default if accounts are not finalised promptly.  For companies with going concern challenges, accountants are tending to include a “material uncertainty” disclosure – this falls short of a qualification (which would trigger debt defaults) and is linked to downside case projections triggering a covenant breach at a subsequent quarter end.

  1. Will COVID kill off the traditional company AGM?

Few companies relish the time and cost a normal AGM takes! We’ve seen a switch to closed meetings of two people only, supported by UK Government guidance.  Practice is mixed on whether some form of webcast or conference call facilities are being offered – and it seems largely to depend on the size of your retail shareholder base and the attitude of your board. Will we see a long term switch to virtual meetings? There’s more traction in the US, but the only UK example is shoemaker Jimmy Choo in 2016.  Institutional guidance is currently against virtual AGMs – their concern centres around shareholders not being able to hold directors to account; Other impediments to virtual AGMs include reliability (shareholders must be able to participate throughout – and be able to hear, speak and vote), the cost of the technology, and ability of shareholders to access that technology.

  1. Why has it been so hard to invoke force majeure in this pandemic?

We have seen “can’t pay, won’t pay” style negotiations as companies seek to cut costs by renegotiating contract terms.  Companies have also been looking hard at force majeure clauses. Legally, these clauses are all different, but it has not proved easy to fit the current crisis into the force majeure provisions.  You have to show a sufficient degree of causation and often a disproportionate effect on the relevant business.  If a force majeure dispute reached the courts, they would look negatively on anyone seeking to obtain a commercial advantage from the current crisis.

  1. Debt financing- how helpful are lenders being?

We are seeing a combination of extended maturities, covenant waivers and/or increased headroom.  In general banks are sympathetic to the first two of these – they have no interest in enforcing on loans right now and are encouraged not to by government.  Banks are suggesting shareholders should be approached for equity.  In certain circumstances companies are looking at alternative debt sources (e.g. PIPEs) or hybrid capital.  Pricing however is eye watering.

  1. What do lenders want in return?

They want cashflow/earnings models and enhanced monitoring.  Dividends are also being restricted.  Banks are also seeking waiver fees in some cases – between 10 and 20 basis points is the normal range.  Banks are preferring to flex coverage ratios and also limit the period for which they apply – “we’ll get you through the next few months, but come back and talk to us again after that”.  Some companies are turning to equity to “take debt off the table”.

  1. We’ve seen a trickle of equity fundraisings- will this become a flood?

There has been a focus on equity financing options for businesses with little alternative given their existing leverage.  Some have also been pushed in that direction by banks as a quid pro quo of covenant waivers/extensions.  At the start of the crisis (pre-lockdown) companies sought to raise equity quickly by way of a non-pre-emptive placing.  This limited the size of issue to 10% given institutional guidelines and with a rapidly falling share price many companies felt that this would not raise enough money. The next stage was prompted by a combination of share prices stabilising and institutions accepting non–pre-emptive issues of up to 20%.  Now we expect larger equity issuance towards the end of May/June.  That gives companies time to prepare the prospectus for a rights issue and will allow a preliminary picture of what the return to normal is starting to look like. The desire to “take debt off the table” is strong as the road to recovery will be bumpy.

  1. M&A- can you wriggle out of a deal?

M&A activity unsurprisingly has been hit during the crisis.  The biggest issue is valuations. How can you tell the right price is for a business? Financing is also tricky.  Many deals in the course of negotiation are paused or being abandoned.  For deals between signing and closing, there is speculation about renegotiation or termination.  The market’s move in favour of sellers in recent years means that most MAC (‘material adverse clause’) protection for a purchaser is not triggered by Covid.  So buyers are looking at other conditions such as regulatory clearance as a way out. Of course sellers are alive to this and focusing hard on purchasers’ compliance with promises to get the regulatory process done – so watch out for litigation.  Some purchasers simply may be unable to fund at completion.  They may simply copy tenants’ “can’t pay, won’t pay” approach to trigger renegotiation. As for future activity, it will come for sure, but not yet.  We need valuations to settle and financing to come back on stream.  We need a return to some kind of “normal” so that the weak and strong can be identified and consolidation ensue.

  1. Where is private equity in all this?

Private equity is biding its time.  They are engaged in stabilising their own portfolio companies and are conscious of the political risk of preying on weak businesses at the very moment they are lobbying government for help with their existing investments.  Activists also very wary of managing their reputation.  They look back on the financial crisis and the reputation damage suffered by banks. Distressed M&A will come, but Q4 2020 is the timing.

  1. Looking ahead – what happens as we leave lockdown?

The great unknown. The first hurdle is companies getting back to something close to normal operations and the route out will be more difficult than the route in.  Businesses will be very cautious of how they get back to normal – take a restaurant, pub or cinema chain for instance.  You may be allowed to open, but once you do your landlords will demand full or increased rents, you will need to bring employees back from furlough, social distancing may limit capacity and, in any event, will anyone actually want to go out into a crowded environment.  So what do you do? The crisis will be an opportunity for businesses to look at their operations and cost base and make hard decisions.  Expect business contraction before growth returns.

 

 

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About the Author

James Isola

jisola@maitland.co.uk

A former financial journalist with Bloomberg News, James focuses on advising financial services clients in sectors including asset management, private equity, hedge funds and activists. He also specialises in providing media and presentation training for clients

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