HomeInterviewsRestructure your business early and often, not when it’s too late
By Hadi Khatib
October 14, 2022 9:21 am

Restructure your business early and often, not when it’s too late

PwC: Where your cash goes determines where your business is heading
Mo Farzadi, Partner, Business Restructuring Services Leader, PwC Middle East

Large enterprises didn’t get that big or profitable by not doing several things right. But sometimes the simplest things can result in these companies’ undoing.

The thing is, sometimes, size gets in the way. Companies start to falsely believe they can venture into non-core businesses or foreign territories, simply fail to check which business units are consistently experiencing negative cash flows or neglect to recognize what legacy systems need to be overhauled or sold.

To delve further into these critical issues, Economy Middle East interviewed Mo Farzadi, Partner, Business Restructuring Services Leader, PwC Middle East, who has more than 19 years of experience in leading complex, financial advisory mandates in Europe and the Middle East, with 12 of those years in the latter.

Our discussion about distress-causing factors started with the issue of cash.

“It’s important to look back at the pre-pandemic period when businesses in our region were dealing with less than best-in-class capital management, liquidity management, and cash culture practices,” Farzadi said.

“A cash culture then was not a priority. Most businesses were looking at growth, top line, profitability, and PNL, instead of focusing on liquidity matters which, if ignored, can become drivers for business failure,” he added

The need for a cash culture


Covid-19 shone a spotlight on liquidity, working capital, supply chain and localization when businesses suddenly experienced a halt in orders and foot traffic.

“After an initial survival period during the pandemic, many companies have now taken steps to improve and support their working capital and embed a cash culture,” Farzadi said, but cautioned: “We still have a lot of room for improvement when compared to more mature territories and markets.”

He explained that the most common challenge with PwC clients – usually large enterprises, governments, or GREs –  was that they perceived cash, liquidity, and working capital matters as functions that reside within the finance team, or the CFO.

“That’s not the case. If during a commercial activity, such as payment terms with suppliers, the operation is not in line with the company’s working capital cycle, that action will already put the business in a difficult position. The finance team will simply be a recipient, rather than an active player, of key decision-making outcomes within Ops,” Farzadi said.

“As such, embedding a cash culture within all layers of the business, from finance to the commercial side of the business, as well as Ops, is critical, and when done right, would really add value to the business.”


Funding for the wrong reasons


Most businesses, from inception and all the way to growth and beyond, require external funding or debt, which historically is a cheaper source of funds than equity.

In a corporate environment where you have proper governance, funding will likely always be used for the right reasons, be it geared to expand a factory by another 20 percent as part of CAPEX or to build new staff offices.

“But one of the issues we see is around the mismatch of funding to assets, i.e. short-term borrowing to fund long-term assets,” Mo said.

He explained that businesses can have huge overdrafts and revolving working capital facilities in the billions of dirhams or Saudi riyals that have been used to buy long-term assets like real estate.

“Although these facilities may have expensive repayment terms, banks will not object especially when companies are able to return credit facilities on time. But that becomes a big challenge when market conditions change or if the values of the assets that those funds have been used to purchase them drop,” Farzadi said.

Not sticking to core business


Another related issue for businesses that struggle is when funding is used for buying non-core assets or expanding to new unfamiliar geographies.

“I had a client in the MEP contracting sector who was very profitable but for some reason decided to take on the role of main contractor and paymaster in Saudi. Initially, there was a lot of positivity around what projects they won,” Farzadi said, “and that was the reason for the company’s downfall because it lacked the expertise to operate, wasn’t able to meet the terms of the contracts, and was met with geographical challenges in the new territory it was in.”

Weak corporate governance


One of the common and main causes of business distress and failure is weak corporate governance where management fails to pick up on issues and warning signs early on.

“Corporate governance means having a proper and qualified board in place to then select a qualified management team empowered to make proper business decisions. It’s also about having the right hierarchy on who can sign and make decisions in a seamless manner,” Farzadi said.

Farzadi added that he worked with exemplary family-run businesses in which the head of the family holds the chairman or vice chair position, but in the presence of a proper structure with the right CEO and CFO placed in strategic leadership positions.

Farzadi warned that any dilution in corporate governance is a recipe for disaster.


Performing and underperforming business sectors


Farzadi said that in October PwC Middle East would publish a more detailed analysis and results of its annual working capital survey, with initial indicators showing that, compared to 2021 Covid-related struggles, retail, and consumer segments, along with transport and logistics, had shown great improvement on the working capital and liquidity side.

“However, the construction and contracting sector continues to be challenged. For various reasons, one of the underlying reasons comes down to contractors not being paid in a timely fashion by paymasters, these often being huge development companies,” Farzadi added.

“Contractors get squeezed from the top and their profit margins are already very thin, usually in the 5-6 percent range. All it takes is one challenging project to undo the profitability for the current year, the one before it or even going back three years.”

Farzadi said construction was a business that needed to be managed very carefully, adding that UAE contractors continued to have challenges in the sector, even as many in this field learned how to deal or pre-empt those situations in a favorable manner, or exited the sector to avoid them altogether.

What companies look for: Sustainable value


Farzadi said that PwC clients, specifically the C-suite, board members, and CEOs, are always interested in sustaining a long-term value proposition by asking questions around three areas:

  • Growth and value enhancement
  • Value preservation
  • Funding

In growth and value enhancement, clients ask PwC: Where can I grow? Should I diversify or not from my core business? What is my diversification strategy and what should my approach be? And can I tap into new markets and sectors?

In value preservation, PwC encounters questions like: What do I do with legacy non-performing assets? How do I manage these? Do I sell them or shut them down? How do I optimize my existing operations? How do I use digital tools more efficiently and effectively?

And, on the funding side, the questions PwC clients ask are: How can I deploy capital from an equity and debt perspective to manage my working capital more efficiently? Should I access pools of capital outside the region that might be more cost-effective or have fewer restrictions?

“Every single challenging situation creates an opportunity for businesses to come out from it leaner, more profitable, and better managed,” Mo said. “We advise our clients to conduct a full evaluation of their existing business portfolio, starting at the top, and look at areas like funding, cost, and performance, with a strategic review from a growth perspective,” Farzadi said.

Depending on the size of the company and the depth of investigation, this process could take anywhere between two to six months.

Farzadi also referenced PwC’s three Cs: character, capital, and capacity, and stressed the need for each portfolio company to really understand under those three Cs what their character is, what their capital requirements are, and what capacities they have or need.

“Companies need to know the cash flow of each business portfolio company at both the individual asset level and the consolidated level, as well as its contribution to business growth, and identify optimization areas like corporate and capital structure, financing and working capital,” Farzadi said.

“This allows companies to understand the areas they want to strategically focus on, what their capital and funding requirements are for that growth, where the cash cows and cash generative assets are, and what are the things that are pulling the business back from funding and liquidity perspectives,” he added.

Sometimes, Farzadi said, a profitable company would have a few business units generating two or three times as much cash as the entire group at a consolidated level, while the rest of the cash flow would be burned by perhaps legacy businesses that were generating negative EBITDA (earnings before interest, taxes, depreciation, and amortization).

“Newer ventures that are in the investment stage always burn money, and need funding and loss-making years, but legacy ventures and businesses need closer inspection to decide on whether to shut them down, turn them around or sell them,” Farzadi said.

Restructuring: A question of when


Farzadi said a restructuring effort should not take place when companies are in trouble.

“Restructuring should not be a reactive measure. We think businesses should use it as a proactive measure when their businesses are absolutely healthy, allowing them to make decisions early and remain in control of their processes and portfolios, and then decide what to do with assets and debt positions with external stakeholders,” Mo advised.

“A lot of distressed businesses, facing breached governance or cash flow issues, come to us late in the game when solutions and options are limited. Coming early allows for making better choices such as selling non-core assets and using funds to improve other parts of the business.”

Finally, Farzadi, who leads a team of 40 professionals on a day-to-day basis, said PwC was very cognizant of the delicate nature of their operation, always conducting it in a manner that was not disruptive to employees or day-to-day operations.

“Having inside knowledge of where challenges are, and seeing us as solutions providers to help turn around the group, employees are often very supportive of our activities and ultimate goal of securing the survival and prosperity of the overall organization,” Farzadi added.