An exploration of options available to organizations facing a cash crunch scenario and bracing themselves for oncoming waves of economic challenges
A global economic downturn following the COVID-19 pandemic is inevitable. Malaysia being part of the global economic eco-system will not be immune even if we can successfully navigate out of this healthcare conundrum. The International Monetary Fund (IMF) forecasts the global economy to contract sharply by 3% in 2020, much worse than during the 2008–09 financial crisis. The World Trade Organization predicts that global trade could fall by 13% to 32%, depending on the depth and extent of the global economic downturn. The full impact will not be known until the effects of the pandemic peak. Generally, a 2021 recovery is expected subject to the duration of the outbreak and effectiveness of policy responses in economies across the world.
The Malaysian Outlook
Based on data released by the Department of Statistic, Malaysia has recorded economic growth of 0.7% (GDP) in the first quarter of 2020 – the lowest since the third quarter of 2009. The loss from the pandemic is estimated at RM22.8 billion in economic output growth for the quarter. Other than the services sector which grew at 3.1% and the manufacturing sector at 1.5%, all other sectors recorded negative growth. Private final consumption expenditure in the first quarter of 2020 was mainly on essential products, such as food & non-alcoholic beverage, communication, housing, water, electricity and other fuels. Household consumption has reduced in petrol, travel, recreation, and outside food consumption.
Our tourism industry is one of the first economic casualty of COVID-19. This sector contributed 15.2% to Malaysia’s economy with a value of RM220.6 billion and employed 3.5 million people. 194 other industries are inter-connected with the tourism sector, such as wholesale & retail trade, transportation, food & beverages, accommodation, entertainment & recreation. These industries are badly affected due to the unprecedented decline in occupancy and patronization rates.
Other economic casualties of the pandemic include the manufacturing sector, mining & quarrying, construction and agriculture sectors which are equally affected by the prolonged movement control order, disrupted global demands for Malaysian outputs and volatile global commodity prices.
The Malaysian government has revised the country’s 2020 economic growth forecast to between negative 2.0% to 0.5%, in line with the World Bank’s estimates. An overall economic recovery to pre-pandemic momentum is expected to only begin in months if not years due to lingering uncertainty of potential contagion, lack of confidence, permanent closure of businesses and shifting behaviours of firms and households.
In the charts below, we attempt to illustrate the potential impact of COVID-19 and the possible recovery path of the various industries in Malaysia.
Challenges & Opportunities
The challenges companies are facing in the midst of the unfolding COVID-19 situation range from the downward trend in earnings, strained cash flow, increased supply chain interruptions, financing disruptions and increased health risk in continuing operations. The sooner an organization develops an effective strategy to navigate these adversities the better the chance it has in surviving the global economic downturn.
However, there are silver linings amidst the clouds. It is often facing adversities that one is pushed to find the resolve to implement change that eludes most during better times. For an organization to successfully navigate this difficult time, it will have to vigorously explore all available options and opportunities to preserve shareholders’ value by rationalizing the overall revenue channels/portfolios, identifying and addressing underperforming assets/operations, and most critically restoring cash to balance sheet. In cases where an organization is running the risk of default on payments of loans or trade debts, more drastic measures may need to be considered to avoid actions by lenders and/or creditors.
The options available to organizations may vary depending on the degree of “stress” they are experiencing in the current economic conditions. Amongst others, organizations may consider the following :
Under existing circumstances, the main aim of the operational reviews will be to rationalize existing revenue portfolio and achieve cost efficiency in the midst of the pandemic induced shifts in customers’ behaviours and employees’ expectations. Most companies will undertake cost-cutting as their short-term measure to conserve cash. These measures should not just be focused on headcount, real estate and business support expenses; companies should explore creative ways of cost rationalization by exploring ways technology may facilitate cost reduction. As an example, companies may consider available online resource sharing applications to either derive revenue from surplus un-deployed resources or reduce cost in meeting capacity deficit.
A review of the revenue portfolio may also be undertaken to explore new or alternate ways of accessing new and/or “lost” customers. Companies may have to re-examine the relevance of its current revenue channels, and if the need arises, re-calibre or re-design its business model to meet new market expectations. Whilst doing so, it is crucial that corporate owners and leaders ensure that a balance is achieved in meeting the organization commercial goals and mitigating their employees and customers’ health risk.
Working capital management
Current uncertainties are putting companies through the increasing risk of delayed collections or bad debts. A robust top-down review of the cash management processes to identify improvements or improvisation will need to be carried out. Measures such as reduction of inventories and receivables; whilst stretching payables balances will have to be considered subject to appropriate risk assessment. Working capital management if done effectively may prevent the need to source new capital funding from either the companies’ shareholders or lenders.
Divestitures/closure of business evaluations
Companies may investigate their organization balance sheet to look for ways to bring in the highest amount of cash from the lowest-performing assets. Hard decisions may have to be made to monetize or exit from any underperforming and/or non-core assets. Amongst the monetization or exit strategies which may be considered include; outright sale of assets, injection of assets into a joint venture or (in the case of a product or service line) divestment or closure of the business. In evaluating the course of action to be taken, companies will need to be mindful of related transactional cost such as real property gains taxes, income taxes, stamp duties, professional fees, and where the applicable cost of business closure (e.g. retrenchment cost and cost related to forfeiture of rights or obligations to compensate etc.).
Financing strategy reviews
Companies may undertake a review of their financing strategy and explore ways to more efficiently fund their business operations. Subject to findings of the review, companies may consider refinancing either by way of debt and/or equity; options include: securing asset-based loans, securing mezzanine and subordinated debt financing, securing new equity funding from existing shareholders, securing new capital from strategic partnering, and/or identifying potential merger candidates.
Companies with low gearing ratio and sustainable cashflow may consider increasing their borrowings. Typically, companies will have to demonstrate to lenders their credit-worthiness and bankability of their business to qualify for new borrowings. Companies should also be prepared to provide securities for new borrowings; such as asset pledges, proceed assignments, land charges, directors’ guarantees, corporate guarantees, debentures and/or third-party pledges.
Debt restructuring should be considered especially for companies with a high level of existing debts and high default risk. With the continuing onslaught of COVID-19, many borrowers will face difficulties in continuing to service their debts. Any default will have a domino effect of making it difficult for borrowers to access new loans. The debt dynamics if not managed well may lead to solvency issue for borrowers.
Bank Negara Malaysia has in March 2020 announced an initiative allowing banks to offer deferment of all loan/financing repayments for a period of 6 months with effect from 1 April 2020. Whilst this measure helps relieve immediate cash flow pressure for most corporations, a mid to longer-term strategy will be to critically review the organization’s cash flow based on post-COVID-19 assumptions and engage with banks to restructure the outstanding debt and renegotiate debt covenants. This will enable the organization to stay afloat during the crisis period and its recovery phase.
Borrowers approaching any lenders to initiate debt restructuring discussions should be prepared to demonstrate that their business is viable, sustainable and bankable despite setbacks caused by the pandemic. Borrowers should also be prepared to present a realistic projection of their company’s cash flow performance based on the new reality taking into account repayment of debt owed.
Debt restructuring discussions may involve various stakeholders, namely borrowers, guarantors, lenders or syndicate of lenders, as the case may be. As such it is crucial for borrowers to be aware of key concerns of all parties and be able to drive negotiations toward addressing these concerns. These discussions generally involve debts owed to banks, and any agreement reached will apply to the parties involved only.
Companies facing pressures from their trade or supply chain creditors may consider applying the corporate rescue mechanisms provided under the Companies Act 2016. There are 3 different modes of rescue mechanisms prescribed under the Act, namely :
- Scheme of Arrangement (“SOA”);
- Corporate Voluntary Arrangement (“CVA”); and
- Judicial Management (“JM”).
These are formal debt restructuring mechanisms which involve applications to court; companies undertaking these modes of restructuring may apply for a court order restraining legal actions by its creditors. Any restructuring proposal approved by the creditors within the formal process will bind all creditors of the company.
- Alternatively, companies may consider an informal process of restructuring their debt through the Corporate Debt Restructuring Committee (“CDRC”). CDRC is an initiative by the Malaysian government to provide a platform for corporate borrowers and their creditors to work out feasible debt restructuring without having to resort to legal proceedings. To be eligible to restructure debt through CDRC, companies must have an aggregate indebtedness of RM10 million or more; have at least 2 financial creditors; are not in receivership or liquidation, and are experiencing difficulties in servicing their debts but may not have defaulted on any debt covenants. Companies listed on the Main Market or the ACE Market of Bursa Malaysia that has been classified as PN17 or GN3 company may also be eligible.
Every company will have a different set of drivers which make any or all of the options discussed herein worth consideration, be it an operational review, working capital management, divestiture evaluation, financing strategy review and/or debt restructuring. Some companies may approach the situation on a “survival” mode, others may take a more “opportunistic” approach. A more comprehensive approach is to consider a combination of solutions. Whichever lever the company wishes to activate depends on the company’s leadership appetite for risks and rewards.
A Time for Action
Economic downturns provide both the greatest need and the biggest opportunity to drive change in an organization. What differentiates a successful organization from the others, is how effectively it navigates and rides through adversities.
Whilst it is still unclear when and how the pandemic will be tamed; we can be certain that action is needed now. All companies, even those with a healthy base, need to take action to strengthen their cash position to face the developing COVID-19 crisis. Companies are advised to take a critical and thorough look at the way they operate within their own organization and with others in their business eco-system. Take stock of available resources and networks, and explore opportunities to leverage these resources to re-calibre and re-energize to surf the waves of adversities. And, don’t forget to enjoy the surf!
“Start by doing what’s necessary, then do what’s possible, and suddenly you are doing the impossible.”
Francis of Assisi
Written by Fiona Soh, Director of 27 Capital. Prior to her involvement in 27 Capital, she was attached with RSM Malaysia as a strategic business advisory director and Ernst & Young Malaysia as a restructuring and insolvency practitioner. The views expressed in this article are the writer’s own, and do not constitute nor is to be construed as an advice from the writer or 27 Capital for any purpose or on any specific issue faced by any companies.
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