Contemplating life after leverage

The sector’s relative journey to a new spiritual world – the life after leverage world – has begun. As companies in the eating and drinking-out creak under the weight of too much debt, a number are now known to be actively engaged with accounting and restructuring firms. They are trying to establish a way forward – most operate sound businesses with unsound financial structures. Under the expectation of what we now know were unrealistic growth assumptions, they were saddled with too much debt. In the past few days it has emerged that Paramount Restaurants, the operator about 80 restaurants including Chez Gerard, is reviewing its financial structure. The insinuation is that surgery is required. CEO Mark Phillips told M&C: “We are in discussions with both our lenders and backers to make sure we are appropriately funded – the existing structure is not ideal.” The group has debt of about £120m although only about half is “performing”, with the rest deferred to when private equity backer Silverfleet exits. But with £60m of active debt, Paramount is likely to face annual interest charges of somewhere between £3.5m and £4.5m. Asked if Paramount was among the first mover on the debt issue, Phillips says: “Possibly, but it is no more than what many other companies will be facing and considering.” In the travel space, it transpired that SSP – the operator of food and beverage outlets in airports and train stations – was in talks with its syndicate of banks, who in turn have asked Ernst & Young to run an eye across the books and business plans. Barracuda is thought to be undertaking a similar exercise and what is certain is that, as Phillips says, many others are at it too. Some suggest there is not a single company that has been the subject of a buyout in the past four years that will not be facing some sort of debt issue. And as we have seen with Premium Bars & Restaurants and some of the leased pub companies, there are also debt issues in the public arena too. It remains to be seen how all this will play out. For some it will be a case of giving the banks a bigger chunk of equity, while some lenders will simply have to take a bath, or haircut, or whatever we’re supposed to call it, accepting that if they are owed a £1 today, they will be owed 60p or 70p tomorrow. Perhaps the unpalatable pre-pack administration process will be deployed some more, as businesses take the nuclear option in riding themselves of loss-making leases. For some companies it is simply a matter of turning off the capex tap, and managing cashflow and costs obsessively. And for a small clutch of companies, there is unfortunately no future. What we are seeing is the first steps on the painful path to life after leverage. Or rather, perhaps more accurately that should be: life after absurd levels of leverage. As President Obama was only re-iterating last week, pointing the finger and issuing recriminations does not help when we’re all trying to solve problems. But what is clear is that the financial structures put in place at a host of companies were not subjected to appropriate levels of stress testing. Gearing up companies to this extent was a punt, against the backdrop of inflating assets and ever-expanding multiples, as buyout groups sought to strike deals with ever-decreasing slivers of equity and ever ballooning levels of debt. Now, to varying degrees, it all needs unravelling. Once the debt is sorted out, the management will be next. For the next big thing after this will be the re-basing of incentivisation schemes, whether it’s private equity backed vehicles or public companies. Investors know that good management teams are going to be in high demand and it will be crucial to make sure everyone is aligned. But for now, after the debt excesses, the focus is firmly on going leverage lite.