Fewer Insolvencies for More Opportunities

At the end of 2021, corporate bankruptcies (for most company sizes and in most sectors) were at their lowest level compared to the pre-COVID-19 figures from 2019, with a 50% drop in insolvency proceedings and a 10% decrease in pre-insolvency situations. This was largely due to the temporary impact of government emergency measures and support, including:

  • regulatory changes modifying the characterisation of insolvency;
  • measures providing cash flow assistance (French State-backed loans, solidarity funds, etc); and
  • tax and employee-related measures/payment extensions (partial activity scheme, moratoria, etc).

However, the current economic cycle is quite unusual. Some companies are over-leveraged, while the financial markets are in turmoil and more and more investors are attracted to the high-yield debt market. This trend offers new perspectives on both the debt and equity markets. In fact, most of the major deals in the restructuring market have involved a reorganisation of both debt and equity.

These trends highlight that a restructuring process requires more than just dealing with debt; it now also requires a holistic and thorough restructuring of a company's balance sheet. In France, "loan-to-own", "lender-led" or "debt-for-equity swaps" are no longer extraordinary practices but are increasingly being considered as the most efficient and effective way to deleverage a company's balance sheet while providing for new streamlined governance structure.

Far beyond the traditional restructuring and insolvency paradigms, this crisis has highlighted the need for multidisciplinary, timely and targeted action involving a deep reshuffling of the often complex equity and debt structure.

Accordingly, the restructuring practice is shifting from emergency liquidity treatment through consensual negotiations and covenant resets to sector consolidation driven by distressed M&A activity, complex lender-led transactions and increased shareholder activism.

Whilst other company-led recovery strategies are possible for financially vulnerable targets (eg, share capital increases or bond issuances), depressed market valuations and lower competition levels allow investors to create synergies, acquire a new product line or establish themselves in new geographical areas.

Finally, this pandemic has inevitably acted as a real wake-up call for some sectors and industries, which need to reset and completely reshape their supply chain. It has also provided an opportunity to reassess partnership models and the possibility of growth through M&A activity. The themes of discounting, green and environmentally sustainable strategies, cost rationalisation, digital acceleration, industry consolidation and corporate innovation should be afforded the highest priorities.

To mitigate the overall damage of this health crisis and ease company recovery, there will be important and vital choices to make: who is the better equipped – existing or new partner-investors? And what strategy, models and organisational changes should – or should not – be pursued?

Market Outlook and Expected Timeline

In the meantime, the pandemic brought forward an unprecedented economic downturn. A reduction in business activity left many European companies heavily indebted and suffering substantial reductions in profitability (primarily as a result of the significant market disruptions during the pandemic); some of those businesses are facing enduring or even permanent changes to their economic environment.

In addition, there are concerns regarding the soaring price of raw materials. These increases, which cannot always be absorbed by a corresponding increase in sales prices, may put pressure on companies’ cash flow, forcing them to fully draw down on their French State-backed loans (if available), or even to use supplier credit and/or extend payment terms. If high(er) prices persist beyond the end of the year and into 2022, it is likely that margins will be negatively impacted, hindering financial recovery and potentially even compromising the survival of certain companies.

As a result, many European companies are likely to be insolvent (or on the verge of insolvency) when the public support measures are withdrawn. A return to more normal levels of financial restructuring and insolvency activity is expected as these measures are scaled down, or even an acceleration of activity mid-2022. This is because substantial amounts of French State-backed loans will become repayable in March 2022; combined with the French Presidential election due to be held in May 2022, it is reasonable to anticipate an acceleration in restructuring activity starting in spring 2022, with a steady flow of restructuring transactions in the following 18-month period.

The recent reforms to the French restructuring legal framework (resulting from the implementation of EU Directive No 2019/1023 of 20 June 2019 on preventive restructuring frameworks), amongst other things, have rebalanced the rights between different creditor groups, and are expected to also help distressed or special situation investors to become more comfortable with the French legal framework and generate more activity (ie, the end of a shareholder-friendly legal framework, which discouraged some foreign investors).

Target Distressed Sectors

The busiest sectors for insolvencies recently recorded in France were retail (eg, Camaieu, Vivarte/La Halle, Celio), consumer products (eg, Office Depot, Groupe Ales, Agatha), media (eg, Ymagis, Technicolor, Solocal, Mars), transportation (eg, Eurostar, Hertz, Corsair) and oil and gas (eg, Vallourec), whereas data for the rest of Europe shows that food and beverages was the busiest sector (alongside retail, consumer products and oil and gas).

Non-digitised retail and consumer product players and commercial real estate groups will continue to be heavily affected. Industrial sectors are also likely to be affected in the near future due to raw material shortages and higher energy costs, which will have a real impact on the market and its participants.

Growing inflation will also have an impact on certain sectors (eg, tech) and can hasten debt reschedulings and financial restructurings. Shareholder activism is also fast becoming an area of focus for stressed or underperforming listed companies, creating opportunities for both defensive and offensive strategies and tactics by distressed investors and hedge funds.

This article was first published by Chambers and Partners on November 23, 2021.