Buying and profiting from distressed businesses can be a viable growth option. Firstly, you need a strategy for identifying the right business, and then to make sure you have the expertise on hand to turn it around. After that, you can decide to make a long-term commitment or sell it on for profit.
There are several factors to take into consideration when buying a distressed business. Chief among these is the entry price, which should obviously be as low as possible. Therefore, it would be wise to pay close attention to the remaining asset value, which will help ensure that your overall risk is limited.
Entry price is closely followed by the nature of the company’s distress itself. With this in mind, it’s probably best to proceed with caution where a business in administration has significant management issues or problematic suppliers, as these can often be difficult issues to resolve.
Nevertheless, if you identify cash flow problems or poorly planned debt repayment schemes, these are often two of the easiest problems to solve, if you can plan the turnaround in just the right way.
Finally, it’s worth looking at the potential to turn the company around versus asset stripping or purchasing purely for assets when you are considering buying a business in administration.
Thinking differently
Most investors looking at distressed businesses seek to buy a single company perhaps entering administration but showing great potential for recovery. They may look for shortfalls in the staffing structure, ways to cut back on excess company assets or methods for attracting new clients in order to turn the business around. After that they may look to sell the company on.
However, while this is a logical and sound strategy, Cyrus Investment Management, an investment adviser company based in London, has taken a very different approach to profiting from buying distressed businesses.
Instead of looking for only one business that is either distressed or close to entering administration, Cyrus Investment Management is buying multiple distressed businesses in a particular sector with the aim of amalgamating the newly acquired companies into one larger business.
Peter Schwabach, Cyrus Investment Management's managing director, spoke to Business Sale Report to explain the philosophy: “We’re not looking to exit individual companies. It’s very much turn it into an operating single group that we then exit at a higher premium”.
Investing in Britain
Cyrus Investment Management have created a £15 million investment fund to buy up struggling British start-up companies that make everything from fighter jet ejector seats to helicopter parts and reinforced steel doors for high-security hangers.
Schwabach explains what to look for in potential companies: “Key to all this is the entry price. The advantage of coming in at the point of administration, liquidation or distress is that you essentially limit the downsides. What we want to do then is get the benefit of synergies with other of our businesses. So we’re able to sell a particular product from company A, or company B, and vice versa. And there is a premium paid for larger profitable companies, which equates to the businesses being sold at a higher multiple.”
The precision engineering industry has grown by 10 per cent over the last two years and boasts some 1,500 specialist manufacturers making parts for the aviation industry, although most are small- or medium-sized businesses in danger of going into administration because of volatile markets and cheap imports from Asia.
However, British engineering jobs are increasingly being ‘reshored’ from places such as China and India, which has added £600 million to the UK economy, according to Engineering UK. The industry body said approximately 10,000 new jobs have been created over the last two years.
Some 15 per cent of British manufacturers brought production back from overseas in 2015 alone. So there really is no better time to explore investment opportunities in the UK’s precision engineering sector, which has already proved profitable for Cyrus Investment Management.
Retaining skilled workers
The investment adviser also places heavy emphasis on saving skilled engineering jobs, rather than gutting the businesses and shedding employees. For example, Cyrus Investment Management saved around 100 jobs when it bought FGP Precision Engineering, which manufactures parts for aircraft and nuclear power facilities, after it went into administration in 2015.
Schwabach explains: “A key driver for our investors is that we grow businesses. When you bring almost the entire workforce back, you have motivated people and it re-energises the business. It’s not in our DNA to strip companies because you don’t necessarily save a business like that. We are mindful of the fact that we have an obligation, where possible, to create jobs rather than take jobs away. If you have a good business and they’ve handpicked people over the last five years, then replacing them is almost impossible.”
The investment in FGP Precision Engineering was made as part of its first fund, which closed last year, and Cyrus Investment Management have grown the company’s value by nine per cent within the first six months. In addition, the investment company fund also bought Rhino, a defence and security firm, which makes giant steel doors that are used in secure aircraft hangers.
Schwabach said the fund could compete with cheap imports from abroad because it only invests in "high-quality, ultra-specialised firms”. The reasoning here being that precision engineering goods cannot be reproduced at scale, require meticulous testing and they are bought by companies, such as Airbus and Boeing, where a supplier’s reputation within the wider industry is everything.
Schwabach added: “We’re not interested in mass-produced products, but companies that make high-end components or offer a highly skilled service.”
The amalgamated company then uses the strengths of the acquired businesses to provide parts, research and manufacturing expertise to major aircraft brands such as Airbus and Boeing.
It should be noted, however, that Cyrus Investment Management often opts to grow acquired businesses organically. This means focusing on building up the profitability of the acquired company before looking at buying the next one.
The key take-away is to do your due diligence to accurately determine why the target business is distressed. Also, be sure to question your strategy for turning the company around. Without these questions answered, an acquisition may not necessarily be the smartest course of action.
Exit strategy
Cyrus Investment Management also provide a lesson in profitable exit strategies. When the time comes to sell, the investment adviser often looks to overseas buyers interested in purchasing larger businesses in the UK precision engineering sector. With the strategy to consolidate all growth investments and assets into a single entity, Cyrus Investment Management hopes to provide improved sales, profitability and net asset value at exit.
Mr Schwabach explains the appeal of consolidated companies to foreign investors: “When exiting these businesses you have, for instance, ten or 12 businesses with a turnover of say £10 million each, then you have a business of at least £100 million and that’s obviously going to be of more interest to international trade buyers and investors.”
Commenting on Cyrus Investment Management’s previous fund, Schwabach said: “We believed that there was value to be made in acquiring businesses, either out of administration or ones in distress, and that we would essentially be able to turn those businesses around.”
As for advice on what investors in distressed businesses should look for, Schwabach concludes: “We tend to look at businesses where the problems are primarily financial, rather than based on poor product or poor management. And where the problems are financial, we have the expertise to bring in capital at a low cost. We make up for the fact that lots of engineers are brilliant engineers, but they’re not great financiers.”
Cyrus Investment Management’s approach shows one of the many ways to approach buying distressed businesses, turning them around and selling them on for profit. Regardless of your approach, however, it’s key to make sure the entry price is as close as possible to the value of the target company’s assets, and to consider asset stripping or purchasing purely for the assets as other viable options.
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