The overriding priority for most boards right now is hanging in there. But focusing on today at the expense of tomorrow is a bad approach to long-term survival.
When the coronavirus threat recedes, the main factor that will be consistent across the boards that successfully navigate this crisis will be the planning they did in this moment. We believe the key to effective planning will be to develop a broad variety of scenarios over a broad variety of time periods – after all no one knows exactly how long this situation will last.
We also suspect that the conclusion of many businesses on a number of their scenarios will be that an equity raise is in order. If that's the case it will trigger a range of other planning requirements. So where to begin?
Effective boards will have been running some sort of risk matrix and business continuity planning. Most, however, will not have planned for an event of the scope we're seeing now.
Continuity planning tends to revolve around events like losing a building or a server going down. It does not generally consider situations like sending your whole workforce home for months and the government banning gatherings of more than 100.
Yet even at this point in the coronavirus crisis, the scope of what could happen may not be fully clear to businesses. No one really knows how long this pandemic will last. And some players have already pulled their guidance, because of the uncertainty around the impact on their business.
Now a board may look at the company's covenants today and consider they look satisfactory. After all, some boards have been rigorous about enforcing an unofficial ceiling of 2x Net debt to EBITDA ratio. But EBITDA may slide extremely rapidly in coming months and that has to be considered with eyes wide open.
A consistent factor we saw during the GFC was that the downside planning of most companies was far too optimistic. Directors should be careful not to fall into the same trap this time around.
The key will be running a number of scenarios analyses on your forward covenant compliance. Boards need to think not just to the next three to six months – but the next 12 to 18 months.
Campaigns should game out hard equations: if EBITDA falls from x to y, how much does it have to fall before we breach our covenants? The critical point here is that boards and management cannot afford a 'wait and see' approach – planning for multiple scenarios has to occur now.
For each of those scenarios all viable forms of raising capital should be canvassed to ensure the company could continue to meet its funding requirements. It's worth factoring in that banks are going to be inundated with requests, and carrying additional constraints around responsible lending as a result of the Banking Royal Commission.
So given the challenges in sourcing appropriate funding from lenders, we suspect the most suitable course of action for many scenarios will be to look to raise equity.
Of course with so much volatility, it hardly seems like an attractive time to approach the equity markets. But if earnings continue to erode quickly you may well arrive at the conclusion that raising equity is the most appropriate course of action.
If you decide an equity raise is in the foreseeable future that opens up a range of other questions to consider.
There are considerations, for example, regarding underwriting. Would underwriters actually be willing to underwrite? Is sub-underwriting available? What about fees? Can you have a whole rights issue underwritten? Or will you consider underwriting only the institutional component of the rights issue and not the retail part?
That question leads to considerations of sizing. Because if you don’t have certainty of proceeds, you may need to oversize the offer.
Then there are questions of timing. As a range of entities come to the conclusion that raising equity is necessary, we suspect you will not want to be at the backend of the wave. It will likely be congested and investors get “deal fatigued”. There is also the risk that the appetite of sub-underwriters dries up which occurred in the back end of 2018. But this question will depend on a rich variety of factors that will have to be assessed on a case-by-case basis.
One factor, for example, would be that when you decide to raise equity it may mean an obligation to disclose your financial position at that time (especially if you are looking to raise equity before releasing your period-end results.) This creates a real balancing exercise – timing the optimal execution moment against when and what may be required to be disclosed.
Market volatility is also expected to continue for the foreseeable future and windows to tap the market will be short and difficult to pre-empt. Boards that are prepared and have the ability to move quickly will be well positioned to take advantage of these small windows.
So planning for true disaster scenarios and plotting a path out is a key lesson from the GFC. But it is also worth bearing in mind that corporate Australia is in a far healthier position than in 2008.
We have robust equity capital markets, and we're fortunate that post-GFC the ASX standardised accelerated rights offerings and normalised various ways of raising capital.
Unlike in 2008, listed companies can avail themselves of various opportunities to raise money from their shareholders and other investors. For example, accelerated entitlement offers (combined with, or without, an institutional placement(s)) are a well-trodden path and raising capital through institutional placements and SPPs is now more attractive given the SPP threshold recently doubled.
The point is regulators today recognise the need to raise capital quickly in a volatile crisis and there are ways to do that in this market.
Boards should be conscious that while the rush to banks is happening now, the rush to the equity market will come later, with a few exceptions. The impetus for planning is to enable you to move quickly when the moment arrives.
In the meantime, rational and unflinching planning in combination with meaning communications with shareholders is likely to have the benefit of calming investor sentiment and maintaining confidence in the board. In today's crisis environment investors are very likely to assume the worst if they are being met with silence. Come AGM season, shareholders are going to want to hear about your plans anyway.