Debtwire sat down with Mo Farzadi, partner and business restructuring services leader at PwC Middle East, to get his views on the restructuring landscape in the region.
Farzadi said that Middle East companies can use restructuring proactively to address the current headwinds and seize future opportunities through better capital management.
The global economy faces another period of uncertainty in 2023, with many countries expected to face recession and continued inflation, putting pressure on both government and household budgets, warned Farzadi.
How is the Middle East positioned to weather economic headwinds?
The Middle East is in a relatively favourable place to navigate the prevailing global economic headwinds. Continued strong oil revenue is expected to enable higher government spending, acting as a buffer. Nonetheless, higher interest rates, which largely track the US Federal Reserve rate, do present a potential barrier to access to cheap credit.
It is clear from our engagement with the public and private sector across the region that there is still plenty of room for improvement when it comes to putting in place the best capital management structures to cope with possible challenges and to seize opportunities as the Middle East’s transformation accelerates.
While the coronavirus pandemic's unprecedented disruption of supply chains and markets has prompted many Middle East companies to take urgent measures to improve their working capital management and embed an efficient cash culture, there is still work to be done compared with more mature territories and markets.
PwC’s latest Working Capital Study of listed Middle East companies shows that around USD 35.5bn in excess working capital is currently trapped on Middle East corporate balance sheets.
That cash could potentially be put to better use to improve performance in challenging market conditions.
Our experience shows the best time to make restructuring decisions, in order to free up funds and focus on the best-performing parts of the business, is when the company is in good financial health.
Where do you see room for improvement in companies’ capital management structures?
Farzadi asserted that improvements in three key areas will help Middle East companies build a sustainable value proposition.
1: Change the perception on cash
In many Middle East organisations, corporate leaders regard cash, liquidity and working capital as specialist matters that are solely the responsibility of the CFO and the finance team. That misses the full picture.
For instance, if a company’s payment terms with suppliers are not in line with its working capital cycle, the business will be jeopardised. In this example, the finance team is simply on the receiving end of a decision made by operations. Yet if the suppliers’ contracts were aligned with the working capital cycle, real value would be added to the business.
2: Stop funding for the wrong reasons and in the wrong places
Most Middle East businesses, like their counterparts worldwide, require external funding via debt to finance growth. In a well-governed company, funding is used for the right reasons, such as expanding a factory or building new offices.
Unfortunately, one of the issues we frequently notice is a funding mismatch, where short-term loans are used to buy long-term assets such as real estate. The outcome is huge overdrafts and revolving working capital facilities being used to fund long-term assets. Companies can also make bad decisions when using funding to buy non-core assets or expand into unfamiliar markets.
The latest Middle East Working Capital study data shows that short-term debt held by listed Middle East companies increased on average by a compound annual growth rate of 6% between 2017 and 2021, and by 10% between 2020 and 2021 alone.
Higher amounts of short-term debt were tolerable - though not advisable - for most companies during this period, when interest rates were low. The real challenge comes now, with interest rates rising and when the value of the long-term assets acquired with short-term debt could fall.
3: Strengthen corporate governance
The third key area for Farzadi was corporate governance.
The large Middle East enterprises that engage PwC have become big and profitable because they get plenty of things right. But in our experience, size can sometimes get in the way of having clear, rigorous oversight of all the measures and actions required to achieve the most efficient liquidity management. Companies do not always “follow the money”, to check which business units are consistently experiencing negative cash flows, or to identify what legacy systems should be overhauled or sold.
As companies expand and diversify, it becomes increasingly important to check which areas of the business are consistently experiencing negative cash flows and to identify which legacy systems should be overhauled or sold.
Good corporate governance in this context means having a qualified board in place to select a suitable management team to make the right business decisions.
In addition, it is about having a clear hierarchy regarding who can authorise and make those decisions in a seamless manner. Even the most tightly held private companies can successfully address this governance challenge.
I have worked with exemplary family-run businesses where the head of the family was chairman/vice-chairman, working with a fully empowered CEO and CFO in strategic leadership positions and a clear corporate governance structure.
How do you create companies with sustainable value and profitability in the Middle East?
Before the pandemic, having a strong, company-wide cash culture was not a priority for most Middle East companies. Instead, they were more focused on top-line growth and their P&L.
However, the COVID-19 crisis made it clear that effective liquidity and capital management could make the difference between survival and collapse, amid global disruption of supply chains and markets.
The issues of cash management, funding and governance highlighted above are not going away, and resolving them is critical if Middle East companies are going to play their full part in the region’s transformation.
Our recently published 26th CEO Survey highlights the sharp shift in business sentiment worldwide in the face of ongoing macroeconomic volatility and geopolitical tensions.
CEOs, Board members and C-suite executives are moving ahead to ‘future proof’ their companies, building in long-term resilience, value preservation and sustained investment that will help shape the economies in which they operate.
To start off, the questions around how a company is managing its liquidity and working capital, and whether there is a mature, deeply rooted cash culture are important. Some natural follow-up questions include what to do about legacy non-performing assets, how to optimise existing operations, and how to use digital tools more efficiently.
We advise clients to evaluate the cash flow of each business in their portfolio and how it is contributing to growth, in order to identify areas for optimisation in corporate and capital structure, financing and working capital.
With a detailed understanding of their portfolio companies, organisations can make restructuring decisions such as selling non-core assets early. Proactive measures will ensure they remain in control of their processes and portfolios.
Middle East companies, like their peers across the world, face challenging times. But every single challenging situation creates an opportunity for businesses to come out of it leaner, more profitable and better managed.
