IFT Member Ian Parker and Interim Executive with Hemming Robeson outlines the trials and tribulations of working as an interim professional on a significant turnaround project for Birkby’s Plastics.
We structured a debt free deal buying the business for a £1 and, through a property transaction, enabled the former shareholders to retain the land and buildings inreturn for a 15 year lease. Post deal, our mission was simple: grow sales, profit and cash! At the time of the MBO Birkby’sbusiness model was entirely automotive supplying components on a just-in-time basis to the principal UK OEMs (original equipment manufacturers) – Honda, Toyota, Jaguar Land Rover, Ford and, via Treves UK, Nissan. Our operations ran 24 hours (three shifts) five days a week, with regular weekend shifts to satisfy the then growing OEM demand. Toyota and Honda accounted for more than 60% of our sales.
For the first six months our major concerns were an upcoming triennial pension scheme valuation, coping with the higher than forecast OEM vehicle builds and finding a business leg outside our traditional automotive customer base. We had £1.8m cash at bank and an un-utilised CID facility to 80% debtors (average drawdown availability £4m). What could possibly go wrong?!
The Lehman Effect from the US
In two words, Lehman Brothers. Consumers stopped going into car showrooms and demand for new vehicles dropped likea stone. Within two months car plants across Europe were substantially cutting back production. In 2009 Honda UK closed for four months and Toyota cut back by 50%. Jaguar Land Rover had its own “life crisis” but came through and Nissan,after a short period of reduction, just powered on thanks to the unrivalled market success of its Qashqai model. Birkby’srestructured, reducing head count by 48% (240) and invested in a new press to produce heavy duty plastic cable troughs for the railway industry.
Since Lehman, both Honda and Toyota have substantially reduced the production output of their UK plants. HondaSwindon produced an average of around 100,000 cars a year for each of the last three years (2007/8: 238,000). Similarly, Toyota Derby averaged around 140,000 cars a year (2007/8: 270,000).
For Birkby’s this meant supplying product at demand volumes well below the forecast volumes that substantiated theagreed quotation prices. In simple terms product quoted on the basis of three shift 5 day demand, was supplied at demand levels equivalent to no more than two shift 5 day working. Inevitably we under-recovered the fixed overheads (24% total overheads) allocated in the quotation calculations to the expected demand of a third shift.
An Earthquake in Japan
At the end of 2010 we recognised that the reduced volumes from Honda and Toyota were not a temporary phenomenon. To survive we would need price increases from both OEMs to recover the lost third shift overhead recovery. In an industry fixated on annual year on year cost reduction asking for increased prices is normally an alien concept. We persevered and won pricing uplifts but our negotiations were interrupted by the Japanese earthquake in March 2011. Both Honda and Toyota rapidly reduced production to even lower levels due to the resultant shortage of critical electronic components. Our challenge became one of survival as car build at their plants dropped for around four months to only 2 or 3 days per week.
In May 2011 we engaged KPMG LLP to find an investment partner or buyer for the business. A private equity buyer with good manufacturing credentials made an offer to acquire 75% of the equity in return for providing the funding the business required. Unfortunately they withdrew at the end of July for internal reasons leaving us with an upcoming cash challenge caused by the annual industry summer shutdown period.
At our Bank’s suggestion we worked with Ernst & Young LLP to secure an HMRC time to pay deferral and by the end of August our cash flow forecasts, based on declared OEM build forecasts, showed we could run the business within our existing banking facilities.
And Floods in Thailand
By September both Honda and Toyota had resumed normal production and we thought we had a way through. But inearly October floods in Thailand caused devastation to the technology parks North of Bangkok. For the second time in ayear a natural disaster caused Honda to reduce production. In November and December production at their Swindon plant was only three shifts a week (an 85% drop on forecast demand!).
By early December we were once again facing the cash challenge of a temporary period of reduced sales. With the support of Ernst & Young we managed to secure support from our customers and engaged Ernst & Young to conduct an accelerated sale process. Due to the highly competitive nature of the industry, the power the customers holdand the backdrop of the two natural disasters, only two parties expressed interest, and we allowed the OEM’s preferred buyer full due diligence access.
Our customers recognised that whatever the outcome they could be facing additional costs. If they refused to fundBirkby’s through the sale process, the company would have no option but to go into administration. And without the continuity of plastic parts supply the OEMs could not produce cars. Birkby’s had over 300 injection mould tools (some weighing up to 38 tonnes) and was their only supply source. Moving the tools without buffer part stocks was just not an option. Clearly an unplanned trading administration was likely to last several months and be very costly. The three principal OEMs wanted to evaluate the costs of the likely outcomes: funding through to a sale, funding a Birkby’smanagement restructuring proposal or a trading administration. At the end of February the potential buyer made aproposal to the OEMs to buy Birkby’s but with conditions that the Customers found unacceptable. The options for the Customers then became: 1) fund a management restructuring proposal or, 2) a trading administration.
In mid February Management had put forward a proposal to the Customers for them to provide the necessary funding support through a combination of permanent price increases and loans to restore the balance sheet. Unfortunately at the end of February our draft triennial pension scheme funding valuation revealed a substantially increased deficit. Largely asa result of changes in the technical provisions (the impact of quantitative easing), this had increased from a manageable £2.4m to £6.8m. Potentially the business was facing deficit payment commitments of £800k per annum!
A revised proposal was developed and we presented our revised plan to the customer group on Tuesday 27th March. At midday on Friday 30th March we learnt that our customers had decided not to support Management’s proposal and the OEMs activated their contingency “tool move” plans. Faced with the reality of no ongoing customer support our Board had little option but to put the company into administration. Ernst & Young LLP were duly appointed administrators on Tuesday 3rd April. It should be noted that Birkby’s administration was not a banking issue. Throughout the period of MBO ownership our banking partner, Lloyds Banking Group, and our Pension Trustees remained fully supportive of Management and the company.
The Outcome: Analysis
So why did Birkby’s fail to get ongoing customer support? There are I think three [four] key reasons.A lack of confidence inBirkby’s business model. Our MBO business model was based on a continuation of the OEM demand patterns enjoyed in2007/8. Post Lehman the reality was substantial volume reductions. We restructured and managed the business through to the end of 2010 using our cash resources (cash reserves and the additional cash generated from the new industrial rail cable trough business).
The two natural disasters in 2011 further undermined our business model. The rapid temporary sales reductions exposed the business to the downside reality of depending on invoice discounting to finance the business. Our Management proposal for Customer support was inevitably dependent on the build forecasts provided to us by the OEMs to enable Birkby’s to pay back the Customer loan monies. Birkby’s future was very dependent on the build volumes for Honda‘s new Civic and Toyota‘s new Auris models. Our turnaround business plan showed we could withstand a volume drop of up to 10% but beyond that our business would once again be under pressure. Consumer acceptance of these new car models was clearly critical (both models are in the B segment and face very aggressive competition; even before one factors inthe risks of a Euro zone meltdown).
The OEMs were also concerned that our growing industrial customer portfolio may not mature as planned; thereby undermining the recovery plan. OEM appetite. Faced with the potential scale of the “ask”, our customers just did not have the appetite for any further support. Jaguar Land Rover is funding an ambitious new model programme and both Honda and Toyota are still recovering in Europe from the Lehman induced sales downturns and the impact of the two 2011 natural disasters. Our customers are fierce competitors. Inevitably individual company objectives to secure supply inthe face of upcoming new model programmes took precedence over any wider considerations.
In contrast to Government support in Japan, USA, Germany and France there has been no tangible UK Governmentassistance for the component sector post Lehman or in reaction to the two natural disasters of 2011 (France: FEMA scheme injected €600m in preference shares to its supply base; Germany: Kurzarbeitergeld scheme – reduced-hours compensation – helped avoid redundancy costs and preserve skills bases).
Quantitative Easing and Pension deficits
In common with many SME’s Birkby’s had a legacy pension deficit. Although our scheme was closed to new members, changes in the discount rate used at successive scheme funding valuations have markedly increased the deficit.
Quantitative Easing (QE) has caused discount rates, a key factor in the technical provisions used to value scheme deficits, to drop to historic lows. Birkby’s pension deficit grew from £2.4m to £6.8m as a result of the changes in the discount rate used in the technical provisions. The potential increased funding requirement, from £250k per year to £800k per year, was not affordable. It is ironic that a central Bank measure introduced to kick start the economy in the wake of the Lehman and Euro crisis’s has the potential to challenge viable businesses through substantial increases in annual pension deficit funding requirements.
Finally, we as Managers became worn down by events. The two natural disasters in 2011 after a prolonged period of reduced sales were a tremendous challenge.The shortage of cash meant that we were unable to replace aging equipment and inevitably the “stop start” impact on production caused operating efficiencies to deteriorate, burning our scarce cash resources; a direct consequence of the shortened build runs, daily start ups and enforced down time.
My initial attraction to Birkby’s was its strong presence with Honda and Toyota. Ironically, what I once considered anasset proved to be a severe challenge to our business model when their UK production volumes dropped markedly post Lehman. The two natural disasters of 2011 caused further build volume reductions at both OEMs. This merely exacerbated an already challenged position and was to prove an impossible backdrop to finding a long term partner for the business.All in all, it goes to demonstrate that despite good management and a sensible plan, there now are global events that no contingency plan other than very deep pockets can deal with.
Ian Parker serves on the IFT North Region Committee and is involved in a number of regional manufacturing, automotiveand industrial projects. Whilst at Birkby’s, he gave a presentation on the sector’s challenges to a private meeting of the Cabinet.
Ian Parker is an Interim Executive with Hemming Robeson and a member of the Institute for Turnaround http://www.instituteforturnaround.com/newsletters/newsletter-6363