Ease the pressure

A recent spate of deals has shown company debt and, in particular, pensions deficits have proven to be a real show stopper in the success of many critical mergers and acquisitions. Only last month, the trustees of the J Sainsbury pensions scheme were preparing to scupper the ambitions of a buyout unless the bidder was willing to fill the pensions deficit of up to £3bn. Similarly, analysts have now suggested Alliance Boots, also subject to a potential leveraged buyout, is facing the same question: Could the pension fund become a deal-breaker?

The new accounting rules, changes to pensions legislation, together with the changes in the market, in relation to equities and longevity increasing beyond all expectation, are at the root of the problem.

Listed companies are only now really starting to get to grips with the new international financial reporting standards which have changed the way company liabilities are represented on the balance sheet. As a company’s pension deficit makes up the capital structure of the company, it is a significant burden for a potential investor and will also be taken into account alongside the company’s creditors. For many companies it means financial flexibility is compromised and optimal management of the business adversely affected. It is a constant reminder to financial directors of the extent of the pension liability problem.

From this month onwards, the new standard will be extended to privately owned UK companies. Increasingly, finance directors are going to find themselves under heavy pressure to reduce their liabilities. Up until now they have had no idea or not enough money to shift the liability.

Furthermore, we are seeing a growing number of highly financed operations being established to buy out pension funds (Paternoster and Synesis Life have joined Legal & General and Prudential). These organisations are starting to do business, but many are struggling with the premium they have to charge, which is typically 130pc of the liability. This makes it unattractive and difficult to sell, so they are looking at ways they can reduce the premium.

Through working closely with businesses, Burcote assesses the financial challenges that affect businesses and comes up with financial solutions that add value by transforming liabilities into cash, thereby reducing the value of the liabilities on the balance sheet. We do this through the innovative use of trade offset, which typically saves 25pc of the cost of a transaction.

Through forming a strategic partnerships with some of the UK’s largest pensions providers, including Prudential, we are applying the trade offset solution to pension risk transfers. The model developed allows part or all of the pension liability to be transferred from the client company to our partner company with the liability and the risk premium being part-funded by the client’s own products or services.

Used in this way, trade offset offers a viable get-out clause for many companies with large pension deficits and for buyout providers looking to reduce the premiums. It can reduce the cash premiums required to buy out the fund by up to 25pc. Furthermore, deals can be unlocked by providing immediate funding to bridge the gap.

Trade Offset
The key to this approach is to monetise spare capacity to part replace cash in a whole range of financial transactions. It’s not just pension liabilities that can be eradicated using this model. Property liabilities, capital expenditure and insurance liabilities can also be addressed. Trade offset not only makes removing liabilities more affordable, it also provides a viable solution to funding issues (for example, a hotel refurbishment) and budget constraints in a number of industry sectors.

Trade offset works by taking a product or service of the business (for example, spare capacity or underperforming assets) in part payment for removing the liability. The impact of cash being replaced by the client’s own products or services in this way is to dramatically reduce the real cost of transfer to the client.

The model works well for companies in a number of industry sectors (including hotels, telecoms, freight and logistics and the media industry) that have under-utilised business capacity, in some cases worth millions of pounds. The wider the gap between the marginal cost of supply and the realisable cash value of the product or service, the more significant will be the benefit.

Our team of trading experts has a worldwide network of contacts, and, by applying the well-established principles of commercial trade, can generate extra value from these products or services to fund the cash shortfall. Trading offers significant advantages where it is used to support the financing of a transaction. Utilising spare capacity or excess inventory as part payment in a transaction offers potential for growing new customers and markets with no additional sales cost. Products or services are not discounted and the headline pricing remains the same. Furthermore, for the companies it offers a powerful new business tool giving a competitive edge to win business, a mechanism for retaining existing business, extending contract periods or introducing new services, whilst maintaining profitability and pricing structure (i.e. no cash discounts).

Research undertaken by Simpson Carpenter supports our proposition. We explored the financial liabilities of around 200 FTSE750 companies. One of the key findings was that pensions liabilities affect more than two-thirds of companies and are the highest priority for financial directors. The fact each firm was saddled with average liabilities of £34m, and liabilities among FTSE750 companies exceed £20bn, illustrates the enormity of the problem and the potential market for our solution. Furthermore, with two-thirds of financial directors actively seeking solutions to their liability and funding issues, we could really have our work cut out.

Tim Glover is a director at Burcote