Restructuring professionals welcome change in the economic order of things. Failed managements’ reactions to change provides increased turnaround opportunities. Companies are forced to adjust to structural change and need professional advice in doing so. With the new U.S. president threatening to upset the established liberal transnational economic order and replace it with a nationally focused protectionist policy, there are significant ramifications for both U.S. and European companies.
The new administration has introduced uncertainty into European business planning. That is bad for investment and business growth. So, by implication, that is good for restructuring. This has been demonstrated with the recent aborted bid by Kraft Heinz for Unilever. Encouraged by a low pound sterling exchange rate, it was an aggressive move driven by synergistic cost reduction. No doubt there will be other European and U.S. acquisitive businesses eyeing apparently undervalued U.K. assets. The U.K. M&A market is in for an interesting time, and as every restructuring professional knows, M&A has a history of underdelivery.
Of early concern in Europe was Donald Trump’s pro-Putin posturing. It sent shivers through European chancelleries, with Ukraine still in an uneasy military standoff with Russia. Trump’s anti-Euro rhetoric also has European bankers and business leaders unsettled. Still recovering from the 2008 financial crisis and with Brexit to contend with, a second U.K. election in June, and a significant election in Germany due in September, Europe has enough home-grown problems.
A Trump-like populist swing in France could have led to the prospect of a French exit from the eurozone and maybe even an exit from the EU. France seems to have avoided that by electing Emmanuel Macron instead. Meanwhile, Angela Merkel is fighting to contain the nationalist and anti-Euro AfD party in Germany, which, while not threatening to take power, could alter the coalition balance and weaken German influence and room for maneuvering in moderating potentially toxic Brexit negotiations.
The very fundamentals of the EU could be at stake and with it the political and economic stability of debt-stricken Greece and Italy. It is early days, of course, and this may be too doom-laden a scenario. Trump’s rhetoric may turn out to be just that, rhetoric. Populism may not actually take a hold in continental Europe. The EU economy, which is slowly recovering, may simply continue its trend. There may yet be a “soft Brexit.” Frexit may not happen. But, in the new world reality, anything is possible.
Forecasting is a difficult process at the best of times. Few policymakers foresaw the 2008 financial crisis, although there were plenty of indications of overexuberant capital markets. What is probable is that considerable uncertainty will continue in Europe for some time. A major recession may be avoided, but economic problems will occur. The roots were already apparent before Trump’s election. Maybe the Trump factor will tip the balance.
The implications of the president’s statements on the U.S. auto industry and jobs for U.S. workers are indicative. GM reacted by putting its European business on the market, resulting in a proposed sale to PSV Peugeot Citroen. Excess capacity in its Opel/Vauxhall business has been a GM headache for many years, but the Trump effect has prompted the automaker to exit from Europe. It is highly likely that the consequence of the sale is that GM’s two U.K. plants will close when their current platforms are due for change in two years. Brexit makes their closure the economically and politically easy option for a part-state-owned French company with a track record of closing U.K. plants. This will reverberate down the supply chain and, by contagion, marginalize other manufacturers’ U.K. plants.
U.K Winners, Losers
U.K. Prime Minister Theresa May’s much-hyped proposed U.S./U.K. trade deal between a global free trade-minded U.K. and a protectionist-minded Trump-led U.S. seems a misplaced political dream, but a commercial hand grenade for the U.K. British industry has restructured progressively and successfully since European Common Market accession in 1973 to integrate and trade freely in the EU single market. It was a slow and lengthy process. Now it may have to restructure again to whatever the new arrangements are. How long will that take?
Trade agreements are a two-way street. A U.S./U.K. trade deal is more likely to favor the larger partner. It could precipitate more business reorganization and job losses. In a U.K./global free trade environment, U.K. lower value-added production will suffer and jobs will be lost as the consequences of economies of scale and lower emerging market labor costs take effect.
While Brexit is bad for exporters and, over time, for low-value-added manufacturing, it is not all bad news for U.K. business. In time, British business will adapt, but at a sunk transition cost never to be recovered. There will be winners and losers. Fortunately for restructuring professionals, if less fortunate for the U.K. economy, there are likely to be more losers than winners.
Losers are set to be those with Pan-European business and integrated supply chains that will be impacted by customs delays and increased tariffs; auto, aviation, and manufacturing engineering are most exposed. Agriculture will also be affected by the exit from the Common Agricultural Policy, but which sectors of agriculture will suffer most, nobody knows. Amidst this uncertainty, agricultural land prices are falling.
Professional services, particularly financial services and insurance in Euro-denominated products, are very vulnerable, and this will have a trickle-down effect on London property markets. Brexit means investment banks are weighing plans to move some parts of their businesses out of London. Some estimate the number of jobs lost in London at up to 70,000. But adding to the Brexit effect on banking could be a Trump move to relax Dodd-Frank financial services regulation, making New York more attractive to bankers. London benefitted at New York’s expense from the passage of Sarbanes-Oxley in the early 2000s. That process may now be about to be reversed, with some U.S. banks seriously considering returning to New York instead of moving to Frankfurt or Paris when they exit parts of their business from London.
Elsewhere in the British Isles, there will be significant issues for Irish businesses on both sides of the Ulster border if the U.K. leaves the customs union, as seems likely. Economic activity has never recognized a U.K./Republic border since the 1922 separation, and the U.K. is Ireland’s biggest export market. Ireland may become the front line between populist nationalist government and European integrationist thinking, with old and deep political wounds potentially reopened. As Brexit moves from airy fantasy to messy reality, only the most deluded think that the Irish business problem can reach a realistic compromise across hard EU/U.K. political red lines.
Ireland could also be a victim of U.S. tax legislation changes on corporate business if, as Trump advocates, U.S. corporate taxes are reduced. The Republic currently benefits greatly from its low-tax environment, having attracted many U.S. businesses as an English-speaking, low-tax entry point into the EU. Having suffered greatly in the 2008 financial crisis, when it was the first eurozone country to address its nonperforming loan (NPL) problems, Ireland may now face another round of economic problems.
The winners from Brexit are likely to be those U.K. companies with minimal European trade or minimal euro and dollar costs that will benefit from currency movement and import substitution. Leisure industries in tourist locations will benefit from increased foreign visitors attracted by the 15 percent depreciation in the exchange rate for the pound. Other foreign buyers will emulate Warren Buffet and look to profit from cheaper U.K. assets.
However, until the Brexit divorce settlement is agreed upon and businesses can assess the new playing field, investment decision making will be deferred and competitiveness eroded. This could be two years at the very best but looks likely to be longer. Neither side seems willing to compromise over its red lines on free movement of labor, and the leverage appears not to favor the U.K. negotiators.
So much for Britain and its self-inflicted Brexit problems. What of Continental Europe? It is likely to be largely immune to a significant Brexit effect, but the EU’s leaders will be extremely worried about the potential impact of Trumpian populism. As previously stated, such populism threatens the very fundamentals of the EU.
Europe’s leaders will, however, take some solace from the fact that people should now at least know that populist electoral revolts do not necessarily solve economic problems. This was evident in Greece in 2014, when the populist movement did nothing but defer the problem of debt. And it is this debt issue that will be occupying EU leaders as much as the threat of populism and nationalism over the coming years.
With more than $1 trillion of NPLs clogging the arteries of the banking system, a mammoth program of NPL workouts is still needed. While only one-third of that amount is corporate debt and a target for turnaround professionals, this is more than enough to keep the turnaround and restructuring industry busy for the next few years.
More than half of this NPL debt is in two countries: Italy and Greece. The European Central Bank (ECB) and the EU have made great strides in preparing the way for progressive workout reduction. Insolvency legislation has been changed in Italy to reduce the timeline of in-court restructuring to encourage buyers of distressed portfolios.
A realistic plan has evolved in Greece, encouraged by the ECB and European Stability Mechanism, to work out its nearly $120 billion of NPLs over three to five years in conjunction with U.S. and London-based funds and the involvement of internationally recognized turnaround and restructuring firms. While there is a long way to go and Greece is capable of many surprises, much uncertainty has been removed. Stability and international support, not Trumpian populism, is needed to get Greek banks lending and the economy moving again.
The Long View
“May you live in interesting times” is a euphemism, of course, for troubled times and should perhaps be the watchword of TMA, whose members certainly live in interesting times on both sides of the Atlantic. It is not unreasonable to assume that the convulsions that are being brought about by the populist reaction to globalization and which led to both Trump and Brexit will significantly upset established business structures and open opportunities for the turnaround and restructuring industry across Europe.
It is not something that anyone should necessarily wish on the world, but TMA members can take comfort in knowing that they have the skills and knowledge to help. With the progress the industry has made since TMA was established, today’s turnaround and restructuring professionals are in a better place to manage the problems than were their forebears.
Nationalism and protectionism brought Europe to its knees once before. The EU has helped restore Europe with 50 years of peace and prosperity. The EU is not perfect, but it is better than the alternative of nationalism and trade conflict offered by populism. Political backlash is trumping economic growth right now, but in the long term, “it’s still the economy, stupid.”
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