Back in the early 2000s the metals industry faced oversupply, plummeting prices and a wave of consolidation. Once-mighty companies such as the now-defunct Bethlehem Steel saw their credit ratings decline and failed to meet covenants on their cash-flow credit facilities. A sea change in financing tactics ensued. Lenders and metals companies turned away from cash-flow credit facilities to asset-based lending (ABL) because ABL offered the companies the flexibility and liquidity necessary to compete in a highly cyclical, global marketplace.
To illustrate why cash-flow loans fell out of favor, consider the business model of service centers, which act as distributors. They hold inventory for a short period of time, approximately 30 to 90 days. In a rising price environment their margins will improve, but in a falling price environment those margins may contract and perhaps turn negative. As a result, a company with a cash-flow facility that has financial covenants could quickly find itself in default if commodity prices tumble and cash-flows drop.
Today, ABL is the predominant way companies in the metals industry finance their working capital. With ABL, the amount of credit extended by lenders is based on the liquidation value of the assets owned by the business. Asset-based revolvers help companies to bridge the gap between the cash-flow they eventually will receive from sales and the amount of their current expenses.
Besides working capital needs, there is growing demand for merger and acquisition financing, as well as large capital expenditures among some metal companies. For example, both the service centers and scrap companies are fragmented sectors comprised of hundreds of small, medium and large firms that could consolidate. Meanwhile, fracking technology and the emergence of shale plays are propelling the pipe and tube sector. Many of these companies are looking upstream and downstream for acquisitions or considering building new facilities for heat treating and threaders, for instance, to vertically integrate and capture more of the profits along the value chain.
The Critical Difference
For metals companies reaching for these kinds of growth opportunities, asset-based loans offer valuable financial flexibility. Typically asset-based loans do not have standing financial maintenance covenants. Instead, as long as the borrower maintains a certain threshold of borrowing availability, it never has to prove compliance with financial covenant ratios. This gives the company the sort of flexible financing necessary to handle unexpected problems and seize opportunities without worrying about financial covenants and the potential negative implications on funding.
In addition, because ABL availability is based on asset levels, availability grows as asset levels increase. Thus asset-based loans are a useful financing alternative for mid-size and even larger middle-market metals companies. This is especially important in the metals industry, where inventory prices can ebb and flow with the business cycle.
Whatever the situation, the industry’s cyclicality and exposure to commodity volatility make it critical to work with a lender that understands the industry and exhibits patience throughout the cycle. The right lender will help a company navigate the tumultuous ups and downs of the market and build the business for the long term.
Paul Feehan is senior managing director, Metals and Mining, at GE Capital, Corporate Finance (gecapital.com/metals). He specializes in providing commercial loans and equipment finance to mid-size companies for growth, acquisitions, turnarounds and balance sheet optimization. He can be reached at email@example.com.