Key Takeaways
- Recent financial difficulties at Greensill Capital highlight the nascent risks associated with supply chain financing.
- The sudden withdrawal of supply chain financing can create a material working capital squeeze and pressure a company's credit quality.
- Separately, partial asset sell-downs can have material consequences for creditors despite the accounting optics of such transactions. Accordingly, they offer no free lunch for corporates.
Recent financial difficulties at supply chain financier Greensill Capital highlight nascent risks associated with the use of supply chain financing (also known as factoring or reverse factoring). The sudden and unexpected withdrawal of these short-term financing arrangements can create a material working capital squeeze and pressure a company's balance sheet and credit quality. The rapid demise of U.K.-based construction company Carillion plc in 2018 was precipitated, in part, by the withdrawal of supply chain financing.
S&P Global Ratings may consider supply chain financing as debt where it accelerates the monetization of receivables or allows a company to extend its creditor payment credit terms to derive a material working capital benefit. This is because the working capital benefit arising from these arrangements will generally need to be refunded if the financing arrangement becomes unavailable.
Here's an example of how we may adjust debt for supply chain financing (see chart 1). Let's assume the industry has standard creditor payment terms of 90 days. Any material working capital benefit derived by the customer from extending payment terms beyond 90 days may be added to the customer's debt. Similarly, any material working capital benefit derived from the supplier by receiving payment within 90 days may be added to the supplier's debt.
Chart 1
Like other forms of short-term funding, supply chain financing is subject to refinancing and liquidity risks. If facilities are not rolled over or withdrawn, the supplier would be left with a working capital shortfall and would subsequently seek to reinstate shorter payment terms that existed before the supply chain financing facility was established. By doing so, the supplier would effectively transfer part of the working capital shortfall to its customer. The original benefit to customer and supplier would, therefore, unwind.
The risk of withdrawal of supply chain financing facilities is generally lower for more creditworthy customers and their suppliers. Although these facilities are often evergreen with no maturity date, financial intermediaries are generally under no obligation to provide ongoing supply chain financing. Facilities are most likely to be withdrawn in response to a deterioration in the customer's credit quality. However, funding can also become unavailable for other reasons, such as problems at the financier (such as in Greensill's case) or broader credit market disruption.
Importantly, poor accounting disclosures can mask the existence of supply chain financing. This can obscure a company's underlying financial health and frustrate like-for-like comparisons. Accordingly, improved disclosures are encouraged to ensure that the risks are properly understood by creditors and other stakeholders.
Partial Asset Sell-downs--No Free lunch For Creditors
In recent years, a growing number of corporates have looked to divest a minority share of some of their most creditworthy businesses. This includes Australia-based Telstra Corp. Ltd., through its partial divestment of its telephone exchanges, and Ampol Ltd., through its partial divestment of its convenience store network. We understand that more companies are considering similar transactions, primarily to access the lower cost of capital of potential acquirers.
On the face of it, the idea seems compelling. Companies divest less than 50% of their best assets while continuing to consolidate 100% of the assets and associated cash flows. Voilà! The seller realizes significant cash proceeds from the sale while the financial statements and key credit measures remain intact. The cash leakage to minority interests is buried deep "below the line."
However, the accounting optics often bely the underlying economic reality of such transactions. Creditors are clearly worse off when part of the borrower's best assets are sold to third parties and the proceeds are, in some cases, distributed to shareholders. This is akin to you selling 49% of your mortgaged home and expecting your mortgage provider to be indifferent when you spend the proceeds on an extended holiday. This is particularly the case when you continue to occupy the entire house and are obligated to pay rent to the new minority owner.
Our analytical approach attempts to capture the loss of ownership of these high-quality cash flows in various ways. Accordingly, we may partially deconsolidate the asset from the seller's financial statements to reflect a "true sale" of the monetized portion of the asset. Where a true sale best represents the substance of the transaction, we must also assess its impact on the seller's business risk or debt capacity.
Consider, for example, a company that has two similarly sized business: one business is high risk and one is low risk. If the company permanently divests 49% of the low risk business, two-thirds of its future owned cash flows will be derived from the higher risk business, compared with 50% previously. Accordingly, these types of transactions can meaningfully degrade the quality of a company's future cash flows and therefore its debt capacity at a given rating.
In other cases, the substance of the transaction may not reflect a true sale. This is particularly the case where a company continues to control and substantially benefit from the cash flows generated by the monetized asset. Here, the partial sell-down is often structured more like a sale-and-leaseback or financing transaction. In such cases, we may leave the asset on the balance sheet and the business risk remains unchanged. However, we adjust the seller's financial statements for the debt-like lease obligation associated with the divestment. This approach was applied to Telstra's financial statements when it sold a minority interest in a portfolio of telephone exchanges.
We acknowledge that these types of transactions are often effective in maximizing shareholders' value. However, the risks to creditors can be material. Accordingly, we capture the substance of these transactions either via our credit metrics or business risk assessments. Neither is a recipe for a free lunch.
Related Criteria
- Corporate Methodology: Ratios & Adjustments, April 2, 2019
- Guidance: Corporate Methodology: Ratios & Adjustments, April 2, 2019
Related Research
- Reverse Factoring: Why It Matters, March 10, 2020
This report does not constitute a rating action.
S&P Global Ratings Australia Pty Ltd holds Australian financial services license number 337565 under the Corporations Act 2001. S&P Global Ratings' credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act).
| Primary Credit Analyst: | Paul R Draffin, Melbourne + 61 3 9631 2122; paul.draffin@spglobal.com |
| Secondary Contact: | Graeme A Ferguson, Melbourne + 61 3 9631 2098; graeme.ferguson@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.