While Governments Deliberate, Auto Suppliers Can Act
With a 21.9% fall in UK new car registrations in February and reports of shorter working weeks and job losses, the news for the motor industry is rapidly going from bad to bleak, and industry suppliers are worrying more and more about their receivables. However, they can do more than just sit and wait.
In the US, auto suppliers are facing similar problems to those in Europe and in recent weeks there has been a flurry of activity around the auto industry rescue with the Treasury Secretary holding the first meeting of the Auto Industry Task Force (AITF), Chrysler and GM presenting their formal restructuring plans and bailout proposals to the AITF, and the major auto supplier industry groups Motor & Equipment Manufacturer’s Association (MEMA) and Original Equipment Supplier Association (OESA) making a plea for government intervention. In all of this activity and in the hundreds of pages that make up the various proposals, there are lots of good ideas, the merits of which the government will have to weigh. And while they do this, auto suppliers wait. But do they have to? The answer is no.
While lawmakers and others ponder what the right course of action may be, suppliers understand they must take control of their own fate. And one way to do this is by leveraging their non-auto receivables. Whether the government accepts MEMA & OESA’s proposal to back the auto industry portion, receivables are the critical key to unlocking the cash flow that auto suppliers so desperately need to survive.
The initial focus of the auto bailout was on the ‘Big Three’ automakers. But it has quickly become clear that even more pressing is the need to secure the automotive supply chain.
According to Chrysler’s bailout plan, 22% of their spend – or some US$8.5bn – is with financially troubled suppliers – a number which is up from 10% only last August. In a letter to Treasury Secretary Timothy Geithner, MEMA states: “Recent industry surveys indicate that approximately one-third of all suppliers are currently in severe financial distress and another one-third will be in distress by the close of the first quarter of 2009.” Respondents to a measure conducted by the OESA support this claim:
The positive news is that the automakers, after slowing down production significantly over the past few months, increased it in March and are planning to ramp up production again in April. But restarting full-scale production does present a unique challenge to the auto supply chain. Because of the production slow down, and subsequently lower sales and cash flow in the previous months, suppliers will be faced with a severe cash flow crunch as they await payment on their new orders for 45 days or more. Not enough cash coming in the front door to fund production would be problem enough, but according to the Chrysler report, 43% of Tier 1 suppliers have also received requests from their sub-tiers for payment terms compression.
The combination of delayed cash flow from their buyers and accelerated payment to their sub-tier suppliers puts auto suppliers in the untenable position of having to find liquidity amid a cash flow drought without the ability to use one of their greatest assets – their receivables. According to one Tier 1 supplier who responded to the MEMA survey: “We are all very concerned that our receivables are at risk. There is nothing we can do in the current market to protect our receivables, at any cost.”
Hence the proposals requesting that the government act as a kind of Federal Deposit Insurance Corporation (FDIC) for receivables giving assurance to the capital markets that it is safe to use receivables to fund cash flow by providing insurance against auto industry non-payment or even late payment. Might we see a new federal agency – the Federal Receivables Insurance Corporation or FRIC?
This idea should certainly be more politically palatable than a direct bailout of the automakers, as it requires no immediate, direct outlay of funds by the government, and quite likely would limit the ultimate amount of bailout funds required in the long run. As MEMA notes: “Of these proposals, the government guarantee of supplier receivables is considered the most expeditious support for suppliers and the most fiscally conservative – from the US Treasury Perspective.” And any government FDIC-type programme for receivables would almost certainly restore the cash flow value of auto receivables to suppliers, enabling them to use various means to unlock that value.
This is all well and good, and it will certainly be welcome news if the government acts on these proposals, but what can suppliers do in the meantime? And how can they take advantage of the opportunity when and if the government acts to back their receivables?
Right now, suppliers can act to access the cash flow potential in their non-auto receivables. Rather than waiting for the government to decide whether they’re going to back their auto receivables, suppliers can take matters into their own hands now through a mix of traditional methods and innovative solutions to secure cash flow from their non-auto receivables
While taking advantage of what bank products they may still have available, suppliers now have some very good options outside of the traditional credit markets, which are more part of the problem than the solution right now. Some of these options include working with buyers to accelerate payments in a mutually beneficial manner, and using bank-neutral supply chain financing or receivables auction providers to connect with sources of liquidity in the capital markets looking for good short-term asset classes, such as receivables, in which to invest.
All of the industry proposals note that government backing of receivables “will enable suppliers to once again use their receivables as collateral for working capital loans from traditional banking sources”. While this is true, traditional banks are not the only source of working capital and likely may not be the best. Bank funding of receivables is still debt on a supplier’s balance sheet and will continue to expose suppliers to the risks and restrictive covenants of traditional bank debt.
However, non-bank providers, such as Orbian and The Receivables Exchange, give suppliers access to large pools of alternative sources of capital via models that allow the supplier to engage in a true sale of their receivables, thus lowering their days sales outstanding (DSO) and accessing accelerated cash flow without adding a single penny of debt to their books. What’s more, the competitive nature of the receivables sale to a variety of capital providers bidding for these assets drives the price down through market forces, assuring suppliers of the lowest possible cost of cash.
Any provider of funds for receivables, be they a bank, a third-party trade finance provider, or a receivables auction, will require some number of days for due diligence and system access. For many of these options, suppliers can lay the groundwork without committing to a binding obligation and can test the waters with their non-auto receivables. Taking these steps now will ensure suppliers are ready to start the flow of cash the moment the administration acts.
As the saying goes, when the going gets tough, the tough get going. Auto suppliers have been down before – and they’ve emerged out of a downturn successfully. By tapping into innovative tools that allow them to convert their receivables to cash, they will rise again.