Where complexity meets flexibility: An introduction to Capital Solutions

November 26, 2024

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Many companies in Europe urgently need transformation. Private capital can help, argues Carlo Bosco.

The past five years have severely tested the resilience of businesses across Europe. From the seismic shock of a global pandemic, which caused lasting disruption to supply chains, to a rapid surge in inflation that led to the most aggressive interest rate-hiking cycle since the 1970s.¹ And from declining access to bank capital² to an uncertain macroeconomic environment.

For some companies, however, the challenges have been particularly acute. Loans to non-financial corporations in the euro area totalled €5.15 trillion at the end of June 2024.³ But the headline figure masks a stark reality: 13.6% of these loans (€698.9 billion) are classified as underperforming (technically known as Stage 2 loans) with an additional 3.6% (€183.6 billion) deemed non-performing (Stage 3 loans).

Furthermore, the pandemic's financial aftershocks continue to reverberate. Approximately €300 billion in state-guaranteed loans⁴ and a significant number of leveraged buyouts completed before the pandemic are coming due and will need to be extended or refinanced.⁵

Even if the region sees a material reduction in interest rates, this will not alleviate the pressures facing borrowers if existing creditors are unwilling or unable to maintain support. While many businesses were kept afloat through state-guaranteed loans and shareholder support, they now face mounting debt service requirements through amortization and maturing obligations.

The scale of the challenge is significant. Based on an assessment of 2,000 public companies listed in Europe, Boston Consulting Group (BCG) estimates 21% “currently face strong pressure to transform”, up from 14% in 2023, while 7% “are in a more challenged position and face strong pressure to restructure”.⁶ Smaller companies – those with revenues of less than €500 million – are considered most vulnerable; BCG estimates 37% of these businesses need some form of transformation, while 22% require restructuring.

Capital Solutions: An all-weather strategy

Transformation or restructuring processes are often highly complex, requiring expertise and solutions that may not be readily available from traditional funding sources.

Capital Solutions targets an underserved segment of the credit market, where complexity limits competition, complementing our broader private debt offering to European middle-market companies.

These solutions seek to provide flexible financing for companies that find themselves excluded by traditional lenders due to operational challenges, regulatory changes or market turbulence. We believe this strategy can play a vital role in providing capital to help sound companies navigate complexity while supporting existing and new shareholders.

While some target companies face financial stress, we distinguish carefully between 'stressed' and 'distressed' situations. A stressed company maintains reasonable prospects for returning to profitability, while a distressed company has typically reached an irreversible position. Capital Solutions focuses exclusively on the former category, aiming to create value for all stakeholders – borrowers, lenders, and investors.

For our investors, our goal is to deliver a higher return per unit of risk than traditional private debt, capitalizing on an environment where capital demand from borrowers is high and supply remains constrained.

Wide opportunity set with a focus on collateral

Capital Solutions transactions vary significantly in structure and purpose. They may provide new capital through super-senior financing or bridge loans to facilitate a transformative transaction. Alternatively, they might involve opportunistic refinancing or more complex restructuring, including refinancing at a discount to par to reduce leverage and enhance capital structure sustainability.

Our selection process emphasizes two key elements:

1. A thorough assessment of the company's business plan to evaluate post-transaction capital structure sustainability.

2. Robust collateral packages to protect invested capital.

This heightened focus on collateral distinguishes Capital Solutions from traditional private debt strategies, which primarily emphasize cashflows and typically involve limited collateral.

Beyond physical assets as collateral, we leverage various restructuring frameworks that can provide super-seniority rights, similar to debtor-in-possession financing in the US. We may also implement graduated step-in rights, allowing equity owners and management to maintain operational control while preserving our ability to take remedial action if necessary.

Managing complexity

Since launching our Capital Solutions strategy in 2021, we have invested in 12 companies out of 400 reviewed opportunities, with three transactions already fully realised. These successful exits, while diverse in circumstances, shared a common need for structural flexibility beyond traditional lending parameters:

• We supported a business exposed to grain and energy prices at the outbreak of the Ukraine war, enabling it to operate in and come through an extremely uncertain environment, protected by strong collateral.
• We facilitated the post-COVID reopening of a resort, providing shareholders time to realize asset value without having to sell at distressed levels.
• We helped a company complete a debt restructuring, bridging it to a market refinancing backed by asset value and operational performance.

From disruption to opportunity

In our view, the current environment presents significant opportunities for Capital Solutions. With traditional lenders retreating and over one-fifth of European public companies facing transformation pressure — rising to 37% for smaller enterprises — Capital Solutions strategies can help bridge this critical funding gap.

Additionally, for investors seeking exposure to a sophisticated, risk-aware approach to private credit, Capital Solutions offers the potential for attractive returns while supporting European businesses through complex situations.

 

References

1.Statista, ‘The Most Aggressive Tightening Cycle in Decades,’ December 14, 2023
2.European Central Bank, ‘Q3 2024 euro area bank lending survey,’ October 15, 2024
3.Trading Economics, ‘Euro area loans to non-financial corporations,’ October 2024
4.European Council, ‘A recovery plan for Europe,’ April 9, 2020. Most recent data available.
5.S&P Global, ‘Maturity wall looms higher for speculative-grade debt,’ February 5, 2024
6.Boston Consulting Group, ‘Why One in Five European Companies Needs to Transform,’ June 2024

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of November 2024 and may change without notice.

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