Financial engineering vs business basics

Some years ago, a colleague and I had a discussion about why businesses existed.  He had a private equity background and asserted that businesses were there to be bought and sold, basically that the businesses were as much of a commodity as the products or services they produced.  Another colleague was working at the time in the former Yugoslav Republic for a tyre manufacturer and asked why a plant had been established in a particularly remote location.  He was told that it was because they were able to provide employment to thousands of local people.  Having an operations background, my response to both was that businesses are there to be managed in the most effective way to meet the needs of their customers and thereby deliver a return to shareholders.

I was reminded of this by the announcement last week that 80 of the 110 sites of Nationwide Accident Repair Services in the UK had been sold through a “pre-pack” administration to a subsidiary of Redde Northgate, best known as a major player in the fleet leasing market.  “Pre-packs” are a financially efficient way of shedding liabilities, and keeping only the bits of business you want, even if in my personal experience, they turn out to be less efficient than the modelling might suggest.  There is probably another blog topic in why a leasing company is expanding into a number of areas that relate to the operations and maintenance of vehicles during their lifecycle – aligned with the ICDP research related to the trends towards bundled leasing and build and operate models, but that is for another day.  I would like to focus on Nationwide and related issues.

For those who don’t know, Nationwide had become established as the largest player in the UK accident repair market through a combination of acquisition and organic growth.  They were acquired in 2015 by Carlyle, a well-known private equity player with a solid knowledge of the automotive and other engineering industries.  Even if I knew the details, it would be inappropriate to share them here, but there is a significant hole in the Nationwide pension scheme, it carried a lot of debt on its balance sheet as is normal in private equity funded businesses, and it was operating in the only marginally profitable UK accident repair market.  They provided significant capacity to the major UK insurers and were able to apply some leverage to push back on changes that would reduce the already-thin margins.  However, they had already had to close some under-performing sites under pressure from Carlyle, and then were hit with the collapse in repair volumes due to the Covid-related drop in traffic volumes and accidents.

We were pleased to have Nationwide as members of our research programme until earlier this year, and my judgement was that it was a fundamentally sound business with capable management, but running on a knife edge due to the combination of the market environment and the demands of its shareholder.  The collapse has provided a great opportunity for Redde Northgate, but cost over 500 employees their jobs, and left the dealers who supplied parts nursing substantial losses that are unlikely to be recovered.  Due to the general reduction in business volumes, other repairers will step in to grab the business, even at the rates that helped take Nationwide down.  The structural issues in the sector will remain.

So what’s the relevance to other parts of the industry and other markets?  In the coming months, there will be other players who find that business does not return as quickly or as far as they hope.  We still face considerable uncertainty as an industry, and businesses that were financially stretched before may not find their shareholders are supportive, regardless of whether they are private equity, family owners or corporate parents.  Discussions that I have had recently suggest that the number of actual business failures like Nationwide may be quite low, with pressured shareholders doing deals to sell on their businesses as going concerns.  It is clear that some dealer group investors are gearing up for these opportunities, and I would also expect further consolidation in parts distribution.  It is likely that some of the start-ups, so-called disruptors, and service providers will have to retrench, refocus or sell up.  Some will simply disappear.

In the end, what counts is running a sound business.  Playing games with the financials might work in the good times by some measures, but it will not sustain you through leaner times.  Building a strong team is important, and I can remember the days long ago when I used to measure my own stature by how many people I had reporting to me, but businesses need the right sized team of the right quality to deliver value to their clients, and thereby to their shareholders.  We all face tough times, but if we stick to the basics, we improve our chances of success – no tricks, no games, no grandstanding.