Published: November 01, 2010
As a mid-sized private organisation, Copap, like many others, needs cash to grow. The financial crisis could have signalled the end of our business as liquidity became constrained. In fact, despite a complete withdrawal of financing from our pre-crisis banks, the company emerged from the credit crunch better equipped to manage our cash flow efficiently, with record financial results in 2009. There were two elements to our strategy: firstly, optimising cash flow internally; secondly, working with external partners to achieve the right financing solution for our business.
Despite the growth of electronic media, the pulp and paper industry continues to grow strongly, with an annual turnover of $1.3tr. World demand for paper and paperboard is expected to grow from 390m tonnes in 2007 to 542m tonnes in 2025. Pulp and paper producers are global players, with mills in most parts of the world where there is fibre, water and access to energy. Copap alone does business with paper mills in about 30 different countries. Over the last decade, the sector has experienced considerable rationalisation, with significant structural changes in terms of individual firm capacity, corporate growth, and location of assets. For example, the world’s largest paper company, International Paper, has increased its paper and paperboard capacity by 3.1m tonnes annually. Large mergers between Jefferson Smurfit and KAPPA in 2005 and Abitibi and Bowater in 2007 resulted in asset closures of around 2m tonnes annually. Over the same period, producers like Chinese Nine Dragons and Southeast Asian APP increased their capacity by 5.3m and 1.3m tonnes a year respectively, while other Chinese paper producers also saw significant growth. Today, the ten leading paper firms account for 25% of the world’s paper and paperboard capacity, compared to 27% five years ago. The balance of power in the paper industry is shifting towards the East, with Chinese and Asia Pacific companies (excluding Japan) increasing their market share from 8% to 14% between 2005 and 2008, and Asia’s net import requirements expected to reach 14m tonnes by 2025, double its 2007 imports.
Our customers have also not been immune from the effects of the crisis. Like pulp and paper producers, consumers of these products have been experiencing sustained industry concentration, brutal competition from the electronic media, reduced margins and tight credit conditions. With both suppliers and buyers experiencing cost, competition, environmental and financing constraints, in a capital-intensive industry, the need for cash is critical.
These figures are significant as to be successful in this industry, a company such as Copap needs to maintain a global view, and a keen awareness of what is happening in each market. Our solid experience in Europe, and awareness of financing opportunities that were available in overseas markets was critical to our success when North American financing dried up. Copap prides itself in being an entrepreneurial business. Optimising our cash flow situation at all times is essential for our business, not only a prerequisite for sustained growth, but for survival. Even before the crisis, we were already using every element of the supply chain financing to improve cash conversion. When the crisis struck, our bank providers of financing simply disappeared, there were few avenues that had not already been explored.
Copap aims to form a bridge between producers and buyers of pulp and paper products worldwide. Our transactions are all international, in multiple currencies, and over 95% are performed on an open account basis. Our payment terms average 30 days in North America, 75 in Europe, 120 in South America, and about 90 days in the rest of the world. On the other hand, in order to benefit from cash discounts wherever possible, we aim to pay our suppliers quickly, so we need access to large amounts of liquidity to finance the difference. Around 85% of invoicing is handled through our head office in Montreal, with the remainder managed by our offices in France, China and Brazil. Our average invoice amount is $55,000, with a maximum of $800,000, and our average purchase order is $160,000, with a maximum of $1.7m. We have in-transit inventories in France, Spain, Brazil, and China. These are part of our growth strategy, and account for only about 5% of our overall turnover at this stage. Effectively, therefore, we provide credit terms, we pay cash, and we maintain some inventory. Cash flow management is therefore a vital aspect of our business.[[[PAGE]]]
Copap aims to form a bridge between producers and buyers of pulp and paper products worldwide.
Although we had already invested in an efficient financial supply chain, we identified four areas in which we could enhance our cash flow management: receivables management; payables management; asset-backed lending solutions, and an efficient financial platform. We addressed each of these as follows.
Receivables management
Due to our intermediary role between producers and consumers of pulp and paper products, and with small inventories, our receivables are by far our largest source of cash, approximately 85%. Most of our receivables are credit insured, enabling us to sell receivables to financial institutions (i.e., banks and factoring companies) for 100% of their face value in immediate money, without recourse. These transactions are true sales that convert receivables into cash. They are off- balance sheet, and they free us from trade credit risk. Faced with a lack of liquidity and a reduction in bank credit, we made every effort to shorten payment terms with our clients, e.g.. in Europe, we reduced average terms from 110 to 75 days. It was interesting that the country in which we lost the most customers due to reduced payment terms was Greece, which turned out to be positive. Political decisions in some countries also helped. France, for instance, obliged payment terms to be reduced for some industry sectors. These decisions, both by Copap and externally, enabled us to clean up our receivables portfolio and enhance our customer profile.
Payables management
It became obvious that as well as ensuring that customers paid us sooner, we had to extend payment terms with our suppliers to improve our cash flow. Convincing our suppliers to do this was much more complicated. However, we found ways of making it acceptable, and even positive for them. To achieve this, we designed a strategy to demonstrate to both our suppliers and their own credit insurance companies what was different in our business model, and how that translated into healthy results. Presenting our quarterly financial statements to bankers and analysts, even though we are not a publicly-traded company, was the best way to earn the financial community’s understanding and respect. This proactive business approach helped to make a real difference.
The fact that we were granted high credit levels by credit insurance companies convinced many of our suppliers that they too could sell and discount their Copap receivables to their bankers to obtain cash. They could now positively answer our request for longer payment terms. Using this approach, credit insurers work with both us and our suppliers, which makes for a win-win situation.
Through banking inventory financial facilities, we have been able to generate 60% cash from designated inventories at market value.
Another avenue that we are considering, but have not yet used is reverse factoring. Reverse factoring involves transforming a cash payment to a supplier into a 90-day term invoice for us, through a financial institution. The bank or factoring company receives all the invoices due to us from the supplier, pays them, and at 90 days charges us for the invoice amount plus financing costs. This is still cost-effective as we have the benefit of a discount from the supplier for early payment, and as we pay the factoring company at 90 days, our cash position is also improved.
Asset-backed lending solutions
Another mechanism we have adopted is to use our inventories as a source of cash. Through banking inventory financial facilities, we have been able to generate 60% cash from designated inventories at market value. As our inventories are located in diverse locations, with complex set-up arrangements, our lenders quickly disallowed them as collateral at the onset of the financial crisis. We therefore reduced our inventory levels to a bare minimum and transferred the ownership and responsibility of some inventories to suppliers. However, as soon as the economy showed signs of recovery, our inventories returned to levels in line with our growth strategy. By consolidating and reinforcing our equity, we were able to obtain operating lines of credit from our bank, which meant access to cash without receivables or inventory to back it up.
An efficient financial platform
The final tool we used to improve our cash flow was benefiting from an efficient financial platform that gave us more rapid or even immediate access to cash located across our business. For a company like Copap, with multiple locations in different time zones, having access to cash a few days earlier significantly improves our cash position. We realised that we needed one or more financial institutions with a strong international presence, a good knowledge of our industry and a good electronic platform, so we could transact electronically with our offices in South America, Europe, and Asia, and could eliminate some paper documentation. We found that HSBC met many of these criteria, and since we started using its electronic platform, HSBCnet, many aspects of our cash circulation have improved significantly.
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One of the key factors in successfully optimising cash flow at Copap was the close co-operation with our partners, both internal and external. They understood our philosophy, accepted our business model and shared a genuine mutual trust. Internally, we are privileged to work with quite a small team of highly qualified and committed people. We also make sure that we have an intimate knowledge of our suppliers and customers. Our management team comes from the pulp and paper industry. They know its needs and developments, and they often visit plants and installations around the world to maintain personal ties with producers and users of pulp and paper products. With our invoices generating 85% of our cash flow, our cash flow is as good as the creditworthiness of our customer portfolio and customer satisfaction.
Before the crisis, we obtained financing from three partner banks, located in Montreal. As North American and European banks were forced to reduce lending, we were advised by all three of our banks that they wished to terminate their relationship with us, despite our excellent financial situation and partnerships extending over many years. This followed a long period of group restructuring to consolidate our financial operations in North America, at the request of our bankers, so it was ironic that when we had finally accomplished this, our bankers suddenly vanished. We rapidly sought to establish relationships with other banks in North America, but given the financial climate, we had little success. However, we were very fortunate to make contact with HSBC, with whom we had a completely different experience. The bank structured a small facility for us, which was a major breakthrough at the time, and recognised our industry reputation, track record of sustained growth, and the strength of our business strategy.
Furthermore, our strong presence in Europe and ability to maintain and accelerate our growth through access to virtually unlimited financing by factoring companies has been critical to our survival and ongoing success. Today, our financing is well diversified and balanced, with one bank in North America and two factoring companies in Europe to finance our accounts receivable. This has proved to be a good combination for us, because we can balance the advantages and disadvantages of banks versus factoring companies and use the most appropriate financial solution for each type of transaction.
Banks are known and appreciated for their global networks, their international electronic platforms, their customised credit facilities, and the ease with which day-to-day banking services can be accessed. But they also have strict covenants, rules, and regulations, set-up fees and high overheads. They are also more expensive in general. Although we were very disappointed by the attitude of our banking syndicate, we really appreciate our present business relationship with HSBC, and the fact that this bank plays a very important role in our global business strategy.
Factoring companies have an entirely different profile. On the plus side, they have no set credit limits and are more open and flexible than banks in financing terms. Their electronic platforms are efficient, they have greater tolerance for certain risks, and they can offer specialised products at competitive prices. On the minus side, factoring companies are regional and virtually absent in North America, and they sometimes find it difficult to finance receivables outside their geographical area. Consequently, we now work with two different factoring companies: Natixis to finance our European receivables, and Cofacredit (80% owned by GE) for receivables in the rest of the world.
Generally speaking, for this type of financing, a bank will ask for collateral security, e.g., a first-rank moveable hypothec over the universality of the borrower’s assets. And the amount of this hypothec can be three or four times the value of the total receivable purchase facility, whereas a factoring company might ask for a guarantee fund of up to 10% of the value of the receivables, with a negotiable, pre-determined maximum amount. Whether we work with our bank or with factoring companies, one thing is clear, however: most of our receivables sold must be credit insured. Our clients understand this and like us, they also work with credit insurers.
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Credit insurance is an essential part of our business model. It removes the credit risk that is normally attached to the type of transactions we make, and it enables us to sell our receivables at competitive rates, on a non-recourse basis. Before the financial crisis, we had policies with two credit insurers, Coface and Euler, but the credit shortage forced credit insurers to scale down their global exposure, regardless of the specific dynamics of countries or industry segments. This caused alarming casualty levels in the risks they covered. Consequently, when they decided to cut their overall worldwide exposure by 10 to 15%, they did not have the time or opportunity to be selective. This quickly created a bottleneck for us, because when financing was available, we could not exceed the credit limit that the insurance company had set. Consequently, we had to change our business model a little and accept that we would have to assume a calculated risk on specific receivables, to the detriment of our cash flow.
We also decided to look for a third credit insurer, and selected a state-owned company in Spain for this purpose. Unfortunately, we are not able to work with the Export Development Corporation, as despite Copap being a Canadian company, we cannot meet the 50% Canadian goods stipulation. None of EDC‘s competitors we work with have requirements of this nature. Inevitably, our international presence was an important factor in finding support and today, our Group has four policies with three credit insurers: Coface, Euler, and CESCE. The choice of a credit insurer is really crucial, because the insurer is also potentially at risk. By choosing to add a third insurer, controlled by a national government, to the #1 and #2 credit insurance companies in the world, we felt well protected.
During the crisis, national governments supported and stimulated their respective economies in various ways. For example, in France, instead of credit insurance companies simply reducing or cancelling customers’ limits, the government encouraged previous limits to be restored, at least in part, and guaranteed to compensate losses from a dedicated fund.
Supply chain financing can be a very effective tool to improve cash flow, but it is not yet widespread amongst multinational corporations, although an increasing number have plans in this area. For Copap, our success was founded on a sound business model, with a good balance sheet and a credit worthy customer base. We are geographically diverse, both in terms of financial partners and credit insurance, and have a proactive approach to maintaining strong supplier and customer relationships. During the crisis, we were forced to adapt rapidly to changing market conditions. For example, while it took us some years to restructure our financial operations in Montreal, it took less than two months to undo some of it in order to access European financing). Finally, we never forgot that by following the trade, you find the money.
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