Rising debt levels place companies at risk

Financial directors need to start paying almost as much attention to the
holders of their debt as they do to their shareholders, debt advisers have
warned.

Over the past year, debt trading has flourished in Europe, as the holders of
debt have sought to reduce their risk exposure to particular sectors and
regions. Executives, however, are unaware of the potential impact this
phenomenon could have on their companies.

Low interest rates have seen companies carrying more debt on their balance
sheets. According to the Centre for Management Buy-Out Research, more than 50%
of UK buyouts were funded by debt in 2004.

Research by Close Brothers, meanwhile, found that FTSE250 companies were
carrying higher levels of debt than five years ago. The merchant bank said that
average gearing in the FTSE250 was 4.1 times earnings before interest, tax and
depreciation (EBITDA), up on the 1.75 times the EBITDA figure revealed in a
report in 2000.

In the report The growing importance of debt in European corporate
transactions Ernst & Young said that as long as interest rates remained low
and trading conditions were healthy, companies with high gearing would remain
safe.

But if interest rates climbed from their historical lows and the economy
slowed, these companies could find themselves in trouble.

Their shareholders, who are traditionally the focus of management’s energy,
would be replaced by the holders of their debt in the pecking order.

‘As soon as a company runs into trouble, the balance of power shifts
dramatically in favour of those holding its debt rather than its equity,’ said
an E&Y spokesperson, adding that many investors were aiming to take hold of
a company by purchasing its debt rather than its equity.

Nick Hood, partner at corporate recovery specialists Begbies Traynor, said
company directors, particularly in smaller plcs, were not aware of the growing
importance of debt in their capital structure and the implications of their debt
being traded.

‘It is paramount that executives understand the importance of debt, because
when your debt is traded you never quite know what you are dealing with. Unlike
banks, the buyers of debt have varying agendas,’ Hood said.

Neill Thomas, head of debt advisory at KPMG, said that private equity-backed
companies were most likely to run into trouble because of high gearing.
‘Generally speaking, quoted companies are sensibly geared. Private equity
companies are the most vulnerable, especially if they operate in sectors where
trading cracks appear,’ said Thomas.

COMPANY REPORTS

FTSE100
Imperial Tobacco will have until the end of March next year to sell its
popular ‘singles’ tobacco product in Germany at a lower tax rate. Singles are
pre-rolled cartridges of tobacco that can’t be smoked when purchased. Singles,
sold exclusively in Germany, were taxed as fine cut tobacco, but after a ruling
in the ECJ (European Court of Justice) earlier this month, they will now be
taxed as normal cigarettes. Following the ECJ ruling, the German Ministry of
Finance announced that all singles products will continue to be taxed as fine
cut tobacco until the March deadline. ‘The strength of our broad product
portfolio leaves us well placed to capitalise on the anticipated consumer
migration to other tobacco products and low price cigarettes,’ said GarethDavis,
chief executive of Imperial Tobacco Group.

FTSE250
Umbro, the sportswear manufacturer, is searching fornew finance
executives afterCFO Geoff Haslehurst told the company that he would be leaving
the group next year to pursue other interests. Chief executive Peter McGuigan
said: ‘Geoff has made an important contribution to the company, including the
IPO process last year.’