Managing Risk in the Marketplace
Advice from the Big Four Appraisal Firms
Date July/August 2018
Originally featured in ABF Journal - by Nadine Bonner
Lending money is a risky business, whether borrowers are large corporations or small businesses. For ABL lenders, working with a reliable appraisal firm can minimize the risk and staunch the losses if things go south. Like lending itself, the appraisal and liquidation businesses have seen dramatic changes in the last decade as technology and globalization have transformed their business models. To gain insight into the current landscape, executives from four of the world’s largest firms shared their experience and expertise.
“The basic methodology of doing an appraisal is still based on our fundamental knowledge as an asset liquidator,” says Doug Jung, managing director at Hilco Valuation Services. “That hasn’t changed. Technology has created the ability to obtain data and obtain quality data in a much easier way than ever before. Data collection and data mining technologies are much better and, therefore, improve the mechanics of doing our appraisal work.”
Michael Marchlik, partner and CEO of Great American Group Advisory and Valuation Services concurs. “The methodology of the appraisal and how you approach it hasn’t really changed. What has changed is the amount of data that we have and the information that we have from prior appraisals and prior liquidations and how we use that information to shape better opinions and better blueprints to mitigate risk and put together hypothetical liquidation strategies in the appraisals.
“They’re better, they’re sharper, they’re more accurate because we have more experience, not only as a firm, but we also have better access to our own data and, in some cases, data that’s available in the market.”
At Gordon Brothers, Chris Carmosino, president of Valuations, points out his company tracks more than 10 million transactions. “This was one of the strongest benefits of our acquisition of AccuVal-LiquiTec in 2015. This database has been enhanced and now reflects Gordon Brothers’ disposition activity; we do over $10 billion of dispositions annually across all of our retail, commercial and industrial sectors.
“Beyond the enhanced scale of data that we reference, our process is essentially the same. We are very merchant-focused; we have specific experts looking at the assets being appraised in light of our recent disposition experience and proprietary data. We also work cross-divisionally across all of our disposition practices to make sure that our valuations are in line with our expertise and recent history in those practices.”
Dan Kane, co-founder and managing member at Tiger Capital Group, explains, “When we do appraisals, we’re armed with more intelligence about the gamut of what different types of collateral - retail or wholesale inventories, customer lists, furniture and fixtures, you name it - are actually worth in today’s marketplace.”
All of this data has a dual purpose. Not only does it help the appraisal companies provide a more accurate valuation at the start of a deal, but accurate and rapidly transmitted data is invaluable during the liquidation process.
Data Driven Models
“Having that market and customer intelligence as we head into a liquidation helps us know exactly what the optimum sale discounts need to be. Years ago, you might apply a blanket discount to all men’s shirts, let’s say. Now we know the relative values that particular kinds of men’s shirts are likely to yield for the recovery. We can actually assign separate discounts to polos, tees and dress shirts in ways that we know will maximize sales. These data-driven approaches are tremendously valuable,” Kane says.
Kane also says technology has changed the way companies promote liquidations. In the past, liquidators would rely on expensive half page newspaper ads or radio and television advertising to promote “going out of business sales.” Today, that audience has fragmented between streaming video and the disappearance of print media, but liquidators can access email addresses of regular customers and send targeted blasts.
“Naturally, all of this has translated into quite substantial changes in how we look at asset values, both for appraisals and liquidations. The great thing about the data revolution is that it helps us do a better job on both fronts,” Kane says.
When it comes to liquidations, it is impossible to ignore the many iconic retail businesses currently being dismantled after filing for Chapter 11. All four companies are working to liquidate the U.S. Toys “R” Us stores. Great American and Tiger are closing down the Bon-Ton department store chain. But all of them view this as a process that will make retail stronger and bring changes to the marketplace.
“I think the concept of retail apocalypses is not true. I don’t believe the retail industry is in a freefall. I think what’s happening in retail has happened before. I would call it a disruption. Technology combined with regulatory change has caused this disruption combined with management teams that are inadequately prepared for change,” Jung says. “I remember, and I’m not sure all of your readers will remember, but there was a day when Home Depot and Wal-Mart were supposed to put small business owners out of business. Right? That was the fear, and the Ace and True Value co-op business model stepped up to keep pace and kept their local independent hardware stores relevant, and they’re still around.”
Thanks to Amazon, no one can deny people are buying everything online, from diapers to soy sauce, but Marchlik notes a new model, integrating both worlds, is growing.
“You see companies like Wal-Mart that are adapting their business. They’re all trying to do what Apple did, what Apple mastered. They built their retail model with what we’ve referred to as clicks and mortar,” Kane says. “Apple has an online presence, and you can buy computers online, but then you can place the order and go pick it up at a location that you know is available because you want it today, and they’ve mastered that. Now Best Buy is trying to do that. Now Wal-Mart is doing that.
“The pressure from Amazon and other online sellers will continue. But I also feel that there is a certain percentage of consumers that still want to touch and feel merchandise and have real-world shopping, dining and social experiences.”
Jung points to the repurposing of malls as an example of this. “Many brick and mortar stores are adopting an ‘experience’ concept,” he says. “You can buy whatever you want on the internet, but you can’t get the ‘experience’ on the internet. So, they’re adopting that. Coworking is the next thing. Who knew five years ago that the way we work was going to change? I could see potentially some retailers putting pop ups in a coworking space.”
Lack of vision, Jung contends, is responsible for many retail failures. “At the end of the day, if you have poor management, poor execution, lack of competitive advantages, management teams failing to pivot for the future, they’re all to blame for business failures,” he says. “So, there will always be a need for liquidations. That is how I view what people refer to as the retail apocalypse.”
Kane says some of the gloss is wearing off online shopping as the cost of convenience grows. “People count the cost of all of those online returns and shipping fees. They understand that it can be cheaper to shop brick-and-mortar, especially now that the Supreme Court has cleared the way for more sales tax fairness,” he says, referring to the recent decision requiring online merchants to collect state sales taxes. In the past, online sellers were only required to pay sales tax if they had a physical presence in the state of the person purchasing the item.
Carmosino adds, “Many retailers view much of the activity that’s occurring as rightsizing the brick and mortar store footprint and despite the store closing sales, they’re very proactive and healthy for retailers. We encourage our clients to analyze their top, middle and lowest performing stores relative to their entire portfolio. As digital shopping channels gain traction, we expect to see more store closings over the next 24 months. However, this is a necessary strategy for retailers to survive. It doesn’t necessarily suggest a free fall or an apocalypse. It’s just a better way to manage the store footprint and be efficient in their operations.”
The ‘Amazon Effect’
Part of the so-called “Amazon effect” is the increasing globalization of the marketplace. While we all have grown accustomed to purchasing clothing and household items manufactured in Asia or South America, today our Amazon (or Alibaba) purchases may be coming directly from vendors in those areas. As national borders become more porous, both businesses and the appraisers find themselves working globally to some extent.
“We are seeing far more cross-border deals than we have in the past. And each and every year, that particular type of work has grown with Hilco having teams in Europe, Australia and Mexico,” Jung says. “Having a global presence with Hilco employees is a tremendous value-add. It’s being in the local markets and knowing what’s happening in those markets.
“Our clients are trying to get deals done, so from a lender perspective or a private equity perspective, having a closer understanding of the jurisdictional and legal landscape that needs to be navigated is beneficial to our diligence, field exam and valuation businesses and ultimately to our clients. You really have to have boots on the ground and global expertise in local markets. That provides better insight to the collateral values and other local insolvency or commercial issues - both on the appraisal side and field exam side.”
Gordon Brothers recently expanded its presence in Australia, opening an office in Melbourne. In addition to its North America home base, the company operates from 25 offices across Europe, Asia, Australia and South America.
“Lenders are more connected and vulnerable to change in other parts of the world. Working with appraisers with a global perspective is more critical than ever,” Carmosino says. “Our clients are looking for partners who understand the importance of having that global perspective and back it up with a broad, international network. We are well-connected across industries and geographies, and our practices are integrated, which means the client experience is seamless and our perspective is worldwide.”
Just as technology has made the world smaller and created this worldwide perspective, the threat of impending tariffs and a possible trade war will have an impact on all of the appraisers. All of the executives admitted uncertainty, but they all agree there will be an impact.
Be Close to Your Borrowers
“Tariffs are always going to affect values for sure,” Jung says. “We saw this with U.S. duties on Chinese tires back in 2013, 2014, 2015. Costs spiked way up for a lot of the tire importers, and it could happen [again].
“ABL lenders and their portfolio teams really need to be close to their borrowers, and they have to talk to them about what they see on the tariff front. In their respective industries, [the borrowers] should be watching this very closely. They have their own industry associations and their own political action committees and lobbyists, and they should be paying attention to all that so that they can be prepared.”
“Tariffs have real implications for consumers, retailers and manufacturers alike. Competitive manufacturers are going to be looking at getting around these tariffs by moving production facilities around,” Kane says. “After all, they have to find a way to get their products made at the best price. All of this has potential implications for the ABL sector. So this situation with tariffs is something we need to pay close attention to.”
Marchlik compares the tariff situation to the recent tax cut, which, he notes, also created uncertainty in the marketplace until the 2017 tax year ended and accountants could move on to dealing with 2018 and the changes.
“It’s something we’ll keep an eye on,” he says. “We have folks who are focused on industry verticals, such as metals, but it varies. It varies by country, and it varies based on any waivers that some of these countries might get. It also varies based on the material at various stages of completion.” This last point is due to the fact that some tariffs may be on finished products and not the raw materials.
Gordon Brothers is also keeping a wary eye on the situation. “As a result of the recently enacted tariffs, certain companies may face unexpected cost increases that could compress margins,” Carmosino says. “At the same time, inventory values may be impacted and, in certain sectors, they may be increasing. It’s important to understand the current market value could deviate from historical norms. The need to reappraise is critical. It can affect different borrowers in different ways.”
Through the Crystal Ball
Recognizing the current economic upswing will eventually turn downward, we asked the executives to look into their crystal balls and predict when it could happen and what the signs of an impending downturn would be.
“We expect a pullback because of the growing friction between housing wages, money supply and unemployment rates,” Marchlik says. “We expect a pullback,not a wipeout, not a bomb - not what we dealt with 10 years ago. But we expect some type of an adjustment, a downward adjustment or correction of some type in the next year to two years.”
“My opinion is that if we don’t have any unforeseen negative events, like true tariff wars or some kind of wildcard like a deteriorating relationship with North Korea, we likely have a couple more years of growth ahead of us, given the tax cuts, low unemployment and strong consumer confidence that we’re seeing today,” Kane says. “But I will admit that I’m concerned about the possibility of a trade war, whether that’s with China, our continental neighbors or - God forbid - all of them at once.”
Jung declines to prognosticate. “It’s really hard to say. I do think it’s just best to be prepared, to be current, to be in the market and have resources to react to changing market dynamics.”
Carmosino agrees. “Economic cycles and periodic business downturns are inevitable. It is very difficult to predict when they occur and what the catalysts will be. However, we firmly believe that managing risk through the cycle is one of the biggest challenges that our clients face. At Gordon Brothers, we work closely with our clients to help them be as prepared as possible for the inevitable downturn by having a good understanding of valuation, and the forces that impact valuation.”
Words of Wisdom
For asset-based lenders, the executives had words of wisdom and sound advice.
“Whenever there’s a competitive environment there’s a lot of liquidity in the marketplace,” Jung explains. “The first thing that lenders give away is price, and then people start giving up structure to win a deal in order to keep the lights on. That becomes a very slippery slope. From the new deal side, I think to the extent they can, they need to stick to their knitting on structure. It’s not easy. The market forces are very challenging, and the pressure to do deals is challenging. But from a new business perspective, that’s my advice.”
Marchlik urges lenders to call upon appraisal companies for advice, even before a deal is closed. “We’re here to help,” he says. “We want to help. Just call us on the front end.
“Surprises are for birthdays, so let’s minimize the surprises. When you get an appraisal back from us, and it didn’t meet your expectations, call us. When we get calls early, it’s easier for us to help manage our clients’ expectations and for our clients to manage the potential borrowers’ expectations. We are an extension of our clients, so we want to make them look good. We’re not just trying to take their money and do an appraisal.”
“I think the biggest challenge for the ABL community is to continue to manage their businesses for long-term strategic value, but also prepare to manage through the inevitable credit cycles,” Carmosino says. “That means being proactive and staying vigilant and continuing to innovate their practices. It also means maintaining discipline and staying on the alert for indicators of a downturn. We are ready to help clients navigate that process in good times and in bad.
“Final advice - maintain credit discipline through the cycle, which means continue to maintain the proper monitoring, controls and discipline even in seemingly good times, because good times won’t last forever.”
Kane adds, “Uncertainty means that it’s more important than ever to work with appraisers who know particular industries inside and out, as opposed to just looking for the lowest fee. When you’re choosing an attorney or a financial adviser, you typically don’t do that based strictly on what they’re going to charge. It’s about whether the attorney or financial adviser has the reputation and experience you’re looking for - and gets results. The same is true for appraisal and liquidation firms. You want to build a partnership based on confidence and trust.”
Then, tipping his hat to his three competitors, he says, “The four companies you’re talking to have completed thousands of appraisals in all kinds of categories and under nearly every circumstance imaginable. They’ve tracked asset values for years with the help of increasingly sophisticated methodologies. In all likelihood, they’ve got more specific data available than the banks. That’s part of what makes them such an invaluable resource.”