Ecosystem assumes brace position as “more corporate distress” looms

Partner organisations are assuming the brace position as the threat of recession looms large over Australia, with the ecosystem anticipating more “corporate distress” during the months ahead.

Amid increased inflation and interest rates, local technology providers are joined by other sectors navigating “significant pressures” related to rising cost bases (86%), rising wages (59%) and cash flow and management (56%).

A waiting game is now underway as a growing network of partners, vendors and distributors hold out for the economy to “normalise” and return to a “real world setting”. But the wait could be longer than expected.

According to the latest annual Turnaround Survey, 90% of management and turnaround professionals believe there is potential for Australia to fall into a recession within the next two years, with 70% confident that this will happen within the next 12 months.

The research was conducted by KordaMentha and Turnaround Management Association (TMA) in Australia and involved insights from board members, lenders, lawyers, insolvency professionals and turnaround advisors.

Within this group, 47% expect inflation to remain around the current levels of 6% following a peak of 7.% in late 2022. The financing impact is that that 70% expect it will become more difficult for businesses to obtain new debt whether from new or existing lenders.

“The business community is predicting some tough times ahead as the economy normalises after the artificial stimulus caused by COVID-19,” said James Wagg, Executive Director of Performance Improvement at KordaMentha.

“This is not a doomsday spiral, instead we believe it is just the economy getting back on a real world setting post-COVID-19 which cannot be achieved without some pain.”

According to Wagg, Australia has been operating in an “artificial economic environment” due to the impacts of COVID-19.

“The government subsidies followed by increased revenues have had a positive impact on profitability, which means many businesses have not been focusing on costs,” he explained.

Following damaging supply chain issues in technology during and post-pandemic – in addition to a lack of materials in other sectors – businesses are now battling rising interest rates and inflation. The end result is cost increases that are causing a drop in discretionary spending and profitability.

The key for the technology ecosystem is passing through these costs to customers as much as possible but that could prove challenging given IT spending is also expected to only increase by 5.8% in Australia during 2023.

According to Gartner, most local CIOs are becoming more “hesitant, delaying decisions and reordering priorities”. But opportunity can be found in software and IT services which are expected to grow by 10.9% and 6.1% respectively.

“Wage increase decisions are causing pressure in service industries as well and increasing interest rates have made access to finance more difficult,” Wagg added. “So many borrowers have been forced to the secondary, more expensive money market.”

Assessing Australia’s insolvency environment

According to Turnaround Survey findings, the most influential trigger for formal insolvency appointments during the next 12 months will be Australia Taxation Office (ATO) enforcements.

Of note to the ecosystem, average monthly first-time company appointments of external administrators have steadily increased since the peak of the pandemic, rising to 576 per month compared to 381 during COVID-19.

“The ATO have been proactively reducing their arrears for some time now and we expect this trend to continue and the ATO to be more proactive in the market,” noted Sebastian Hams, Partner of Restructuring at KordaMentha.

“Directors need to continue to be cognisant of their obligations across the board in a dynamic operational environment and seek early and appropriate support in times of financial stress.”

The impact of increased insolvencies is also set to impact mergers and acquisitions (M&A) activity in Australia.

While not expected to be directly linked to a highly acquisitive technology market in Australia – one that is predominantly pursuing growth and expertise – it must be noted that a section of partners do remain challenged by the current economic environment. Challenged to the point in which selling up and getting out of the game is a viable option.

“Strong M&A activity since COVID-19 has been from companies seeking to grow, prompted by buoyant conditions and the availability of low interest funds,” Wagg observed. “Now it’s the reverse. Companies will be seeking to contract, prompted by distress and the need to liberate capital or lower costs.”

Indirectly, the impact on key customer sectors will also have a waterfall effect for the ecosystem.

“Construction was the first industry to be affected, unable to pass on rising costs due to fixed price contracts,” Wagg explained. “We are now seeing other industries affected, like retail impacted by increased cost of living and reduced consumer spending.

“The next are likely to be services industries such as health, as government funding fails to keep up with increasing costs. It’s trickling through the economy.”

To keep on the front-foot, the majority of businesses – including partner organisations – are prioritising cost reduction (84%) as the most important short-term initiative. This is in addition to revenue growth (36%) – considered less important this year – and the divestment or closure of business units, now viewed to hold moderate to high importance (80%).

“The immense amount of stimulus in the economy throughout the COVID-19 period allowed business to access cheap capital and focus on growth at all costs,” added Suzanne Wauchope, Partner of Performance Improvement at KordaMentha.

“With cost pressures mounting on the back of rapid rises in inflation and interest rates, businesses are being forced to preserve and deploy relatively sparse capital with a focus on survival. This may take the form of streamlining operating models and reducing duplication, through to strategically refocusing and reprioritising individual functional areas of the business.”