Financing change

The constancy of change is an old axiom for a reason, and recyclers often find themselves having to adapt to market fluctuations, changes to the regulatory landscape and the evolution of processing technology. Responding to changes such as these can necessitate investment, and recyclers could find themselves examining their lending options. Beyond traditional lenders such as banks, recyclers might want to consider a private credit fund, which is a form of nonbank lending or alternative lending.

White Oak Global Advisors LLC (WOGA) is one such nontraditional lender. Since its foundation in 2007, WOGA says it has deployed more than $8 billion across its product lines using an investment process that focuses on delivering risk-adjusted investment returns while establishing long-term partnerships with its borrowers.

WOGA describes itself as a leading alternative debt manager specializing in originating and providing financing solutions to facilitate the growth, refinancing and recapitalization of small and medium enterprises. Together with its financing affiliates, WOGA provides 25 credit products to the market, including term, asset-based and equipment loans, across industry verticals, says John Felix, the San Francisco-based managing director and head of originations at WOGA. He has been investing in middle-market companies for more than 20 years.

WOGA and its financing affiliates can provide waste management and recycling companies with equipment finance and asset-based lending as well as with commercial finance and inventory finance, Felix says. “We offer term loans for capital expenditures and nondilutive growth financing—we do not seek to take an ownership position in any of the companies we are investing in—including for recapitalizations, whether it be equity or debt refinancing.”

Felix adds, “We also have a very robust ESG (environmental, social and corporate governance) strategy where we invest in projects or companies that, for example, are favorable to the environment, to human rights or emerging technologies that assist with the efficient and environmentally friendly aspects of waste management and recycling.”

WOGA provides working capital and longer term capital solutions for the waste and recycling industry ranging from $5 million to $150 million, he says.

In the interview that follows, which was edited for brevity and clarity, Felix answers questions related to financing.

Recycling Today (RT): How has the pandemic affected the waste and recycling industry’s access to capital?

John Felix (JF): The waste and recycling industry appears to have not been more impacted by the pandemic than any other industry. Frankly, what is ironic is that waste management and recycling is one of those economically indifferent and cyclically agnostic industries that, regardless of the economic movements or cycles, people are still producing waste and the recycling industry continues to be fairly robust.

Coming out of the pandemic, we have seen a number of commodities, such as steel, have tremendous price spikes, so the recycling of steel and other metals is becoming more and more attractive, and as a result the demand for recycled product because of the end pricing has probably increased considerably.

For companies with meaningful amounts of steel exposure, the price increases have negatively affected margins. Many of these companies may or may not be able to pass those costs along to their ultimate customers, so there could be margin compression.

The other side of the equation is that, if you are a recycler, you may be getting an uplift from the same dynamic. If you are buying scrap and reselling to producers or recycling and reselling, then you are likely to benefit from the price spike as well, so it is probably a demand driver for recycling businesses.

The market generally has a growing appetite for businesses that fall into this space. One of our portfolio companies was recently acquired for a very healthy multiple with a bid that was unsolicited from a public company.

Outside of commercial banks, there is also more availability of capital for businesses that are pioneering new technology in waste management and recycling.

RT: How have the pandemic-related economic downturn and the emergence from that downturn affected interest rates?

JF: For the longest time, the [Federal Reserve System] has been operating on a monetary easing policy, which effectively has been resulting in injecting a considerable amount of money into the economy in the form of reduced interest rates. We have seen that even down at the consumer level, where returns on savings are next to nothing. This is not unusual in an economic profile whereby easy money is a way to solve a great deal of economic problems.

That combined with the fact that $3 trillion or $4 trillion dollars have been pumped into the economy has put money in many people’s pockets and the economy may now transition into what many fear is going to be a fairly robust inflationary environment.

While people are calling it temporary, we believe it is going to be very difficult to avoid inflation going forward in the intermediate-term. Although recently the Fed said a rise in interest rates is likely far off, with inflationary pressure occurring, there is always a chance rates could rise sooner, which of course can translate into increased rise in capital cost for those borrowers—so hopefully their profitability and cash flow generation will be able to support the rise in interest rates to service the debt they have taken on or expect to take on.

It is a bit of a catch-22, but it is inevitable when the government pumps that much money into the economy that there is likely going to be a resulting rise in inflation and interest rates.

RT: What is factoring? To what extent is factoring used in the waste and recycling industry? What advantages/disadvantages does it offer?

JF: Factoring refers to the sale of receivables to a third party. For waste management and recyclers, it often expedites the working capital conversion timeline and smooths out the ability for operators to earn their near-term capital needs.

For example, you might have a waste recycler whose customer is a municipality. That municipality pays the recycler every 120 days on invoices due. The recycler has expenses, like biweekly payroll, that obviously need to be paid for work that is being done to earn the receivable from the municipality, which will not actually be paid by the municipality for an extended period.

What a factor would do in this case is purchase from the recycler the receivable owed by the municipality for a discount, say 98.5 cents on the dollar or something to that extent.

The recycler receives the funds immediately and can use the proceeds to finance their short-term working capital needs, and they get the funds for a slight discount to what they were owed by the end customer.

A disadvantage to factoring is that it may be expensive. It may not seem that expensive at the surface level: Let’s say you’re selling this invoice at a 2.5 percent discount, so your cost of capital is 2.5 percent. That is an incorrect way to look at it because if you’re factoring every receivable from this customer, it’s really 2.5 percent per transaction over the course of the year to get your cost of capital. So, if you are doing it on one invoice, it’s pretty painless; but, if you aggregate all the discounts you take over the course of a year, it can become quite expensive.

Factoring can be seen as a double-digit cost of capital depending on how frequently you are factoring your receivables, to what extent you are factoring and the credit quality of your customers, which also dictates what the discount is on those receivables and the timeline for extending credit to those end customers.

If you compare that to a traditional bank asset-based lending (ABL) revolver, which has its own set of criteria, the cost of capital on that may be low single digits: something between 2.5 to 4 percent typically on funded capital and maybe 50 basis points on unfunded commitments.

As a company grows, predictably their creditworthiness increases, and so our ability to extend credit on the ABL revolver basis becomes more appropriate. So, White Oak looks at businesses that are a little bit smaller and probably less profitable than what a commercial bank may. Some may be in less favorable industries or going through some type of financial or operational transition at a given time, and we’ll be more aggressive in lending to that profile of borrower for a slight pricing premium than a regulated bank lender.

Comparatively, if the lowest cost of capital of a traditional bank ABL revolver is 3.5 percent all in, unregulated lenders such as White Oak can offer a similar product at about 4 to 6.5 percent all in. What we are getting paid for is the size premium as well as the risk associated with the situation that we are assuming.

Overall, a company with a lower credit profile or that is younger in its development will likely be a better candidate for factoring than one that has been around for a number of years with a higher quality credit profile who is more likely to be eligible for an ABL facility.

For waste management and recycling, it is a commodity-in commodity-out industry, so it is often difficult to maintain consistent financial performance if a company is subject to market dynamics on costs and market dynamics on the revenue side. That kind of tumultuous environment businesses are operating in generally lends itself better to alternative lenders rather than a commercial bank.

RT: What funding sources do executives overlook that they should consider tapping into and why?

JF: The government, to some extent, is a funding source. Understanding what programs, grants and subsidies are available to your company on a federal, state and local level is critical for waste and recycling operators because governmental agencies are continually seeking ways to minimize landfill volumes.

The keen operator really must have a grasp of any and all advantages that are at their disposal. It would be a shame if they were leaving money on the table for lack of knowledge of what is available.

Asset-based lending is also worth noting; most operators probably already know they can leverage their assets when it makes sense. It is often the cleanest way to do it and the least impactful on ownership—you do not have to give up your stake in the company—but it’s also the most common.

RT: When might leasing equipment be preferable to buying? What advantages could recyclers see as a result of leasing?

JF: The clearest benefit of leasing rather than buying is you are smoothing out the capital requirement.

Rather than having lumpy upfront payments that are large capital outlays and burdens on the cash flow of the business, you are smoothing out that burden over a five-, seven- or 10-year period, depending on the equipment and the structure you’re engaging in with your lender.

As a lender, we see there are benefits to buying and leasing. However, it does depend on what the operator has available at their disposal. White Oak has an equipment leasing arm, so we are able to provide that product, but we also look to businesses that own their equipment as a source of repayment if we’re lending to them.

So, for operators who have more ownership over their equipment, we may have an avenue to get more aggressive with what we are offering them in terms of debt quantum. From an operator’s perspective, being able to circumvent those large, lumpy capital expenditures is probably what is most important.

RT: What should executives keep in mind when trying to balance budgets and access new capital?

JF: To unlock capital and growth, executives must be mindful of the full scope of options available and look beyond traditional lending sources, such as commercial banks. Many banks are becoming less reliable as a financing source, especially for low-margin businesses or those that have seen volatile performance because of the pandemic.

Less-traditional sources of capital, such as nonbank lenders, can provide flexible structures and solutions and can do so in amounts that are unavailable through the commercial banking market. As alternative lenders, many can be more flexible and creative with the financing solutions available.

Certain private capital providers, such as White Oak, have developed lending models that look beyond anomalous events to get a clear indicator of risk and business potential despite recent performance inconsistencies, whether it be from COVID, an ice storm or even malware attacks and labor strikes.

With ESG being a major focus in alternative investing today, we believe that waste management and recycling operators are uniquely positioned to benefit from the increasing availability and decreasing cost of capital.

John Felix is the San Francisco-based managing director and head of originations at White Oak Global Advisors LLC, a role he has served in since 2017. More information on the company is available at https://whiteoaksf.com.