The physics of lending to multinational corporations

Scenario analysis is a key component of any decision-making process, particularly in credit investing, where preventing losses and understanding the range of potential downside scenarios is essential. When a multinational corporation (MNC) borrower underperforms against initial projections, the consequences can extend beyond a simple drop in earnings before interest, taxes, depreciation, and amortization (EBITDA) or a lower enterprise value (EV)/EBITDA exit multiple. While these are certainly unfavorable and plausible outcomes, they do not necessarily model sufficient downside when lenders need to exercise control over a distressed group of companies. In such cases, the dispersion of outcomes is dependent on three specific variables that can be drawn from the world of physics: distance, time, and velocity. 

The ubiquity of MNCs

A 2022 study¹ of over 6,000 major international corporations found that MNCs collectively manage more than 370,000 subsidiaries worldwide. On average, this equates to roughly 60 subsidiaries per MNC, with the most active managing nearly 2,700 subsidiaries. While these findings may not be surprising given the study’s focus on large corporations, they highlight a broader trend: with today’s interconnected global value chains, even smaller companies can have dozens of subsidiaries spread across different regions. 

Variable one: Distance

A lender’s ability to effectively control an MNC borrower in distress often depends on the distance between the borrowing entity and the MNC’s key subsidiaries, which hold critical assets and operations. The greater the distance, the more challenging it becomes to control the outcome. However, this distance is an artificial construct that can be managed by understanding the group structure of the MNC borrower. 

Group structures are designed to help an MNC achieve its strategic objectives. For instance, if an MNC aims to maximize profitability, it typically pursues this goal through three structural silos that include increasing operational efficiency, optimizing capital allocation, and tax structuring. The MNC’s group structure reflects these silos, helping the lender understand how capital flows from the subsidiaries’ cash registers to the borrowing entity, the likely point of attachment for the lender. 

Consolidation analysis of an MNC’s accounts is another useful method for evaluating the group structure, as it maps each subsidiary’s contribution to the group and highlights key inter-group dependencies. This becomes particularly useful during a crisis when pockets of cash need to be identified and accessed within a short time frame. 

Variable two: Time

When a borrower encounters corporate “turbulence,” it often coincides with a period of declining cash reserves. In such cases, the critical factor becomes the time remaining before cash depletion. If this period is shorter than the time required for lenders to take control of the MNC, the downside analysis should either include provisions for additional capital injections or account for the potential risk of value destruction (beyond lower EBITDA and reduced exit multiples). Since the directors of the MNC borrower and its subsidiaries often hold significant control over both cash management and timelines, understanding their level of involvement is crucial. 

Directors are agents of the shareholders, which generally is not an issue, since all stakeholders—shareholders and creditors alike— aim for the company to be well-managed and profitable. However, issues may arise if directors are not independent (friends or family members) and not disinterested (i.e., they have a substantial economic or personal interest in the company). In such situations, the rights of other stakeholders, particularly creditors, may be overlooked. Therefore, it is often beneficial to create a map of directors responsible for decisions at each of the MNC’s subsidiaries and actively monitor any changes, as directors have the authority to pass resolutions, transfer shares, sell assets, approve financials, and manage operations. 

In a business-as-usual scenario, this may seem excessive since the group will often operate as one, with customers, suppliers, creditors, and other stakeholders generally disregarding the group structure. However, in times of distress, the group structure may be utilized at the discretion and speed of the borrower to protect shareholder interests, potentially at the expense of creditors’ rights. Achieving a creditor-friendly outcome could be challenging, which is why it can be helpful to bear in mind an adapted version of Gordon Pepper’s law,² i.e., calculate the maximum period of time that a situation will take to resolve itself favorably, and then double it.  

Variable three: Velocity

Velocity is a combination of speed and direction. Depending on the jurisdiction of the MNC borrower and its subsidiaries, the speed of movement can be extremely fast but in the wrong direction, such as transferring assets beyond the reach of the lenders. Alternatively, it can be extremely slow when required to move in the right direction, such as replacing directors or enforcing a share pledge. 

Due to globalized value chains, restricting credit investment decisions solely to “Goldilocks jurisdictions,” where the velocity of lender outcomes is just right, is not always feasible. Therefore, an interesting aspect of allocating capital to an international group of companies is the interplay between different geographies and the effect that legal systems can have on the terminal velocity of a business.  

The geographical dispersion of MNCs may pose challenges when pricing credit risk. Lenders could be inclined to take a macro view and assign an MNC the credit spread based on the location of the ultimate borrowing entity even though the underlying operations and significant assets or sources of value are scattered across the globe. Depending on the size of the MNC and the distance and time factors discussed earlier, it might be appropriate to adopt a more granular view in analyzing the fundamental credit exposure. This approach can help in adjusting the pricing and introducing contractual protections, or alternatively, considering the walk-away option. 

In summary, lenders need to be adequately compensated for the complexity they are importing into their portfolio of risks. This is especially true when venturing across borders, where factors including supply chain disruptions and geopolitical dynamics can shape the range of possible outcomes. Using principles such as distance, time, and velocity to map out and quantify those sets of outcomes at the start of the underwriting process can help identify the right levers needed to drive a successful resolution in times of distress. 

By Paul Leggett, Partner and Vuk Prelevic, Director, Strategy & Transactions, Deloitte Middle EastEndnotes

Endnotes

1. Investment Monitor, ‘Where do the world’s top companies have subsidiaries?’, (2022) https://www.investmentmonitor.ai/features/where-do-the-worlds-top-companies-have-subsidiaries.
2. Russell Napier, ’Twenty-one lessons from financial history for the way we live now’, (2024) https://www.libraryofmistakes.com/lectures/professor-russell-napier-twenty-one-lessons-from-financial-history-for-the-way-we-live-now/.