What should banks know before lending in the foundry industry? Learn insights from John Green of FL Sales Inc. as he provides insight to David Fiegel of Blackbird Asset Services.
About this segment of Blackbird TV
Recorded: September 28, 2020
Published: December 7, 2021
John Greene, FL Sales, Cleveland, Ohio, thanks for your help with this. What should a banker be wary of or be knowledgeable in before they start lending into a foundry business? Most of the foundries are what I call a capital project. When you look at a sand system which has a muller and sand cooling belts, elevators and conveyors and so forth, it’s a, let’s use the word hodgepodge, they can be vertical, they can be horizontal. But we see a lot of vertical sand systems that’ll go up 5, 6, 7 floors. Typically, it was built in part of the building. That infrastructure is expensive to put in. Oh, millions of dollars. And as a bank, you may be loaning somebody five or $10 million to put in a new sand system. And in an appraisal scenario, majority of that system has no value because it’s going to cost more to take it down and try to put it up somewhere than it would cost to build a brand new one. So we typically, let’s say, when we’re buying and selling, the only things that have value are certain assets. Usually, it’s the muller, a sand cooler a few converyors. Typically, the elevators and the belt conveyors have no residual value whatsoever. But they cost money and they need to be lent against. So if I’m advising a banker and in the term of art, their normal advance rate is 60%, 70% of the auction value, that appraisal really should reflect that some of that equipment, even though it’s brand new when they’re making this loan, may not have any real residual value at the end should something go wrong in the business plan. And typically, I mean, the first question I ask the bank is what value are you looking for and give them a very brief explanation of capital projects. Are they looking at a forced liquidation value, orderly liquidation value, a fair market, or a fair market in place, and each bank has its own formula that they use. And as an appraiser, I mean, we’re dictated to by the bank of which values we provide to them, and we just make sure that in our appraisal we have to have, we cover ourselves and say that a good portion of this equipment has no residual value. As an advisor, as a consultant in conversation with someone who’s in the banking business, it’s important that they know that the soft costs involved in building out a foundry are of a greater proportion than other industries, such as a machine shop or a metal fab shop. Absolutely correct. And I’ll give you one example. When you’re putting in an aluminum melting furnace, let’s call it a reverb furnace or jet melt furnace or something similar to that. The lining inside could cost a quarter of $1,000,000 to put in. You take that furnace and try to take it out and resell it. You’d have to replace the lining. Zero. It’s worth zero. Exactly. The only residual value that that furnace has are controls if they’re updated, burners and maybe some components, especially when you get into the larger melting furnaces. Like, we just did it an appraisal. It had a 50,000 pound capacity aluminum reverb melting furnace. And that’s big, isn’t it? 50,000 pound aluminum furnace that would be considered a large furnace, right? Correct. OK. And you’re looking, you know, it’s the size of a room, 20 feet by 20 feet. Well, that’s a big furnace. That’s a big furnace you can’t even ship it as a whole. You have to cut it into little pieces to ship it. Wow, Here you have a lining that costs, let’s say, a quarter of $1,000,000. You have to literally be cut apart the furnace. You’re better off buying a new one. So the depreciation schedule for these kinds of businesses may not reflect at a first glance what the reality would be if something went sideways. Less so than a more conventional industry. Very true, and a lot of that is dictated by the appraisal that you’re doing and the time frame. You’ve done appraisals before. Typically, your bank will say we want a three to six month liquidation scenario or a six to nine month. Also, in our industry, it’s a lot smaller than the machine tool industry. There are roughly and I’m guessing at this, about 1100 foundries in the United States. It’s not as active. It takes longer to sell equipment. As a dealer, we have to sit on it for longer. As an appraiser, if somebody says I have to sell it in six months or that’s the scenario that they’re using the time frame, it may be unsaleable. Or, for example, we just did an appraisal. They had 15 of the same exact machine. We sell two to three a year, and they’re asking us for a nine-month valuation on it. You’re not going to sell most of them. Yeah, and and it takes an expert. Blackbird’s connected. John Greene’s a foundry guy. John, thanks for your time this morning. You’re welcome, David. Thank you.