Now, more than ever, hard-pressed CFOs must yearn for the luck of Kevin Hillier, the Australian who took his new metal detector out for a trial in October 1980 and discovered a 60lb (27kg) gold nugget worth US$1m (€770,000). The largest nugget still in existence, Hillier’s find is now on display, appropriately enough, at the Golden Nugget casino in Las Vegas.
The search for capital hasn’t got so desperate that CFOs are jumping on a plane for Vegas to try their luck. But with the banking industry in crisis, the regulatory landscape unclear, and recession undermining confidence, CFOs are going to have to be a lot more creative in their quest for capital.
To explore this challenge, Agenda talked to three specialists who see the credit crunch from different perspectives: Simon Collins, Head of Corporate Finance for KPMG Europe LLP and partner in the UK firm; Josh Lerner, professor of investment banking at Harvard Business School; and Stephen J. Marzo, group CFO of Noble Group, a global supply chain business.
Is the credit crunch with us for the long haul?
No. If you had asked me 18 months ago whether that period of irrational exuberance in the financial sector would last forever, I’d have said no, but I couldn’t see the definitive reason why it should end. Now I can’t see the event that will take us on from where we are now. What’s needed might be that old elusive chestnut: certainty.
This is a cycle. A severe one, probably the severest I’ve experienced in my 25–30 years in the business, because of the significant over-leveraging in many financial sub-sectors, but I don’t believe that credit will be more expensive for everyone. The banks will focus on certain companies — I was talking to one the other day who said they had 10,000 major corporate clients and, in future, they’d be focusing on 3,000 — but good businesses will be able to borrow money on attractive terms. The reason there’s no liquidity at the moment isn’t because there’s no capital, it’s because lenders don’t have the confidence.
The good news is that what we saw in 2005-7 was so extreme. The feeling at the time — that if we don’t do this deal it will damage our share price — led to such extremes that it’s absolutely clear there will be a lot of pain as a consequence. The big question is: just how apocalyptic will it be?
Collins: The credit market in 2006 and early 2007 already looks like an aberration, a strange period where too many people forgot the old rule that lending money to people who probably can’t pay it back isn’t very good business. The difference in price between good loans and bad loans narrowed stupidly. But at some point, when confidence returns, we will go back to reasonable access to capital at a price that reflects the genuine risk.
What lessons should the CFO take from this crisis?
Look after your cash. Be in control — have a Plan A, B and C because if you don’t, Plan B may turn out to be insolvency. Know your investors and lenders. And generically, work much harder at managing cash and run your business for cash and not for the price of your share options.
You need to really understand your financial model and make sure you have the appropriate level of long-term funding for your business. Receivables and inventory, for example, are seemingly short term but nevertheless they present a long-term funding requirement. It’s a good idea to pay for the assurance of having legally contracted credit facilities for, say, two to three years, enough to give you breathing space. You can trade fees for a smaller margin on the loan and it will help you sleep at night.
Now is the time for seriously questioning assumptions. A lot of businesses I talk to say they had run worst-case scenarios, but what happened was far worse than anything they envisaged.
The credit markets of 2006 and 2007 tell everyone — bankers, CEOs, non-executive directors and leaders of government — that we should not be afraid to ask just what the emperor’s new suit is made out of.
How do you expect different sources of capital to behave in the next few years?Banks will get back to doing what they used to do best: lending money to someone they trust because they believe that person is a good risk. They will be far less likely to make or buy loans on the basis that they believe they can sell them to someone else and make a profit.
SWFs have had their fingers burnt with some investments. Their wealth is fed by natural resources so, as prices are low, their surplus funds are lower than they were a year ago. But if I were an SWF, I’d be thinking: ‘Why rush?’ Prices are only going to go down. To me, that explains their temporary absence from the market.
Private equity firms have plenty of cash in their war chests, but their model needs redesigning. They can’t get the leverage to deliver the returns they were used to and that isn’t going to change soon. But some funds may emerge as long-term owners and specialize in sectors, managing portfolio companies.
CFOs shouldn’t forget that there is still a lot of money in China. Being based in Hong Kong, we’ve been able to access a lot of capital from China. I won’t go into figures, but it’s maybe 20–25 percent of what we’ve raised — compared to 10 percent two years ago — and we believe there’s more potential there.
I would urge CFOs to look at Islamic funding. We recently raised the first Islamic loan for a Hong Kong-based company. It wasn’t a lot of money, but developing a knowledge of that investor base, and helping them get to know your business, could prove invaluable.
In Asia, the development of local bond markets in places like Australia, Singapore, Taiwan and Thailand is a necessity if businesses are to rely less on short-term funding. Lerner The worry, especially for the U.S., is that the venture capital business seems to be gridlocked. Companies backed by joint ventures created 10 million jobs and US$2.2bn (€1.7bn) in revenue in 2006. Investing in an entrepreneur is a leap of faith and when there is no confidence, it’s hard to have that faith.
Tighter loans and a slower economy will make it harder for private equity firms. The deals that were done belong to a different era. And this approach has attracted some misguided political attention. Our research shows, for example, that debt from private equity-backed companies defaulted at roughly the same rate as all other corporate debt. But private equity may need to put more emphasis on a back-to-basics approach that focuses on managing assets.
One of the great unanswered questions is exactly how much of a free economy will emerge from this wreckage?
I believe it will be necessary and desirable for governments to play an interventionist role for some time to come. The role of government is being redefined as we speak, but it’s clear that we will end up with a very different kind of free economy. Many governments will be direct investors (taking stakes in companies), indirect investors (through regional development grants and banks) and more vigilant regulators.
Will regulation affect the availability of credit?
It will to some degree. Banks won’t be able to leverage the same asset 25–30 times, there’ll be more vigilance about what is on and off their balance sheets and they will be required to be more vigilant about return on capital. Regulation of the financial and banking markets is too disparate and leaking. I hope the regulations needed to patch the holes do not clog the constructive creativity of the investment banks in their approach to finance.
I don’t think anyone should underestimate the palpable public anger, especially in the U.S., against the banks and Wall Street and the amount of money that every taxpayer is effectively paying to bail out some of these institutions.
There is a real risk of regulation contagion. That is a concern because if you look, for example, at the history of anti-trust enforcement in the U.S., it is littered with well-intentioned actions that prevented businesses from taking actions that would have benefited them and society.
Governments haven’t launched into a knee-jerk regulatory purge. You can argue that some kind of regulatory failure has occurred, but hopefully governments will not overreact with a formulaic, prescriptive set of rules.
Will the crisis affect the way CFOs run their business?
You’re going to need to be more modest in your spending, focus heavily on your capex plans and adjust to the fact that the risk/return spectrum has been recalibrated. And you’ll need an integrated, well-run risk management function to survive. Prudent, conservative financial management will be rewarded.
Noble has demonstrated over the years a conservative approach to liquidity, as evidenced by our historical high cash levels. Our financial profile also reflects a high level of flexibility, with nearly 50 percent of the company owned by management and staff. Our prudent approach will be an asset as new opportunities present themselves.
Any CFO looking to the long term will have had a powerful lesson in the cyclicality of the availability of capital and that what you may face tomorrow will be very different from today. This lesson might be useful. While it is tough to resist the pressure of market cycles, keeping an eye on the broader ebb and flow of the financing environment is essential.
The first target has to be survival. And not being in a position where you have to borrow heavily in the next 10–12 months. Beyond that, I would say look for the opportunities to exploit distress. Companies that can access capital will find there are opportunities. We don’t know how long recovery will take, but history suggests that we are incredibly resilient and things will bounce back.
Marginal players — companies who only have a slice of the value chain — will find it harder to survive. We’re already seeing consolidation in some commodities, for example. Efficient, lean capital management is never out of vogue. Companies that do survive will benefit from greater pricing power and, if they have the capital, be able to seize opportunities.
Simon Collins
Head of Corporate Finance for KPMG Europe LLP, a debt finance specialist and partner in the U.K. firm
Prof Josh Lerner
Professor of investment banking at Harvard and regarded as one of the most advanced thinkers in the field. Has testified before the U.S. Congress on venture capital and private equity
Stephen J Marzo
Group CFO of Noble, a Hong Kong-based global supply chain management group which debuted on the Fortune 500 last year and reported a 124% rise in profits for 2008
Previously published in Agenda Issue 3
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