The Credit Crunch - How could they not see it coming?

The phrase Credit crunch was the start of media frenzy back in 2007 and every household felt the impact. Most people seem to think this is a new phenomenon but it was happening to Canada in the 80’s, Argentina in the turn of the millennium, and the great depression of 1929. Although, it is believed that this crisis is bigger than the Great Depression. The scale of the economic breakdown is difficult to comprehend. No previous economic crisis has involved this sum of money, in the trillions of dollars, that have been squandered by the governments to prop up the banks and financial institutions who activities have triggered the global meltdown.

Credit rating agencies have been vilified for failing to properly assess the risks associated with subprime and other low quality mortgage debt ahead of the financial crisis. They gave triple A ratings to billions of dollars of mortgages securitisations that turned out to be far riskier. The impact caused banks and investors to suffer huge losses. It goes back to 2001 when the crack started to appear after the dotcom bubble and 9/11 attacks, but the full extent did not come to light until April 2007 when New Century Financial, which specialises in subprime mortgages, filed for bankruptcy. This was the start of the domino effect. Then in July Investment bank Bear Stearns hedge funds failed to perform and banks refused to bail them out. This continued when Investment bank BNP Paribas that could not value two of its funds, the amounts of money was substantial and realisation that the banks and investment centres were financially exposed. As the German bank Sachsen Landesbank faced collapse after investing in the subprime markets and had to be sold. This spark international attention and finally the finance world were listening as concerns of various issues relating to the subprime market emerged. As news stories develop you see a compound effect.

Banks lending to banks started to drop and interest rates started to increase, attaching much higher risk values to lending. You have to ask the question, what were they thinking using short term finance to finance 25 years mortgages? Then finally on 13 September 2007 the well publicised in the press bank Northern Rock now owned by the Virgin Group had to bailed out by the Bank of England, which started media frenzy, frightened customers queued for hours to withdraw their fund amounting to £1billion in one day and finally even the average Joe off the street knew about the financial crisis.  


May 2008 saw reports of more than 850 companies going into administration hitting the high street hardest, some of well known and loved shops started to disappear as the highly geared companies failed to pay back loans. Still five years on and it does not look like the end is near, shops are still disappearing as consumers are keeping hold of their money. The biggest losers in the financial crisis have been the UK and USA as small and medium sized companies fail for administration one by one, but some winners have materialised, Australian, Asian and Latin economies have emerged with clear balance sheets. The Asian economy escaped the worst of the banking sector problems. Something good that has come out of the crisis is tougher regulations on banks, but the economic profession does not come out smelling of roses. You have to wonder how did they fail to foresee the economic crisis of the noughties?  


Source: Arnold, G. (2008), 'Corporate financial management'.
              

Mergers and Acquisitions: How did they do it so right?

In recent year’s mergers and acquisition activity has been rising steadily. The UK has seen high levels of acquisitions in the pharmaceutical, banking and electrical sector.  Two factors that fuel an acquisition are strategic and financial forms. Companies may become subject to mergers and acquisition due to the possession of particular value chain strengths. This could be in the form of technology development or even research and development advances. Basically if your company has something they want, and they can create additional value from the activities in excess of the acquisition costs. If this is the case whether it be for market dominance, economy of scales, to diversify or just because of corporate egos, they could just be round the corner.

In the past companies have not always purchased other companies for the right reason, the main strategic goal should always be shareholder wealth maximisation. But sometimes they have got carried away, in pursuit of market dominance and realised that all they have been left with is a big pile of debt.  Vodafone went on a spree in the last decade running up to the economic downturn, which forced a group-wide consolidation of assets during the past three years. The arrival of the new chief executive in 2008 Mr Colao, markets the end of the “empire building “effect. The company has since focused on consolidating its position in its core stable European and growing emerging markets, and disposing of, or merging minority or subscale interests elsewhere, pretty much getting rid of any dead wood, which I’m sure the shareholders will be very happy with, as the money will be distributed amongst them.

This could also be to raise funds for a merger with struggling telecom group Cable and Wireless Worldwide, which they have announced an interest in. The company went through a demerger in 2010, since then they have had several profit warning and the company is not in good shape. But it does have a bunch of subsea cables, some tax assets, data centers and British bulk telecom networks. At the moment Vodafone is using rented land lines from BT, they are BT largest customer. Which, when you put it into context could mean huge savings for Vodafone if it goes ahead with the deal by off-loading some of its mobile data traffic to the fixed lines of the telecom group. As with any company this size, they are also looking at other options including FDI in India if regulations will allow it. At the moment no offers have been made but it will be interesting to see, which route they choose.

A successful merger that took place in 2004 was between General Electric NBC and Vivendi Universal Entertainment (VUE) forming NBC Universal in the largest media deal that year. Universal had come close to bankruptcy and the owners needed to get the debt down, so began the process of trying to sell as many assets as they possibly could, but burdened with €35bn debt agreed to sell its controlling stake in VUE to NBC. NBC revenues were 90% advertising and the rest from cable fees and VUE was the opposite, with box office and DVD’s. When you put this together, makes it 50/50, spreading the risk. This is a perfect example of a merger that gone right, they had other options to buy MGM as well but felt it was not in their best interest right now to grow any larger.  As they try to implement product quality and production efficiency, increasing cash flows.

The merger worked that well that in January last year Comcast completed its purchase of NBC Universal, when it acquired 51 percent of the media group by paying $5.8bn to Vivendi and $7.1bn to GE. The group now also has cable channels worth $30bn that Comcast has thrown into the pot, helping the media company become a successful combination of content and distribution.  In this fast moving environment it pays to be strategic and keep an eye, on what else could be a good cash injecting string to your bow. With this in mind NBC Universal, the media company owned by Comcast, agreed to buy Blackstone 50 percent stake in Universal Studios Florida in a $1bn deal that consolidates its ownership of the theme park. Confirming its long term commitment to NBC Universal, as Universal Park has enjoyed success from the Harry Potter attraction. The park offers consistent and significant return and free cash flow is performing well. As always, what it comes back to is Shareholder wealth maximization and they are bang on the money as it raised dividend payments due to strong earnings.


Source: Arnold, G. (2008), Corporate Financial management
Schoenberg, R. (1999), What Determines Acquisition Activity within an Industry?, European Management Journal, Vol. 17, pp. 93-98, 

Foreign Direct Investment: maximising shareholder wealth in multinational companies

FDI is the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. As with all companies their aim is to increase shareholder wealth maximisation; and by saturating untapped or developing markets; where foreign governments have adjusted their policies to allow for FDI to take place, is an ideal investment opportunity.

China has been a magnet for FDI since the 1980’s, and has seen a huge rise in wages of 12% after adjusting for inflation over the past few years. But instead of FDI going elsewhere they have opted to go to China’s inland provinces. The shift inland has attracted the likes of Hewlett-Packard to the lower wage costs. China has managed to fight off competition due to its superior education levels in workers to that of other developing Countries like India and Indonesia. But in December it was reported in the Financial times that China’s economy was down for the first time in 28 months and that there was evidence of a growing economic slow down.

With this in mind, companies are looking for new areas to saturate and maximise share holder wealth as there are not many untapped retail markets left; and India with a population of 1.1billionn is a major source of future revenue growth. The Indian government now believes liberalisation of legislation regarding FDI will secure much needed investment into India’s farming sector and control continually high food inflation. Investment by Multinational companies will be capped at 51 per cent of any retailer; and the government will require foreign forms to commit a minimum of $100m of investment in the country. There would also be strict rules on acquiring their products from small to medium sized traders.

But with so many restrictions in place will it attract multinational companies to India? Carrefour, the French supermarket chain which has been in talks with the Indian government for over a year had warned that placing restrictions on local sourcing and requirement of minimum investment might affect viability of the projects. Other supermarkets which have jumped on the multinational band wagon are Walmart and Tesco’s, which may soon be allowed to open stores under stringent norms.

The legislation being set, in theory, helps the Indian economy and promotes employment opportunities. Marks and Spencer’s, started in India ten years ago as a up market chain as it was restricted by expensive imports, which had to be passed onto the customers. It has now successfully focused on the middle market, expending its network, cutting expensive imports and has started buying locally. This has allowed them to tailor their products to the local market. M&S first came to India in 2001and ran its stores as a franchise using a local Partner, Planet Retails which imported goods from the UK but this caused high duty costs. M&S are a perfect example of maximising shareholder wealth and increasing profits, through opening its doors to a larger market area by sourcing locally. It has also adapted to its environment, selling colourful clothing. Reaching out to its target audience as colour is an important factor in Indian Culture.

The concerns with FDI from multi brand firms are that local businesses in developing countries could be pushed out of business. Which when you look at the bigger picture just means that they may not be increasing employment but just replacing the jobs that were already there in the first place. But with the absence of adequate roads, airports, power and the world class telecommunication network can they afford not to allow FDI not to happen?


Source: Arnold, G. (2008), Corporate financial management'.
              beyondbrics, (2010), No win? How to price good inflationary india', FT.com
              Jopson, B, (2010), Walmart's $4bn bet on Africa consumers, FT.com
              Kazmin, A. (2010), Indian retail, more political backing for breaking the FDI taboo,      FT.com
              Surendar, T. (2010), 'Marks & Spencers Retail Rethink', FT.com
              Awal, A. ~(2011), India: a new brief for M&S, FT.com
              Wagstyl, S. (2011), Asia: growing economic gloom, FT.com