The Fractious
Beginnings of Global Economic Renewal -
The investment climate
presently appears stormy if not treacherous on almost a global basis.
The ongoing calamity of China's stock-market turmoil in turn
decimating local and international confidence. The recent western
rebound considered a 'dead-cat bounce' by bears and opportune market
re-entry by structural American bulls. Yet undeniably, the impact of
capital flight from the global economic engine that is 'The Middle
Kingdom' having crushed what was, until August, generally positive
sentiment across international bourses.
Consequentially,
further increased economic pressures within BRICs, MINTS, CIVETS,
their slowdowns increasingly problematic given the exacerbated impact
of the FX effect between a strengthening and so rising US$ - the
typical denomination of corporate and national debt – and further
delay of very much needed global export earnings.
Given the previous
improved situation across western bourses thanks to unprecedented QE
and monetary policy actions, it appears that the west is now
fractured between those nations that have reached the required
'escape velocity' – even if tentatively recognised – and those
for whom the effects of such policy actions have yet to take effect.
The ECB's apparent willingness to yet again resort to more
'unconventional policy', so as to fuel regional economic spend and
parallel the Yuan's recent fall, demonstrating what many observers
long recognised as the vital importance of competitive currencies
given the seemingly entrenched inter-continental “race to the
bottom”
Hence the international
influence of China's capital markets retraction and continued
economic slowdown (plateauing at an expected 'normal' 5%), will
undoubtedly buffet the Eurozone far harder than either the USA or UK. As
stated variously over the years ever since 2008, America's strength is its ability to
purvey economic self-reliance. Whilst the most internationalised of
nations given its global expansion over the last 120 years, it also
retains perhaps the most unique commercial capability of stretching
across an ever widening value chain.
Though diminished
relative to yesteryear, it retains much its origins in 'primary'
areas such as agriculture and extraction, likewise in processing and
finished manufacturing, is now able to effectively re-create
semi-finished manufacturing with greater added-value thanks to its
technological prowess with lower labour costs, and continues to
expand across the 'tertiary' commercial arena from Wall St to Palo
Alto with associated satellite regions around the country. And
critically, the phased QE has now filtered through the banking
sector, been applied nationally by investment banks under-pinning the
resurgence of the USA at large cap and small cap levels, and (once
surplus housing capacity has been re-absorbed) the now
internationally strengthened, but more domestically free-flowing US$,
through credit expansion is set to re-feed the economic cornerstone
that is the real estate market.
The Federal Reserve's
decision to finally lift rates, even if only fractionally, given
various positive stable data trends may be implicitly recognised as a
overtly subtle vote of confidence in America's ability to overcome
previous (and still very visible) economic woes.; even with what
should have been an expected poorer performance in December.
To this end, the USA is
in a very different and far more positive position compared to the
rest of the world, even if the S&P500, NYSE and NASDAQ is highly sentimentally impacted by China's own ructions.
The consequences of the
Great Recession heralded a structural overhaul of the American
economy, but now it is once again in a position to reclaim its title
as the world's economic engine. That restrengthening, obviously
domestically biased first, has been seen to be underway; examples
ranging across the new crop of automotive-centric small enterprises
servicing much from hi-concept eco-mobility to the realm of classic cars to the
merger and acquisition activity of regional dealerships swallowed by
major conglomerates or patriotic investment houses (eg formation of
Berkshire Hathaway Automotive via purchase of Van Tuyl Group).
Clearly demonstration
of 'new beginnings' for America, national growth and prosperity and
eventually global regeneration.
The stage then has been
set.
Conversely, the
Eurozone will inevitably be hit harder by China's ripples. Its
re-emergence delayed longer than expected....yet again. The previous
rapaciousness of Draghi propelled capital markets is now much quelled
by the realisation that Europe is both anaemic and in actuality
continues to be politically and philosophically divided; even if the
financial division has tempered. A mix of still prevalent
intra-national self-interest, lack of true labour and industrial
reform in various states, a loss of global exports (especially from
Germany - the EU's own economic engine) and consequentially increased
cross-border strains, means that real-world economic traction for the
Eurozone as a functioning whole will inevitably take longer.
However, as also seen,
from a desperately low re-emergence base, and though still fragile,
the economies of Germany, The Netherlands, Italy, Austria and parts
of the Balkans, are slowly forming the regeneration path for Europe.
This thanks in no small part because of the economic stewardship of
old industrial families and contemporary holding company counterpart;
less so the volatile voracity of stock markets.
These establishment
interests continue to bargain hunt across the continent. To take
advantage of deflated industrials and associated services, to
cherry-pick tomorrow's SME winners during the present export downturn
to (investment stagnated) BRIC, MINT and CIVETS regards capital
goods/ machinery.
This means that in the
short-mid term Europe suffers greater internal constraint than is
ideal or indeed recognised. Far more so than the USA. Nevertheless,
its own pan-European network and future phased impetus underpins more
subtle long-term confidence than is presently obvious.
Although impacted by
the global downturn, India itself retains internal domestic strength at 7.5% growth rates,
even if regional exports suffer across MENA and SE Asia, so
illustrating Indian resilience. This now coupled by the promise of
industrial input cost reductions and new market opportunities given
the strengthening of diplomatic ties with Pakistan; so able to
partially off-set lost exports elsewhere.
And lastly, although
hit hard by the previous collapse of consumer durable export markets,
China's own long-haul structural reform toward a far better balance
of domestically generated B2C and B2B demand bodes well. But that
rebalance will be more tortuous than internationally recognised, and
the rise of required internal demand will take longer than generally
anticipated as Chinese consumers revert back to their traditional
defensive behaviour. More so than western experience.
That defensiveness
first seen in the out-bound international flight of the wealthy, away
from homeland hard assets.
Ongoing deflation of
previous bubbles in stocks and real estate, plus the gradual
weakening of the Yuan, altogether indicates broad expectation of
better general economic stability, even if at about a notionally
lowly 5% growth or so (as predicted by investment-auto-motives some
time ago). Any such 'new norm' at least it preferential to any
continuation of 'boom and bust' patterns. Especially so given China's
present global impact; and thus better suited to latterly attracting
foreign capital into bourses and project-based FDI, so creating the
firm foundations for its own climb up the commercial value curve. For
now however, that era seems somewhat remote.
Thus we see that today
the world could be said to be entering a new era of growth, led by
the USA, and perhaps latterly viewed in time to come as the
determinant age for global resurgence.
It is upon this
understanding that the established automotive firms should look
beyond that which is perceived as industry-set limitations, their own
conventional corporate mindset and explore intra and inter functional
practices.
The Far Horizon Need
for Innovative Organic Growth -
Over the last four
decades top-line western corporate growth has all too typically been
'bought' via acquisitions, the cost of such seen to be the price of
business to maintain a stable or grown slice of sector-specific
market-share.
The reduction - indeed
often absence of organic growth in some sectors - indicates that when
notionally 'large' a firm, as a complex entity, becomes highly
administration al, thereafter overtly cumbersome, increasingly
conservative and unfortunately ever more bound by self-serving
internal politicking; as executives and managers seeking to secure
themselves sizeable personal gains from the stable sizeable firm.
This of obvious concern to the investor. Instead of mapping and
exploring potential new opportunities (on a risk-reward basis) the
status quo is effectively retained by 'bolting-on' all too similar
target acquisitions, to simply enlarge the entity and consequentially
senior figures' remuneration. The all too unfortunate outcome is that
younger, entrepreneurial members become stifled and so leave; thus
the firm has deprived itself of alternative perspectives and analysis
and associated new commercial possibilities.
Perhaps the only truly
plausible conventional acquisition is when a firm enters a new
geographic territory through purchase, thereby gaining access to a
likely stable or high growth country or region to which it would have
otherwise been effectively explicitly or implicitly barred.
Conventionally,
acquisitions serves best - and should be applauded - when
demonstrating a truly synergistic expansion of internal capabilities;
whereby two obviously complementary companies are merged, but only
when “the numbers stack up”. This can occur vertically,
horizontally or indeed diagonally, across the specific sector's
value-chain
[NB Here we can see the
powerful logic of TATA's purchase of JLR: positive brand, global
reach, aluminium structures, etc. Little wonder the Mahindra has been
seeking to somehow replicate the move.
Rationale for
Sainsbury's recent bid for Home Retail - Argos has seemingly been
driven by the very tangible need to fill floor-space, presumably gain
a fixed per sq ft income from the concession space; even if argued on
the Amazon basis of immediately enlargening its own delivery
distribution network. Whilst simultaneously lowering estate costs for
Argos use Sainsbury's customer car-parks to increase the sales of
higher priced, large and bulkier items carried by car; important at
this early point of the economic upswing. However, there is a
notional 'brand clash', this undoubted viewed as less acute given the
cross-demographic cost-consciousness.]
Presently at the
low-point of the global economic trough, yet with what is set to be
an improving western-led economic climate (by way of US and UK) with
respective regional 'green shoots' firms eventually and inevitably
return to a 'business as usual' mindset. The order book slowly
re-expands and an improvement of utilisation in plant and labour
arrives; thereafter traditional everyday activities demonstrating
their worth and investment value. After the long struggle thus far
since the trough of the Great Recession, reaching a renewed normality
is welcome, and many will undoubtedly seek to enjoy the returned
comfort.
Yet, with reaching such
a welcome phase comes the need to strategically consider the mid and
long term horizons.
What can the firm do to
secure its future? How can the very internals of the company be
reconsidered to provide an expansionary platform for additional
wealth creation once the marginal utility of everyday operations has
been exploited, and ultimately diminishing returns experienced?
Looking Beyond the
Business Cycle -
The standard cycle
sees:
1. the initial major
restructuring to ensured a new lowered cost base. (as per US/UK
today).
2. the associated
'early days' profitability gains from traditional activities.
3. the eventual
experience of a profit plateau (rising input costs and reduced output
pricing elasticity due to increased competition of a 'healthy'
marketplace).
4. the need to further
differentiate to maintain margins and avoid value destroying price
wars, typically through product and service innovation.
Whilst a well funded
research and development budget (typically measured as a % of
revenues) provides an important start-point to provide all-new
offerings and generational updates to in-market items, the new
products / solutions devised may not be exactly matched to the
market's own needs, wants and desires. Business text books abound
with apocryphal case studies of the failed new; most evident in the
FMCG sector, but prevalent across virtually all; including
periodically the functionally led B2B arenas.
[NB the B2B arena is
less beset with failed products and services precisely because of the
close working relationship between supplier and client. In B2C realms
since the 1980s such intelligence gathering exercises have increased
but tend to be far less immediately prescriptive and so more tenuous
problematic. Very often surveys and focus groups only ratify what is
already well recognised, adding confidence but little new learning,
and as so often experienced in the automotive sector, have
effectively been moulded and 'back-fitted' to support a vehicle
programme already far in advance].
With this, and the
similar 'corporate haze' understood, board directors and managers
must ask themselves not only how standard procedures should be better
deployed, to truly add insights, but as critically what can be done
to better exploit the innards of the company. So as to achieve a more
secure path to higher profits, in turn raise investment
attractiveness, lower the cost capital, boost top-line sales, reduce
internal costs, and so improve investor returns?
So although the US and
UK are today still within the fortunate 'early days' of conventional
practice and superior marginal returns - presently unrecognised by
capital markets given the sentiment driven sell-off of late -, and
thus some years from approaching this very real 'new thinking'
impetus, the broad spectrum of firms (from multi-nationals to
resuscitated SME 'zombie' firms) must begin to better appreciate
exactly how they might expand beyond the standard operational
practices of 'business as usual'.
Questioning
Conventional Wisdom -
Conventional wisdom –
as propagated by fee earning investment banks – is that the company
should undertake a new cost-down initiative to improve margins and
cashflow, divest low-value assets to strengthen the balance sheet,
and improve output levels to gain economies of scale, most easily
achieved via merger and acquisition of an close competitor firm.
These are all obvious
solutions, especially so the last mentioned, given the general rise
in the number of potential targets, themselves established and grown
because of cross-sector globalisation, and best achieved when such
firms have over-reached and face a local market credit-crunch, thus
more easily captured by any predator with available cash and credit
facilities.
Yet, as must be
recognised, the very fuel that feeds mergers and acquisitions deals
is the buoyant 'animal spirits' financing climate which arrives
between the mid-point and high-point of the economic cycle. Thus
inevitably leading to the innate over-pricing and over-bidding of a
target company's true worth; as the measures that support the frothy
numbers are themselves based upon overtly optimistic maintained
growth scenarios and often knowingly artificially boosted DCF
calculations.
Mergers and
acquisitions then are best value to investors when undertaken and the
beginning of a new economic cycle, such as with FIAT's swallowing of
Chrysler and the idiom of 'destructive creation'. Then able to deeply
gauge-out waste and costs, and effectively re-start as a new leaner,
bigger entity at the very the bottom of the new economic upturn. Yet
even these instances are very dependent upon the exacting details and
dynamics of the firm(s) and marketplace.
A vital perception that
appears obviously lost within the contemporary bank-driven business
landscape is that of its polar opposite: intelligently lead organic
growth.
This achieved by not
only sweating the conventional 'hard' and 'soft' assets, but by
recognising new opportunistic avenues that can be exploited within
the individual functional domains themselves, or the possible
synergies across functions applied in new ways, and the ability to
create new independent cost-centres or 'spin-offs' from both within
and by partnering with external suppliers or indeed customers.
Over recent years the
very notion of organic growth has been almost specifically related to
the most obvious of 'high growth' sectors:
communications-technologies, social-media, info-tainment and branded
service portal smert-phone 'apps'. If successful these will indeed
access and monetise an enormous user-base of potential prospects.
But whilst those few
“ten-bagger” 'unicorns' have been proven as enormously powerful
new businesses (either regards MarketCap or Revenues or both), the
grass-roots reality is that – akin to the paucity of strong FMCG
product launches – there is enormously high failure rate. And even
with the explicit use of the term 'unicorn' demonstrating rarity, it
seems that swathes of the overtly optimistic cyber-cult investment
community are blinkered to that reality; preferring to throw enough
money at enough start-ups to eventually hit the jack-pot.
Whilst unfortunately
amongst “feet on the ground” realists, given the massive failure
rates within an IT sector, the very phrase 'organic growth' has
become sullied.
Far too much
speculative expectation and far too little professional management of
meaningful and step-phased research and development.
This present mindset
needs to be reversed. Especially considering the market realities of
far less ethereal manufacturing and manufacturing-service based
sectors and companies.
Instead corporate
leaders should be inspired by the realism of old fashioned,
substantive organic growth approach within their own seemingly
'yesteryear' sector, which whilst harder to gain the type of 'FANG'
stock speculation interest, when mapped with true acumen should
provide valuable primary, secondary and tertiary revenue streams into
the far future.
Thus ensuring the
robustness of the company, improve the bottom-line and maintain
investment community interest.
A matter of:
“Less Financial
Engineering”...
(oft achieved through
merger and acquisition)
...Better Operational
Re-Engineering”
