Sunday, 24 January 2016

Industry Practice – 'Value Stream' Exploitation – Identifying New Possibilities (Part 2)

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”