Bank of America Merrill Lynch CFO Outlook 2014 Asia

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A new survey conducted by The Economist Intelligence Unit for Bank of America Merrill Lynch finds that optimism abounds among Asia CFOs but financial concerns are becoming more pressing. More than three-quarters of Asia's finance chiefs (76%) expect revenues to grow this year, up from 72% in 2013. However, optimism on profits is tempered by intensifying margin pressures. The proportion of CFOs in Asia that expects profits to grow has fallen to 60% from last year's 65%. The report is now free for download at http://bit.ly/1hMIq7R

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Bank of America Merrill Lynch CFO Outlook 2014 Asia

  1. 1. 2014 CFO Outlook Asia A Survey of Chief Financial Officers Wellspring of Growth Optimism is driving a new age of growth in Asia
  2. 2. 2014 CFO Outlook | 32 | 2014 CFO Outlook Wellspring of Growth About the survey 2 Welcome letter 5 Key findings from the 2014 survey Top findings infographic 6 Key learnings summary 8 Part 1 - The big picture: Regional overview and trends 10 Case study: PLDT: Innovation to combat margin pressure 17 Part 2 - Risk: High, but manageable 18 Risk infographic 19 Case study: DBS: Managing resources and performance strategically 30 Part 3 - Growth: Going organic 31 Case study: Siam Cement’s sweet spot 42 Part 4 - M&A: The lure of the Southeast 43 M&A infographic 44 Case study: China Resources Enterprises: M&A to the core 53 Part 5 - Finance: Cash is king — and risk is ever present 54 Case study: Owens Corning: Impatient with China, but wanting to believe 60 Conclusion: The consequences of growth 62 Contents About the survey In January 2014 The Economist Intelligence Unit surveyed 639 financial officers from companies across a range of industries in 12 countries and territories in Asia (Australia, China, Hong Kong, India, Indonesia, Japan, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand). Respondents included chief financial officers, financial directors, senior vice-presidents of finance, treasurers and those with other senior finance- function titles. Half the respondents were from multinational corporations and half from companies with operations in only one country. All multinational companies that participated have global annual revenues of at least US$500m; all local companies have revenues of at least US$100m. NB: Although several questions are repeated from the 2013 CFO Outlook Asia, the methodology for 2014 differs in that unweighted survey data is used in this year’s report. Unweighted data from the 2013 survey is also used for comparative purposes, meaning results cited for that year may differ from the 2013 publication, which used data weighted by nominal GDP. Other methodological changes have also been applied. For certain questions respondents could pick more than one answer, meaning responses may not always add up to 100%. The EIU also conducted in-depth interviews with a number of CFOs across Asia. Our thanks are due to all interviewees and survey respondents for their time and insights.
  3. 3. 2014 CFO Outlook | 54 | 2014 CFO Outlook Welcome to the Bank of America Merrill Lynch 2014 CFO Outlook Asia. This report is the third edition of an annual survey that combines the thoughts and insights of over 600 CFOs and other senior financial executives in Asia Pacific, with more than half representing corporations with annual revenues of US$1bn and above. We have updated the survey questions to reflect current themes and market concerns, while keeping relevant questions from last year to capture trends. Read about the perceptions and expectations of key financial decision makers in terms of revenue and profit, financing, key financial and operational risks, and M&A vis-à-vis organic growth. On behalf of Bank of America Merrill Lynch, I want to thank all the senior financial executives who took time to participate in the survey and for sharing their thoughts with us. I hope you will find this report insightful and informative. Steven Victorin Head of Asia Pacific Corporate Banking & Global Corporate Banking Subsidiaries Bank of America Merrill Lynch Welcome
  4. 4. 2014 CFO Outlook | 76 | 2014 CFO Outlook …but margin pressures are buildingConfidence in the region abounds... 2014 CFO Outlook Top Findings The big picture More CFOs expect revenues will grow in 2014 than in 2013 But fewer CFOs expect profits will grow 2014: 76% 2013: 65% 2014: 60% 2013 72% 2013: 72% 2013: 65% 2014: 76% 2014: 60% 7 percentage points Margin gap 2013 16 percentage points 2014 Expect revenues will grow Expect profits will grow China and the West fall from grace: Southeast Asia: 41% India/ South Asia: 40% Emerging Southeast Asia: 36% M&A focus will be strongest on: China North America Western Europe 1st 4th 5th5th 11th13th 2013 2014 Main goals for MNCs’ Asian operations: Business expansion: organic growth preferred Innovate in new business lines: 42% Invest to grow revenues: 44% Expand into new countries: 46% of CFOs say they will use surplus cash for organic expansion 51% 45% Operational efficiencies 41% Improvement of working capital management Technological advances/ automation Focusing on fundamentals to improve profitability: Margin pressure is driving a focus on core disciplines—and technology: A drop in planned capital expenditure increases: 49% 24% will spend it on M&A plan to raise capex 2013: 46% 2014: 35% Note: All figures are percent respondents from 2014 CFO Outlook Asia survey unless otherwise indicated. Figures may not round to 100 either due to rounding or because respondents could select multiple answers. Ranking of target M&A markets and bank loans remain top financing choice of companies will decrease long-term debt weighting in 2014 41% 57% Bank loans Internal sources or self-funding Malaysia Taiwan India 67% 67% 63% Metals and miningPharmaceuticalsManufacturing Many are seeking to reduce long-term debt; most will rely on bank lending Bank borrowing appetite highest in: Finance: focus on banking relationships, internal strength 64%66% 61% 29% Selecting as greatest financial risk Concern over financial risks growing... Risk: dangers discounted 2014: 35% 2014: 30% 2013: 22% No opinion/disagree Negative impact expected Agree Positive impact or no impact The end of quantitative easing in the US will cause major problems in Asia 59% 41% Currency volatility Liquidity 13% 87% …but a minority are worried about US “tapering” and political change Political changes: an opportunity rather than a risk? 2013: 16%
  5. 5. 2014 CFO Outlook | 98 | 2014 CFO Outlook Confidence in the region abounds More than three-quarters of Asia’s finance chiefs (76%) expect revenues to grow this year, up from 72% in 2013. This figure far outpaces expectations for sales growth in the US 2014 CFO Outlook (54%) and is an endorsement of resounding confidence in the region’s business prospects, despite an abundance of macroeconomic and market risks. “Growth rates throughout Asia are still strong, despite some slowing, and have been for some time… Remember that 7% growth in China now probably equates to 14% growth 10 years ago. That’s massive.” Robert van der Zalm, CFO, Noble Group Optimism is tempered by margin pressures The proportion of CFOs in Asia that expects profits to grow is also very high, yet has fallen to 60% from last year’s 65%. The “value gap” between those who expect revenues to rise and those who expect profits to rise is 16 percentage points, up from 7 last year—suggesting that it is getting tougher to extract value out of revenue growth. “We are going through a significant change… a shift in revenue mix causing some margin pressure across Asia—and the world.” Chris Young, Chief Financial Advisor, Philippines Long Distance Telephone Co CFOs are looking to technology and efficiencies to raise profitability Pressure on margins is driving Asia’s CFOs to focus on raising profitability through core disciplines like operational efficiencies (picked by 45%) and better working capital management (41%). But a greater proportion, 51%, say they will seek to build profitability through the use of technology and automation, such as customer relationship management programmes, better management and supervision of supply chains and forecasting. Financial risks are the top concern, while a minority are worried about US tapering 36% of Asia-based CFOs say financial market risk is their single greatest concern in 2014, compared to 22% in 2013. A minority (41%) agree that the end of quantitative easing in the US will lead to major problems in Asia. Many CFOs interviewed for this report feel that markets have discounted the effect of tapering. “[Tapering] will offer some respite for the inflow of liquidity into Asia and may be a good thing for Asian countries with strong fundamentals.” Chng Sok Hui, CFO, DBS Currency volatility and liquidity are driving financial concerns Among financial risks, currency volatility is seen as the most serious (picked by 35%, up from 22% in 2013) while liquidity is in second place (30%, up from 16%). Political change is seen as an opportunity rather than a risk Just 13% of CFOs are worried that political change in their home countries this year will have a negative impact on their business; 38% across Asia expect a positive impact. Political risk is shrugged off in Thailand (where just 10% are worried), while majorities in Indonesia (57%) and India (53%) are optimistic about the impact of elections this year. “Political parties across the spectrum have supported the growth of IT and IT-enabled services industries, and we expect this to continue in the future as well.” Abraham Mathews, CFO, Infosys BPO Key learnings from the 2014 survey Organic growth preferred, but Southeast Asia is top M&A target Organic growth is the number-one way CFOs intend to use surplus cash, while just 24% will spend it on M&A. Some 62% of CFOs say that they do not have M&A plans in 2014, around the same proportion as in 2013. Of those that do, the most popular market is Southeast Asia—ranked first in 2014 from second last year. “[In Southeast Asia] there are interesting investment opportunities, but asset values are still high. Some companies have been taking on a lot of leverage. Some will have to deleverage, and assets that are not on the market at the moment, will be, reasonably, given time.” David Nicol, CFO, Metro Pacific Investments M&A: China and the West fall from grace Just 15% of CFOs in Asia with M&A plans this year pick Greater China as a target market, with its ranking falling from first in 2013 to fifth. Western markets are also out of favour, with just 6% focusing on Western Europe for deals this year and 4% on North America. “[In China] you can still make good money, but not quick money.” Frank Lai, CFO, China Resources Enterprises Multinationals have a value edge A substantially higher proportion of multinational CFOs (66%) say they expect profits to grow in 2014, compared to CFOs from local companies (54%). This is despite similar expectations for revenue growth in each group—suggesting local companies will face even tighter margin pressure this year. “For eight years, our ambition has been to grow in the region. We have invested and expanded. This region should be growing for another 20 years.” Chaovalit Ekabut, CFO, Siam Cement Group (SCG) Many seek to reduce long-term debt; most will rely on bank lending Some 41% of CFOs say their companies are likely to adjust their capital structure to decrease the weighting of long-term debt. In terms of the type of financing, bank loans are the stand-out preference, picked by 57%. For many, internal funding sources are greatly preferred to any other means of finance. Meanwhile, around a third of CFOs (31%) expect capital costs to rise. Just 35% plan to raise capex, down from 46% in 2013. “We’re uniquely advantaged compared to businesses that require capital to sustain growth. We believe it will become increasingly harder to access capital and at a higher cost.” Huiping Yan, CFO, Home Inns
  6. 6. 2014 CFO Outlook | 1110 | 2014 CFO Outlook Part 1 The big picture: Regional overview and trends CFOs are confident that revenues will grow, but earnings might not follow suit. There is optimism about economic growth across the region—particularly among manufacturers. A mandate to grow, but margin pressures are building Chief Financial Officers in Asia are embracing a growth agenda. Some 76% of the 639 CFOs and finance leaders that responded to this year’s survey say that they expect their revenues to grow, up from 72% last year (Figure 1.1). That figure shows Asia’s finance leaders are far more optimistic than their counterparts in the US, just 54% of whom expect top-line growth this year (according to the US edition of this survey, published in March). Figure 1.1: Good to grow Do you expect your company’s revenues/profits to grow, contract or stay the same year-on-year? % respondents expecting growth in revenues; change year-on-year in percentage points. 2013 Change Y-O-Y2014
  7. 7. 2014 CFO Outlook | 1312 | 2014 CFO Outlook Figure 1.2: A profitable year? Do you expect your company’s revenues/profits to grow, contract or stay the same year-on-year? % respondents expecting growth in profits; change year-on-year in percentage points All the CFOs in Asia interviewed for this report have strong confidence in the region’s growth prospects, though most use the measured tones appropriate for the CFO’s role as custodian of the balance sheet and monitor of risk. Frank Lai, CFO of China Resources Enterprises, puts it this way: “You can still make good money, but not quick money.” In fact, robust growth prospects pose a challenge for companies in their quest for value. The proportion of CFOs that expect profits to grow declined to 60% in the 2014 CFO Outlook Asia survey, from last year’s 65% (Figure 1.2), suggesting that even as revenue expectations soar, it is getting tougher to grow profits. Strong growth markets tend to be hobbled by the search for profits, as companies pour more into the cost of sales to gain market share, adjust pricing amid higher competition, and face higher costs. Causes vary according to sector and market, but margin pressure is a commonality. In 2014, for example, 84% of respondents in Japan expect revenues to grow, while 57% expect profits to grow, a difference of 27 percentage points. That gap has expanded substantially from last year, when it was only seven percentage points. The difference in South Korea between revenue and profit expectations amounts to 36 percentage points this year; last year it was only four points. In China, the difference this year is 19 points, up from 13 points in 2013 (Figure 1.3). The trend is not universal, though. In Thailand, the difference in 2014 is 13 points, tighter than the 17 points recorded in the 2013 survey. Meanwhile, this year Singapore and Malaysia are the only two countries with a negative margin gap—that is, where more CFOs expect profits to rise than expect revenues to rise. Figure 1.3: The margin gap Difference between proportion expecting revenue and profit growth in percentage points Optimism about growth across the region Despite the pressure on margins—and taking into account the diversity of economic cause and effect in each market and sector across Asia’s enormous geographical spread—buoyancy about the Asian growth story is undeniable. Expectations that revenues will grow are highest in Japan and Thailand, both at 84%, and South Korea, at 82%. Optimism about Japan has been one of the most notable trends in Asia in recent months, given excitement about “Abenomics”—the economic policy pursued by the prime minister, Shinzo Abe, who took office in December 2012. CFOs there appear confident that top-line growth will continue. When it comes to the bottom line, though, in general more CFOs in Southeast and South Asia than in other subregions expect growth this year. Some 71% of CFOs in Thailand expect profits to grow, while in India, the figure is 72% (see box). Both are well above the median of 60% for all CFOs polled in Asia. By contrast, the number of CFOs that expect profits to grow is below that average in Japan and South Korea, where the results are 57% and 46%, respectively. 2013 Change Y-O-Y2014 20132014
  8. 8. 2014 CFO Outlook | 1514 | 2014 CFO Outlook India: Hope for a year of change? What explains the relatively bullish outlook for India? Some 72% of survey respondents—or a larger proportion of CFOs and finance leaders than in any other country—expect profits to grow this year. This is despite a turbulent year in 2013, when exasperation with the slow pace of reform and the country’s susceptibility to capital flight were both exposed. With a general election underway and more solid economic data coming in confidence has returned, but problems remain. Despite these obstacles, CFOs in the country are sure of their companies’ ability to produce profits. “In India, change is driven through wide consensus, and since getting consensus across the spectrum is not easy, change is slow. This is reflected in infrastructure growth as well,” says Abraham Mathews, CFO of Bangalore-based business process outsourcing giant Infosys BPO. Yet, he says, “The outlook for growth continues to improve, though at different rates in different industries.” Mr Mathews is sanguine about political change in India this year. “Political parties across the spectrum have supported the growth of IT and IT-enabled services industries, and we expect this to continue in the future as well.” Like Mr Mathews, Indian CFOs are putting stock in their companies’ ability to build value in textbook ways, preferring this over mergers and acquisitions or buying market share by slashing prices. Some 58% of India’s CFOs say that they will utilise surplus cash for organic expansion (the highest proportion among all the other countries surveyed, bar 60% in Indonesia). Forty-eight percent of CFOs in India say they will invest cash to grow revenues. “In India, change is driven through wide consensus, and since getting consensus across the spectrum is not easy, change is slow. This is reflected in infrastructure growth as well,” In comparison, only 22% of India-based CFOs say they will use excess cash for acquisitions. A conservative approach to managing financial operations also seems a factor. A high proportion of CFOs in India say they intend to improve profitability through better working-capital management (59%), technological advances and automation (62%), and operational efficiencies (68%). Infosys is an exemplar of this conservative approach: it has no long-term debt, Mr Mathews says, and prefers to finance growth by tapping its cash buffer. How does a company grow without turning to the debt capital markets? By culture, organisation and process. Improving performance in all these areas falls directly under the CFO’s remit. “It means doing the right things to ensure growth, despite obstacles that persist in markets. That can only be done with discipline,” says Mr Mathews. It seems the mantra for all CFOs in this year’s survey. Manufacturing to stay profitable; less so mining The generally optimistic outlook across Asia is reflected in key industry sectors, to varying degrees. Expectations that revenues will grow are highest in manufacturing (83%), metals and mining (81%), and pharmaceuticals (75%). In manufacturing, expectations that profits would grow are strong, at 69%. In pharmaceuticals, they are just at the median of 60%. But the metals and mining sector is the least optimistic: just 50% see higher profits this year than last year (Figure 1.4). The strong result in the manufacturing sector is not hard to explain. Broadly speaking, manufacturing has undergone quiet but substantial change in the region. The region’s development has favoured diversification of markets and encouraged the discovery of lower-cost centres of production. Ten years ago, China was commonly called the “factory of the world”. It still holds that mantle, but import demand from many of China’s key customers has declined over time, and support for manufacturing for export is no longer a cornerstone of China’s economic policy. Because of rising costs in China, supply chains have shifted throughout Southeast Asia. Political differences between Japan and China—as well as rising China costs—have provided an incentive for Japanese manufacturers to extend supply chains throughout Asia, such as Japanese car manufacturers’ investment to expand facilities in Thailand over the past decade. Trade pacts have reduced tariffs. Meanwhile, private consumption growth is accelerating all over Asia as new markets blossom. The World Bank projects private consumption to grow in East Asia and the Pacific by 7.7% in 2014, up from 7.3% in 2013.¹ In the metals and mining sector, the situation is fundamentally different. The world’s miners of benchmark commodities, such as iron ore, thermal coal and coking coal, project long-term price drops in all three materials. Moreover, mining majors in Australia (and their counterparts like Vale in Brazil) have invested billions in expanding capacity over the past five years. As a result, each is ramping up supply. They will have to sell more—and at today’s lower prices—to sustain the same level of profits. Figure 1.4: Great expectations Do you expect your company’s revenues/profits to grow, contract or stay the same year-on-year? % respondents expecting growth, 2014 ¹World Bank, Global Economic Prospects—East Asia and the Pacific, 2014. Available at http://www.worldbank.org/en/publication/global-economic- prospects/regional-outlooks/eap ProfitsRevenues
  9. 9. 2014 CFO Outlook | 1716 | 2014 CFO Outlook Confidence in scale: Asia’s bullish multinationals Geographical diversification, it turns out, inspires confidence. A higher proportion of CFOs from multinationals (66%) than those from local companies (54%) say they expect profits to grow in 2014. Moreover, CFOs at multinational companies (MNCs) express that confidence despite similar expectations for revenue growth (78% vs 74%). This confidence is born from scale. Many multinationals have the ability to diversify against higher operating costs by moving some services to lower-cost markets—as, in one example, many manufacturers have moved operations to Vietnam or Bangladesh. Moreover, multinationals with a global presence have a natural hedge across a variety of currency exposures, allowing them to manage risk more effectively than in a single- currency environment. This confidence is also reflected in findings on capital expenditure expectations. Some 41% of CFOs at MNCs in Asia expect capex growth, versus 30% of those at local companies. A greater number of MNC CFOs (51%) also plan to improve profitability through operational efficiencies over their local counterparts (40%), suggesting a confidence that best internal practices can be applied effectively across different geographies. Moreover, multinationals with a global presence have a natural hedge across a variety of currency exposures, allowing them to manage risk more effectively than in a single-currency environment. Meanwhile, financial market risk is named as the single most important concern for 2014 by 32% of MNC CFOs, versus 40% of local finance chiefs, suggesting that hedging options for MNCs via treasury centres and global bank relationships somewhat mitigate this concern. The bullish view of MNCs in Asia is reflected in their M&A plans, as well. More MNC CFOs (31%) say that their company plans to use surplus cash for acquisitions than those from local companies (18%), About the same proportion (32%) of MNC CFOs indicate that M&A is one reason for plans to alter their capital structure this year. Likewise, 8% of MNC CFOs indicate that their companies plan major transformational deals in 2014; a small figure, but far larger than the 1% of local company CFOs that have similar plans. The Philippine Long Distance Telephone Co (PLDT) is what analysts call a national play: it is a benchmark stock in the Philippines and a business that touches the lives of millions of users, serving as a symbol of the nation’s economic wellbeing. It is the largest and most diversified telecommunications company in the Philippines. It has three major business segments—wireless, fixed and others—and operates an extensive fibre-optic network as well as wireless, fixed line, broadband and satellite networks. “What we have in common with Singtel, with telcos in Korea, with NTT in Japan is that we are all adjusting the business models to become more efficient, coming up with ways to mitigate the impact on our margins.” PLDT’s principal shareholder is Hong Kong-based First Pacific, led by Philippines investor Manuel V Pangilinan. First Pacific began its investment with a 17.5% stake in PLDT worth US$745m in 1998. A year later, PLDT forged a strategic partnership with Japan’s NTT Communications Corp, a subsidiary of Nippon Telephone and Telegraph Corp, and also bought a Philippines mobile phone service provider, Smart Communications. First Pacific fortified its interest in PLDT by appointing Chris Young to turn around the company’s financial position, which had faltered in the 1990s, leading to continued losses, especially in the wake of the Asian financial crisis of 1997. Mr Young, a long-time employee with experience overseeing finance in other First Pacific investments, joined the company in 1998 just as it bought Smart, a move that supported PLDT’s bottom line amid declining revenues from fixed-line services. Today, the variables have changed and PLDT is experiencing declining revenue growth in its mobile businesses, looking instead to its data businesses as a new staple for value. But there are challenges. “In the telco sector, sadly, there’s margin pressure,” says Mr Young. “We are going through a significant change, Case Study PLDT: Innovation to combat margin pressure Chris Young, Chief Financial Advisor, PLDT moving away from the business of voice and SMS towards one where data use is growing rapidly for the corporate and the consumer. It’s a shift in revenue mix causing some margin pressure across Asia—and the world. “The cost for us to provide data for customers is higher: the margins are a bit lower than for traditional voice. The difference is that people tend to spend more on data.” “What we have in common with Singtel, with telcos in Korea, with NTT in Japan is that we are all adjusting the business models to become more efficient, coming up with ways to mitigate the impact on our margins.” “Fortunately, our market is growing. We’re the largest provider to the largest corporations here. And large corporations are growing, due to the success of the business process outsourcing industry in the Philippines, and an expansion of bank communication facilities.” But PLDT can’t rely on that growth alone, Mr Young says. “The shift in revenue mix demands a new business model, and telcos have never been strong on innovation,” he says. PLDT’s solution: spending more on research and development, innovation centres, and hiring employees with backgrounds outside the traditional telecommunications career track. “To succeed,” says Mr Young, “we’ve got to understand what’s going out there, how people’s ideas and habits are changing. And we have to be part of that innovation.”
  10. 10. 2014 CFO Outlook | 1918 | 2014 CFO Outlook Part 2 Risk: High, but manageable Across the region currency volatility and concerns over China’s slowing economy stand out as primary worries. US “tapering” and political risk aren’t seen as major concerns. Slowing economies pose problems: 23%worried about slowing growth in home markets 33%worried about slowing growth in overseas markets Most worried 40% Malaysia 37% Taiwan 35% India Thailand India Indonesia 35% 30% 20% 15% Currency volatility Liquidity risk Interest rate movements Counterparty risk 13%14% 16% 22% Politically optimistic, even in: Negative impact Positive impact 10% 39% 14% 13% 53% 57% Volatility in financial markets driving focus on hedging currencies: 48% hedging recognised FX assets and FX liabilities 41% hedging expected FX exposures 28% hedging net investment FX exposures 23% hedging interest rate exposures 20% hedging commodity exposures Just 3% are not hedging any risks Yen and US dollar: greatest exposures, most hedged: 21%have significant exposure in yen 20%hedge against adverse movements in yen 24%have significant exposure to US$ 23%hedge against adverse movements in US$ ¥ ¥ $ $ RISK Concern over financial risks growing... 2014 2013 Note: All figures are percent respondents from 2014 CFO Outlook Asia survey unless otherwise indicated. Figures may not round to 100 either due to rounding or because respondents could select multiple answers. No opinion/disagree Negative impact expected Agree Positive impact or no impact The end of quantitative easing in the US will cause major problems in Asia 59% 41% Political changes: an opportunity rather than a risk? 13% 87% …but a minority are worried about US “tapering” and political change
  11. 11. 2014 CFO Outlook | 2120 | 2014 CFO Outlook Financial worries rising but “tapering” already factored in CFOs in Asia see financial market volatility as the key risk to their business, reflecting the currency shifts that began in 2013 with Abenomics and the gradual reduction of quantitative easing by the United States Federal Reserve. The impact of these events still reverberates throughout Asia and adds volatility to currency, equity and fixed-income markets. However, most CFOs see risks associated with the so-called “tapering” of Fed asset purchases as discounted in the region’s markets. Only a minority (41%) agree that the end of quantitative easing in the US will lead to major problems in Asia, while 59% have no opinion or disagree. Moreover, all the CFOs interviewed for this report feel that markets have factored tapering in. “Tapering has to come, because it reflects expectations of recovery of the US economy,” says the CFO of Singapore’s DBS bank, Chng Sok Hui. “Our view is that the US will pace quantitative easing a bit more.” For Asian central banks, Ms Chng says, continued tapering will call for “good policy coordination”. In general, however, she believes that the tapering “will offer some respite for the inflow of liquidity into Asia and may be a good thing for Asian countries with strong fundamentals.” One effect of tapering, Ms Chng adds, is that local customers “seem to think a rise in borrowing costs is imminent, and they are trying to lock in their funding costs.” In Shanghai, Lawrence Lau, Asia CFO of US manufacturing firm Owens Corning, says, “I don’t worry about Fed tapering at night. I’m much more concerned about the uncertainties in China as various structural reforms take place. As a CFO my concern is how that translates to impacts on fundamental operational and financial performance of the company in the mid to long term.” And in Thailand, “we keep an eye on it, but we’re not overly worried,” says Krailuck Asawachatroj, CFO of Thai energy, transport and fertiliser conglomerate Thoresen Thai Agencies. Figure 2.1: Financial risks dominate Which broad category of risk is your greatest concern for the year ahead? % respondents Figure 2.2: More worried than before Which subcategory of financial risk is your greatest concern for the year ahead? % respondents, all countries These responses reflect an underlying view across the survey that all categories of risk—from operations to regulation to financial markets—can be mitigated, understood and factored into the daily drive for opportunity. Notwithstanding the confident attitude towards the impact of tapering, survey respondents display a heightened awareness of financial market risk. Some 36% of Asia-based CFOs say that it is their single greatest concern in 2014, compared to 22% in 2013 (Figures 2.1 and 2.2). The highest percentage of CFOs showing this concern is in South Korea, where 47% name financial market risk as the greatest threat facing their companies, followed by Japan (43%) and Taiwan (40%). Currency volatility a key risk Looking deeper into the components that contribute to financial risk, currency volatility is the major concern among CFOs in many countries, for reasons as distinct as these varied markets. Some 70% of respondents in Indonesia regard currency volatility as a primary concern (Figure 2.3). The rupiah’s decline against the US dollar in 2013 was reminiscent of, if not as severe as, the Asia-wide currency collapse of 1997. Back then, Indonesian companies with a high component of US dollar debt encountered greater and greater difficulties servicing that debt. In 2013, the currency posted its biggest annual decline against the US dollar since 2000, a fall exacerbated by Indonesia’s yawning current account deficit. Wider-than-usual swings in recent years in Singapore’s currency explain the 55% of CFOs in that country naming currency volatility as their primary concern. The Singapore dollar strengthened against the US dollar for several years after the global financial crisis, with a negative impact on some Singapore businesses. Because of Singapore’s status as international centre for businesses in which receivables are typically in US dollars (from shipbuilding to fuel oil), companies with payables in Singapore dollars felt the pinch. While tapering has weakened the currency against the US dollar, easing this vexing situation, wariness of sharp turns in currency markets remains heightened. In contrast, fewer CFOs in South Korea (22%) and Hong Kong (25%) see currency volatility as a primary risk. The South Korean response reflects local confidence in the fundamentals underlying the nation’s economy—a hefty current account surplus, small budget deficit and substantial foreign-exchange reserves. Hong Kong’s dollar is pegged to the US dollar, so is underexposed to major fluctuations. Figure 2.3: Currency worries Currency volatility is the greatest financial concern for the year ahead % respondents. 20132014 Operational risk Macroeconomic risk (eg, slowing GDP growth) Regulatory/compliance risk Financial market risk (eg, currency volatility)
  12. 12. 2014 CFO Outlook | 2322 | 2014 CFO Outlook Hedging in a more volatile world The focus on currency volatility has shaped CFOs’ hedging preferences. Twenty-four percent of Asia’s CFOs say they have significant exposure to the US dollar, while an almost equal amount (23%) hedge against adverse movements in the dollar (Figure 2.4). The strengthening of the US dollar comes as no surprise to CFOs as the Federal Reserve winds down its asset-buying programme, but volatility is expected in dollar markets throughout the year. Projected US growth and improving fundamentals are encouraging a relative “flight to quality” back to US markets, but uncertainty exists over the Fed’s stance on interest rate policy. Likewise, 21% of CFOs say that they have significant exposure to the Japanese yen, while 20% say they are hedged against adverse movements in the yen. The yen is regarded as among the most risk-sensitive of currencies this year, as indications arise that the government’s fiscal stimulus and monetary easing policy may be losing momentum. There is considerable uncertainty about a hike in April of Japan’s consumption tax, which may take the wind out of Abenomics’ sails. Other factors have added volatility to Asian currencies, shaping CFOs’ points of view. Even some of those countries with closely managed exchange rates have surprised markets: China’s authorities, for example, engineered a sudden and sharp decline in the value of the renminbi against the US dollar in late February, followed by a sharp rise in early March. Reflecting concerns about currencies, about half of the CFOs in the survey (47%) acknowledge that they are hedging against recognised FX assets and FX liabilities, while 41% are hedging against expected FX exposures and 28% are hedging net investment FX exposures (Figure 2.5). In contrast, less emphasis is being placed on hedging against exposure to interest rate risk (23%) and commodity price volatility (19%). Figure 2.4: Feeling exposed What are your main foreign currency exposures and are you hedged against adverse movements in them? % respondents, all countries Figure 2.5: Hedge trimming What types of risks are you currently hedging? % respondents, all countries Liquidity a rising concern Concerns about liquidity are highest in South Korea, where 49% of CFOs cite this as the single greatest financial risk facing their companies (Figure 2.6). The result from South Korea reflects the high level of leverage in major conglomerates in the nation, some of which have gearing ratios of 200% or above. Liquidity concerns at large companies have been flagged by the nation’s central bank. Liquidity concerns are also significant in China, cited by 40% of CFOs based there. A spike of interbank lending rates in December—followed by an earlier similar spike in June 2013— exposed banks’ own concerns about asset quality throughout the banking system. The concerns are partly based on banks’ exposure to the so-called shadow banking market, in which wealth management products have been marketed by trust companies through commercial banks. The instruments have proliferated, and uncertainty still exists over their credit quality, the extent that businesses have relied on these off-balance sheet debt instruments for funding, and the degree of exposure to investors. “Stability in China’s banking system is an ongoing risk that we monitor,” says Frank Lai, the CFO of China Resources Enterprises, a major state-owned conglomerate that is listed in Hong Kong. Figure 2.6: Needing a drink? % respondents ranking liquidity as greatest financial concern for the year ahead Hedged?Significant exposure?
  13. 13. 2014 CFO Outlook | 2524 | 2014 CFO Outlook Figure 2.7: Keeping an eye on the markets Which category of risk is your greatest concern for the year ahead? % respondents Meanwhile, some 43% of Taiwan’s CFOs cite liquidity risk as a concern, a result reflecting the degree to which Taiwanese businesses rely on operations and sales in China. Breaking the survey results down by industry shows, perhaps unsurprisingly, that concern over financial market risk is highest among banking-sector CFOs, cited by 46% as the greatest financial risk they will face this year (Figure 2.7). Banks’ chief concern is the credit quality of their clients—and the value of on-balance-sheet instruments in their own portfolios. Concern over currency volatility is highest among manufacturing company CFOs, cited by 42%, but here it reflects the upset to costs that currency fluctuations can cause for manufacturers with receivables in weakening currencies across Asia’s markets. Political change an opportunity rather than a risk To a surprising degree CFOs in Asia see political change in 2014 less as a risk than an opportunity. Several major political shifts are afoot in the region, starting with the national elections in India this year. Indonesia faces a change of president. China’s government, meanwhile, is only a year into the term of the fifth generation of Communist Party leaders. The Bo Xilai scandal that culminated in a showcase trial in 2013 was the precursor of a thorough and on-going anti-corruption campaign, embroiling foreign and local companies alike. Nonetheless, across the region just 13% are worried that political change in their home countries will have a negative impact on their business this year; 38% expect a positive impact. Political risk is shrugged off in Thailand (where just 10% are worried), while majorities in Indonesia (57%) and India (53%) are optimistic about the impact of this year’s elections. In China some 89% of CFOs feel that political change will either have no impact (61%), slight positive impact (27%), or major positive impact (1%) on their businesses this year (Figure 2.8). Figure 2.8: Political risk in Asia—no big deal How significant an impact on your business will political changes in your country of residence have in 2014? % respondents The results in India reflect generally positive business opinion about this year’s national election—with Narendra Modi, the front-runner to become prime minister, lauded for the economic achievements seen in Gujarat during his tenure as chief minister of the state. Optimism also surrounds the candidacy in Indonesia’s presidential election of Jakarta’s popular governor, Joko Widodo. Thailand, meanwhile, is amid a fractious challenge to the nation’s government that has been disrupting daily life in Bangkok for months. In that country a full 90% believe that political change will have either no impact (52%), a slight positive impact (19%) or a major positive impact (19%) on their business this year. Slight positive impact No impact Major negative impact Major positive impact Slight negative impact Operational risk Macroeconomic risk (eg, slowing GDP growth) Regulatory/compliance risk Financial market risk (eg, currency volatility)
  14. 14. 2014 CFO Outlook | 2726 | 2014 CFO Outlook Figure 2.9: Other things to worry about % respondents picking political unrest as primary operational/enterprise risk “The growth rates throughout Asia are still strong, despite some slowing, and have been for some time. This tends to take precedence over concerns about local market political risk,” says Robert van der Zalm, CFO of Noble Group, a Hong Kong supply-chain solutions company. “Remember that 7% growth in China now probably equates to 14% growth 10 years ago. That’s massive.” Responses assessing risk from political change reflect conditions specific to each country—and those countries in which businesses are heavily invested. Of any CFOs in Asia, those in Japan and India are most likely to cite political unrest as their foremost operational risk, cited by 36% and 32% respectively (compared to an average of 26% across the region—Figure 2.9). In Japan, this is likely to reflect the high level of direct investment Japanese multinationals have in politically volatile countries like Thailand and concerns over the potential disruption of supply chains there. In India, meanwhile, despite the general optimism a good deal of uncertainty still surrounds the forthcoming election. Perhaps most surprisingly just 20% of CFOs in Thailand believe political unrest is a primary operating risk. The relatively tranquil result from Thailand (only the Australia and Taiwan responses were lower, at 12% and 17% respectively) comes in the face of declining GDP growth in 2013 largely due to civil unrest. For the full year, GDP growth stood at 2.9%, according to the state planning agency. Growth in the final quarter of the year slowed to just 0.6% compared to the previous three months as anti-government protests intensified. In contrast, GDP growth in Thailand for all of 2012 stood at 6.2%, despite continued recovery from devastating floods in late 2011. Many multinationals in Thailand are sanguine about the domestic political environment, for the time being at least. “We have a natural hedge against disruptions in Thailand because much of our business is overseas,” explains Krailuck Asawachatroj of Thoresen Thai Agencies. “Since two of our major businesses are in energy and shipping, our receivables are primarily in US and Singapore dollars. Our exposure in Thai baht is limited.” Slowing economies pose problems Slowing growth in respondents’ home markets is the biggest macroeconomic concern for CFOs in Malaysia (cited by 40%), Taiwan (37%) and India (35%—Figure 2.10). Malaysia’s economy posted 4.7% GDP growth in 2013, down from 5.6% in 2012. The economy is predicted by the Organisation of Economic Cooperation and Development (OECD) to average 5.1% growth between 2014-2018. This is a robust figure compared to many emerging economies, but the slowing rate of growth reflects a need to improve productivity as the economy expands. In common with Thailand and other nations in the Association of Southeast Asian Nations, the OECD says, Malaysia faces a “middle income trap” in which structural reforms are needed to accomplish a shift from growth based on investment to growth based on productivity. India’s Central Statistics Office, meanwhile, projected that the nation’s growth would hit a decade low of 4.5% for the fiscal year 2012-2013 ending in March, attributed partly to slowdowns in the construction and mining sectors. The figure for Taiwan comes despite three years of strong GDP growth, with good prospects emerging as export demand picks up in US and Europe. But Taiwan’s high reliance on exports has created awareness among CFOs—and economic policymakers—of the economy’s vulnerability and a need to expand domestic markets. Figure 2.10: Macro risks at home and abroad % respondents selecting as greatest macroeconomic risk for the year ahead Slowing growth in home marketSlowing growth in overseas markets
  15. 15. 2014 CFO Outlook | 2928 | 2014 CFO Outlook Figure 2.12: Not so bad after all How significant an impact on your business will stricter regulation of financial instruments have in 2014? % respondents Surprise, surprise: bankers welcome tighter regulation At first glance, one of the more curious results from this year’s CFO survey springs from the assessment by financial services CFOs of the impact of stricter regulation of financial instruments (referring to such measures as the 2010 US Dodd Frank Wall Street Reform and Consumer Protection Act and the Basel III capital adequacy rules that began coming into force in January 2013). A significant majority of financial services CFOs (65%) say that stricter regulation will have a positive impact on their businesses, while 25% believe it will have no impact (Figure 2.12). Perhaps the result isn’t so surprising, though. Many financial services CFOs in the region regard compliance as a necessity and a basic good that will provide uniform transparency and help stabilise markets. This view may be more prevalent in Asia than in other regions, in part due to precautionary rules already in place in some jurisdictions. For example, Chng Sok Hui, CFO of DBS in Singapore, notes that conforming to higher standards of compliance is simply a corollary of being a Singapore-based institution, as the nation’s monetary authority has a higher requirement of capital adequacy than the Basel III rules seek to impose. Another banking-sector CFO interviewed for this report suggests an alternate angle for the positive response: as US banks grapple with the structures of the complex Dodd-Frank law, local banks in Asia may be proving more nimble in meeting some customers’ needs. Moreover, disclosure requirements in new regulations make pricing more transparent, allowing customers to assess the position of local banks versus global banks, sometimes to the advantage of the former. Figure 2.11: Industry concerns % respondents selecting as greatest macroeconomic risk for the year ahead Meanwhile, more CFOs in China are concerned over slowing growth overseas (47%) than their compatriots in other countries. Similarly, both Hong Kong and Singapore CFOs (each 42%) see slowing growth in overseas markets as a main concern. These figures suggest that a reliance on exports, long a staple of the Asian growth story, is still very much an economic driver in the region. Looking at industry sectors, a higher proportion of CFOs in banking (39%) think that slowing growth in their home market is a primary risk than their colleagues in other sectors (Figure 2.11). Doubtless this reaction links to sensitivity in the banking sector about the effect slower growth will have on the credit quality of domestic corporate and retail clients. CFOs among real estate companies, meanwhile, are by far the most concerned over slowing growth overseas (which is cited by 48% as the primary macroeconomic risk, compared to an average for the whole sample of 33%) reflecting the industry’s reliance on foreign investment. Slowing growth in home marketSlowing growth in overseas markets Slight positive impact No impact Major negative impact Major positive impact Slight negative impact
  16. 16. 2014 CFO Outlook | 3130 | 2014 CFO Outlook The question of whether finance acumen needs to be imported or can be learned at the coalface of Asian markets prompts predictable answers. Most CFOs in the region think that while Western schooling and business experience is helpful, it is not mandatory. Many companies are taking matters into their own hands by developing their own talent pool, or as the chief executive of Singapore’s DBS bank, Piyush Gupta, has put it, “growing our own timber”. There is perhaps no better example of this ethos than Chng Sok Hui, who became CFO of DBS in 2008 and has been a career banker at the financial institution. Ms Chng joined DBS in 1983 and held many positions there, including group head of risk management, prior to her appointment as CFO. Among many other public-service positions Ms Chng also previously served as vice chairman of the risk management committee of the Association of Banks of Singapore. Not incidentally, she was awarded a DBS scholarship. The cross-fertilisation of risk and finance expertise has given Ms Chng an opportunity to establish a strategic corporate treasury function anchored on a stewardship model, as well as a performance-management system that plays out through every aspect of the bank’s business. “The key question is how do you get the recorded revenue attributed to the people who have the global or local relationship with the customer?” “As the CFO, I have leveraged the corporate treasury function to entrench a strategic capital and balance sheet capability for DBS. This has fundamentally changed how DBS functions, bringing into acute focus how scarce corporate resources are to be holistically managed and allocated in close partnership with business units through a revamped funds transfer pricing framework for loans and deposits,” she says. Ms Chng set up the corporate treasury function at DBS shortly after she was named CFO. The idea was to centralise the treasury function to gain what Ms Chng calls a strategic view of the entire balance sheet, not just day-to-day funding. Case Study DBS: Managing resources and performance strategically Chng Sok Hui, CFO, DBS Treasury functions were formerly part of the bank’s Treasury and Markets division. Under the restructuring, they were placed in DBS’s six key regional markets—from Hong Kong to India—reporting to the local CFOs and also to the bank’s group corporate treasurer, who reports to Ms Chng. The structure allows the bank to use its strong funding capability to support funding needs across the organisation, and manage the balance sheet as a whole. As CFO, Ms Chng was also instrumental in setting up a metrics- driven system of accountability through every country, product group and customer segment. “Finance has stewardship of this score card,” she says, “which ultimately determines how we conduct our business reviews, setting objectives quite specific to business lines, product groups and countries.” Building a system of revenue attribution to promote internal collaboration and connectivity has been another key initiative spearheaded and supported by the finance function, with the goal of aligning the bank’s business units as one team and one face to the customer. “The key question is how do you get the recorded revenue attributed to the people who have the global or local relationship with the customer?” says Ms Chng. DBS has developed a management information system with a capability to establish that link. The technology infrastructure “supports the measure not just of returns, but also risk at the granular level, to form a view that the revenue we make for a given amount of risk is an appropriate rate of return.” Finance under Ms Chng is also the steward of a strategic cost- management programme, with the goal to “do it better, do it smarter”. In 2013, Ms Chng says, the programme delivered savings exceeding 4% of the cost base. Part 3 Growth: Going organic CFOs across Asia show a distinct preference for organic growth as new markets open and customers become more sophisticated. Margin pressures are driving a focus on core disciplines—as well as technology—to grow profits
  17. 17. 2014 CFO Outlook | 3332 | 2014 CFO Outlook Figure 3.2: Cash to buy % respondents who plan to use surplus cash for acquisitions in 2014 Confidence to grow but concerns about costs Across Asia, CFOs pick organic growth as their preferred method of expansion for 2014. When asked how they intend to deploy excess cash, 48% choose organic growth this year (Figure 3.1). In contrast, only 24% say they will use excess cash in mergers and acquisitions (Figure 3.2. M&A trends are examined in Part 4). Indeed, “organic expansion” remains the top priority for usage of surplus cash in every country and region surveyed, with the exception of Taiwan (where companies are marginally more likely to prioritise increasing cash reserves). This is a far more uniform response than in 2013 (Figure 3.3). “We plan to grow organically across all our markets in Asia,” says Lawrence Lau, Shanghai-based regional CFO for US manufacturing company Owens Corning. “We’re looking for acquisitions, too, when the right opportunities arise, but we see big opportunities for organic growth in the region—and we’re making the most of them.” By nation, CFOs in Indonesia, where consumer markets are rapidly developing, are most likely to say they will use excess cash to grow organically (cited by 60%). Using cash to grow organically is also on the agenda in India (58%), Japan (56%) and Hong Kong (48%). In each of these places the proportion of CFOs intending to use cash for M&A is decidedly smaller, with 10% of Indonesians citing M&A, followed by 22% in India, 25% in Japan and 29% in Hong Kong. In China, too, where asset values are high and domestic markets are expanding, the preference for using cash for organic growth (52%) over M&A (24%) is pronounced. The reasons for the focus on organic growth are both positive and negative. They underscore the broad optimism about Asian growth this year, but also take into account that many CFOs (31%) see capital costs are on the rise (Figure 3.4). One reason may be that many CFOs believe that tapering by the US Federal Reserve will eventually play out in higher funding costs across Asia (a key risk examined in Part 2). In an environment with positive prospects for local-market growth and rising funding costs, growing organically—increasing output and enhancing sales—is the obvious option. Figure 3.1: Cash to grow % respondents who plan to use surplus cash for organic expansion in 2014 NB: Six options were 1. Acquisitions; 2. Increase cash reserves; 3. Organic expansion; 4. Ours is trapped, so unsure; 5. Return cash to shareholders; 6. Other Figure 3.3b Ranking of “acquisitions” among six options: Figure 3.3a Changing priorities How will your company use surplus cash in the coming year? Ranking of “organic expansion” among six options: Figure 3.4: Costlier capital Over 2014, the cost of capital will… % respondents, all countries “Internationally, we will extend the business,” says Huiping Yan, CFO of China-based Home Inns, a fast-growing owner of economy hotels in China. “We’ve started looking in the Asia-pacific region, such as Indonesia, where current market conditions are very similar to the Chinese market ten years ago. There is a demand for a network of economy hotels that consistently provides quality service to travellers from small and medium-sized businesses. Taiwan is another market where we want to be able to serve inbound Chinese visitors as well as catch the attention of local customers. But remember, we are not acquiring. We are exporting our branding and know-how, through a master agreement or a joint venture.” Country 2014 2013 Australia 1 3 China 1 1 Hong Kong 1 1 India 1 1 Indonesia 1 1 Japan 1 4 Malaysia 1 1 Philippines 1 1 Singapore 1 1 South Korea 1 2 Taiwan 2 2 Thailand 1 1 Total 1 1 Country 2014 2013 Australia 2 1 China 2 3 Hong Kong 3 2 India 4 3 Indonesia 4 4 Japan 2 5 Malaysia 2 2 Philippines 5 3 Singapore 2 3 South Korea 3 3 Taiwan 3 4 Thailand 4 4 Total 3 3 DecreaseIncrease Stay about the same as previous year
  18. 18. 2014 CFO Outlook | 3534 | 2014 CFO Outlook More adventurous, but no easier to grow The preferred means to grow organically vary. For CFOs in the region, when asked for what purpose they would consider financing this year, 28% said they would do so to expand outside their current country or countries of operation, with the strongest results coming from Australia (40%), Singapore (39%), Taiwan (33%) and Japan (33%; Figure 3.5). These markets are more mature than the faster growing economies of Southeast Asia, meaning the best options for both organic and M&A-driven expansion are likely to be elsewhere. In line with this result a smaller proportion of CFOs in the Philippines (23%), Indonesia (10%) and Thailand (10%) say they are seeking finance for expansion outside current markets. CFOs here aren’t less adventurous, necessarily; they just have much to do in the markets where they operate currently. When asked if they are considering financing for expansion inside their current country or countries of operation, finance leaders in the Philippines (47%), Indonesia (53%) and Thailand (48%) have a much more robust response (Figure 3.6). Figure 3.5: We’ve done all we can here... % respondents considering financing for expansion outside current country/ countries of operation in 2014 Figure 3.6: Home is where the value is % respondents considering financing for expansion inside current country/ countries of operation in 2014 In these same countries, the preference for considering financing for expansion at home compared to last year is growing. This is now the top priority for financing for CFOs in the Philippines, moving up from third place last year. In Thailand it is now in first place, versus second last year. CFOs in Indonesia consider financing for this purpose their first preference this year, as they did last year. Making the most of opportunities for profitability in their own high-growth markets is the clear priority (Figure 3.7). Meanwhile, a preference for financing to expand outside their countries of current operation has become dramatically stronger in CFOs reporting in Singapore, where it moves to first place from fourth, and most dramatically in Australia, where it moved to first from eighth—in precisely those markets where costs are high and economic growth is expected to be slower. The result from Australia, where resources companies abound, could also reflect expansion opportunities in M&A as low commodity prices have reduced asset values in minerals and mining operations throughout Asia (examined in Part 4). None of this means that organic growth is getting easier. “Markets are changing as they grow,” says Richard Beacher, group financial controller of First Pacific, a Hong Kong-based investment company that owns a majority share of Indonesia food and agriculture giant Indofoods. “There’s an increase of consumer spending power in Indonesia and across Southeast Asia. New markets are opening, but competition is heating up as well. It’s getting a little tougher to sell that pot of noodles or bag of chips.” Mr Beacher cites a double-digit rise in the cost of sales in some product categories, saying that Indofoods has to go the extra mile to gain new customers and retain existing ones. “We’re bringing in cows to Indonesia for the first time,” he says. “People want the real thing, not powdered skimmed milk.” Figure 3.7a: Financing growth, inside and out For what purpose are you currently considering financing? Ranking of “Expansion within country/countries of operation” among eight options: NB: Eight options were: 1. Acquisition; 2. Capital expenditure; 3. Expansion within country/countries of operation; 4. Expansion outside of country/countries of operation; 5. Recapitalisation; 6. Refinancing; 7. Restructuring; 8. Working capital Figure 3.7b Ranking of “Expansion outside current country/ countries of operation” among eight options: 20132014 20132014
  19. 19. 2014 CFO Outlook | 3736 | 2014 CFO Outlook Margin pressure driving focus on core disciplines In this environment, pressure on margins (see Part 1) is driving CFOs to focus on the classic disciplines of the job—better working capital management, gaining efficiencies in operations and harnessing technology to improve performance. Some 41% of all CFOs in the survey pick better management of working capital as a means to grow profitability, ranking this third among all the ways in which a company might expand the bottom line, compared to second last year (Figure 3.8). The figure is highest in Malaysia (66%), India (60%), Japan (47%) and Indonesia (43%; Figure 3.9). Cash typically becomes trapped in a company’s value chain during periods of high growth, as companies invest to gain market share and grow revenues. Inventories build, the time it takes to collect receivables increases and days working capital—an accounting term describing how many days it will take a company to convert cash caught in the system into revenues—balloons. Figure 3.8: Core disciplines How will you improve profitability in 2014? Rank among options listed, all respondents Rank 2014 2013 1 Technological advances Operational efficiencies 2 Operational efficiencies Improve working capital management 3 Improve working capital management Technological advances 4 Increasing capital expenditure Increasing capital expenditure 5 Headcount reductions Headcount reductions 6 Tax optimisation Tax optimisation 7 On- or off-shoring functions On- or off-shoring functions Figure 3.9: Working working capital harder Intend to improve profitability through improving working capital management in 2014 % respondents Avoiding a situation in which working capital is growing at a quicker rate than revenues involves direct supervision by the CFO and a sharp focus on processes. “We have a tight focus on using internal resources to grow” says Suryanarayanan S, director of finance of Ecu-Line, a logistics company that has operations in 90 countries and has acquired businesses in Europe and the US. “We manage our working capital efficiently and plough as much cash freed from working capital back into the business,” Mr Suryanarayanan says. “But to ensure that we’re getting optimal growth from our model, our goal now is to establish a single system of integrated decision making across markets globally.” Unifying processes and gaining efficiencies is a common goal among the CFOs in the survey. The proportion of CFOs saying they will build profitability through operational efficiencies grew to 45% in 2014, with the figures highest in India (68%), Thailand (65%), Singapore (55%) and Australia (52%; Figure 3.10). Overall, operational efficiencies rank second among CFOs in Asia as a priority for improving profitability—compared to first last year. Figure 3.10: Efficiency drive Intend to improve profitability through operational efficiencies in 2014 % respondents
  20. 20. 2014 CFO Outlook | 3938 | 2014 CFO Outlook Figure 3.11: Strength through technology Intend to improve profitability through technological advances/ automation, such as forecasting, CRM, supply chain management in 2014 % respondents A focus on better technology Under these circumstances, a dramatic rise in demand for the tools to realise gains from financial and commercial operations has emerged. Some 51% of CFOs in 2014 say they will seek to build profitability this year through efficiencies gained through use of technology and automation, customer relationship management (CRM) programmes, better management and supervision of supply chains and forecasting (Figure 3.11). In 2013, although technology was ranked second place overall in terms of priorities to improve profitability, it was often subordinate to simple operational efficiencies (Figure 3.12). CFOs this year seem more willing to take risks to invest in potentially money-saving technologies as the economic outlook brightens. CFOs in China (67%) in particular are focused on capturing growth potential through better use of technology and systems, as are their colleagues in India (62%) and Taiwan (60%). Figure 3.12a: Shifting priorities to improve profitability How will you improve profitability (2014)? Select strategies only, rank among seven options CFOs in mature north Asian markets are putting less of an emphasis on this option, with 32% of CFOs in Japan and 38% in South Korea indicating plans to grow profitability through use of technology. In these markets, investments in legacy systems have already been made and new technology expenditures are harder to justify—while saturation means many of the easy gains have already been made. The push to build profitability through processes and systems is outpacing one traditional avenue of growth. The proportion of CFOs in the region who forecast capital expenditure growing this year (35%) is 11 percentage points lower than the proportion that said the same in 2013 (46%; Figure 3.13). A greater proportion (47% this year, compared to 34% last) see capital expenditures staying the same. This means expenditure on new technology is likely to be netted out by efficiencies realised elsewhere. This isn’t an easy job in the region’s faster- growing markets, with the overriding priority on growing organically. “Organic growth remains a real opportunity now in Asia,” says Mr Beacher of First Pacific, “but only as long as you’re moving as fast as the market.”. Figure 3.12b How will you improve profitability (2013)? Select strategies only, rank among seven options NB: Options listed were: 1. Headcount reductions; 2. Improve working capital management; 3. Increasing capital expenditure; 4. On- or off-shoring functions; 5. Operational efficiencies; 6. Tax optimisation; 7. Technological advances Figure 3.13: Capex caution Do you expect your company’s level of capital expenditures to be higher, the same or lower than last year? % respondents 2014 2013 Same Lower N/AHigher Operational efficienciesTechnological advances Headcount reductionsImprove working capital management Operational efficienciesTechnological advances Headcount reductionsImprove working capital management
  21. 21. 2014 CFO Outlook | 4140 | 2014 CFO Outlook In telecoms, making the most of Asian growth CFOs in Asia’s telecommunications industry (55%) are most intent on devoting excess cash to organic expansion, followed by oil and gas (50%), and banking and pharmaceuticals (both 49%; Figure 3.14). With national regulatory barriers in many Asian markets increasing the difficulty of cross-border M&A opportunities in the telecommunications industry, making the most of growth in existing operations becomes the natural focus. Moreover, a growing demand for data services over voice and texting services is opening new opportunities to expand corporate and consumer customer bases (see, for example, the case study in Part 1). The response from oil and gas CFOs reflects expected gains on recent investment in offshore exploration and production in the region, with many projects expected to come online or increase output throughout the region this year. In pharmaceuticals, sales of newer drugs are accelerating as economic growth elevates more people into the middle class, meaning they can now afford to spend more on health remedies. Meanwhile the banking sector, which has expanded rapidly throughout the region since Asia’s recovery from its currency crisis 15 years ago, is now seeking to consolidate those gains, establish niches and win customers through more focused application of service offerings. Figure 3.14: Industries growing internally % respondents who plan to use surplus cash for organic expansion in 2014 In pharmaceuticals, sales of newer drugs are accelerating as economic growth elevates more people into the middle class, meaning they can now afford to spend more on health remedies. Figure 3.15: Technology paying off % respondents intending to improve profitability through technological advances/ automation, such as forecasting, CRM, supply chain management in 2014 Building profitability by automation is on the agenda for telecommunications companies (60%), manufacturers (58%) and metals and mining firms (57%; Figure 3.15). Data collection capabilities in the telecoms sector open up opportunities for sales gains through customer relationship management tools. Building efficiencies in manufacturing, particularly as companies expand in new markets, requires investment and sound use of new technology, as well as eking efficiencies out of supply chains. With new capacity coming on line in the coal and iron ore industries worldwide, just as prices for these commodities are in decline, the world’s major mining companies are now relying on investment in tools that will enhance value across their operations. Building efficiencies in manufacturing, particularly as companies expand in new markets, requires investment and sound use of new technology, as well as eking efficiencies out of supply chains.
  22. 22. 2014 CFO Outlook | 4342 | 2014 CFO Outlook Some 71% of CFOs from Thailand in the 2014 survey say that one of their focuses of M&A activity this year will be on the emerging Southeast Asian economies of Cambodia, Laos, Myanmar and Vietnam. SCG, with US$13.4bn in annual sales one of Thailand’s largest industrial conglomerates, has been exploring the “frontier” markets of these four nations for many years. In doing so, it is setting the groundwork for expansion via organic growth or M&A. “We have business in many parts of the world, but our main focus is Southeast Asia,” says Chaovalit Ekabut, CFO. “For eight years, our ambition has been to grow in the region. We have invested and expanded. This region should be growing for another 20 years.” SCG, Mr Chaovalit says, focused on investing in both its home nation and Southeast Asia during the region’s long recovery from the 1997 Asian currency crisis “when we weren’t seeing projects at all. So now that the economy is fully recovered, and many countries are investing to develop infrastructure, this will stimulate other investments and a second wave of growth.” SCG increased its investment in Indonesia in 2012 with two major commitments. First in February of that year it bought a 100% stake in Boral Indonesia, a ready-mix concrete maker, from Australia-based Boral, valued at US$135m. It has since committed US$356m to building a new plant, with completion scheduled for 2015. The investment, one of many, is aligned with SCG’s ambition to establish growth industries throughout Southeast Asia as the Association of Southeast Asian Nations (ASEAN) rolls out its plans for a regional “Economic Community” based on trade liberalisation. The most recent target is for the completion of this bloc in 2015—although there is still some doubt as to whether ASEAN’s 10 member countries will meet the deadline. As for the emerging Southeast Asian nations, SCG has been laying the groundwork for years. “We’ve been in Cambodia for 20 years, and we have had a small business in Myanmar for a long time,” says Mr Chaovalit. “Having the presence is a way to understand what you don’t know about the market, but at a size where the risk is manageable.” Case Study Siam Cement’s sweet spot Chaovalit Ekabut, CFO, Siam Cement Group (SCG) “We do most of our financing through debentures, and most of this borrowing comes from retail investors in the local market. They have a four-year term, and when the term is up, we have a 90% resubscription rate.” In September 2013 the company announced it would spend US$386m on a cement plant in Myanmar, scheduled for completion in 2016. But as the country only passed a foreign investment law in 2012, legal boundaries are still being debated and established. “Not everything is clear at the moment,” says Mr Chaovalit. “But remember, we’re doing cement, a material that the nation needs to develop. We’re quite optimistic.” Bolstering the company’s region-wide expansion is a strong and reliable funding base in Thailand. Although common, this year’s survey suggests the preference for tapping bank lending is not universal—nor is the perception that the cost of capital will rise this year (68% of those responding believe it will stay the same or decline). For his part, Mr Chaovalit says that the materials giant prefers short- to medium-term debt, but from local and loyal retail investors, rather than from banks. “We do most of our financing through debentures, and most of this borrowing comes from retail investors in the local market. They have a four-year term, and when the term is up, we have a 90% resubscription rate,” Mr Chaovalit says. Mr Chaovalit also believes that funding costs for major companies like SCG in Thailand will not rise this year. “It depends on who is borrowing,” he says. “If you are a real-estate company and borrowing from a foreign bank, the political situation in Thailand may make the bank more reluctant to lend. But markets are still growing here, and there is confidence in growth. Companies that are part of that trend have a lot of choices in their banking.” “At the moment, it’s better for the borrower here than for the lender,” he adds. Part 4 M&A: The lure of the Southeast CFOs remain cautious about M&A but those that want to buy are looking to opportunities in Southeast Asia to do so. Inbound deals to Greater China look likely to keep falling.
  23. 23. 2014 CFO Outlook | 4544 | 2014 CFO Outlook Do not plan to undertake M&A in 2014 Have no plans to sell or divest assets 62% Plan to achieve growth goals Plan to acquire technology Plan to acquire intellectual property Plan to enhance production capability 70% 34% 30% 30% Acquiring the tools of growth: M&A focus to acquire technology strongest in: 55% 46% 41% M&A focus to enhance production capabilities strongest in: 51% 45% 30% TelecomsOil and gas PharmaceuticalsMetals and mining Real estateManufacturing Southeast Asia: 45%46%49%52% Emerging Southeast Asia (Cambodia, Laos, Myanmar, Vietnam): 39%40%41%48% India/ South Asia: 38%41%47%56% Taking the lead in South and Southeast Asia: M&A Who? Why? Of those that will undertake M&A: China and the West fall from grace: Targeted growth—with an eye for southeast asia Note: All figures are percent respondents from 2014 CFO Outlook Asia survey unless otherwise indicated. Figures may not round to 100 either due to rounding or because respondents could select multiple answers. China North America Western Europe 1st 4th 5th5th 11th13th 2013 2014 Ranking of target M&A markets Australia South-east Asia India/ South Asia North America South America South Korea Greater China Emerging SEA – Cambodia, Laos, Myanmar, Vietnam Japan Western Europe Sub-Saharan Africa Eastern Europe/Russia Middle East/ North Africa n 2014 n 2013 Where? M&A focus will be strongest on: Southeast Asia: 41% India/South Asia: 40% Emerging Southeast Asia: 36% 1st 2nd 2nd 3rd 3rd 7th 4th 8th6th 11th7th 12th 10th 13th 10th 8th 9th 9th 5th 1st 13th 4th 11th 5th 12th 6th 41% Forget the West; go Southeast In a year in which organic growth is the preferred mode of expansion, a large proportion of CFOs (62%) say that they do not have M&A plans in 2014—around the same proportion as in 2013 (Figure 4.1). The reasons are many: volatility in Asian markets as tapering plays out in the US; a perception that funding costs will rise; major elections in Indonesia and India and civil unrest in Thailand; slowing growth and debt woes in China; and a sense that this is a year to lock in gains derived from both strong domestic growth and more efficient—and therefore more productive—operations. Nevertheless, for those that do have M&A plans, the focus is to do deals within Asia itself. There is a distinctive trend for companies in larger economies—China, Japan, and South Korea—mulling acquisitions in Southeast and South Asia and eschewing M&A in North America and Europe. CFOs in Japan show a strong preference for Southeast Asia (47%) and India (47%), but none indicate North America and only 7% are eyeing deals in Western Europe. Likewise, CFOs in China— despite several big deals unfolding at the very beginning of 2014—show an attraction for Southeast Asia (50%), less of an interest, but still a significant one, for India (27%), but zero interest for North America and very little (3%) for Western Europe. For all CFOs in the survey, an unambiguous preference for Southeast Asia has emerged. “Southeast Asia is where the best growth story may exist right now,” says Mr Lau of Owens Corning. Figure 4.1: M&A caution % respondents who do not plan to participate in M&A in 2014 2013 Change Y-O-Y2014
  24. 24. 2014 CFO Outlook | 4746 | 2014 CFO Outlook Japan strengthens Southeast ties; Thai horizons broaden The response from CFOs in Japan underscores the strength of the nation’s appetite for buying Southeast Asia assets. The depreciation in emerging market Asian currencies that started in the second half of 2013—with the largest drops in India and Indonesia—has afforded cash-rich Japanese firms the firepower to buy into Southeast Asia, where production costs are still cheap and consumer markets are still expanding. It appears to have wiped away reservations about buying foreign assets during a period when the yen has been weakening. Japan was the world’s largest M&A investor into Southeast Asia in 2013, with a 48% share of total inbound deals, worth US$11.1bn. Mitsubishi UFJ Financial Group launched one of the largest deals in Asia in 2013, with its US$5.5bn purchase of a 76% stake in Thailand’s Bank of Ayudhya from GE Capital. Small-cap deals, too, were on the agenda of Japanese companies, which launched 15 deals alone into Southeast Asia collectively worth US$400m, targeted into industrial and chemicals sectors. In key markets in Southeast Asia itself, CFOs have a strong M&A agenda, with respondents from Malaysia (45%), Indonesia (43%) and Thailand (43%), signalling their interest in this mode of expansion in the region. Ongoing political concerns aside, the Thai M&A scene—both inbound and outbound—is one of Asia’s brightest. Thailand saw some of the largest deals in Southeast Asia in 2013, led by Thai company CP All’s US$6.2bn bid to buy a majority stake in Thai retailer Siam Makro from SPV Holdings of the Netherlands. CP All, which owns Thailand’s Seven-11 chain and is led by tycoon Dhanin Chearavanont, plans to invest up to US$276m in 2014 to build market share following the acquisition. It also projects revenue growth of 15% this year, endorsing the view that high goals for organic growth can still be achieved in Thailand. Some 41% of the CFOs polled say their companies are focusing on M&A in Southeast Asia—making it the most popular location for companies across Asia (Figure 4.2). The finding is in line with recent M&A trends into the Southeast region. Inbound activity—strong for several years—was down somewhat in 2013, with 376 inbound deals totalling US$64.9bn, representing a decline of 15% in deal value compared to 2012. But CFOs’ preference for the region this year (see box) is encouraging news for prospective dealmakers in Southeast Asia. The strongest responses from CFOs saying they are considering Southeast Asia for M&A come from Australia (52%), China (50%), and Japan (47%). In Australia, where metals and mining is a major industry, companies are looking to invest in resource- rich Southeast Asia, where lower commodity prices this year have driven asset values down. China’s hunger for outbound M&A is a feature of this year’s global M&A scene (see box), and Southeast Asia’s strong regional growth story is attractive for cash-rich Chinese firms. Figure 4.2: Piling in to Southeast Asia % respondents with M&A plans focusing on region in 2014 What a difference a year makes: China falls from grace CFOs’ preferences for M&A target markets within Asia have changed over the past year. Ranking 13 global target markets by preference in 2014 compared to 2013, Southeast Asia moves up to first position this year from second, while India/South Asia moves up to second position from third. Emerging Southeast Asia climbs from seventh place to third—reflecting in part greater excitement about the most recently opened market in the region, Myanmar (Figure 4.3). Greater China, by contrast, moves down to fifth place from the top position in 2013. China’s inbound M&A story has been declining for some time. The slowing of China’s economic growth, higher labour costs and uncertainty about China’s political transition have all contributed to a dwindling appetite for deal-making. “Structural corrections that persist in China, coupled with the rising opportunities in other regions in Asia, make us think if we should diversify our portfolio a bit and to leverage on growth opportunities in these areas such as the Southeast,” says Mr Lau of Owens Corning. “The huge issue is that costs keep rising—all low-end production is moving to nearby countries such as Vietnam. Meanwhile, a lot of growth is happening in Southeast Asia; we have more confidence in going there and looking for opportunity.” Regulatory hurdles in China can be high as well, particularly in telecommunications, internet, media and financial services. Deal approvals are generally slower than in the US or Europe (for businesses that aren’t considered a national security issue). For instance, in 2011, Nestle of Switzerland’s purchase of China’s Yinlu Foods Group took seven months for regulatory approval, which had to be obtained on the national and local level. In contrast, China-based Shuanghui International Holdings US$4.7bn buyout of US-based Smithfields Foods took about four months for US regulators to rubber-stamp. (Shuanghui International recently changed its name to WH Group.) Foreign inbound M&A into China totalled US$31bn in 2013, below the US$33.6bn averaged over the past five years. Inbound deals dropped in number, too, to 540 in 2013 from 831 in 2012. Will it be this way forever? Mr Lau sees opportunity emerging as reform keeps pace. “There’s an opportunity going forward in industrial consolidation in China,” he says. “It will be more possible to find good quality assets, at much more reasonable multiples. “Structural corrections that persist in China, coupled with the rising opportunities in other regions in Asia, make us think if we should diversify our portfolio a bit and to leverage on growth opportunities in these areas such as the Southeast.” Emerging SEA – Cambodia, Laos, Myanmar, VietnamSouth-east Asia
  25. 25. 2014 CFO Outlook | 4948 | 2014 CFO Outlook “There’s an opportunity going forward in industrial consolidation in China,” he says. “It will be more possible to find good quality assets, at much more reasonable multiples.” Figure 4.3: Favoured regions Rank 2014 Rank 2013 Change South-east Asia 1 2 1 India/South Asia 2 3 1 Emerging SEA - Cambodia, Laos, Myanmar, Vietnam 3 7 4 South Korea 4 8 4 Greater China 5 1 -4 Middle East/North Africa 6 11 5 Sub-Saharan Africa 7 12 5 Japan 8 10 2 South America 9 9 0 Eastern Europe/Russia 10 13 3 Western Europe 11 5 -6 Australia 12 6 -6 North America 13 4 -9 ”Outbound M&A from China is another story, with spectacular growth in 2013 of 31% over the previous year to a record US$68.7bn. This year outbound M&A is off to a full-throttle start with two major deals announced by computer manufacturer Lenovo, to buy IBM’s low-end server unit for US$2.3bn followed by the US$2.9bn purchase of Google’s Mobility unit. The biggest outbound deal from Asia in January was Japan’s Suntory Holdings US$13.6bn acquisition of spirits company Beam, producer of Jim Beam and Maker’s Mark bourbons. Asia-wide, however, CFOs’ preference for outbound M&A from Asia to mature markets appears to be dropping. Ranked by preference, North America drops from fourth place to last position this year. Western Europe falls to 11th position from fifth, and Australia to 12th from sixth. Early days for emerging Southeast Asia M&A scene Enthusiasm this year for high-growth emerging markets in Southeast Asia—Cambodia, Laos, Myanmar and Vietnam—is strong. Thailand seems to have the strongest interest in its high-growth neighbours, with 71% of CFOs in the country saying their companies plan to focus M&A activity within at least one of the four nations (Figure 4.2). In one example of the enterprising atmosphere for M&A developing in Thailand, local telecom group True Corp PCL said in early March 2014 that it intends to take on a foreign partner in the second half of the year to expand in Southeast Asia, a sign of the ambition of Thai firms to grow in neighbouring countries. A large proportion of CFOs in Australia (49%), too, are at least looking into acquisitions in emerging Southeast Asia, a result that dovetails with the interest by metals and mining CFOs in general in the area (41%)—the second highest after financial officers in the telecoms sector. M&A for Cambodia, Laos, Myanmar and Vietnam is still very much an emerging-markets play, in which fast growth is expected as governments sell assets to raise funds and create growth through more private ownership. GDP growth in Myanmar is projected by the Asian Development Bank to reach 6.8% this year, up from 6.5% in 2013; in Cambodia, 7.5% from 7.2%; in Laos 7.7% in 2014 up from 7.6% in 2013. In Vietnam, where the economy is larger, growth will be more moderate but still substantial, at 5.5% in 2014 from 5.2% in 2013. Growth expectations for 2014 exceed those in other ASEAN nations with the exception of the Philippines, but growth there is expected to decline to 6.1% this year, from 7% in 2013.² The advantage of tapping these markets through M&A is powerful. To take one example, growth in the telecoms sector in Myanmar will be assured because currently usage of mobile phones is very low, as it is estimated that over 90% of the population don’t own the gadgets. But regulatory hurdles are a factor that can undo M&A ambitions as governments grapple with the new experience of swinging doors open to foreign investment. For example, Myanmar passed a new foreign investment law in 2012, but there remain significant issues of interpretation and consequently deal flow has been small. “There’s a limit to what we can do in a highly regulated industry in markets where the buyer of the service is government- controlled, as remains the case in markets that are opening in Southeast Asia,” says Richard Beacher, chief financial controller of Hong Kong-based First Pacific, a principal investor in Philippines Long Distance Telephone Co (PLDT). PLDT was not included on a preferred bidding list of 12 companies to gain licenses to provide telecommunications services in Myanmar last year, due largely to the government stipulation that the acquiring telco should already have overseas services, which PLDT lacks. The eventual winners were Norway’s Telenor and Qatar Telecom. The runners up, who will replace the winners if they are unable to meet stringent post-selection requirements, were France’s Orange and Japan’s Marubeni. David Nicol, the CFO of Philippines-based public private partnership Metro Pacific Investments, co-owner of power distribution businesses, toll roads and transportation assets, believes that it is a good time to start investigating Southeast Asian markets for acquisitions, but that it may still be too early to take the plunge. Throughout Southeast Asia there are “interesting investment opportunities”, Mr Nicol says, “but asset values are still high. Some companies have been taking on a lot of leverage. Some will have to deleverage, and assets that are not on the market at the moment, will be, reasonably, given time.” “For now,” he says, “we’re keeping our powder dry.” ²Asian Development Bank, Outlook 2013 Update. Available at http://www.adb. org/sites/default/files/pub/2013/ado2013-update.pdf
  26. 26. 2014 CFO Outlook | 5150 | 2014 CFO Outlook Despite political uncertainty, India still appeals M&A into India and South Asia continues to be an attractive story for CFOs in Asia, 40% of whom name the region as an area of focus for their companies’ M&A plans. The strongest preference comes from CFOs based in Hong Kong (55%), followed by India itself (51%) and Japan (47%). India seems to be getting more attractive to foreign buyers. In 2013, inbound total deal value actually shrank by 20% to US$14.3bn compared to 2012, but deal volumes by overseas buyers climbed to 147, a record. Many of the deals from foreign buyers targeted small-cap companies. Foreign acquirers appear to be holding off until this year’s elections before matching deals on the scale of the biggest deal in India last year: Unilever’s US$3.5bn stake of 14.8% of Hindustan Unilever, announced in April. Buying in India often comes with unexpected operating and regulatory risks. When asked whether he would consider an M&A targeting India, Owens Corning’s Mr Lau says, “We have operations in India, but unfortunately the economic condition didn’t allow us to create tremendous value from them yet. The political structure is challenging but we hope to see improvements after the election. We will continue to have a presence, but it’s going a little bit slower than originally thought.” India is the world’s second-largest telecoms market after China, and a draw for the world’s M&A-keen global telecoms companies this year. But new M&A rules recommended by the nation’s Telecommunications Commission and passed by the government in February 2014 now require companies buying cellular assets pay a fee to the government, greatly raising the acquirer’s potential total deal cost. Figure 4.4: Intriguing India % respondents focusing on India/South Asia for M&A activity in 2014 Buying the building blocks to grow While a large proportion of CFOs in telecoms firms (52%) say their companies are looking at Southeast Asia for buying opportunities, other tech and research and development-reliant industries aren’t far behind. Some 49% of CFOs in metals and mining companies said their companies would focus M&A activity on Southeast Asia this year, followed by 45% in both oil and gas and pharmaceuticals (Figure 4.5). Why are they buying? As mentioned, the response in metals and mining illustrates why 52% of CFOs in Australia named Southeast Asia as a key M&A destination target. Interest in the oil and gas sector comes as energy demand grows (the International Energy Agency predicts energy demand to expand in Southeast Asia by 80% by 2035³) and exploration increases in offshore projects such as those in Vietnam, Indonesia and Australia. Figure 4.5: Industry insights % respondents focusing on specified regions for M&A activity in 2014 ³International Energy Agency, Southeast Asia Energy Outlook, September 2013. Available at: http://www.iea. org/publications/freepublications/publication/SoutheastAsiaEnergyOutlook_WEO2013SpecialReport.pdf South-east Asia Greater China Emerging Southeast Asia India/South Asia
  27. 27. 2014 CFO Outlook | 5352 | 2014 CFO Outlook The heightened interest from pharmaceutical firms in the region tracks expanded interest globally by big pharmaceutical companies in M&A. Companies in the sector are looking to fill what Ernst & Young calls their “growth gap”—the ability to produce revenues at the pace of pharmaceutical market demand. Meanwhile, their equity values are higher than in most of 2013, when M&A activity was minimal. A sizeable proportion of pharmaceutical sector CFOs (38%) indicate that India, too, will be a target for M&A activity. India is the world’s third-largest market for pharmaceuticals and is expanding fast. Last year, pharmaceutical deals represented the highest proportion of M&A market share at 20.1%, edging out construction at 19.7%. Total volume for pharma and life sciences deals in India in 2013 was US$4.2bn for 38 deals, up 188% from the previous year. In contrast pharma deals in Southeast Asia in 2013 amounted to only 2% of the entire M&A market share, worth a combined US$1.3bn. CFOs in these sectors are seeking to gain more than market share in a new country, or the ability to tap markets where organic growth can be supported by a rising middle class and expanded consumption. They appear to be seeking processes, technology and R&D that will help them grow in their other markets as well. When asked by sector what goals they had established for M&A, the majority of respondents (70%) simply say it is to achieve growth goals (Figure 4.6). But 34% say a primary goal is to acquire technology, with the strongest responses from telecoms (55%), manufacturing (46%) and metals and mining (41%, Figure 4.6). Enhancing production capabilities is named as a primary driver by CFOs in manufacturing (51%) and metals and mining (45%). Outside the Southeast Asia context—but in line with these sectoral findings—Frank Lai, the CFO of Hong Kong-listed conglomerate China Resources, argues that paying a little more to buy assets with better operational capabilities is a good defensive acquisition move in China. Figure 4.6: Why buy? What are the primary drivers of your merger or acquisition activities in 2014? (NB: excluding “achieve growth goals”) % respondents Frank Lai, CFO of China Resources Enterprises, joined the Hong Kong-listed retail arm of state-owned China Resources in 2009 after working for one of several holdings in the latter’s portfolio, including semiconductor maker CSMC. During his first year the chief executive, Chen Lang (who joined the same year), gave him an M&A challenge. “When we first came in, we looked at the business—it was a huge conglomerate, but for the shareholder, it didn’t seem to give value; it had too many things,” Mr Lai recalls. “We had an investment in the container port with Hutchison Whampoa, franchise businesses with retailers Esprit and Calvin Klein, a textile business, a beer joint venture [China Resources Snow Breweries, with SAB Miller, started in 1994], other retail businesses and we were even into pork—we were the largest Hong Kong importer. And we had HK$10bn [US$1.3bn] worth of investment property.” “But our share price never traded. The shareholders looked at us and didn’t know what we were doing. The new CEO brought me in with a simple goal: to focus and restructure the company, so we can show some form of core competence. Our investors said to us: ‘We can invest, we don’t need you to do that for us. What we need is to know you’re creating value.’” “When we first came in, we looked at the business it was a huge conglomerate, but for the shareholder, it didn’t seem to give value; it had too many things,” China Resources’ core competency, it turns out, is operating an ownership stake in a China joint venture to extract maximum value for both parties. After selling various units, the company began to focus on expansion in China in the beverage business via a 60-40 joint venture with Japan’s Kirin. The goal was to bring together distribution and retail skills to grow in the China market. China Resources was already selling a popular bottled water product, C’est Bon, while Kirin is one of Japan’s most popular beverage makers. At the time of tie-up, the combined company’s annual sales amounted to Rmb1.8bn (US$231m). In 2013 sales climbed to Rmb6bn, ahead of the stated goal for the joint venture to achieve Rmb5.8bn by 2015. Next Mr Lai began negotiations (via China Resources’ joint venture with SAB Miller) with the largest beer retailer in Southern China, Kingway. The deal, in which the joint venture purchased a 100% stake, closed in 2013 for US$851m. China Resources Snow Breweries is now the biggest beer retailer in China by far. “In China, it’s important that one party has control,” says Mr Lai. “In my own experience, 50-50 doesn’t work. You have to establish who leads—but also make sure that both sides have the long-term view. We’ve followed this strategy: in the joint venture with SAB Miller, we own 51%; in Kirin, we own 60%; in Kingway, 100%, and in Tesco’s China operations, we own 80%.” The Tesco deal—China Resources’ most recent major transaction, worth US$573.5m—reveals how their core competency in joint ventures creates value: through the melding of experience. The deal had strong attractions for both sides. Tesco had struggled to establish international business in the US, Japan and China. Through the tie-up with China Resources—which merged Tesco’s 134 stores and 11 “Lifespace” shopping malls in China into its own 3,000-store group of Vanguard supermarkets and convenience stores— Tesco could retain its presence in the world’s second-largest economy and Asia’s primary growth engine. China Resources, in turn, gained access to Tesco’s global market knowledge and operational acumen. “[Tesco] is not growing as fast in China as local companies,” says Mr Lai. “But in fact, they’re much more advanced. So they suffered a little setback now. They’re a strong competitor. And in an alliance with them, in ten years’ time we just grow with them—and become much more competitive at a faster rate.” Case Study China Resources Enterprises: M&A to the core Frank Lai, CFO, China Resources Enterprises Acquire talentAcquire intellectual property Enhance production capabilitiesAcquire technology Industry consolidation
  28. 28. 2014 CFO Outlook | 5554 | 2014 CFO Outlook Part 5 Finance: Cash is king—and risk is ever present CFOs have their eye on reducing leverage, tapping bank lending relationships, and relying on internal funding as much as possible Staying away from long-term debt, but planning for the long term For Asia’s CFOs this year, the risk-management instinct—in the form of reducing long-term debt exposure and relying on cash wherever possible—seems to be prominent. When asked about their financing plans, 41% say that they will likely adjust their capital structure to decrease weighting in long- term debt (Figure 5.1). The strongest responses here come from South Korea (57%) and China (49%). The explanation is clear: some South Korean conglomerates are among the most highly leveraged companies in Asia, while debt problems in China’s banking system and corporate sector have already been mentioned. An aversion to long-term debt is not isolated to these markets. It is also the case in the Philippines, one of the region’s star performing economies, where structural reforms and a sovereign rating upgrade in 2012 were precursors to strong growth last year. “In the Philippines,” says David Nicol, CFO of Metro Pacific Investments, “a lot of ten-year-debt reprices five years from maturity. And, to put it bluntly, markets aren’t sophisticated enough to allow companies to hedge risk satisfactorily. It’s difficult to get a peso-dollar swap for three- to-five years.” Across the region CFOs interviewed for this report maintain that caution is advisable, as is forward thinking. It’s not just a matter of avoiding excess leverage, but relying on cash flow whenever possible to fund projects, and making sure that the debt they do have is aligned with businesses that offer strong, reliable long-term returns. “How do we manage our balance sheet?” says Frank Lai of China Resources. “You can’t follow the economic trend. Over the last five years you’ve had periods of China bank liquidity flooding you up to the ears. Then you’ve had periods of no liquidity at all. If you dance with them, then your finance strategy changes all the time. “But we can’t,” he adds. “We are planning for the longer term. The next best thing I can do is manage my balance sheet carefully by squeezing all my debt to replace what we regard as passive assets with active assets.” Mr Lai says he prefers using cash from divestments to fund growing businesses over debt, and says that he won’t tap equity markets again until he deals with the “inefficiency in my own share structure by selling non-core assets.” Translation: use cash whenever possible, and when you do take on debt, make sure it supports assets that will deliver consistent long-term growth. Figure 5.1: Lever down How is your company likely to adjust its capital structure in 2014? % respondents, all countries Decrease weighting No change Don’t knowIncrease weighting

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