Firms learning to be careful about modes of financing10 min read . Updated: 04 Dec 2009, 02:47 PM IST
Firms learning to be careful about modes of financing
Firms learning to be careful about modes of financing
Mumbai: Adil Zainulbhai is the head ofMcKinsey and Co.’s India operations. McKinsey has worked with some of India’s best known companies over the past two decades. Without divulging details of the firm’s clients, Zainulbhai, who rarely interacts with the media, spoke to Mint on larger trends he sees in India as it recovers sharply from the slowdown. Edited excerpts:
So, is the worst really over?
Making predictions about the future is really not such a good idea in these times. Things have stabilized, but it’s probably going to take a while for it to get back to how they were in the past. The problem is that unlike in the past, when you could talk with some certainty about what is likely to happen in the future, right now, there are so many uncertainties that you have to take probabilistic views.
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What will drive this recovery? If you look at the last big boom, not just in the US, but everywhere else too, it was driven by productivity gains, which, in turn, were driven by the IT (information technology) revolution. What, in the next 5-10 years, will drive growth?
Let me talk about India first. At one level, both India and China are catching up with 150 years of lack of growth. These economies have 25-30 years of growth left at reasonably high rates. It’ll go up and down, but fundamentally, if economy transforms from an agricultural economy to a more modern economy whether it’s a manufacturing economy or a services economy, it has many years of growth left. Of course, we have to get the right policies in place to do that. But, in addition to that, a part of India’s growth is coming from becoming a part of a world like training system and a world like financial system, and, therefore, things, at the third, in the rest of the world (are), of course, affecting it.
We have done a lot of thinking about this issue that has come up, which is to what extent does India couple or decouple. It was actually the wrong question because nothing is ever 100% coupled or decoupled—it’s only a question of what sectors are coupled and how much. We are somewhat coupled on the manufacturing and trade front less than China, but on the financial front all countries in the world are very closely coupled. To the extent that the external world is slow to recover and to the extent that financial flows around the world are slow to recover, ...it will affect India.
In India, all factors of productivity—IT, conversion to a manufacturing economy, conversion from an agricultural economy—all of the factors are still valid and will continue to drive growth for a long period.
Given this, what would your advice to large Indian conglomerates be? Should they focus on the domestic market? Should they go out and buy companies that are still available at fairly attractive valuations?
It really depends on the sectors. I would say roughly 30% of the sectors in India in services and manufacturing were not affected a lot. A third was affected somewhat and another third was hit very badly—anything that had to do with textiles exports, mineral exports was hit very badly.
If you think about the mood of the companies, there were several things that drove this. One was demand and pricing, and the second was their ability to fund.
That change probably started around May of this year when the markets did well and, therefore, companies could raise money. In a sense, it’s a virtuous cycle: markets open up, companies raise money, companies start investing. Right now, we are in that. So, right now, we are in that virtuous cycle. Last year, we were in the vicious cycle.
The mood among companies is very good and because they have a lot of confidence in the long-term growth of India. All companies that are looking at the growth in India are feeling very good now.
There are certain industries where you have to become a global player, and if you have to do that then it’s a strategic imperative to expand globally.
It’s not a choice for them, it is a strategic necessity. If you believe it is a strategic necessity then as soon as you have money, you’ll start expanding. There are some companies that are expanding, so that’s one category, and if you look at certain steel companies and others, they believe it was a strategic necessity, long term, to be global. There are sets of companies, they are looking at it and saying there are interesting markets overseas where Indian products will do well and, therefore, we should expand in those. So when they have the money, they’ll expand; when the demand is there, they’ll expand and when the demand isn’t there, they’ll step back.
There are two classes of companies: those who are expanding into OECD (Organisation for Economic Co-operation and Development countries) and the US, and those expanding actually into Africa, Middle East, Central Asia and South-East Asia.
But the ones who are expanding the fastest are the companies that are betting on the growth in India because around the world there are only a few bright growth spots.
What should companies do? Domestic demand by and large is better than almost anything else.
But when we have a lot of money in our pockets, we don’t look at how we spend it. The Indian economy went through around a three-four-year period that everybody had lots of money in their pockets and the mantra was just grow, grow, grow.
And then, all of a sudden you don’t have money in your pocket then you suddenly realize that many of the things you were spending on, you shouldn’t have been spending on. So (today) almost every company is running a major cash programme to ensure that they have enough cash on hand and that they are getting rid of all the wastages.
Still, I am a little worried that many of the good things that companies could have put in place might not be put in place because money is available. Every CEO I know, again, is talking about the fact that they have got investment bankers lined up at their doors offering them money.
I think there is one thing we have to make sure that our companies don’t get back to some of the ways that they had during the grow-grow-grow years.
So what have Indian companies really learnt from what happened last year?
There are some real lessons they have learnt and there are some lessons I wish they had learnt.
The No. 1 lesson that everyone has learnt is that you must have cash. Not having cash is a bad news and having too much debt is a bad news.
The No. 2 lesson I think we have learnt is that you can’t expect the grow-grow era to continue forever. There will be a slowdown. We have not solved the problems of business cycles in the world and even in India, this can occur, which I think people had forgotten.
The third lesson people have learnt is that if you left your cost and your spending get away from you, it will come back to haunt you.
I think the corollary to that is you have to be very, very careful so you don’t get hubris. Many companies have learnt a lesson to be a little humble. My cynical view is that I would like to hope that those lessons stay learnt. The scars are still there, but they seem to be healing and they are seem to be healing really fast and I am just hoping that companies don’t forget those lessons.
Are you seeing the reverse problem? We did a study recently on mid-sized IT companies; we picked around a dozen of them and we found out that over the last one year, all of them had just slashed their marketing spends, and classic instance of an entire group of companies becoming probably far too cautious. Are you seeing a lot of that also?
It wasn’t that people got cautious, they got scared. We had never seen that kind of environment in several years and all of a sudden companies had run out of money. So if you look at marketing spend, not just for mid-sized IT companies, but for all companies in India—advertising agencies tell me this—the media spend dropped by 30-40%. That’s part of the problem: you over-react. When you have consistency of purpose and a well thought strategy and you are cautious, you can design a strategy and the execution plan that works in many environments, then you can manage and adjust in a reasonable way. But when you are in the grow-grow era and you suddenly determine the era has ended, then you have to slash. I think that’s all happened. It was such a huge growth that when things stopped, everybody just had to slash dramatically.
What you saw in mid-sized IT companies is being played out in lots of ways across the world. What I am concerned about is the way going forward. (Companies shouldn’t say), “now things are better, so let’s get up spending and then in the next slowdown, we’ll slash". Instead of that, if we have learnt our lesson then we will manage it well.
Where does this consistency of purpose you speak about come from? Typically, sentiment always leads reality.
There is a lot of discussion about corporate governance. And there is a lot of discussion about whether family-run companies or those where the (founding) entrepreneur is still around are run better for the long term than others. India has a lot of family-run companies. There are badly run family-run companies, and there are well run family-run companies, but there is a theory that says that a well run family-run company where the (founding) entrepreneur is still there can take a better long-term view of what is happening. Their long-term view is longer than one cycle: it’s 20 years, 30 years. The long-term view of a CEO in a Western environment is often three years. That’s the life cycle of a CEO. So if we believe that to be true then you could argue that, in fact, some of the best family-run companies in India should, in fact, be in a position to take a longer term view because they are going to own it for a long time. Whether it will happen or not, I don’t know, but I am saying that could be one thing because, structurally, they have that advantage that they can take a long-term view.
In India, a lot of companies have the original founder, and the original founder is still a director, and, therefore, they have this advantage.
Let’s move the discussion a bit to financing. Last year, the big problem companies faced was that they didn’t have enough money. And they couldn’t raise it from anywhere. This year, it’s become easier to raise money from the market and the banks are lending. Are there any lessons in financial structure that these companies have learnt or you think should have learnt in the past year?
Companies learnt several lessons. Anything that looks too good to be true in financing probably kills. So a lot of companies jump after derivatives and it was a disaster over time. I think a lot of companies decided that they could hedge and they believed that there were foolproof ways to do it.
I think that one thing people are learning is to be careful about modes of financing because what appears to be risk-free actually has a lot of risk. I think that’s the one thing companies have understood.
The second thing that they have understood or, at least, hopefully understanding, is that you can’t get into a point where your leverage is so high and the markets will forgive you for it. The markets are looking at it and, therefore, the mix of equity and debt that will be raised (now), I believe, will be different than it was in the past.
The second part of this interview will appear tomorrow.