• Tuesday, May 21, 2024
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Strategic intelligence for CFOs in economic downturn


Elijah Oladunmoye

The role of CFOs has become far more challenging and evolving of late. Not only is the CFO expected to run an efficient finance function, influence investors and other stakeholders, he is also required to drive business performance while complying with a multitude of regulations.
But increasingly, most Chief Executive Officers expect the CFO to perform the role of business partner. According to CFO of Sasol Limited, CFOs are the tools the executives use to assist in making strategic decisions. In addition to being responsible for shareholder guidance, determining the entity’s predator-prey standing at every point in time and advising on appropriate actions also has become a responsibility of every proactive CFO due to the capricious economic landscape. He predator-prey or the hunter and the hunted dichotomy, a common phenomenon of the animal kingdom have become a common feature in the corporate world, especially with growing competition in the marketplace. Apparently, the predator-prey status is non-static and continuously requires attention of proactive corporate executives. The fact that an entity ranks as a predator at a particular period of time does not guarantee a permanent safety net from a takeover artist. However, the understanding of this phenomenon assists corporate executives in their strategic thinking.
The focus is on how corporate bodies, based on some fundamentals, determine their predator-prey status in their sectors and develop appropriate strategies to either strengthen their position as a predator or as identified preys shield themselves from the predators.
Strategic behaviour of firms to a large extent is determined by the market structure, which in turn determines the cost of predation and its economic viability. The monopolist does not predate since it oftentimes produces product for which there is no close substitute and there is barrier to entry for other players. However, for other types of market structures such as oligopoly, monopolistic competition and perfect competition, predation may make economic sense depending on the number of firms in the industry, market share and the target’s position on its product life cycle.
Based on a recent research by BCG, certain factors determine a company predator-prey status in the marketplace. These factors among others include the company’s relative position in the capital markets based on current valuation and historic shareholder return and its financial health defined by operational performance and level of debt. Companies with relatively high valuation multiples, impressive profitability, low leverage and strong shareholder returns compared to their peers may evolve as predators during economic downturn while companies with the opposite features may perhaps emerge as preys in takeover bids. The opposite features stated above include strong operation with financial weakness, high leverage ratio, poor valuation, and unimpressive shareholder returns. The takeover of Spring Bank Plc by BankPHB Plc is a good example.
It is highly essential for proactive executives with the assistance of their CFOs, to know what their ranking is on the predator-prey scale. This helps potential predators to identify suitable prey while potential preys come up with adequate strategies to improve their positions and protect themselves from being taken over.
Based on facts from M&A world, potential targets need to restructure their businesses to achieve improvement in profitability, asset productivity and reduce leverage to survive the harsh economic climate and strengthen their position against their predators. They should also divest unprofitable units or sub subsidiaries (to improve liquidity and probably cement a deal with a long-term equity investor). Although divestment is often considered a negative or reactive tactic, nevertheless, liquidity level can be improved to salvage the company from liquidity shock. For instance at Constellation Energy Group, the company divested its upstream gas assets in August 2008 to create more cash flexibility and rescue it from the initial liquidity freeze.
For targets adopting restructuring as an option, achieving value adding corporate restructuring requires a portfolio of proven financial management strategies. A good restructuring plan demands an in-depth review of the business operations and an understanding of what drives costs, profits and cash flow. After analysing the business model and its structure, consideration should be given to the restructuring options available, taking into account relevant commercial and legal constraints affecting the business operations and its cash resource. Restructuring is mainly carried out to remove financial burdens that may include the cost of premises, employees, unprofitable contracts, or loss-making subsidiary companies, operations and non-core patents. However, care must be taken to only cut the fat and not the bones and muscles in order to avoid disarming the company from moving up when the market picks up. Based on personal experience, better result will be achieved if professional advice is sought.
As noted by proven M&A strategists, potential predators should identify targets with strategic fit with emphasis on relative profitability, financial soundness with more consideration on leverage ratios and the relative size of the target. In carrying out the strategic fit analysis, the target’s business life cycle should be taken into consideration in order to determine the best acquisition strategy that will best achieve value realisation.
Generally speaking, the current economic situation presents a new testing ground for CFOs. Whatever is an entity’s predator-prey status, it is imperative to ensure all efforts are fostered towards improving competitive edge, achieving efficient and cleaner balance sheet and ultimately to improve and sustain liquidity in the long term. Constant stress testing will also go a long way in assisting companies to identify their weaknesses and take appropriate corrective actions.