Exchange Rate Risks, Ethics and Tax Avoidance

On Thursday David Cameron talked about an anti-business culture developing in the UK with wealth creation being referred to as 'anti social'. With all of the discussion of senior executive pay, big business is feeling 'un-loved'. The fact of the matter is that the UK economy is reliant on multinationals, they may represent only 2% of British companies but they are responsible for 38% of British industrial employment, 23% of service sector employment and four fifths of all spending on research and development.

The UK is home to half of all multinationals headquartered in Europe who presumably are there to minimise the company's tax burden.

For a business, what does achieving the most efficient tax result mean? There are ethical pressures to pay tax at the appropriate rate, in the appropriate country, at the appropriate time but what about those of your competitors who don't? The result will be that they will have higher cash reserves, lower cost financing and increased dividends. Back to the ultimate business objective, Shareholder Wealth Maximisation. In this context, moving or allocating profits to a low tax jurisdiction, your shareholders may say was an obligation.

Certain things would have to happen in order to create a level playing field with regard to tax avoidance,  international co-operation and transparency being just two of them. The Tax Justice Network (TJN) produce a Financial Secrecy Index which ranks companies according to their secrecy and the scale of their activities. The members have a shared concern that tax avoidance causes poverty.

The World Economic Forum in Davos in January this year shared that view too, Nick Mathiason from the Guardian came up with five steps to end global tax evasion. The discussion at the WEF was about using this funds, (avoided tax) by big businesses, which could be accessed if we all pulled together, and we could use it to beat austerity. What a good idea. I wonder why we aren't doing that now? Seems simple.

Could it be because recently we have seen that individuals too have ways of minimising tax payments.The current UK top rate of income tax is 50%. They pay themselves though private companies and save themselves thousands just like Moira Stewart from Radio 2, (well, I'm old) top NHS civil servants and the student loans chief Ed Lester. But, won't they be spending their (available) money in this country which generates more wealth? If the government (be it Cons/Labour/Lib) got it, what would they do with it? Instigate more public sector reforms which costs millions and ultimately fail or use it to pay benefits to those who don't deserve it?

The Guardian reported on 23rd February that a spokesman for the Her Majesty's Revenue and Customs (HMRC) task force, targeting those individuals who evade tax, say they have found evasion to be as high as 75% in the selected group. They're targeting people who own property abroad, fast food retailers and market stall holders, i.e. small businesses. Something tells me they're missing the point. Back to upsetting big business.

Another real issue for businesses who import or export goods is currency related risks. In an extreme example, the sanctions in Iran have caused the rial to fall drastically against foreign currency which has resulted in businesses not only being exposed but suffering transaction and economic risk. Iranian students studying in other countries are unable to receive currency from families, only the rial which is reducing in value every day. Sanctions have been placed on Iran because of their nuclear activity and in this case it's not just the businesses who are directly effected by the devaluation, it's all of the population.

During the last quarter of 2010, money spent by big business on investment was down but UK exports rose by 2.3%, that's good news but ultimately puts those exporters at risk, however these risks can and are managed. A forward contract may at least provide some guarantee of what future costs may be but benefits may not be derived if rates are favourable. Businesses could insist that all trade, whether that be import or export, be settled in their home currency, thereby avoiding the exchange rate risk. That risk is then passed on to the customer. Not necessarily risk free then - you'd have to be in a pretty good position to expect that of your customers, no competitors and so on.

Netting is another method where inter-organisational currency debts are settled for the net amount, taking into account the 'some you win, some you lose' attitude. Matching inflows and outflows and concentrating on the part of the trade which remains unmatched can work for some. Gambling (in an educated guessing kind of way) on what you expect the currency market to do is also an option adding in a borrowing factor just to make things really interesting.

There are many options to manage risks associated with currency exchange rates, the ultimate aim being that you (the management) aim for best value for the shareholder, but the tax question, that may not be so simple.


References: Hyrck and Andreoli (2005) Foreign Tax Strategies can be a boon to Multinationals. BBC news.  Guardian news. FT. Arnold.

Raising Finance - so many options

When considering raising finance for new projects the main considerations for companies are availability and cost, or when can I get it and how much will it cost?

During the 'credit crunch' there was a shortage of credit, banks no longer wanted to lend. The banks hadn't been wise enough to keep a nest egg for those who hadn't been wise enough to keep a nest egg. Today, funds are directed from the Bank of England to high street banks with the specific purpose that it is loaned to businesses.

There was national surprise when established businesses such as Woolworths went bust. How could it be that such a well know town and city fixture was financially unstable? Everyday we read that some well known brand was struggling and in need of finance. The truth is that without finance, many businesses could not operate.

There are different types of finance available, a project may be funded internally using retained earnings, (or profits from last year,) but what if you didn't make a profit last year? Other finance options include Equity and Debt finance, or a mixture of both. Either way, investors expect a return on their investment.

Vodafone has recently been discussed in relation to an 'all cash' deal to buy Cable and Wireless. UPS are in talks to buy TNT Express, offering 9 Euros per share and although Anglo American ended the year with debts  following the purchase of a stake in De Beers, they plan $7bn capital expenditure in 2012.

An initial float on the stock market is a lengthy process so would be associated with long term strategic intent rather than an opportunity the company couldn't miss. It involves sponsors, prospectuses and loss of control but brings with it no obligation to make regular payments - unless they want to pay dividends. If the company's shares are attractive to the market, this may be a good way to raise finance, either on a local market or globally. Issuing shares is costly but also helps to raise the profile of a company.

Debt finance may be a better (and probably less expensive) option for some companies, particularly those who prefer not to 'float', Phillip Green, Richard Branson, Mr JCB etc.There are many options available to businesses, not just bank loans, they can use bonds or even syndicated loans if the amount of borrowing is extremely large (£100m upwards). The major benefit of this type of borrowing is that there is no loss of control (provided you can make the repayments).

Dominos pizza company is a good example, they moved from the AIM to the main market in 2008, earnings per share and dividend per share have increased year on year by at least 24% over the last five years. The management have big plans and their investment has paid off. Currently they have a loan for £25m. Their business model includes being highly geared. Their gearing ratio has been as high as 73% (2009). The 2010 long term liabilities were £54m, total equity stood at £42m.

Dominos have had a programme of share buybacks which has generated artificial interest in the company and falsely inflated the share price. They chose to buy back shares rather than reduce their debt. Their manipulation of the stock market could be a viewed as beating the market, but is heavily reliant on a strong business model, they have used value enhancing methods very well and can cope with the associated risks. They chose to take out a loan rather than giving away any further control to shareholders and by using a less expensive form of debt, they have lowered their weighted average cost of capital. Very good.

Bonuses, can't live with them, can't live without them!

For seven years I was paid a salary plus bonus. The idea was that the bonus was an incentive to make us do more. Did it? Yes. For weeks the news has been dominated by discussions about Royal Bank of Scotland’s Chief Executive Stephen Hester’s £963K bonus. Now the discussion has moved on to Barclay's CEO Bob Diamond. Should he? Shouldn't he? Will he? Won't he? 

In the business world it is accepted that if you don’t pay a bonus, you won’t get quality individuals (i.e. men – but that’s another story) to undertake such important roles. Hester’s salary for example is £1.2m; that obviously doesn’t guarantee quality leadership. I thought it would. Chris Roebuck of the London Business School said RBS had no choice, if they didn’t award this level of bonus, Hester could ‘walk 50 yards across the street’ and get another job somewhere else.  He has this week discussed his 'deeply depressing moments ' during the last three years. Hester turned down the bonus and even considered leaving RBS. Surely not.

If shareholder wealth maximisation is the primary objective, Stephen Hester has done his job and deserves his bonus, RBS is now making money. Under the principles of Corporate Governance, incapable managers are removed by capable ones. Based on his results, Hester can't be described as 'incapable'. Diamond on the other hand has given up his 2013 profit target in favour of an 'in time' time scale, (which is no time scale) but will he be awarded a bonus? Or more to the point, should he be awarded a bonus? Depends what he was asked to do and if it was dependant on achieving 6.8% then no, he shouldn't. He probably will, although it may be 25, 32 or 45% down. 

In 2002 Charles Handy remarked that there is more to a business than making a profit, the level of profit simply allows the business to 'do something more or better' and the 'something' becomes the real justification for the business. 

Handy talked about the workforce being a community who all benefit from the company doing well. He said that we should measure success in terms of outcomes for others as well as ourselves. The outcome for Hester is good, potentially, and for the shareholders too, RBS has made a profit under his leadership. Is that the kind of community Handy meant. Sounds ok to me.

On Friday when Barclays announced that they had missed their 2011 profit expectations, Diamond took the focus to 'Citizenship'. No, they probably weren't going to make their 2013 target but 'look at the other things we've achieved' (I think was the general message) which would have been admirable had they not included paying tax in one of their contributions to society. We all pay tax, it's an obligation not a thing simply to 'help economies progress and grow'.

Until this week, my opinion on share prices or 'the market' as it is known, was that it (trading) was little more than gambling, some you win, some you lose, certainly based on luck or something beyond my control going on the in the Global economy. Now I've discovered that the market is actually efficient so is there any point in trying to beat it? The standard finance theory is that the market is efficient so don't try to beat it, the behavioural financiers (or professionals) oppose this theory since it makes what they do redundant. Rational/irrational? Normal/abnormal? Who's right and how would you test? (Statman 1999)

Barclays share price closed yesterday at 234.05p, the day before the news about the profits, it has closed at 233.1p. No over or under reaction there then.

At the World Economic Forum in Davos a few weeks ago the issue of inequality was repeatedly raised. The gap between the 'haves' and the 'have nots' appears to be growing. Is it? Who knows? The constant reminder from the media about higher costs and lower wages only serves to reinforce a picture of bleakness where even people who achieve what they're employed to achieve shouldn't be recognised in the (business) appropriate manner.

Only time will tell whether Hester stays with RBS to complete his task and ensure the bank is sold at a good price and the UK taxpayers get their dosh back, or indeed whether Barclays hits its 2013 targets and continues to contribute to society by paying its tax. 

    

      

   

Spanair, does anyone care?

In March 2009, SAS Group, the Nordic regions largest airline, sold 80% of Spanair. It retained 11% and on the day Spanair filed for bankruptcy, it's shares fell by 9.5% in one day. Sture Stoelen, SAS's investor relations chief said it was 'too bad' but added it was 'completely manageable for us'; 20,000 passengers were stranded in Europe. John Strickland of JLS Consulting said to Mark Barton on Bloomberg Television's 'The Pulse' on January 30th that it was 'a long time coming'.

In 2010 Spanair reported an operating loss of 115m Euros. (BBC News Website) The collapse comes after Qatar Airlines stopped takeover talks. Demand for air travel is weak in Spain. In 2008, Spanair was involved in  Spain's worst aviation disaster, killing 154 people. A warning system failed to alert pilots that there was a problem. The regional government of Catalonia had helped Spanair stay afloat with more than 150m Euros of subsidies from as far back as 2008, Spanair were cutting jobs to save money. Spanair's mission was to 'connect Barcelona with the world and the world with Barcelona'.

Ryanair's Chief Financial Officer, Howard Miller talked of Spanair being a 'broken business', he sent resources to 'rescue' travellers although he doesn't want to consider taking over Spanair, he is interested in taking over some of their flights.

SAS which is part owned by the governments of Norway, Sweden and Denmark hasn't posted a full year's profit since 2007. It sites rising aviation fuel costs as a major reason together with competition from low cost carriers. Without the writing down associated with Spanair, SAS claims it expected to make a profit in 2011 without 'non-recurring items'.

The situation for Spanair does however provide an opportunity for other low cost airlines, Ryanair, Europe's biggest discount airline has raised it's profit target. It is described as 'sharp' and 'adaptable', all the things Spanair weren't. Ryanair take action to fill their seats, they are proactive, selling seats at low prices where there is the highest need to fill seats. They are glad to see Spanair's capacity disappear.

After doing a little research, I have to agree with Mr Strickland, it has been a long time coming. Spanair seem to have been operating at a loss for some time (at the time of bankruptcy they had 300m euros in liabilities), and bailed out repeatedly by government. The assumed objective of corporate finance from an Anglo-American perspective would be Shareholder Wealth Maximisation. At Spanair there was no greed, the board did not focus on making a profit, they got used to making a loss. They were waiting for Qatar to bail then out further, when they didn't and the Government stopped their 'investment' it could mean only one thing for Spanair. The competition from companies such as Easyjet and Ryanair also helped to push Spanair out of business.

There is little doubt that Spanair's reputation was damaged following the 2008 disaster and to recover from that would it seems take a miracle (or a highly skilled board). Even SAS thought so, they sold their 95% in 2009. Wasn't the writing on the wall then? I wonder what motivated Ferran Soriano to continue business. Were egos at work?

'The demise of Spanair is the result of bad management' said Inversis analyst Julian Coca. I wonder why Mr Soriano was not replaced since he did not create any shareholder wealth. I understand that Value Creation is subjective; it's based on what shareholders expect, i.e. what's acceptable, it seems here that it was expected that Spanair would not make a profit for its shareholders (or maximise their wealth) and so it never did.

Or is that a little unfair? Charles Handy (2002) discussed the different approaches taken to shareholder wealth across Europe, he talked about a 'greater reliance on long-term bank finance' in fact 'the cult of equity is not as prominent in mainland Europe', so maybe Soriano just did what was expected of him, I guess it depends on your expectations and objectives.