Courage, Covid & Corporate Finance
A seasoned Middle East C-suite Investment Professional with more than 10 prominent international transactions with billion dollar companies in the last 12 years across the Middle East.
What does one need in times of a black swan event like Covid? A bit of courage to take bold steps towards present resilience & future sustainability and some smart corporate finance policy framework to tide over crises like these. As we focus on immediate impacts of COVID-19, we need to keep an eye on the long-term repercussions of the new world order post this event.
This is the second crisis of monstrous proportions on either side of the last decade. Not to forget another one at the beginning of the previous decade. This is all becoming like a déjà vu occurrence every eight to ten years. And still we have learnt nothing from history. Companies loaded their balance sheets with leverage to enhance the return to their equity shareholders, only to be looking at the governments now to bail them out. Vanity mergers & acquisition activities to spread wings into completely new sectors beyond the core competence of the corporations, without proper diligence.
As the cliché goes, history repeats itself and it is very much repeating itself again, as we speak. Many times, I ask myself, how can businesses and management not be prepared to withstand loss of revenue with existing cost structures for one to two quarters? Why do they need to tread on such thin ice, that any out of book event, puts a question mark on the entire continuity of the business? Why are even big corporations looking for a bailout with one quarter of suppressed or lost earnings? Why are businesses structured in a manner that allows such a weak financial resilience of shareholder value?
Companies with more prudent capital structures with less gearing and sufficient reserves, will be able to ride out this crisis and the highly leveraged & unprepared ones will fade into history. Companies which have the sufficient cash to buy back their shares and avoid taking dividends will do better during this period shall the requisite cushion to the gravity defying share prices and dwindling profits.
Moreover, there will be massive loss of trust among businesses and equity markets with the frequent
occurrence of these crises. One cannot avoid a black swan event, but the frequency of these events and more so the impact of such events on the companies, points to a much bigger structural problem.
This time around, should we not look to rewrite the general convention of corporate finance? It’s at these unprecedented times of extreme distress that a new manuscript is written to prepare for the next pandemic or an economic crisis. Shouldn’t companies, after the crisis, built their capital and corporate structure in anticipation of these all so frequent events. Shouldn’t the leverage strategy, dividend policy & equity reserve levels, all devised to ensure, there be a cushion to ride over these events? Aggressive dividend policies or even reinvestment of reserves at the expense of maintaining a sufficient loss absorbing buffer, is what put the solvency of a company in question, during these times.
One needs to look at several changes to make corporations less immune to these crises. Let’s look at a few of them. Keeping aside a certain portion of distributable dividends into a contingency reserve to ensure continuity & solvency at all times will be very effective. A relook at the corporate tax law & policies, with respect to tax deductible interest charges, linked to the leverage taken, to fund any distribution to shareholders. From a corporate governance point of view, a black swan downside scenario should be included in the annual reports for shareholders to properly gauge worst case, value at risk.
A black swan downside scenario should be included in the annual reports
Similarly, financial institutions should look to hire people with real operating experience to estimate the real risk while lending to a particular business. A more wholesome fundamental and operational understanding of the business is required to take right lending decisions.
As for the current situation, all stakeholders including companies, financial institutions, and the national government need to work together to ride out of this crisis and survive to live another day. Commercial banks will have to play a critical role in a mutually beneficial debt restructuring for some of the fundamentally strong companies, in conjunction with the government policies to support MSME and large corporates, with an undertaking from them, to make the right changes in the capital structure and corporate policies over the longer term. They need to proactively engage with customers and understand the immediate and long-term repercussions for each client. In many cases a bank may be serving both a company and its customer base. In this case all three parties need to work together to manage their cash flow profile and arrive at a win-win (rather than a survive-survive) strategy. This is clearly not straightforward as many times this is a tradeoff between playing a bigger role in the crisis versus protecting its own balance sheet. But this is a scenario where all players need to play for the bigger goal rather than playing for individual glory.
After speaking about COVID and corporate finance, let’s talk about courage. I have always believed the best form of defense is attack. As companies look to survive, they forget that some of the bandwidth may be used towards attacking i.e. looking at the opportunity. Despite an across the board carnage, there have been sectors which have been positively impacted. Businesses need to find a way to reach out and try to win market share in those sectors, as all the competitors put their guard down. An attack or show of courage can take many forms including productivity improvement, use of alternate sales and delivery channels, cost optimization, innovative marketing techniques, change in product positioning, new product development, to name a few.
As the Great Warren Buffet famously said, “You only find out who is swimming naked when the tide goes out”, once the crisis abates, it’s the companies which can use the two ‘Cs’ are the ones that shall be able to come on the other side as leaner and meaner corporations.