In December, German multinational Siemens was granted a banking license allowing it to lend to customers. It was a practical move. While the world’s largest companies are flourishing (the planet’s top 25 enterprises saw net earnings surge 63% last year), their suppliers and customers are complaining about recalcitrant lenders.
Are MNCs Facing a Cash-Constrained Future?
There’s a lot of excess funds for Siemens and other MNCs to tap. Including emerging ones in China, India and other places in Asia, they are sitting on huge cash hoards – American MNCs alone are estimated to have US$2 trillion on their balance sheets.
Yet when they have spent their hefty reserves, multinationals may face a more credit-constrained future. The implementation of Basel III rules from 2012 will compel banks to keep bigger reserves of capital, affecting their profitability and return on equity and potentially their ability to lend.
Private equity may not be able to take up the slack. Research company Preqin says private equity fundraising was at its lowest level for six years in 2010. And global net financial wealth is predicted to fall 36% by 2024, a drop in savings that will further lessen cash available to banks.
Are multinationals prepared? KPMG Agenda asked three experts to look into the issue: Jitendra Sharma, KPMG’s Global Risk Management Leader; Adam Gilbert, Head of Regulatory Policy in JPMorgan’s Corporate Risk Management Group; and Steven Kaplan, Professor of entrepreneurship at University of Chicago Booth School of Business.
Would it be fair to say multinationals have had too much easy access to capital for their own good in the past?
Sharma: There’s no doubt there has been too much credit. Excess liquidity in global capital markets reduced the cost of borrowing. But I don’t think multinationals having access to relatively cheap funding was a major contributory factor to the recession. There were many factors, but on the corporate front, excess liquidity led to highly leveraged M&A and that market came to a standstill in the summer of 2008.
Kaplan: The untold story is that multinationals, particularly non-financials, have been spectacularly successful lately. They have US$2 trillion of cash on their balance sheets – which means they have come out of the worst downturn since the Great Depression in marvellous shape. It’s part of the reason that stock markets have recovered so strongly, and that things aren’t worse all round for everybody.
Businesses have been prudent. They have cut quickly for the downturn and they are coming out of it healthily. That’s very different to something like the downturn of the late 1980s/early 1990s, when multinationals came off very badly.
Why do multinationals have so much cash, and how long do you expect them to hold on to it?
Kaplan: Three things are happening. One, which affects US multinationals, is the tax disadvantage of bringing cash back to the US. The second is that companies may have been more successful than they anticipated. They have really tightened up and got more efficient.
Thirdly, there is a sense in which multinationals’ baseline is a little higher than normal, for precautionary reasons. When we went into the crisis, they wanted to reduce their bank debt and make sure they had a reasonable amount of cash. Now they’re waiting to see whether there’s a recovery, and they’re keeping the cash there until they do.
Gilbert: There’s a bit of a chicken-and-egg thing going on here. The [US] economy won’t get going until companies start investing in things and generating household income, but they won’t do that until they start seeing income from households. It’s hard to see what will break that. We’re in an exceptionally low interest rate environment and companies would rather have cash than invest in new equipment.
Sharma: Keeping cash isn’t a new development – cash reserves at multinationals have been steadily increasing as they have found ways to reduce costs and increase profits by finding new markets.
Twenty years ago, they were converting assets to cash because they were looking to emerging markets for expansion. Right now, there’s a lot of uncertainty about what part of the cycle we’re in.
Companies are very cautious about what sort of multiples they are willing to pay. And countries like China are trying to increase domestic consumption, albeit with protectionist undertones.
What effect will Basel III have on banks and, by extension, large businesses?
Gilbert: Basel III is an appropriate move. It will increase risk weights in certain activities and will increase the calibration of capital that’s required even if banks just want to stand still. It strikes at the heart of bank activity, which is capital liquidity.
Banks can respond in a few different ways. They can front it up and lower their return on equity, they can change product offerings to clients to become more capital-neutral or they can pass costs along. You’d expect a net increase in cost to banks of any given asset, but it’s not clear to what extent.
Sharma: Banks will have to tighten their belts and be a lot more efficient. They will need to be more disciplined about who they do business with and how they maximize returns on capital. It won’t affect the Procter & Gambles of this world, but mid-market companies rely much more on the sort of capital that banks provide.
Kaplan: Any time you increase capital requirements, you make capital more expensive and see less of it. Banks will have less to lend. How big will the effect be? I’m not sure it will be that large. Large corporates operate in capital markets, and they have plenty available.
Private equity took a major hit during the recession. Will it ever recover?
Kaplan: Reports of private equity’s demise were premature. Two years ago, a report claimed that a large fraction of private-equity funded companies would default. But that assumed the deals were imprudent, which they weren’t.
Debt structures in the recent boom were more conservative than in the 1980s, one reason why a large number of defaults have not materialized. Private equity will be smaller than 2007, but it isn’t going away.
BlackRock has raised a US$15-billion fund – that’s not the US$21-billion-plus it was several years ago, but it shows the interest is still there.
Sharma: Private equity often comes in when companies are restructuring, and that is driven more by the business cycle. PE firms might be taking a look at their own funding as a result of the crisis, and it’s not yet clear how that will shake out.
Gilbert: Private equity has always been important, and it always will be.
Is Siemens’ move into providing capital for customers a positive development, and will other large companies follow suit?
Sharma: It could work, depending on your strategy. There’s a fundamental business logic to it for many companies. Banks have retreated from certain sectors that might be central to your business model, so it makes sense to fund them directly, although they would need to be prepared to deal with the infrastructure, governance and compliance costs of getting into that space.
Kaplan: Chinese companies already provide very attractive finance to their customers. But on the flip side, this has been tried before in the late 1990s, particularly among telecoms companies, and it ended up causing a lot of trouble.
Gilbert: There’s a pretty strong strain against mixing banking and commerce. Regulation may make a lot of people, including banks, skittish about the lending environment. And if banks are eschewing activity because it isn’t economic for them any more, that may open the door to innovation.
But the barriers for companies entering markets like this are quite high, and they need to be prepared for the scrutiny that comes with it.
What would your priorities be if you were a CFO, and how optimistic would you be about the future of capital?
Gilbert: I’d be broadly optimistic about access to capital. The question is: at what price? I have great faith in the ability of financial markets to come up with new vehicles, and it may be that CFOs look increasingly to non-bank providers.
Kaplan: The bank markets will get better, so I would be optimistic. Debt markets and high yield markets are holding up. Obviously, the wild card right now is the Middle East.
Sharma: In many ways, for creditworthy multinationals, 2010 was a great year, with plenty of access to low-cost funding. Yes, there are problems, and there may be bigger worries on the horizon such as issues with the Eurozone and sovereign risk.
In the medium term, I would be examining my funding mix quite carefully.
This interview is republished from KPMG Agenda Magazine, the website on advisory and other issues by KPMG, a global network of professional firms providing audit, tax and advisory services.