WHERE TO SPEND IT
In a downturn, CFOs make the most of cash to capture future growth
By Abe De Ramos

Few CFOs can afford to smile like Frank Chan does these days. At a time when Asian companies are holding on to hard-earned cash to soften the blow of recession, Chan is leading Hong Kong-based Techtronic Industries in its global expansion. The company used to make power tools and vacuum cleaners for Western private labels, but in a span of just a year, Techtronic bought its own brand through the North American and European units of Japanese industrial group Ryobi. An Australian acquisition should follow by March. This may sound a little bold for a 16-year-old company that makes just US$500 million a year, and it is. But Chan speaks of it matter-of-factly. "We are merely building on our expertise," he says.
He may be too bashful. Techtronic is actually trying to break out from the mold of business that Asia has been known for. The region remains a factory for the world; some of its largest corporations are contract manufacturers, assembling gadgets or weaving clothes for, and designed by, Western companies. While many can only aspire to move up the value chain by owning a brand, Techtronic is doing it one continent at a time, and has even started outsourcing some of its own products. Chan bets on transforming Techtronic from a workshop to a market leader, pitting its Ryobi brand against Black & Decker in the US, and Bosch in Europe and Australia.
So far, Chan is making strides. Techtronic last year sealed a 20-year contract to keep its Ryobi power tools on the shelves of Home Depot, the largest do-it-yourself (DIY) retailer in the US, and Castorama, its equivalent in Europe. Analysts see 2001 profits reaching US$230 million, up 20 percent from a year ago. To be sure, Techtronic is a story in progress, but if it succeeds, it could become a model for other businesses in the region. For Chan, the formula is simple. "Our products are in the consumer category," he says. "To maintain leadership and to survive, we need to continue to invest in new products and new technologies."

Beyond the Fog

Not surprisingly, few CFOs in Asia are as willing. The weakness in capital markets, not to mention the global economy, has led many businesses to put revenue initiatives and strategic moves on hold, at least until the second half of the year, which is the most optimistic prediction of a recovery.
They may be missing a great opportunity, as asset prices have fallen dramatically. "Downturns don't last forever," says Crawford Gillies, managing director of consultancy Bain & Company in London. "Leaders who swim against the tide and manage for the long term will not only position themselves for the future, but will often do better in a downturn."
That statement is something no CFO could deny, and in fact a few have set their capital expenditure at a wide range this year, reflecting a reluctance to be too opportunistic. The problem for those on the side of conservatism is that they could not see past the fog of uncertainty. "It's not like we're in a recession and so they don't invest," says Martin Cubbon, group finance director of Swire Pacific, the US$2 billion-a-year conglomerate that controls Cathay Pacific Airways and vast upscale properties in Hong Kong. "It's that there is not enough clarity for some people who want to invest." On the other hand, those with decent enough cashflows are in a better position to capture future growth, either through acquisitions or by gobbling the market share of weaker competitors.
"The current timing, for cash-rich buyers, is a real opportunity, especially in negotiating asset prices with vendors," says Miller Chen, CFO of Taiwan-based VIA Technologies, the second-largest supplier of chipsets in the world, which outsources all its manufacturing. "The challenge that a CFO is facing is how to maximize his choices and minimize expense," says Chen.
That is a mighty challenge. CFOs nowadays have less cash to work with, and so their role as advisors to CEOs, and champions of shareholders, on where to spend it could not be more critical. Right investing can steer a company through the downturn, edge out competition, and transform a company from an also-ran into an innovator. Noble goals all, but what Chan, Cubbon and Chen know is that price and potential returns are only half the equation. When promised returns far outstrip cost of capital, a company can easily overlook whether or not it has the expertise to make it work. "When we invest, we first ask ourselves, 'What is our skill set?'" says Cubbon. "Having defined those skills, we then say, 'If we can see a project where we can apply those skills and obtain a return above our cost of capital, we'll be interested in it."
So it is for Chan. As he put it, Techtronic is merely building on its expertise. Its acquisition of Ryobi diversified its product line in the same category. Techtronic is a major manufacturer of cordless tools; Ryobi gave it the skill and capacity to move into the higher-end corded tools. But more importantly, the Ryobi venture was actually an acquisition of not just the brand name, but its marketing, sales and distribution assets.

The Great Migration

Techtronic started in 1985 as an OEM, or original equipment manufacturer, making goods for the likes of Ryobi, Bosch, and Sears, Roebuck & Co. But its founders, Horst Julius Pudwill and Chi Ping Chung, who hold masters degrees in engineering, knew they could do more than that. They abandoned the OEM model after just three years in the business, and invested in design talents, now numbering 110 people in Hong Kong. With no marketing expertise, Techtronic was happy to be an ODM, or original design manufacturer, building prototypes of items such as drills and vacuum cleaners, and mass-producing them for private labels.
Opportunity knocked in 2000 when Ryobi decided to abandon its power tools business and focus on die casting for motor equipment. Chan knew it was a risk he had to take, never mind that he traditionally spent just US$20 million to US$25 million a year on capital expenditure. "We never thought of owning our own brand, because we were happy to stay as an ODM," says Chan, who paid US$89 million for Ryobi North America in August 2000, and US$6.7 million for Ryobi Europe in August 2001. "But this was a golden opportunity, and we saw no reason why we should not migrate ourselves, from OEM to ODM, and now to OBM (original brand manufacturer)."
The price of this transformation was a sharp turn in Techtronic's balance sheet; its debt-to-equity ratio shot up from 0 to 91 percent in 2000. It has since gone down to 80 percent through refinancing, but Chan will continue to spend for marketing and distribution, design and development of new applications and product improvements, and shifting most of the legacy manufacturing of Ryobi in the US to its factories in China.
So far it has been money well spent. Analysts predict revenues in 2001 reached US$770 million, and its future as a US$1 billion-a-year company isn't too far. Chan is convinced the power tools business, which makes up two-thirds of Techtronic revenues, is immune to a downturn. Crisis or no, walls will have to be mended and dirty rugs vacuumed, he says.

A Mean Brew

Cubbon continues to learn a thing or two about transformation. As a 130-year-old company, Swire evolved from a port operator into a prime property developer, an aviation leader, a Coca-Cola licensee, and a trading house. Take Cathay Pacific, which as an airline naturally needs engineering services such as aviation maintenance. In 1950 Cathay moved its engineers into a separate company, Hongkong Aviation Engineering, and soon gained business from other airlines. "Suddenly there was a separate company and a separate business, which in turn took its skills to China," Cubbon recalls. "Now it's a big facility in Xiamen and it's doing very well."
With that success, Swire should know better than to stray. But in 1995 it invested in a joint venture with the Danish company Carlsberg to brew beer in China. "We have expertise and assets in the distribution, merchandising and sale of Coca Cola in China, and we thought we were going to do the same thing for Carlsberg," says Cubbon. But brewing operations demanded a skill set that Swire did not have. "We had involvement at the board level, but we couldn't confess to be experts, so we couldn't bring in a lot of people with background in beer to help improve the business." The partnership failed, and in November 2001 Swire sold its entire stake in the venture.
Now, in his latest foray into China, Cubbon is going back to familiar territory: prime property development. Last year, Swire entered into a joint venture with the Guangzhou Daily News Group to build a US$512 million hotel, retail and residential property in Tien He, Guangzhou. "It's a mini Pacific Place," he says, referring to Swire's successful mall-cum-condominium in Hong Kong. He expects the project to be completed in five years. Cubbon also hopes to learn new skills. "We'll take this very seriously and we're going to learn a lot from this. We're confident, though we can't say for sure, that it's the first of many," he says.

The Stress Test

All this is not to say that new ventures have to be ruled out. Neptune Orient Lines (NOL), a shipping company in Singapore, has successfully entered into the logistics business in the US with the acquisition in 1997 of APL Logistics. It wants to establish a presence in Europe and Asia, and to this end CFO Lim How Teck raised US$700 million in credit facilities last year. "At any one time, we have more than US$1 billion available," Lim says. "For our company, you can't live on a shoestring budget of just hundreds of millions of standby money."
But despite NOL's wealth, Lim is more stringent in his investment decisions than ever before. His business is dependent on global trade, something that will not look healthy in 2002. Its main revenue contributor, liner shipping, is cash-intensive, so Lim wants to make sure that every penny he spends will more than make up for the cost, and will be sustainable in the long term. How will he do it? "Given this sobering environment coming up, we have to be very selective in 2002," says Lim. "That means that we are more stringent than the previous years, and if good projects come along, we would have to run it by more benchmarks," he says.
For Lim, it all boils down to a simple question: "Will we be able to survive a really bad patch, which may be prolonged if we imagined wrongly?" he asks. "If the answer is yes, then it is an opportunity, because when everybody feels weak and you have the capability to do so, then it is a competitive advantage," he says. Needless to say, a large part of the answer depends on whether your business has the skill set to support it. "In getting to the logistics business, we try to get the maximum synergy between our line of business, which is liner shipping, and logistics," he says.
The downturn affirms NOL's decision to focus its efforts on asset-light ventures such as logistics. Due to oversupply in services of liner shipping, NOL has had to reduce tonnage and cut prices. Revenues from this side of the business shrank 2 percent in the first half of 2001 versus a 63 percent rise for logistics. The contrast will widen when full-year figures are reported. Turnover from logistics is expected to grow 75 percent. "For liner shipping, we have delayed an additional loop that goes into the Asia-Europe trade," says Lim. "We're trying to change to a more asset-light business model," he says.
Lim may have hit the nail on the head. In a survey based on share prices from December 1995 to May 2001, advisory firm McKinsey said the best value creators in Asia generally had three things in common: a global strategy where more than half of revenues come from overseas markets; a business focus where more than 80 percent of revenues come from a single main industry; and they are asset-light. To produce US$1 of sales, the biggest value creators in Asia need only US$1 in assets, compared with US$4 for the average Asian company, says McKinsey. Among them are Li & Fung, a Hong Kong-based global supply chain company, and Hindustan Lever, a consumer goods company in India, which has an asset-to-sale ratio of 0.5.
"Rather than invest in physical assets, the most profitable Asian companies focus on intangibles such as fostering human capital, exploiting network effects, and creating synergies based on brands or reputation," according to McKinsey consultants Tobias Hoschka and John Livingston, in a paper called "Winning Asian Strategies". They say: "This asset-light approach is particularly critical in Asia, where currency fluctuations can dramatically alter the value of assets."

Bonds of Loyalty

While opportunities to invest in asset-light ventures may not knock everyday, CFOs agree that in a downturn they can at least spend on taking care of those who do knock on their doors everyday: their customers. The benefits are clear: providing the best attention and service to customers in bad times will earn their loyalty, and should generate better business in good times. It sounds pretty obvious, but the practice isn't.
"Strengthening the bonds of loyalty with key customers is probably not the first strategy that springs to mind when considering how to best navigate a downturn," says Gillies of Bain. He argues that customer loyalty directly results in increases in profitability. "By holding on to your most attractive customers, you reduce your spending on acquiring new ones, your marketing initiatives become better targeted, and you are often able to charge increased premiums and offer additional products and services."
In the technology arena, holding on to customers is inextricably linked with the capability to develop and make newer products. That is why Stan Baumgartner, CFO of Hong Kong-based ASAT, which makes semiconductor chips for companies such as Lucent Technologies and Motorola, is boosting his capital expenditure for research and development (R&D) and marketing. "In fact, they were specifically cited as items not included in the cost-cutting," says Baumgartner. "When your customers begin to see a sharp upturn, they want to be sure that you have the capability and the volume to meet their demand, so if you don't invest, you're certainly going to take a reversal in market share," he says.
ASAT's R&D investments are small compared to the larger chip contract manufacturers in Taiwan or Singapore. ASAT will increase R&D spending by about US$1 million, to US$7 million this year, about half of estimated capital expenditure for 2002. The gesture, however, says a lot. Since the technology bubble burst early last year, ASAT has laid off half of its 18,000 employees in Hong Kong.
Its capacity utilization is less than 25 percent, and its P&L swung to a loss of US$5.5 million in the quarter ending October 2001, from a profit of US$34 million in 2000. Early indications point to a better 2002, especially in the second half, and Baumgartner is trying to position ASAT for it. "We've invested at selling efforts," he says. "It means either more sales, customer service or engineering people. Not a lot, but it means adding at a time when you think that all you're doing is cutting now," says Baumgartner. A stronger marketing team is crucial for ASAT. The company is trying to diversify its client base to rely less on the communications sector, probably the most battered sector in the last year. "Diversification would alleviate some of the volatility in communications, and it gives us broader markets to sell many of the same products that actually go to the communications market as well," he says.
Singapore-based Chartered Semiconductor, the third-largest semiconductor foundry in the world, is in an almost identical mode. In November, the company added to its executive management team. The senior vice-president of technology development, Sun Shi-Chung, will look after Chartered's development of leading-edge technology. Sun will have his hands full this year. For fiscal 2001, Chartered increased its R&D spending by 35 percent to US$80 million, or 15 percent of its total US$550 million capital expenditure. A further two-digit increase will happen this year.
Although not diversifying its market segment, Chartered is diversifying its customer concentration. "We have made a lot of progress in broadening our customer base, but a lot more needs to be done," says Chartered CFO Chia Song-Hwee. "In year 2000, our top five customers occupied about 40-odd percent of our revenues, so what we are trying to do there is to lower the concentration of that top five or top ten customers."
To do that, Chia is investing in back-end design services support through joint ventures that will make use of each partner's existing resources. Back-end support will allow customers to design their products and quickly qualify into Chartered's manufacturing process, allowing them to get to the market faster. To this end, Chartered is partnering with a few integrated circuit tools providers such as US-based Synopsys. "It involves us running silicons and test chips, but at the same time, there are commercial agreements between us and the providers in the form of engineering charges and royalties," Chia says.
With his foundries' capacity running a low 22 percent, Chia also has a lot of time to improve manufacturing operations, including cutting the prototype cycle time, or the time it takes for Chartered to deliver a working sample of a customer's design. The initiative started in early 2001, and so far Chartered has been able to reduce it from 1.5 to 1.8 days per chip map layer, to just one day.

Hot Property

For Jaime Ysmael, CFO of Ayala Land, finding out where to spend his money is easy. "There are bright spots out there, it's just a matter of identifying them," he says. That bright spot is the middle class. The Philippine property market has generally been depressed since the financial crisis of 1998 except the middle income segment. "We have established a new special business unit (in 2001) which we tentatively call core-middle income housing, which will address the higher end of the spectrum," says Ysmael.
Ayala Land, which generates much of its revenues from sales and rental of upscale condominiums, shops, offices and hotels in Makati and Cebu City, is shedding its image of being a developer for rich, urban Filipinos. In the past year, three of Ayala Land's largest investments were in the construction of a no-frills, single-bedroom condominium unit for yuppies in Makati, and two malls for the low-middle income class in Manila.
This year, Ysmael will continue to spend for the completion of these and other projects. He is also preparing for the acquisition of a prime, 150-hectare property being sold by Metro Pacific, a unit of Hong Kong's First Pacific. Metro Pacific has put a US$200 million tag for the property, an amount Ysmael thinks is too high. But in the meantime, Ysmael is channeling some of Ayala Land's resources to consumer financing to help buyers pay for the property he sells.
The company has typically sold property on the basis of a 30 percent down payment, and it is up to the buyers to find their own financing for the balance. "We now give them the option to pay us only 10 percent, and for the balance we extend a loan basically at interest rates which are effectively higher than the banks'," he says. To recover the cost, Ysmael sells other receivables older than two years. "In effect we're leveraging the strength of our balance sheet by extending in-house financing to our buyers. We're recovering the cost, and even getting a slight premium for the risk." Over at Ayala Land's sister company, Globe Telecom, the most profitable mobile phone operator in the Philippines, CFO Delfin Gonzales is hiring more people and improving IT systems to support customer service. "It's a system that monitors specific behaviors and patterns of usage of customers, so that today, if you are for instance a premium member and you call customer service, you're immediately identified as a premium member, and you get a service level higher than the average," Gonzales says.
NOL is improving its interface with clients through electronic bills of lading (BL), a document that establishes the terms of a contract between a shipper and transport company. "We are introducing electronic BL to facilitate and cut down the supply time for customers who get their BL processed with the banks, and that has been possible with the technological breakthroughs," says Lim. The companies under NOL have also just centralized their backroom operations in Shanghai and Kuala Lumpur, an investment that will bring down overhead cost and improve efficiencies in the future.
It might be a small effort, but it will reap big benefits when NOL completes its acquisition strategy. Big or small, investing in a downturn is a strategic move that demands both a disciplined and focused use of cash, and an ability to take calculated risks. "If you have the money and the balance sheet, use it," says Lim. Carefully applied, these efforts should pay off, as timing is on his side.

Abe De Ramos is a senior writer for CFO Asia based in Hong Kong.