STANDING UP TO SARS
Finance and risk management in the time of contagion.
By Tom Leander, Abe de Ramos, Justin Wood

There's a certain zest brought on by a crisis that suits Martin Cubbon, group finance chief of Swire Pacific, a Hong Kong-based conglomerate that owns beleaguered airline Cathay Pacific. Even as the deadly Sars virus rampages across Asia, he coolly taps his fingers on his desk and rattles off calculations that would have lesser men reaching for the door.

Take Cathay Pacific's cash flow. "We can't sustain this level of cost forever," he says calmly, noting that passenger traffic through Hong Kong's Chek Lap Kok airport - Cathay's main hub - was down almost 70 percent in April thanks to Sars fears. "We have a burn rate of US$3 million a day - and a war chest of HK$13 billion (US1.6 billion). Work it out: we can keep going for ten to 12 months. But obviously, if the situation continues, no one here is going to sit on their haunches." Another drum roll of his fingers. "At some point there will have to be a more dramatic restructuring of operations."

Welcome to Sarsville. Cathay Pacific may be one of the hardest-hit companies in Asia, but it's by no means the only business feeling the economic grip of the contagion. As we go to press, the scourge has found its way to 32 countries around the world, and led economists to slash their growth forecasts for many of them.

What's more, the outlook for the disease is, at best, uncertain. True, some of the more badly stricken territories, such as Singapore and Hong Kong appear to have brought Sars under control, with a steady reduction in new cases each day. But the situation in China remains dangerously volatile, and who's to say that this little understood virus won't re-emerge in new places and in new ways? For finance chiefs like Cubbon and others across Asia, the dangers are undeniably great and their response at this stage could have far-reaching implications.

Quick to Action

Important questions about risk management emerge, such as how soon did CFOs recognize the crisis, and when were contingencies put into place? Did CFOs wait for governments to react, or did they make their own decisions? Were they protected against liquidity risk? Were they prepared for the crisis to affect their supply chain? And looking ahead, have they shored up their companies against further possible ravages of the disease?

The answer is that big, well-managed companies - multinationals like Eastman Kodak, Hewlett Packard, AstraZeneca, Siemens, and the major banks - reacted quickly and with little need to wait for government encouragement. But where businesses were tied to China, where the government only admitted to the scale of the Sars crisis long after it had spiralled out of control, companies were reluctant to second-guess the powers that be.

At Hewlett Packard, the Asia Pacific leadership team swung into action in the last week of March and formed a Sars crisis management team to formulate policy and firm up contingency plans. For two weeks after that, says Gilbert Ponniah, vice president of finance for HP Services in Asia, the team met on a daily basis, consulting with government officials and health authorities to stay informed.

In dealing with the threat, HP rated each country in Asia on a three-point scale depending on the severity of the Sars situation and then took action accordingly. For example, in some countries, staff were banned from travelling and the use of surgical gloves and masks was made mandatory. HP also beefed up its internal communications to keep workers up-to-date, while its IT division made sure that employees could work remotely from their homes if need be.

The key to HP's response, says Ponniah, has been balancing caution with a sense of proportion. After all, he says, "We're talking about a way of life that may be with us for months, even yearsÉabove all, coping with Sars is about having a healthy respect for the virus and using that to propel us into action."

Interestingly, adds Ponniah, the outbreak and spread of Sars has reinforced the notion "that the world, our region is more interconnected than we ever imagined". For finance chiefs, there's no such thing as a regional risk any more. Computer viruses, financial crises, outbreaks of disease - all can encircle the globe in a matter of days.

China Syndrome

Still, while companies like HP could act on available information, and were unfettered from doing so by fear of contradicting local authorities, others could not. In the People's Republic, many companies - particularly Chinese firms with a state-ownership or large contracts to the government - found themselves hamstrung.

In fact, Beijing's waffling even affected some multinationals. Pamela Chen, CFO of Xerox Greater China, acknowledges that her company only put aggressive action in play, including travel restrictions throughout most of China, in April. Says Chen, "In March we were alerted to what was happening, but at that time, we were still not concerned apart from Hong Kong and Singapore, where [company units] did take action and contingency plans. In China, it was just a concern, until April when we put policies and actions in place." Why did Xerox wait until April? "We held back in China because we understood it was not coming here yet." In fact, it had been raging in China for months.

Similarly, Kodak installed an emergency plan in Hong Kong the week of March 25. But it too waited for Beijing to acknowledge the crisis before it announced its China crisis plan on April 18. That said, the plan had been formed many weeks earlier and was waiting, like an idling engine.

Where companies were able to react ahead of the government, they did so on guesswork, and circumstantial and piecemeal information. Ng Wai Lun, CFO of Astra (Wuxi), the China unit of British pharmaceutical giant AstraZeneca says that the company's sales force was getting word of the deadly disease in its travels in China in early March. By mid-March, more than a month before Beijing admitted the gravity of the contagion, Astra (Wuxi) had forbidden its sales force to travel on China's trains.

Frank Lai, CFO of CSMC, a semiconductor manufacturer now owned via a majority stake by China Resources, and also based in Wuxi, says he relied on his information about Sars from reports based on visits to Singapore and information that was informally handed back via suppliers working in southern China. He quietly began putting a program in place before Beijing admitted to the gravity of the situation.

A Viral Effect on Profits

Still, no matter how quickly or slowly companies reacted, few are likely to escape the effects of the virus. At CSMC, for example, Lai is fully expecting to take a hit to his bottom line. The company's overseas customers - 30 percent of the total - have stopped visiting the foundry, where they talk to the engineers before approving designs. What's more, adds Lai, "unfortunately, our company is not big enough yet to buy sophisticated tools like videoconferencing."

And it's not just companies in China that are feeling the fallout. Consider Barber International, a Malaysia-based ship management business. Mee-Yin Soong, Barber's head of corporate finance, reports that quite a few of the company's clients have postponed meetings "so we expect to see a dip in sales in the short-term, especially of our IT solutions." That, in turn, has had a knock-on effect. "Capital expenditure and new investment have been hit to a degree," admits Soong. "In unaffected territories we're continuing as usual, but in places where Sars is an issue we're advising our business units to delay new investments."

David Uhazie, Kodak's regional CFO based in Hong Kong, expects Sars to have a serious impact on consumer sales, which represent 50 percent of revenues in the Asia/Pacific region. Falloff in both local and foreign tourism will reduce revenues from China and throughout Southeast Asia. One result of the Sars crisis is that Kodak may be putting more development money into medical imaging equipment.

"It's not a time to panic, but to react and lead," said Uhazie, shortly after Kodak installed its emergency plan in Beijing.

At Cathay Pacific, the company's response has needed to be a little more dramatic for the shock has been many times greater. "We're in an exceptionally volatile business, with a high fixed cost base, and strong rigidity in terms of labor market and suppliers," says Cubbon. "Unfortunately, times like this keep coming back to haunt us - but that's the nature of the industry."

Still, Cubbon remains sanguine. As he sees it, the crisis is less a question of whether Cathay can survive, but how well it survives. He argues that the airline has been the victim of a general alarm about flying that may be overstated. It is unproven - and appears increasingly unlikely say medical experts - that Sars is transmitted through air ventilation systems in aircraft, but rather through touch in toilets and elsewhere. Yet Cubbon recognizes that health authorities have an incentive to slow down air traffic because it inhibits the movement of travellers who can spread the virus around the globe.

Given his situation, and "an unclear trajectory" for the disease, Cubbon says his strategy has been to reduce services only to the point where the network is not compromised. That means keeping all routes open, but cancelling as many flights as possible. It also means promoting Hong Kong for transit flights, where passengers on long hauls don't pass through immigration but continue on their journey. At press time, demand had stabilized at between 8,000 and 11,000 passengers a day, compared to almost twice that much under normal circumstances.

"This is terrible," says Cubbon, "but not bad compared to two weeks ago." He adds that the cargo business, while suffering, is still healthy.

As for containing costs, Cubbon says he instituted programs of unpaid leave wherever possible and has delayed capital payments. In one example, Cathay is in talks with aircraft manufacturers to defer delivery of all passenger planes this year. This might involve a penalty, but would forestall a huge cash outlay. And in cahoots with other airlines, Cathay has approached Hong Kong Air Cargo Terminals for a rebate on rental of airport premises for the remainder of the year.

He concedes, however, that these measures can only have a temporary effect. "If the global impact is such that you don't have the capacity to withstand it, then you're going to have to start thinking about permanent cuts. That would mean selling aircraft and headcount reductions."

Swires's cash-rich buffer has so far ring-fenced it against knock-on risk from Cathay. Some 70 percent of the parent's operating profits come from property rentals - a blessing now. While Cubbon says that the real estate market in Hong Kong "couldn't get much worse", Swire's rental business, largely from multinational customers in downtown office towers and shopping malls, hasn't been seriously affected.

The buffer of diversification has benefits particularly in the debt capital markets, says Cubbon, who adds: "We're definitely assisted by being a conglomerate." Moody's reviewed Swire's financials in light of Sars on April 24, and reaffirmed the company's A3 rating. Standard & Poor's likewise reaffirmed its BBB+ rating as stable on April 9. Both agencies pointed to Swire's large war chest and diversified businesses as the reason for leaving their ratings unchanged.

As Tarek Anwar, a director in the treasury services division of Bank of America in Singapore, notes, the Sars crisis is forcing treasurers to re-think how much cash they should carry on their balance sheet. "With business confidence dented, and tough capital markets, companies might find that they should be carrying more cash than traditional finance theory dictates. Shareholders are going to come to expect that," he says.

In a bid to keep its cash situation healthy, Swire has publicly announced that it might even cut Cathay Pacific's final dividend this year - a move that would add as much as HK$4.84 billion to the company's coffers. It wouldn't be the first time. Back in Asia's last crisis - the financial troubles of 1998 - Cathay also took a knife to its payout policy in order to stay liquid.

In the Hot Zone

Another company struggling under the impact of Sars is ASAT Holdings, a NASDAQ-listed, Hong Kong-based company that tests and packages semiconductor chips for customers such as Texas Instruments. For Robert Gange, the firm's CFO, Sars has hit its business plan during a period of restructuring, making an already difficult job even tougher.

Gange and most of ASAT's senior management were brought in by then newly appointed CEO Henry Rozakis in December last year to restructure a company that has been in financial freefall since it first felt the impact of the bursting of the technology bubble in 2001. In fiscal 2002, ASAT recorded a net loss of US$102.7 million compared to a profit of US$19.4 million the year before. With total debt of US$98 million, its cash position is in dire straits, plummeting from US$80 million in 2001 to US$35 million currently.

"Sars comes at a terrible time," sighs Gange, "what with the war in Iraq and global economic stagnation."

As if orchestrating a tricky restructuring wasn't enough, Gange now finds himself having to prove to customers that ASAT can run normally in spite of the spread of the virus, especially since all of its factories are located in the centre of the hot zone in Guangzhou. To that end, Gange, who is also head of human resources, took steps to ensure business continuity, the first of which was to require all employees, including the CEO, to wear masks in the office at all times.

Like most businesses in Sars-affected areas, ASAT has not received a single visitor from overseas since the World Health Organisation issued a travel warning, yet ASAT's business requires a close interface with clients. For that reason, Gange has temporarily relocated chief technology officer Neil McLellan to its sales office in Fremont, California.

"Since most of our customers are US-based, we've taken steps to upgrade our office in Fremont, and our CTO is now based there," says Gange. "This way, we'll have almost the same amount of customer contact, although not in the factory, but in our sales office. It shouldn't change the quality of the product."

To make sure that production isn't delayed, ASAT is running "cleansing drills" to see how quickly operations can resume should one section of a factory get contaminated by an employee carrying the virus. "We've done a couple of these already, they're sort of like a fire drill but in terms of cleaning the facility, so we know how quickly we can get it done and be back in operation," says Gange.

Elsewhere, ASAT has had to tweak its logistics too. "We've been able to keep our supply chain flowing in and out of here, in terms of materials coming in and delivering to customers, but due to airlines making changes, we've had to make some modifications," says Gange. "There has been some re-routing - let's say whereas before we went straight to Malaysia, now we have to go through Taiwan."

How long this will last is anyone's guess. "As Sars concerns deepen and broaden, it's only a matter of time before the quarantining of people extends further to the quarantining of materials and shipments from affected areas," says Kristian Steenstrup, research director at Gartner Dataquest in Sydney. "Companies trans-shipping, importing or exporting to affected areas should consider additional needs for inspections, treatments or quarantine of goods." This may be alarmist, but as the outbreak is far from being contained, no one can tell what the worst-case scenario could be.

What the Sars crisis does highlight, says John Dawson, director of corporate affairs at Exel, a logistics group, is that companies need to build greater flexibility into their supply chains and production facilities. "A lot of companies have shifted big chunks of their production to China and perhaps run the risk of over-concentration," he says. "If companies can arrange their supply chains so that factories and suppliers are in a variety of locations, so much the better."

Still, Dawson doesn't see China losing its status as the center of global manufacturing. "China is too important as an emerging market to ignore," he says. "Companies can't afford not to be there."

Andrew Cheung, director for finance and planning at the Hong Kong headquarters of Rockwell Automation, a US-based equipment manufacturer, is another finance chief who is rethinking his supply chain in light of Sars. In particular, Cheung says his company is working closely with customers to make sure that it has an ample stock of products within the region should certain suppliers or supply routes close down unexpectedly.

Currently, Rockwell, the second largest provider of automation equipment in the world, keeps up to two months worth of stock in Asia as a "customer satisfaction arrangement" should customers in the region need its products urgently. However, before the Sars outbreak, the company has been reducing this to 1.5 months and even less as its supply chain management from the US to Asia improved. This goal may now have to take a rain check. "Obviously this may cost us a little more money but it's justified because it provides customer satisfaction," says Cheung.

In other measures, Cheung says that "due to the slowing economy, we have frozen new headcount except for key sales people in China".

Headcount isn't the only thing being frozen. Frank Martin, president of the American Chamber of Commerce in Hong Kong, says its members, when surveyed last November, were bullish on plans to expand from the Special Administrative Region into China in the next three years. Now he reckons they may be re-thinking their answers. "To the extent that plans are underway, many have no choice but to continue," Martin says. "But those who have not yet started may decide to delay."

ASAT and Rockwell belong to the former category. Rockwell, for example, last month opened a manufacturing facility in China. Cheung says the company chooses to be pragmatic about the issue - after all, China is still the place to be for companies that want to lower their costs.

The same pragmatism applies at Swire, where Cubbon says that business must continue. And to that end, in the first week of May Cubbon says he has to visit Guangzhou and that he plans to travel by train because of the short distance from Hong Kong. Will he be wearing a face mask?

"Perhaps," he says.