FINANCE ON THE LINE
As the Philippines plunges into another political scandal, its CFOs are getting fed up.
By Abe De Ramos

Jose Sio has had a colorful career keeping the books of one of the largest conglomerates in the Philippines. As CFO of SM Investments (SMIC), the 65-year-old Sio saw how a humble shoe store in gritty old Manila grew into a US$900m-a-year retail, banking, and property group. With near-religious belief in cash accumulation, Sio helped SMIC become the largest mall operator in a country that has for decades been plagued by dictatorship, military coups, popular uprisings, rampant corruption, and a mismanaged economy. Yet as another political turmoil unfolded in June – this time involving allegations of electoral fraud against President Gloria Arroyo and gambling kickbacks by her husband – Sio seemed the least bit hardened. “Maybe we should study whether having full democracy is the right formula for us,” he bristles, “at this stage in our country’s development.”

Such strong personal opinion is hardly heard in a country that prides itself in being the freest in Asia. But it’s only a strong testimony to how fed up the business community has become with the seemingly endless series of events that rock their operating environments. Just three months ago, Arroyo wore a victorious smile after Congress granted her power to raise taxes to bridge a deficit that threatened to nip a blooming economy. On June 27, a tired and somber head of state publicly apologized for what she called a “lapse in judgment” for speaking to a senior election official before results were announced, but denied committing fraud. As the scandal unravels, Delfin Gonzales, CFO of US$1bn-a-year Globe Telecom, could only offer what could pass as self-deprecating humor. “The Philippines has a way of shooting itself in the foot just when things are beginning to gather pace,” he says.

Collateral Damage

It’s easy to see where both finance chiefs are coming from. The Philippine economy grew 6.2% last year, the highest growth rate in 15 years. It came at the heels of relative political stability since Arroyo took over from former President Joseph Estrada – deposed in 2001 by a popular uprising – and won voters’ mandate in last year’s election. Over this period, Arroyo improved state efforts to raise revenues, most critical of which was last April’s amendment to the value-added-tax (VAT) law. Markets responded with a stock market rally, and the peso strengthened to 55 to the US dollar from 56 at the start of the year. Average daily stock trading volume has also bounced to US$30m from US$5m in 2001. Last March, SMIC became the largest initial public offering ever, raising the equivalent of US$530m. And in the first quarter, average incomes by listed companies grew 19% year-on-year.

The last two years has also witnessed bold corporate moves that were unheard of after the 1997 financial crisis. San Miguel, the country’s largest company, took full control of Australia’s National Foods in June for US$1.5bn, while US$640m a year Jollibee Foods, the largest restaurant group, bought China’s Yonghe Group for US$11.5m last year. At home, SMIC broke ground for a 60-hectare business park in Manila, while US$357m a year Ayala Land, the largest property developer, ventured north for the first time with a US$58m resort. “Most of the companies had not really gone into a massive expansion since the crisis, and they wanted to see how Arroyo’s official mandate will pan out,” says Alex Pomento, head of research at Macquarie Securities in Manila. “Before this scandal came into the picture, most of the companies were really gung-ho about expansion.”

How much the scandal will change this is anyone’s guess. While Congress acts on a motion to impeach Arroyo, business leaders think she is unlikely to be unseated. “The support against the incumbent is not as pronounced as it was before, so the disruption will not be as significant,” says Jaime Ysmael, CFO of Ayala Land. But the scandal introduces a new round of uncertainty that will have repercussions in the near term. The Philippine currency and stock market were the weakest performers in Asia last June, and investors are likely to stay at the sidelines as the political opposition produces evidence against Arroyo – including a wiretapped conversation between her and the election official – and her family members. This means CFOs may have to divide their financial-management priorities between expansion and the ability to raise capital while mitigating foreign-currency risk.

The scandal is especially ill timed because it occurred just as the Philippines is facing new taxes and higher oil prices, which could dampen consumer demand. The tax laws approved last April, to take effect on July 1, raises the VAT rate to 12% from 10%, and removes exemptions on gas and electricity, among others. With record-high oil prices, the cost of transport and other goods are also likely to rise since the Philippines imports all of its oil. Lawmakers also raised corporate income taxes to 35% from 32%, with a promise to bring it down to 30% in 2009. “We did not want to see the corporate income tax rate go up, but the big picture was, we needed a law to address the deficit,” says Guillermo Luz, who heads the powerful lobby group Makati Business Club, which openly backed Estrada’s ouster. “We said, that’s fine, but we would still like to see that changed.”

Most disturbing is the impact that loss of confidence with Arroyo would have on much-needed economic and administrative reforms to attract investments and create jobs, which CFOs would like to see more than anything else. “It’s the collateral damage that’s the real cost,” says Tom Crouch, Philippine country officer for the Asian Development Bank. “Whether the charges are proven or not, the political environment becomes less conducive for the administration to pursue its difficult reform agenda, which affects perceptions of its capacity to manage the economy, which in turn is a key ingredient in an investment climate.” Adds Agost Benard, credit analyst at rating firm Standard & Poor’s in Hong Kong: “This implies further distraction for the legislature and president from their reform tasks, and the increased likelihood of an ineffectual presidency for the remaining five years.”

Sentimental Journey

CFOs are watching the developments closely. Ysmael of Ayala Land, which develops residential property, leases commercial buildings, and operates malls, hotels, and resorts, says property sales – which made up 53% of revenues last year – are driven as much by sentiment as affordability. This is more evident among high-income buyers who buy for investment, and who account for 67% of sales. “Affordability is probably not an immediate threat, considering that interest rates are low,” he says, “so things affecting sentiment, including the political environment, are more worrying. If the situation worsens, it may affect us to a certain extent. We’re still assessing how large of an effect that would have to our business.”

Gonzales of Globe Telecom is equally cautious. As the addressable market for mobile phones – about 50% of the 80m population – reaches saturation by year-end, revenue growth will come from discretionary usage as opposed to new subscribers. “We’re now in a situation where disposable income plays a much greater role than it did in the past, so we’re looking at the general economy – how GDP develops, how inflation impacts consumer spending, how farm incomes are determined by commodity prices,” says Gonzales.

At US$245m a year ABS-CBN Broadcasting, the largest media group in the Philippines, CFO Randy Estrellado says major shocks often lead to lower advertising, as proven in 2000 and 2001 following events that led to the ousting of Estrada and the September 11 attacks. “Every time there’s political uncertainty, there’s a tendency to hold back on product launches, or just advertising in general, because it’s usually the first (corporate expenditure) to be cut,” he says. “To the extent that consumers are less prone to spending, manufacturers tend to cut back on inventory levels, so it doesn’t make sense for them to advertise that much.” Should GDP contract, advertising will almost certainly follow due to their strong correlation: advertising grows 1.2 times faster than GDP, says Estrellado.

Liquid Buffer

For now, CFOs aren’t yet going back to their drawing boards. “We’ll just try to manage the consequences of these daily events, but we should not lose track of our long-term goal, which is to expand,” says Sio, “so that when things stabilize, we’re already there.” This December, SMIC will open the first phase of Asia’s biggest mall, aptly called Mall of Asia, in addition to three smaller ones in and around the capital, which will bring its gross floor area to 3.2m square meters. It also plans to open four or five other malls across the country next year. Jollibee, on the other hand, plans to open 100 new restaurants in the Philippines and 25 in China this year, while it actively seeks to acquire a fast-food chain in India, says CFO Ysmael Baysa.

Both companies’ ability to expand is aided by conservative financial management that focuses on accumulating cash and keeping a low debt level, a discipline they have adopted in response to the country’s political and economic volatility. SMIC’s gearing is only 8% while Jollibee is in a net cash position. “Foreign funds say we’re not maximizing our debt capacity, but I remind them we’re in the Philippines,” says Sio. “No crisis has prevented us from opening new malls because we’re liquid and thus can withstand shocks.” Despite having high costs of capital, the two have some of the highest returns on equity among listed companies – 51% for SMIC and 20% for Jollibee. “We go against the cost-of-capital argument because we’re able to utilize our cash to finance our investments for long-term growth,” says Baysa.

To be sure, not all companies have this luxury. Those that have been funding their growth with internal cash flow will find themselves vulnerable should revenues fluctuate due to the current political or economic circumstances. Globe Telecom, for example, has 73% gearing, and 75% of its debt is in US dollars. With only half of it hedged and no steady dollar revenues to offset the rest, Globe’s foreign-currency exposure could pose a challenge should the peso go into a tailspin. ABS-CBN, on the other hand, is expecting to see a decline in revenues and profits this year due to competition. As corporate taxes rise to 35% this month, the company’s effort to accumulate cash is undermined. “As far as our own planning is concerned, there’s now 3% of profits that won’t go to cash generation,” says Estrellado.

As such, with little room to maneuver their funding strategies, CFOs are taking a long hard look at their operations to cut costs. Since last year, Globe Telecom stopped awarding turnkey contracts to network providers Nokia and Ericsson and now builds its own, cutting costs by 25%, says Gonzales. Ysmael of Ayala Land, whose biggest cost is depreciation, has found that sourcing from China saves the company 40% on the cost of furnishing and construction materials. ABS-CBN has started to import and adapt reality-based shows that are less dependent on highly paid actors, while looking to reduce its headcount. Jollibee, which saw a profit decline in the first quarter due to higher electricity, gas, and transport costs, is rationalizing operations in its commissaries to use less electricity.

Mercifully, CFOs can count on a buffer should the political scandal turn for the worst. In recent years, private personal consumption has been detached from macroeconomic indicators such as GDP and inflation. The reason? An estimated 8m Filipinos live or work abroad – one for every ten people in the country – sending vast amounts of money to relatives for living and discretionary expenses. “Much of the growth in private consumption is supported by overseas Filipino workers’ (OFW) remittances,” says Crouch. Last year, remittances through banks reached a record high of US$8.5bn – equivalent to 10% of GDP, and greater than foreign direct investments, portfolio investments, and tourism receipts combined. Unofficial estimates that include those sent through non-banking channels reach as high as US$14bn.

These remittances provide corporations with a strong base from which to grow their revenues despite domestic economic and political shocks. Not surprisingly, finance chiefs are quick to acknowledge their importance, and many are now looking at remittance figures as a crucial factor in planning. Although a weaker peso may hurt CFOs’ operating costs, it translates to better purchasing power for OFW beneficiaries. “It has, in a way, replaced low employment figures,” says Baysa. Sio of SMIC estimates that up to 50% percent of sales from malls came from remittances (see box).

The business community has taken OFW remittances as a constant factor in the Philippine economy, says Luz of the Makati Business Club, and the amount is only expected to grow as the country continues to export 2,600 workers a day. “It’s a double-edged sword, because it creates a dependence on those remittances,” says Luz. “The stronger the dependence, the stronger the policy to encourage people to leave. The downside is you lose some pretty good talent with no guarantee of getting them back.”

Economists also argue that the OFW factor is a band-aid solution to the deeper problems Arroyo needs to address in order to achieve sustainable growth: poverty and unemployment. “It’s great that the Philippines has a high level of consumption spending, but how sustainable is it?” asks Crouch. “You need investments to back that up, to ensure that you have future productive capacity.” Ultimately, the long-term solution is to attract investments that will create jobs, Crouch adds. “Most fundamental for the administration is to establish the credibility that it has a strong handle on managing the macro economy,” he says. “That will be a major contributor to establishing a perception that the investment environment is improving, and eventually increase the confidence of consumers and investors alike.”

Foremost among the tasks to gain that credibility was to bridge the fiscal deficit, a major reason why CFOs unconditionally backed the tax reforms Arroyo advocated, even if it meant narrowing their margins. At nearly 4% of GDP, the deficit is the domino that threatened to topple everything else. Having borrowed heavily from foreign sources, the government needs to find the revenues to pay its debts or risk collapsing like Argentina. Under Arroyo, tax revenues as a percentage of GDP fell to 12% from 17% during Estrada. “That’s a huge loss that needs to be recovered, and in large part represents systemic weaknesses and corruption,” says Crouch.

Two books

As finance managers themselves, CFOs have strong feelings about the root of the deficit, which is the government’s inability to collect taxes efficiently. Many like Gonzales of Globe Telecom have suggestions. “We’re hoping that tax administrators will also focus on the segments of the economy that tend to not be within their scope – the underground economy is so big,” he says. “We’re also hoping they don’t penalize the good taxpayers, but instead raise revenues from the segments that haven’t been reporting.”

That’s a euphemistic way of criticizing corruption in the tax system, which Baysa of Jollibee says also creates unfair competition. Having scouted for local acquisition targets, Baysa has seen firsthand how some companies maintain two books of accounts: one for the tax bureau with understated profits and overstated expenses, another for management. On one hand, he says, it reflects poor regulatory enforcement, and on the other reveals how corruption allows revenues to seep through the cracks. “If others don’t pay taxes, it gives them an advantage in that they have more cash to invest,” says Baysa. “Just by the fact that financial information isn’t very good, it’s hampering the development of many industries because investors don’t know whether one is a good investment or not.”

Naturally, these are just a minuscule part of the problem that Arroyo needs to address to create an environment conducive for investments, and consequently, sustainable growth. Other structural flaws that need to be addressed urgently include poor physical infrastructure and the intervention of politics in the affairs of regulatory agencies. Prior to the wiretapping scandal, the business community were convinced that Arroyo – herself a former economist and celebrated trade minister – was in fact focused on urging the two chambers of Congress to pass her long list of pro-business reforms. Her most extreme proposal was to change the form of government into a parliamentary system with a one-chamber legislature, the easier to pass laws.

But as the proverbial shot in the foot, the scandal guarantees that Arroyo won’t be able to move forward easily. CFOs can only watch with exasperation. As Sio of SMIC candidly opines: “My feeling is, we as a people have to change. The form of government may have to change; certainly, the present form that we have is not working for us.”