BIG SPENDER
Long on the sidelines, SM Investments in the Philippines is making big bets on the future. Is the finance function up to the challenge?
By Cesar Bacani

Inside the ornately vaulted church beside Manila Bay, the children could be forgiven their fidgeting. Sunday mass was ending and they were already thinking of the food and fun to come. At last, the mass came to an end, and the 200 or so worshippers dutifully filed out of the Shrine of Jesus, the Way, the Truth and the Life—to head to the mammoth SM Mall of Asia just a few minutes’ walk away. The 19.5-hectare temple to shopping, dining, and entertainment, which also hosts a 1,500-seat Dell call center, is owned and operated by SM Investments, the same company that built and donated the church to the Archdiocese of Manila.

Among the worshippers is Felisa Domingo, 54, who attended the 10:30 a.m. mass because she needed to visit the mall to exchange U.S. dollars for pesos and buy school supplies for her two grandchildren. Their parents, Domingo’s son and daughter-in-law, are medical workers in Saudi Arabia. SM’s foreign exchange centers offer the best rates, she explains, and everything else is there. The kids will buy school supplies at SM Department Store, eat lunch at Jollibee, a homegrown burger chain that leases space at the mall, go skating at the Olympic-sized ice rink, and perhaps see Harry Potter on an eight-story IMAX screen if they are not too tired.

Only in the Philippines, as the locals would say. But it makes perfect sense in this overwhelmingly Roman Catholic country for a place of worship to be just a stone’s throw away from a church of commerce. Flush with record remittances of more than US$1 billion a month from some eight million Filipinos abroad, the economy is seeing a resurgence on the back of spending by consumers like Mrs. Domingo. Helped by a period of relative fiscal and political stability, GDP growth in the first half of 2007 topped 7 percent, the fastest expansion in three decades. The rise in personal consumption in those six months reached 6 percent.

Consumer-oriented firms are reporting stellar results. Profits are growing fast at companies ranging from Jollibee to dominant telecom provider PLDT and property developer Ayala Land. But it is SM Investments that looks like the best-placed consumer play—and also the most vulnerable. What began as a humble shoe store in 1948 (SM stands for “Shoe Mart”) has become a conglomerate built in part around the vision of serving overseas workers and their families at home.

Spending by overseas workers and their dependents now accounts for half of all sales in the company’s 29 shopping malls. SM’s banking arm, Banco de Oro-EPCI, the country’s second-largest lender by assets, has a global network of remittance centers that has about a quarter share of the US$14 billion business. These centers are being tapped to sell mortgages and service payments on SM-built homes in property projects connected to the malls, which are hugely attractive in the mall-crazy Philippines. The success of the strategy is allowing SM to branch out to related sectors like tourism and BPO (business process outsourcing), two of the country’s sunrise industries.

SM Investments is doing well indeed. Sales in the first half of this year nearly doubled to 55.3 billion pesos (US$1.3 billion at the current exchange rate) after the opening of 28 new SM Supermarkets and nine SM Hypermarkets. In three years’ time, says CFO Jose Sio, “we’re looking at a compound annual growth of 12 percent”—meaning a turnover of about 125 billion pesos (US$2.8 billion) by 2009. For the same period, Sio projects a much heftier 30-40 percent compound annual growth in net income to around 23 to 29 billion pesos (US$523 to US$660 million).

Hitting such targets will call for spending on a scale unheard of at the company. As a group, SM firms—which comprise more than 25 major enterprises—will invest 95 billion pesos (US$2.2 billion) over five years. At the 60-hectare SM BayCity, home to the Mall of Asia, the group will build a convention center, hotels, and office towers for BPO and call-center firms. The company also has plans for tourist resorts, condominiums and master-planned communities, and more shopping malls across the country.

It’s all getting a bit hectic for the 67-year-old Sio, who—like other CFOs in the Philippines—has grown used to nursing cash rather than spending it as the country lurched from one crisis to another. Is finance up to the task? For now, the company appears to have no trouble raising funds. But Sio will need all his skills and decades of experience to navigate today’s treacherous financial waters. Even if SM gets all the money it needs, it could founder if, as a newly bulked up enterprise, it loses the agility to maneuver in a volatile marketplace.

Risk and Remittances

There’s no shortage of risks that could derail Sio’s efforts. While buoyant today, remittances are highly sensitive to the economies of the host countries where overseas Filipinos work. During a downturn, domestic helpers, personal drivers, and factory workers are among the first to lose their jobs. That’s no small worry, considering that SM’s exposure to remittances is still growing, particularly in its property and banking businesses.

The two other legs of SM’s expansion, tourism and BPO, are predicated on economic and political stability. But sadly, volatility has stalked the Philippines in recent years (see “Looking Up,” page 23). The series of unfortunate events include the ouster of President Joseph Estrada in 2001 and the ongoing attempts to impeach his successor, President Gloria Macapagal Arroyo, over allegations she cheated in the 2004 elections. New scandals erupted this year over a US$330 million national infrastructure contract with Chinese telecom gear maker ZTE. And anxiety about terrorism intensified in October after an explosion at a Manila mall (not SM’s) killed 11 people and wounded scores more.

SM itself is in transition. Founder and SM chairman Henry Sy, Sr. is 83 and his six children now effectively run the enterprise. The two eldest siblings, Teresita Sy-Coson and Henry Sy, Jr. are co-vice chairmen at SM Investments, while another son, Harley Sy, is president and board director. Herbert Sy heads retail merchandising, Hans Sy oversees mall operations, and Elizabeth Sy is senior vice president for marketing at SM Prime, which owns and operates the shopping malls.

The family appears harmonious now, but there is no saying how things will look when the patriarch is gone. The children have their own ideas of how to run the burgeoning empire, including an increasing reliance on professional managers. Henry Sr. is known to favor family and kin over outsiders. The second generation is also seen as the driving force behind the investing spree. “Henry Sy had been averse to projects with large capex,” notes Alfred Dy, head of research at the Philippine unit of investment bank CLSA. Unlike other Filipino tycoons, the SM founder stayed away from big-ticket ventures like airlines and telecoms, even when the politicians of the day were open to giving him the franchises.

Sio says SM continues to adhere to Henry Sr.’s dictum that the company should get involved only in businesses that it knows well, meaning retail, banking, and real estate. But the Sy children are not shying away from scale and complexity. Sy-Coson, for example, had been dogged in her three-year pursuit of a difficult merger between Banco de Oro and Equitable PCI Bank, which finally came through earlier this year. For his part, Henry Jr. is in a hurry to make SM a major property player. He’s launched five projects in less than three years, with the 1.4 billion peso (US$31 million) Chateau Elysée master-planned community due for completion this year.

The new generation is also eyeing China, Henry Sr.’s birthplace and home until he emigrated to the Philippines at age 12. Hans Sy spearheaded the construction in 2005 of the SM Jinjiang shopping center, located in the patriarch’s hometown of Jinjiang. SM Prime plans to acquire SM Jinjiang and two other Chinese malls currently owned by the family’s private companies. The strategy is to focus on small cities rather than a metropolis like Shanghai, on the
theory that SM’s experience is easier to transplant to smaller urban areas that are closer to the Philippines in stage of development.

Finance in the Hot Seat

SM’s warehouse-like receiving area is almost as bustling as the Mall of Asia in front of it. Job applicants, suppliers, messengers, and potential property buyers fill rows of plastic chairs and sit around little side tables. Models of SM’s housing projects line the wall.

Sio takes a seat in a cramped meeting room. “This is our temporary headquarters,” he explains. The corporate offices will eventually move to OneE-ComCenter, an eight-story building under construction next door to the mall. The vacated strip of prime real estate may be redeveloped into condominium towers. A spare man who shows no signs of slowing down two years past the usual retirement age, Sio is a CPA who earned his MBA from New York University. Recruited in 1990 from the prestigious Manila accounting firm SGV, where he was senior partner, he is one of the first non-family members to be named to a key post at SM.

When CFO Asia spoke to Sio in 2005, newly listed SM Investments was in wait-and-see mode as Arroyo fought off impeachment, the stock market and the peso were on a downward spiral, and newly enacted tax increases threatened corporate profits. “We’ll just try to manage the consequences of these daily events,” Sio said at the time, “but we should not lose track of our long-term goal, which is to expand so that when things stabilize, we’re already there.”

That time has come. The economy and stock market are performing well (see “Ready for Take-Off?”, page 20). The peso has appreciated 21 percent against the U.S. dollar since the end of 2005. International reserves stand at a record US$30.7 billion, up 66 percent from 2005, while unemployment has fallen to 7.4 percent from 11.3 percent in the same period. And with the budget deficit now below one percent of GDP, government spending and revenues may be in balance by 2008.

Sio has been joined in the finance function by other professional managers, among them Jose Amantoy, a CPA with international experience who was recruited in 2005 as controller at property arm SM Development and vice president at SM Investments, and Corazon Guidote, who became vice president for investor relations last year after four years as Arroyo’s presidential consultant for investor relations.

“Our work has become more challenging,” says Jeffrey Lim, executive vice president for finance at SM Prime. “When our president [Hans Sy] wants something, it’s automatic—he would pass it on to our area and we look into it not only from the perspective of finance, but also strategy, operations, and others.” Sio is pushing for more. “While the traditional definition of a CFO is related more to the treasury,” he says, “we would like the [finance function] in each subsidiary to also get involved in risk management, policy decisions, investment decisions, and so on.”

Find Them the Money

Not surprisingly, finance spends much of its time these days helping fund the expansion. Net debt at SM Investments has shot up 120 percent to 42.3 billion pesos (US$960 million) as of June 30, 2007, compared with 19.2 billion pesos (US$435 million) in the same period last year. Sio says the net debt-to-equity ratio is still a comfortable 27 percent, up from 19 percent in June 2006. Even so, the intensified leveraging of the balance sheet is new at SM, which has been more inclined to rely on internally generated funds and the stock market.

In this SM has not been much different from other Philippine companies, particularly after the 1997 Asian financial crisis. That year, Sio orchestrated a US$100 million floating rate note—three months before the Thai baht crumbled against the dollar. The ensuing panic saw the peso fall from 26 to 40 against the greenback. Fortunately, the obligations were fully hedged, a practice that SM follows to this day.

“It means additional cost, but our discipline is not to speculate,” says Sio. About 55 percent of the SM group’s total long-term debt is denominated in dollars, including a US$300 million convertible bond issued in March this year.

Given the peso’s continuing strength and the dwindling differential between peso and dollar interest rates, SM is now turning more to the local currency. In October, SM Prime completed a 4 billion peso (US$90 million) five-year floating rate issue after the central bank cut interest rates by 25 basis points. This followed a similar 3.5 billion peso (US$79 million) issue in June.

More borrowings may be needed, so Sio is strengthening his department’s coordinating role. “At SM Prime, for example, I don’t know what the property and retail groups are doing,” explains Lim. “But Mr. Sio knows all our banking relationships, so he can tell us when and how we can work together and get better rates.”

Also being strengthened is finance’s ability to provide expertise and advice on issues related to accounting, treasury, financial management, and corporate governance, as well as to monitor and benchmark business performance across the enterprise. To this end, the company is considering an upgrade of financial management and business performance software, which is currently a tapestry of in-house programs, Oracle, and SAP. “We do get the information that we want, but right now it is not the fastest way I would like,” says Sio. An efficient flow of information will be essential for keeping the US$2.2 billion expansion program on track.

Art of Cross-Selling

SM Investments’s expansion plans rest on the hope that the new businesses will complement the old. Nona Reyes, assistant mall manager, takes visitors on guided tours of SM BayCity. The three-story SMX Convention Center is nearly complete, she says, pointing to the mall’s north side. It will have a gross floor area of 46,074 square meters, comprising an exhibition area on the first floor, a commercial area connected by a pedestrian walkway to the mall on the second, and meeting halls and function rooms on the third. OneE-ComCenter is being built to the south of the mall; it will be leased to call-center and BPO firms.

Three hotels, serviced apartments, and a sports arena are in the planning stages. “If the first BPO center is successful, we will build more,” says Guidote, the investor relations manager. “That will create more foot traffic for the mall. That’s where the synergy is.” Further synergy is expected from the US$144 million Hamilo resort complex in Batangas province on the other side of Manila Bay, which will be linked to SM BayCity by ferry. A four-times-a-day ferry service from the mall to prospering Cavite province (population: 2 million) was recently launched, cutting travel time from two hours by land to just 40 minutes by sea and thus expanding the mall’s catchment area.

There are any number of cross-selling possibilities. At Chateau Elysée in Paranaque City, about an hour’s drive from the Mall of Asia, SM Development marketing officer Jose Ma. Jens. Zamora III shows off three showroom units. They are furnished with refrigerators, washing machines, and ovens from SM Appliances, sofas and beds from SM Our Home, and decorative items from handicrafts unit Kultura. “We can arrange discounts with these sister companies for our home buyers,” says Zamora. Scale models of the project are on display in SM malls and promotional materials are available in Banco de Oro-EPCI bank branches.

A shuttle bus carries Chateau Elysée residents to the nearest SM mall. The company will apply the same concept to other residential developments.

SM is also tapping its overseas remittances network. After a marketing team visited London in July, says Zamora, “almost 50 percent of sales that month came from nurses there. They found the prices very affordable.” Units at Chateau Elysée start at 940,000 pesos (US$21,400) for a 20-square-meter, one-bedroom apartment. The Banco de Oro-EPCI remittance centers serve as sales venues, facilitators of mortgage applications, and conduits for monthly amortization payments to the Philippines. “Many of the people living here are dependents of overseas workers,” says Zamora, pointing to children splashing in Chateau Elysée’s clubhouse swimming pool.

SM’s key targets for its property projects are overseas Filipino workers in the medical field and other professions in Europe and the United States, rather than the lower-paid domestic helpers in Hong Kong, Singapore, and the Middle East. That’s one reason why SM isn’t worried that an economic slowdown in the West will hurt its property business. “Doctors and nurses are not likely to lose their jobs in a downturn,” says Ismael Pili, an analyst at Macquarie Securities in Singapore. “You can say that the medical sector is almost recession-proof.”

But property accounts for just 13 percent of the SM empire’s net income. Together, retail merchandising and shopping malls contribute 56 percent, and those operations are vulnerable to a slowdown in remittances. Sio argues, however, that a big fall is less likely than it was because the proportion of Filipinos taking overseas posts in hospitals and nursing homes is rising. “The United States alone needs more than 60,000 nurses,” adds Lim.

Philippine demographics also suggest that the flow of workers to aging Western societies can continue for decades. Some 46 percent of the population of 88 million is younger than 20, and children under four are the largest age group—at 10.4 million. By 2025, CLSA’s Dy says, the vast majority of the population will be 44 years and younger. Even if they all stay at home—which is highly unlikely—“the demographics will remain in favor of mass-based consumer-related companies.”

Consumers Plus

In any case, SM’s diversification into tourism and BPO leasing could provide a bit of cushion if remittances and personal consumption slow. Its banking and financial services arm also provides balance with exposure to trade and manufacturing, bancassurance, agriculture, and other non-consumer sectors, in addition to mortgages and consumer loans. It already accounts for 31 percent of net profits.

But does a retailing giant like SM have the expertise and experience to run tourism resorts, BPO buildings, and convention centers? “People forget that we have long been in the tourism business,” Sio responds. “Mr. Sy bought Taal Vista Hotel 20 years ago, and he has always said that tourism is the next big thing for SM after retailing.” The key to understanding SM, he adds, is to look at the group as the sum of its parts. “It’s all part of a plan,” says Sio. “Before we make any major acquisition or expansion, everything is analyzed. What’s the synergy, what’s the cost, what’s the benefit? How would it help grow the entire enterprise?”

This is why SM turned down an opportunity to take over an airline and why it sold a cement plant a few years ago—the group decided that the synergies weren’t there. But the judgment is that resorts, convention centers, hotels, BPO, and housing developments add value to the existing businesses. “We already own the land, so it’s a matter of building structures on them,” says Sio.

Moneyed BPO agents, convention goers, tourists and SM condo dwellers are expected to increase foot traffic to the malls, joining the dependents of overseas workers and other Filipinos who hopefully will be participating more and more in economic growth.

The Next Generation

It’s a self-sustaining business model that Henry Sy, Sr. has long had in mind, says Sio, and one that the second generation is expected to nurture. “It is fortunate that all the children are active in their own area of expertise,” says the CFO. “Mr. Sy is of course still consulted on major decisions, but the initial discussions are conducted by the family members among themselves.”

The succession appears to have been internally decided as well. The expectation had been that Henry Jr. would take over, being the eldest son, but SM’s 2006 annual report described Sy-Coson, 57, matter of factly as “the chosen successor at SM Investments.”

The patriarch Sy involved his children in every aspect of the business from a young age, to the point that none was allowed to study abroad. The children themselves are more relaxed with their own offspring, some of whom are in school overseas. They also remain open to hiring more professional manages to handle day-to-day operations so “we can sit back and relax,” as Sy-Coson once told Time magazine.

SM, in other words, is not only transforming its business, but also its culture as a family empire. “We emphasize transparency and corporate governance, and we know that we have obligations to our stockholders, to our creditors and to our people,” says Sio. Minority shareholders, among them foreign shareholders and lenders, will hold him and the Sy family to that.

cesar bacani is a contributin editor of CFO Asia