The uneven nature of a downturn

All recessions are not created equal that’s for sure. While it is pretty clear that many businesses are feeling the effects of the global recession that is upon us, some are feeling it more than others. Sector to sector comparisons are obvious. I’d rather be in the technology business than the car business for example. However, even within sectors there are businesses that seem to be doing relatively well, while others in the same sector are crashing and burning. Some are losing because they are selling the wrong product and some are losing because they have the wrong customer base. Some are losing because they do all their business in one country, while others are winning for the same reason, they simply operate in a different country. The reasons why people are winning and losing can be due to good or bad management, or down to history. The physical markets people are in were decided a long time ago in many cases – long before the financial markets crashed and took the economy with them.

All of this unevenness (is there really such a word?) makes for some interesting management challenges. For example the cost of leaving a market can be higher than the short term savings achieved by getting out. Equally, changing your customer base isn’t easy when markets are like they are right now. Put another way it is hard for executives to marry the short term financial goals of a business, with the right long term business goals. As a result, I would expect some pretty lumpy performance from companies in the next year or two. This isn’t what financial markets like but for many companies it will be unavoidable. The most important thing is that businesses run their businesses profitably and conserve their cash during a period like this. It is then also important that they learn from this recession. Recessions expose the weaknesses of a business. Ignoring those weaknesses is perhaps the worst mistake a management team can make. All business leaders hate recessions but they are a great test of you and your team and of the business you are running. How well you do is interesting. How much you learn from the test and apply to your business is really important.

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Supply and Demand Economics

It would seem that supply and demand economics rule. For years the valuation of commodities have been driven by this, while the valuation of companies have clung to various guiding metrics such as PE ratios or multiples of EBITDA. All this seems to have changed as the stock markets around the world essentially ignore all multiples and focus instead on whether there is actually someone willing to buy a company’s stock. Classically it has been quite normal for businesses to to have PE ratios of between 10 and 20 and yet right now there are hundreds of companies with PE ratios of 5 and below. Many of these companies are small cap stocks which investors fear because of their liquidity. Ironically though many of these businesses are better run than large companies because a) the managers have some meaningful stock interest in the business and b) because these same managers are closer to the real customers and therefore simply run their businesses better.

Sadly for small business owners this shift to supply and demand valuations is unlikely to change anytime soon. This has broader implications than simply unrealistically low share prices for businesses. The ability of many companies to carry out acquisitions is tied to their valuations. When they are highly valued, companies can use paper (stock) as a means of buying other companies, either by issuing stock to the shareholders of the company they want to buy, or by getting investors to buy a new issue of equity, the proceeds of which can then be used for the acquisition. When stock prices plummet so do the possibilities for these companies to do any buying. As a result, the supply and demand economics then starts to impact the value of private companies. In the PR world there were quite a number of deals done last year based on high multiples. These prices would simply not get paid today unless there ended up being an auction. I therefore confidently predict that the market for acquisitions will become very quiet in the next year. This isn’t because there aren’t companies for sale or companies looking to buy. It is simply because until the valuations of public companies start to rise, a key currency (new shares) will not be available for purchases. At the same time, the better companies will likely defer sales until conditions improve.

Of course companies can still be bought for cash. Here again there is a problem. The global credit crunch has made it harder for companies to raise debt. At the same time, shareholders who, in good times, encouraged businesses to gear up are now demanding that debt be paid down. As a result, companies are hanging on to cash or ignoring the potential of their banking facilities, thus again taking a currency (a very real one) off the table for acquisitions.

You could describe this as the perfect storm for small companies looking to do deals. I would suggest that this storm may be with us for while. Then again I’m British so I’m used to bad weather.


The real economy needs to speak up

Last week WPP‘s CEO talked about the ‘real economy’ and how it’s actually holding up quite well. The same day, IPG also put out some positive statements following good results. Indeed if you look at the business news in recent weeks there have been a string of relatively positive statements made, albeit with some caveats attached. The only sectors that have continued to spew out bad news have been banking, housing and the some parts of the auto industry. Even retail has seemed pretty robust which lead a Forbes columnist to pick Target as a stock worth buying now that its PE has dropped to around 16. All this suggests that there are two economies playing out right now. Unfortunately only one of them seems to be getting any attention. The ‘real economy’ as Sir Martin called it seems to get a passing mention, whereas the the mean, ugly one that the banks are wrapped up in seems to get a mountain of coverage. It sounds to me like the real economy needs some marketing support.