Eurozone Companies: Coming through the Crisis

Q (gtnews): How bad was the corporate casualty rate in the PIIGS countries?

A (Bertram Meyer): It’s possible only to generalise up to a point about five very different countries, but basically each of them was hit by a combination of factors.

These included a heavy reliance on bank lending for the funding of small and medium businesses, a sovereign debt crisis that – among other things – reduced bank lending, bankruptcies in the real estate sector and a breakdown of consumer demand and in discretionary spending. While the financial crises and these and other factors triggered the economic downturn, the problem in solving it lies in the common currency, which does not allow for a quick devaluation to regain competitiveness. As we all know, in times of low inflation it is incredibly hard to regain competitiveness through internal devaluation.

The old adage ‘cash is king’ still very much applies. Europe’s sovereign debt crisis encouraged companies to monitor their cash more carefully and, to the extent they held negotiation power, some of the larger ones were able to extend payment terms. Weaker firms suffered as a result, as alternative sources of capital often weren’t available.

Greece certainly was hit particularly hard and is still in difficulties today, many small and medium businesses went bankrupt while shops and restaurants closed, resulting in double-digit dip in gross domestic product (GDP). Of course, not all companies across the PIIGS suffered; for example, many of the large gas and electricity companies remained relatively stable, whereas small and medium enterprises (SMEs) were hit particularly hard.

It’s well-known that Spain’s construction and property sectors suffered badly from the 2008 financial crisis. Were there other sectors in the PIIGS countries that were particularly hard-hit, or was the pain across the board?

Pain quickly spread from one infected sector to others, as demand fell, austerity measures kicked in and the lending environment worsened.

Also, we’ve seen the classic response for all types of companies. Everyone attempts to hold on to their cash by collecting earlier, but paying later. This hurts the smaller business players the hardest. It’s all very well purporting to trim the fat – but once there’s no fat left to be trimmed, by paying late you’re simply inflicting damage on your supplier, and therefore your supply chain.

Let’s compare Spain’s boom-to-bust to a similar construction spurt in Germany, triggered by the unification of West and East Germany in the early 1990s. Much employment was created, but once the boom ended there was a drop in real estate construction and many firms went out of business. While Germany endured considerable pain due to the unsustainable property bubble, it was able to surmount it.

A similar property bubble occurred in Spain, but in this case it was coupled with several other factors, such as the introduction of austerity measures in aftermath of the financial crises and sovereign debt crises. At the start of the crisis, Spain’s level of government debt was still relatively low and it had ‘kept much of its powder dry’, however, this situation didn’t last for very long and debt as % of GDP increase from around 40% pre-crisis to over 90% in just a couple of years.

Ireland, by contrast, appears to have emerged from recession quicker than the other four countries that suffered a sovereign debt crisis. Why is this?

Ireland is a little different from the other PIIGS as, in addition to a real estate bubble, it suffered from the government’s decision to bail out its inflated banking sector in the early days of the crisis. Like Iceland’s, Ireland’s banking sector at the onset of the crisis was out of proportion compared to the size of the Irish economy. Had that not been the case, the recession in Ireland would have been less hard.

On the plus side, Ireland has been helped by several strong economic features – one of these being the large number of major multinationals, such as Apple, Pfizer and others, with operations in Ireland, which weren’t really affected by the crisis.

How have the companies that survived in these countries managed to come through tough economic times?

I’m sure the reasons vary widely for each company, there are just so many different factors based on the different countries, industries and their individual markets. General themes include cost-cutting to improve operating cash flow and finding alternative sources for demand and/or financing.

What we see globally is that the smarter companies are continually innovating – even through the recent recession – not just their front-end product offerings and services, but in how they deliver those products and services through their supply chains. For example, most people would recognise that there has been a significant amount of innovation over a long period of time in the physical supply chain starting off with the ‘Just in Time’ principle. But it’s only far more recently that this innovation is starting to be matched with innovation in the information and financial supply chains.

Taulia is more involved in transforming the financial supply chain and it’s here that we see people and companies transforming old-fashioned static payment terms into modern, dynamic arrangements that frees up vital cash to flow through the supply chains to the benefit of both buyers and suppliers.

Do you get insights from the treasurers of companies in these countries on the actions they took to ensure survival? If so, are there any common themes that emerge?

Our company’s principal service is to provide a platform that companies can use to optimise their working capital and such initiatives can certainly be part of the solution

Large creditworthy companies can deploy a platform to enable their suppliers to be paid earlier at the cost of only a small premium over their own cost of borrowing, as we can leverage the creditworthiness of the buyer once the invoice has been approved. This makes a huge difference, particularly when the buying organisation is either larger and more creditworthy, or for example based in Germany or other of the stronger north Europe economies with easier access to capital and a supplier in, say, southern Europe where the economy is weaker. By allowing the cash to flow more quickly from the company with lower cost of financing to the one with higher cost of financing, value is created that can be split between the buying organisation and the supplier.

It’s a far better option, whereas extending your payment terms when your supplier is struggling isn’t the smartest move. Small suppliers often have to exist on fairly thin profit margins, such that prolonging payment terms can inflict considerable pain and damage as a result.

A platform is needed, as major multinational corporations (MNCs) typically have thousands or even tens of thousand of different suppliers, of which only the minority is actively managed by procurement. Of course, not all suppliers are vulnerable to the extension of payment terms by their customers. The more differentiated and unique their offering the better their own negotiation position, especially if their clients can’t suddenly switch to an alternative supplier. A classic example of this was provided in 2011, when the Japan earthquake and tsunami temporarily put a number of component manufacturers out of business. Their customers found there wasn’t anyone else to source from.

Were PIIGS companies able to go outside their home country and secure funding from overseas?

Yes, it is part of a trend that has been evident in recent years. Traditionally it was the case that European companies adopted a national view – both culturally and economically – which meant, for example, that German companies were funded by German banks and existing business relationships were typically long-standing.

However, as Europe has steadily become more of a single market, we’ve seen a gradual dissolution of these historic ties. So companies and their treasury departments have looked further afield, across borders and have begun to ask who in Europe is the best provider and who they should source from.

Would you say that Mario Draghi’s speech in July 2012, which pledged to whatever it took to defend the euro, marked a turning point in improving conditions for corporate funding and investment within the PIIGS?

Yes, that move by the European Central Bank (ECB) was both very helpful and much needed, as by that point the situation was pretty bad – it has to be said that Europe’s (and its member states) response to and handling of the sovereign debt crisis wasn’t that impressive! By contrast, the willingness of the five countries to implement some pretty severe measures and the courage of their populations to endure the effects of internal devaluation such as salary cuts has to be admired, as they haven’t been able to resort to devaluing their currency.

Greece had – and still has – the added uncertainty over whether it will remain part of the eurozone or whether it will abandon the single currency and resurrect the drachma. Add to this the problem of many businesses and individuals withdrawing cash from the banking system and creating a further drain.

Without the ECB’s intervention, the crisis would have become far worse though. It marked a significant turning point in arresting what was becoming a downwards spiral. With the exception of Spain at the very beginning of the crisis, each of the PIIGS had relatively high debt rations and the increasing cost of servicing that debt was proving a huge drain on government finances – particularly so as the austerity regimes introduced further depressed their economies. As their debt to gross domestic product (GDP) ratios weren’t improving, the situation was impossible to resolve without the help of the ECB.

And has the ECB’s action been enough?

I believe the ECB under Draghi did largely what it could (albeit late), but other measures could have helped further. One would have been a concerted action by the ECB and European governments to get to a higher level of inflation, which would help the PIIGS to regain competitiveness in a much less painful way. Another one would have been to ask for less austerity measures from the PIIGS and instead focus on more structural reform. And, of course, corporates can help too.

Take the example of Volkswagen, a major German manufacturer with production facilities in Spain. VW can assist it suppliers simply by paying them earlier, thereby improving their access to cash and reducing their accounts receivable (AR) and charging a modest interest rate for doing so. Such a measure is of significant benefit and strengthens the supply chain.

A working capital platform such as Taulia’s offers a flexible tool for injecting liquidity into a supply chain that is threatened – or for repairing one that is damaged.

A double question – firstly, have PIIGS companies that survived emerged stronger as competitors have gone under? Secondly, have they also been able to attract foreign investors because their shares are cheap?

Some did, yes. To the degree that supply needs to be local, the consolidation has certainly helped the survivors. A further factor has been that their unit labour costs are far more favourable than they were five or six years ago – particularly when salaries have actually been shrinking, as has been the case in Greece for example. On the other hand, funding cost in parts are still higher than for comparable companies in Northern Europe.

Of course, access to the capital markets is only for those companies that have a good story to tell and can use it as their way of emerging from the crisis. It’s significantly easier for companies in the US, where there is less reliance on banks and alternative funding methods are more developed.

In Europe, you need to demonstrate that if the economy is weak, your company is moving in the other direction and beating it. A deeper equities market would certainly help this.

Do you expect the ECB’s recent decision to launch a quantitative easing (QE) campaign to help companies in the worst-hit eurozone countries?

A higher level of inflation is certainly a key target to shoot for. Given that we haven’t seen a coordinated fiscal response across Europe, hopes are largely pinned on the ECB. I get the sense that the ECB is almost is at the point where it feels like they’ve tried everything else, and now QE is the next logical step. However, there’s the question about where the newly-created money ends up: will it be held by banks, or does it really end up in households and companies where it’s intended?

Lastly, do you have any thoughts on whether Greece will stay inside the eurozone and will it survive intact?

That is a great question, and it’s very difficult to predict.

One thing is sure: If Greece ends up leaving the eurozone now then a lot of unnecessary pain was inflicted, as regaining competitiveness would have been much easier through a currency devaluation than through the internal devaluation Greece went through. So if an exit is the solution, then it should have happened much earlier.


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