Your business 2010/2011: Forging ahead
- 22 October, 2010 18:14
With the global financial crisis (GFC) behind us, the next 12 months is shaping up to be a dynamic period for the world market.
And, although the Australian market proved relatively resilient through the GFC and subsequent aftershocks, it is still a market that offers challenges for organisations and investors at all levels.
ARN recently looked at the yearly results for some ASX-listed IT organisations. The rule of thumb seemed to be that while profits were up, revenue was flat, or down – a sign that the positive numbers were more a reflection of cost cutting than genuine growth.
So what will 2011 hold? Australia might be relatively sheltered from the heaviest falls, but what happens in the global markets will, of course, have a heavy impact on our own climate moving forward.
“Fundamentally, things look very strong at the moment,” JP Morgan economist, Ben Jarman, said.
“If you look at all the major macro variables in Australia, they’re all telling a similar story, and that’s one of an economy that is growing very quickly and above trend. A lot of that is because of the close tie we have to what’s happening in emerging Asia, China and India, in particular.”
This solid position is largely driven by the resources sector, which continues to act as the beating heart of the Australian economy, but, of course, that sector needs the support of a variety of other industries – including IT – to function.
But it’s not all good. For instance, retail, the largest single employer in Australia, and a good yardstick for assessing consumer confidence, continues to struggle.
“We got some business survey data today which showed a break-down by sector that did show that retailers are feeling the pinch,” Jarman said.
“What we think is happening is we’ve got rising interest rates, which tends to eat into people’s discretionary income, and that’s probably hurting retailers. The second thing is a lot of the stimulus payments that were put in place during the crisis have dried up.
“What those payments did was to boost activity in the short term, but in terms of purchases on one-off items, such as televisions, what that means is that it was a case of 'more then/less now', so we’re seeing those retailers with big ticket items really having to discount to get stock off the shelf.”
And the global economy might yet have an adverse effect on the local environment.
Europe, for instance, is a market that is still a concern. Early in 2010, a debt crisis in Greece set off a renewed wave of economic concern in Europe that quickly enveloped other EU nations such as Spain and Portugal. These economies – and others – were running with very deep budget deficits and high levels of public debt.
In response, emergency funds were organised by the EU and IMF, allowing the troubled economies to draw on money if they find it difficult to get access to funding markets and other sources.
“Things have settled down as a result of that, and the fact that the currency really depreciated in the Euro area, economically some countries are doing really well,” Jarman said.
But at the same time, Jarman said the European markets still had some difficulty to go through yet.
“What we’re probably going to see starting next year and beyond is that these economies that were struggling have to get their finances in order, and that’s going to be a tough process, so the governments will have to cut expenditures and lay off workers, raise taxes and so on.
“Really the can has just been kicked down the road for next year where these fiscal solutions are going to get really difficult.”
And, of course, Europe isn’t the only concern in this regard. Our close neighbour, Japan – the third largest economy in the world after the US and China – is facing many of the same problems that initially tipped Greece over the edge. Most startling is the level of public debt, which is the highest in the world (not including decrepit Zimbabwe) at nearly 200 per cent of GDP.
Though nobody would suggest Japan is close to the same solvency concerns that face Greece and Ireland, its economic struggle has led credit rating agency Standard & Poor’s, as recently as September 14, to state that although Japan’s credit rating of AA is ‘still valid’,and well away from speculative, or ‘junk’, grade bonds (where Greece found itself), it is a credit quality is ‘slowly sinking’.
Worse, for a nation heavily reliant on exports, the Yen is strengthening against other currencies, including the US and Australian dollar, as well as export rival the Chinese Yuan, further hurting a fragile manufacturing industry. Should Japan find itself falling into deeper economic difficulties, the effect on the Australian market could be pronounced.
HOW TO GO ABOUT IT
So, within that macroeconomic framework, what should Australian organisations expect to do, and how should they go about it? In simple terms, they should still expect to grow. With an uncertain global environment, it does not gain the confidence in shareholders to be simply holding ground.
“Treading water in this game is not something that will produce the right types of results,” Hostech executive chairman, Peter Kazacos, said.
“People expect businesses to be growing. But raising the money to do that in capital markets is difficult in this environment – that’s one of the issues around people trying to grow their own businesses.”
Despite this, assuming you can find the capital, the market is ripe for mergers and acquisitions.
Hostech’s own acquisitions in recent months include regional players, Albury-based Netrics, D2K Townsville, as well as Anittel, Accord, Axxis and Aspirence.
The total value of all acquisitions thus far has totalled somewhere around $6.5 million.
“In our acquisitions some of it has been financed through cash flows, and in other cases we did go to the markets to raise funding,” Kazacos said.
It should be noted that neither option is especially easy. Kazacos said Australian investors do watch the US market, and until that ship steadies, they will feel tentative with making substantial investments.
Other organisations might consider listing on the ASX as a way to raise capital, but here too, Kazacos advised caution due to the cautious market.
“The potential kicker you get from the IPO isn’t as great right now,” he said. “To list you’d want to get investors wanting to buy stock, and at the moment they tend to gravitate to investing in already listed entities as opposed to speculating.”
Other options open to organisations could include simply going to the business owners and asking them to add more money to the kitty (for private companies), or looking for overseas funding options, although Kazacos said the latter might be hard to come by.
“Our interest rates are higher, so the potential for getting good interest is good, but people have this expectation that the Australian dollar will reduce in value over the longer term, and then if they leave their money in Australia then potentially when they exit the market they’ll end up with less.”
That said, the indicators are that the dollar will remain consistently strong in the near future.
OTHER AREAS FOR GROWTH?
One interesting potential area of growth for those organisations in a strong position is in overseas expansion, and for the braver of heart, there are wide-open doors for speculating in emerging markets that found themselves deserted by the global financial crisis.
“What tends to happen during a crisis is that there’s what we call the flight to quality,” JP Morgan’s Jarman, said. “When everything is booming and we’re on the upswing than people start to look for places to put their money where they can get exposure to risk, which means higher returns.
“So people start to look at emerging markets, and look at the fact that you can get high-yielding equities and bonds there. During the crisis that really reverses itself, because people are concerned with preserving the value of their money. So these funds flock to the US dollar, and that’s very negative for emerging markets.”
But that same flight might well open up opportunities for Australian organisations looking to fulfil the philosophy of expanding in a tough market.
“A lot of US companies withdrew operations with overseas markets, so to enter those markets which the US has withdrawn from might be an opportunity if you’re selling a competitive product,” Hostech’s Kazacos said.
“Rather than start from scratch though, you might want to buy a local operation. But you have to be careful that you have the cash flow to support it because you’re not likely to see banks giving you money to go into some of these emerging markets.”
Other considerations to make before moving into offshore markets is to take into account the unique culture of each market – and it’s generally wise advice to work in close tandem with a partner rather than attempt to set up a direct presence by oneself.
For those organisations not in a position to make acquisitions or offshore expansion, the market also holds opportunities for organic growth, although finding new business models is all but required to take that path.
“The challenge for resellers is that as the dollar has appreciated by 15 per cent over the last year, if that flows through to pricing you’ve got to sell 15 per cent more product to get the same revenue number as the year before,” Express Data managing director, Ross Cochrane, said.
“So clearly having a healthy blend of services and product will make that less of an impact for you. I think annuity business is definitely something that everyone should be focusing on – things that you’ve sold in the past that are renewable for maintenance or for licensing, or even going in and upgrading.”
Overall, Cochrane stressed the market was currently a good one for IT in Australia, and provided an organisation has a very clear plan of attack, the opportunities were there to thrive.
“I think the banking system in Australia has come through in robust shape, and if you look at the advertising that’s going on, many of the banks are looking for opportunities to lend,” he said.
“Australia has become an attractive investment profile for US vendors where they’re not finding big growth rates in the US or Europe, but they look at Australia and say ‘the economy there is strong, let’s see whether we can get good growth out of that market’.
“I’d say generally for resellers that if you’re going to pick areas to focus on, possible good areas would be to focus on what could be viewed as non-discretionary IT spend. For a CIO quite often a large pile of their budget is involved in keeping the lights on and running the business – they’re going to spend that money, so if you can focus on that space more than the nice-to-haves, you’re setting yourself up nicely.”
HEDGING AND CURRENCY MARKETS: WHAT'S THE FUSS
A good case study on how currency markets can impact on Australian organisations is the story of Red Ant.
In 2008 the Australian dollar crashed against major currencies around the world – losing as much as 37 per cent of its value over a period of a few months to the US dollar, and 20 per cent of its value to the Euro.
In 2009, this climate claimed Red Ant, a distributor of video game software from overseas. In January it appointed Deloitte Touche as its receiver.
Red Ant failed to hedge against the Euro in time to protect itself against that 20 per cent drop, and the subsequent losses that the distributor made on sales would be catastrophic for any low-margin business model.
There are a number of ways that importer organisations can protect themselves – or hedge – against that kind of currency devaluation, and while analysts might not expect a repeat performance in the near term, it is nevertheless something to have in the back of the mind as a just-in-case.
One hedging technique is forward FX contracts. In simple terms, a forward FX contract is a deal to exchange currencies at an agreed date in the future, at a rate agreed on in the present. It is a technique that banks can provide quotes on for almost any currency pair and are calculated from spot value dates and in turn calculated out of the transaction date. FX forwards can usually be taken for maturities from three days to two years.
The other option is the put option. Here, a buyer acquires a short position by purchasing the right to sell the underlying instrument to the seller of the option for a specified price during a specified period of time. Essentially it provides a guaranteed price for an investment, and offers insurance against excessive loss (the dollar starts to slide.)
However, there are problems with these hedging techniques. Often they’re acquired for a premium, and if you are running a low-margin business, there might not be room for those premiums.
Which then raises the question of whether you engage in almost a loss-leading exercise in importing and reselling the technology to protect yourself against currency devaluation and attempt to make the money back on services?
Express Data managing director, Ross Cochrane, put it best in his warning to companies considering becoming involved in the field: “I think the key is for only those businesses that specifically have expertise in foreign exchange management should get involved in buying anything other than Aussie dollars.
“If it’s not your core competency, get a price in Aussie dollars so it’s taken out of the equation for you.”
It’ll mean things will get difficult if the dollar does go south, but especially for the smaller organisations that don’t have staff versed in international markets, for all by the most extreme circumstances, it’s ultimately safer than any hedging technique.