Feeling the pressure? The challenge of enhancing return on equity sponsored by An Economist Intelligence Unit report The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders For 60 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations The firm is a member of The Economist Group Copyright © 2008 The Economist Intelligence Unit Limited All rights reserved Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited All information in this report is verified to the best of the author’s and the publisher’s ability However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it Feeling the pressure? The challenge of enhancing return on equity About this research In March 2008, the Economist Intelligence Unit surveyed 373 C-level, or board-level executives, from around the world about their attitudes to improving return on equity in the current business environment The survey and paper were sponsored by The Royal Bank of Scotland Respondents represent a range of industries, including financial services, professional services, manufacturing, and information technology Approximately 50% of respondents represent companies with revenues in excess of US$500m Around 50% of respondents are chief financial officers, and the remainder are chief executives or other C-level executives Our editorial team conducted the survey and wrote the paper The author was Christopher Watts and the editor was Rob Mitchell The findings expressed in this paper not necessarily reflect the views of our sponsors Our thanks go to the survey respondents and interviewees for their time and insight © The Economist Intelligence Unit 2008 Feeling the pressure? The challenge of enhancing return on equity Executive summary l Return on equity is increasingly at risk As the effects of the tightened credit environment spread from the US to the rest of the world, surveyed for this report are finding their ability to deliver improved return on equity curtailed Beyond the increased cost and reduced availability of finance, a number of factors are exacerbating the problem Chief among these are dampened business confidence, downward pressure on revenues, adverse exchange rate movements and rising costs l There is growing pressure on companies to increase return on equity Just at a time when return on equity is under threat, investors and other stakeholders are intensifying pressure on management to deliver improved performance on this measure Indeed, six in ten respondents say that they have experienced increased pressure to boost return on equity since the start of the credit crisis Although executive management is most likely to drive initiatives to improve return on equity, shareholders and the general competitive environment are also exerting a strong influence l Executives are adopting a cautious approach to balance sheet leverage Senior executives are finding themselves in a corner: where once they would have turned to balance sheet restructuring to drive return on equity, today, few have an appetite for this Instead, many executives are cautiously bracing themselves for the possibility of more difficult times ahead by paying down debt and watching cash more closely Those that have committed themselves to dividend and share buyback programmes to increase return on equity plan to keep these on course; cancellation of such programmes to conserve cash is a last-resort option © The Economist Intelligence Unit 2008 l Greater operational efficiency is seen as an important source of improved return on equity As companies look to the future, they expect to increase their reliance on operational efficiency as a source of enhanced return on equity This could incorporate a range of initiatives, including greater efficiency of business processes, improved inventory management and a stronger focus on working capital management Revenue diversification and enhancement, and renewed efforts to cut costs, are also seen as important tactics l For some executives, it is a time for disciplined acquisitions Corporations with solid balance sheets and strong cash flows may find that the current environment is providing opportunities to drive return on equity by means of acquisitions Many senior executives questioned for this survey see softening valuations of acquisition targets In part, this is due to uncertain growth prospects and diminished competition from private equity operators, whose access to abundant cash resources has been cut back Yet a disciplined approach to acquisitions remains as critical as ever Feeling the pressure? The challenge of enhancing return on equity Return on equity comes under pressure The financial crisis that had its origins in US subprime loans has developed into one of the largest financial shocks in living memory Since August 2007, the so-called credit crisis has been characterised by a widespread tightening of lending and accompanied by sinking stock markets Add in the effects of record-breaking prices for oil and other commodities, a declining dollar, plus mixed economic indicators, and there appears to be little reason for optimism among investors or company executives alike It comes as little surprise, then, that the rapid global expansion of recent years is losing momentum The slowdown has been most evident in developed economies, particularly the US, which is now almost certain to dip into a recession this year, with, at best, a gradual recovery expected for 2009 Growth in Europe, too, is expected to slow this year, again largely as a consequence of the credit crisis The ultimate impact of the credit crisis on the global economy remains unclear What is plain, however, is that anxiety among many corporate executives across the world is running high While, for the time being, the impact in some regions may have yet to be fully felt, many corporations are anticipating worsening economic conditions Among senior executives of companies surveyed for this report, declining business confidence and difficulty increasing return on equity are among the most widely reported effects of the current environment Just under half of respondents report an adverse impact on business confidence, while 37% report a similar effect on their ability to improve return on How significant has the adverse impact of the credit crisis been on the following aspects of your business? Please rate on a scale from to 5, where 1=Very significant and 5=Not significant (% respondents) Very significant Not significant Don’t know/Not applicable Share price 15 17 15 18 27 Cost of borrowing 15 33 16 12 18 Availability of bank credit 12 28 19 15 21 Availability of capital markets debt 11 23 21 13 12 21 Value of assets 20 23 18 26 Capital expenditure plans 10 22 23 22 21 Business confidence 15 30 28 14 13 Ability to execute strategy 25 24 23 19 Ability to increase return on equity 11 26 27 19 15 Strength of balance sheet 19 28 18 25 Ability to fund pension liabilities 10 18 15 26 27 11 © The Economist Intelligence Unit 2008 11 Feeling the pressure? The challenge of enhancing return on equity equity For those companies that carry debt on their balance sheets, the growing cost and shrinking availability of bank credit and capital markets debt are also perceived as a problem Herman Agneessens, of KBC, an integrated bancassurance group based in Belgium, says that he has already felt the impact of this changed environment In December 2006, KBC communicated to investors and analysts its average return on equity target of 18.5% But since then, the worsening environment has increased the challenge of meeting this measure “The targets we set at the end of 2006 will be more difficult to achieve in the environment that we see around us today,” he says For KBC, and many other companies like it, downward pressure on revenues is hampering executives’ efforts to deliver targeted return on equity With a significant proportion of capital markets activity on hold, the company’s investment banking operations face a difficult environment; and in its retail asset management operations, slower customer growth is also set to weigh on revenues One bright spot, however, is its exposure to central and eastern Europe, which have been less affected by the credit crisis than western Europe, and therefore help to stabilise revenues Companies are facing less direct revenue effects, too For example, while central banks in the US and UK have loosened monetary policy in response to the credit crisis, the European Central Bank What change has there been to overall levels of pressure since the credit crisis began in August 2007? (% respondents) Significant increase 13 Slight increase 45 No change 34 Slight decrease Significant decrease © The Economist Intelligence Unit 2008 has kept its interest rate steady due to inflation concerns The resulting strength of the euro versus other currencies, such as the dollar and sterling, is likely to put downward pressure on European exporters’ revenues The French automotive company Renault, for example, reported in April that unfavourable exchange rates had dampened the revenues of its carmaking division by 2.1% in the first three months of this year It is not only revenues that are hit by the crisis – costs are, too “The main effect of the current crisis is on our [cost of borrowing],” says Patrick Claude He points out that, for Renault’s shortterm commercial paper, the spread over European overnight rates had widened from six basis points (bp, hundredths of a percentage point) to 60 bp between the start of the credit crisis and April; for its European medium-term programme, spreads had widened from 40 bp over EURIBOR to 140 bp; and for its Japanese public debt, from 30 bp over LIBOR to 120 bp The difference in interest expense (assuming Renault renewed at April 2008 rates the average debt it had outstanding under these programmes in 2007) is equivalent to almost €50m annually – a cost burden of around 0.2% of Renault’s end-2007 equity (The group’s return on equity in 2007 was 12.7%, according to Bloomberg data) At the same time as return on equity is coming under strain, pressure on company management to increase returns is intensifying Six out of every ten executives say that they have seen heightened pressure to improve return on equity since the credit crisis first emerged, with 13% reporting that the increase is “significant” In some cases, this pressure is from inside the company, for example from owner-managers and from supervisory and executive management boards In other cases, the pressure is from external parties, including institutional shareholders and activist investors, such as hedge funds Feeling the pressure? The challenge of enhancing return on equity Which of the following are currently exerting pressure on your company to boost its return on equity? Please select all that apply Which of the following have exerted pressure on your company to boost its return on equity in the past three years? Please select all that apply (% respondents) (% respondents) Executive management Executive management 53 61 Shareholders (institutional) Competitive pressure 40 37 Competitive pressure Shareholders (institutional) 36 31 Shareholders (activist) Non-executive management 22 25 Non-executive management Shareholders (activist) 17 22 Private equity suitors Private equity suitors 13 13 Other, please specify Other, please specify 3 Under intensifying pressure to deliver higher returns on equity, CFOs and other senior executives are increasingly finding themselves in a corner Textbook methods for driving return on equity include taking on extra financial risk by means of aggressive balance sheet restructuring – increasing leverage, buying back shares, and paying special dividends “But who wants to that in this environment?” asks Peter Clokey, head of the valuation practice at PricewaterhouseCoopers in London © The Economist Intelligence Unit 2008 Feeling the pressure? The challenge of enhancing return on equity A cautious approach to balance sheet manoeuvres In the wake of the galloping global economic growth, low interest rates, abundant capital, strong corporate earnings and rising stock markets that characterised much of this decade, many corporate balance sheets are in robust health As a result, some finance executives have come under pressure to drive returns by leveraging the balance sheet This was certainly the experience of Mr Agneessens of KBC “If you read analyst reports from 15 months ago, you will find that we were heavily criticised for under-leveraging our balance sheet, for carrying excess capital, for being too conservative and for not having sufficient risk appetite,” he says But now, such demands appear to be easing Among respondents to our survey, 28% say that they have already noticed diminished pressure from activist investors, such as hedge funds and private equity investors, to increase levels of leverage A further 43% anticipate this effect In a related finding, almost three-quarters of executives have felt Over the next year, which of the following steps you expect your company to take in response to the credit crisis? Select all that apply (% respondents) Reduce levels of debt 38 Cancel, scale back or postpone capital expenditure plans 34 Refinance debt or bank credit 26 Cancel or postpone acquisition plans 25 Cancel, scale back or postpone debt issuance plans 13 Cancel, scale back or postpone equity issuance plans 12 Cancel or postpone sale or divestiture plans 12 None of the above 23 © The Economist Intelligence Unit 2008 or anticipate a reduced likelihood of takeover by a private equity operator, which may itself ease the pressure they perceive to increase leverage Certainly, an increased debt to equity ratio is not generally seen as a favoured way of improving return on equity over the next three years – just 15% say that this will be an important approach for them A more widespread response in the current conditions is to reduce levels of net debt Four in ten respondents say that they plan to adopt this approach in an attempt to trim their exposure to further increases in the cost of borrowing In a similar vein, some executives – albeit a minority – are scaling back capital expenditure and acquisition plans And around one-third of respondents indicate that they have put plans to optimise their capital structure on hold until there is greater clarity about how the current market downturn will develop But while a significant proportion of companies will adjust their balance sheet according to the prevailing conditions, some prefer a consistent approach to ride out the cycles “We have stuck to our [financing] strategy through the previous cycles and we have no intention of changing it,” says Mr Agneessens of KBC “I think that right now that strategy has been vindicated.” Caution is also the watchword as far as the balance sheet cash goes “If the markets are uncertain, there is nothing like having cash in the bank,” says Vijaya Sampath, Group General Counsel and Company Secretary of Bharti Enterprises, an industrial conglomerate based in India Indeed, when deciding how much cash to hold on the balance sheet, the most widespread motivation cited by Feeling the pressure? The challenge of enhancing return on equity In deciding how much cash to hold on the balance sheet, which of the following are the most important considerations? Please select up to three (% respondents) Holding a "war chest" to protect against future downturns 42 Uncertainty about future investment opportunities 31 The cost of raising additional funds 25 Interest rate considerations 24 The time it takes to raise funds 23 Ability to return cash to shareholders 23 Preference of shareholders 20 Tax considerations 17 Regulatory considerations 11 Potential liabilities (eg, possible litigation exposures in the future) 10 senior corporate executives is to hold a “war chest” in case of possible future downturns Despite these findings, there is little evidence that current conditions have pushed senior executives into hoarding excessive amounts of cash: 63% say that they have about the right level of cash on their balance sheet and just think that they have too These results suggest that few executives have lost sight of the cost of holding cash, despite the more difficult operating environment This is a view that is echoed by Sampath “Holding too much cash means that it is not being put to proper use,” he says What has changed, however, is that companies are increasing the scrutiny of their cash balances to ensure that funds are being employed effectively “[The current environment] is making us use our cash much more carefully and is making us restrict the utilisation of cash more stringently than we used to before,” adds Sampath For many companies, dividend growth is a key element of a financing strategy to drive return on equity These plans so far appear to remain reasonably intact, despite the tightened credit environment Our survey indicates that 62% of respondents have kept down equity by paying out regular dividends in the past three years, while a slightly smaller proportion of 55% intend to continue the payment of dividends in the next three years Sonic Healthcare, a medical diagnostics company based in Australia, is an example of a company that is seeking to maintain, or grow, its dividends Since the company made its first payment 12 years ago, dividends have grown every year, and have remained at a high rate of 70% of net earnings “If the debt markets get really tough, we could consider cutting that – but we would be loath to it,” says Chris Wilks, CFO at the company Much the same applies to companies’ existing share buyback programmes “In the past two and a half years, we have bought back roughly one third of our equity,” says Mr Rigolle of SES Buying back and cancelling shares has helped push the group’s return on equity from 10.3% to 17.7% since 2004, according to Bloomberg data Despite the more difficult economic environment, Mr Rigolle remains confident in the visibility and robustness of his company’s revenue streams and cash flows Nevertheless, he has a last-resort option if economic conditions were to become tougher for the company “We can always delay the increase in our leverage – slow down our share buyback programme for instance, throttle back a bit the cash-out, and wait until sanity returns to the market,” he says Senior executives questioned for our survey clearly face a dilemma On the one hand, their ability to What is your view of the amount of cash that you currently hold on the balance sheet? (% respondents) Too much 17 About right 63 Too little 21 © The Economist Intelligence Unit 2008 Feeling the pressure? The challenge of enhancing return on equity CFOs turn to the bottom line improve return on equity has been hampered by the credit crisis, which has placed revenues under threat and increased interest expense On the other, many report intensifying pressure to deliver improved return on equity In the current environment, few companies are willing to restructure the balance sheet to resolve this dilemma And while there is no magic bullet to solve this problem, our research shows that, increasingly, CFOs and other executives are turning to the bottom line as a way of squaring this circle In turning to the bottom line to drive return on equity, the first option for executives – although it is by no means easy to achieve – is to increase revenues Fully 68% of respondents say that they expect to drive their companies’ return on equity by pushing top-line growth over the next three years But with acquisition-led strategies increasingly under pressure, executives need another approach “That is where the emphasis has to be,” says Mr Agneessens of KBC Some executives are considering diversifying their revenues by expanding into new product and service areas, or by rolling out existing products and services into new geographical markets that are perhaps less affected by the current economic climate For other companies, a less risky and less capital-intensive route to revenue enhancement may lie in making greater use of long-term after-sales service contracts with customers, or in concentrating greater sales and marketing effort onto their most important clients in order to attract a greater share of budgets Still, when comparing approaches taken over the past three years with those that executives plan to take in the next three, it is interesting to note that, while increasing revenues retains pole position both in the past and in the future, increasing operational efficiency gains in importance over this period Just less than four in ten respondents say that they favoured this approach in the past three years, while 59% intend to focus on it in the next three For many of these senior finance executives, increasing operational efficiency includes trimming costs from the income statement For most, internal services such as IT can be streamlined Which of the following have played an important role in enabling your company to boost its return on equity in the past three years? Please select up to three Which of the following you expect to be important in enabling your company to boost its return on equity in the next three years? Please select up to three (% respondents) (% respondents) Increasing revenues Increasing revenues 68 66 Increasing operational efficiency (eg, working capital) Reducing costs 59 51 Increasing operational efficiency (eg, working capital) Reducing costs 56 38 Refinancing assets Divestment 17 16 Increasing ratio of debt to equity 15 15 Refinancing assets Divestment 15 Increasing ratio of debt to equity © The Economist Intelligence Unit 2008 14 Feeling the pressure? The challenge of enhancing return on equity you have to earn a return on that debt We need to see that the internal rate of return that we make on the acquisition is good enough.” To be sure, acquisitions in the current environment will be scrutinised more closely by investors, lenders and supervisory boards alike – increasing the pressure on executives to pursue only those deals that make a clear contribution to strategic, operational and financial goals Again, discipline is key Sonic Healthcare’s strategy includes driving return on equity by folding small and mid-sized acquisitions into its infrastructure worldwide “We try to be disciplined in terms of return on equity, to drive value for shareholders We would like to think return on equity will grow within 12 months of completing a strategic acquisition,” says CFO Mr Wilks So what effect is the worsening credit environment having? “Perhaps we are becoming a little choosier,” says Mr Wilks “Of five acquisitions that we would have been completed previously, perhaps now we may only buy the three most synergistic ones.” 12 © The Economist Intelligence Unit 2008 A note of caution Peter Clokey, head of the valuation practice at PricewaterhouseCoopers in the UK, is all too aware of the effect of the credit crisis on asset valuations “Before the credit crunch, we were living in a world where valuations were driven in many sectors by the private equity community, especially in the US and Europe,” he says “There was a mass of money and easy access to bank financing.” Auctions for assets were increasingly being won by private equity houses, where ordinarily a trade buyer with potential for synergies would hope to win such a contest With large proportions of cheap debt in their financing packages, though, private equity houses were able to pay high prices and still expect a decent return on their investment This is no longer the case With the tightening of the credit environment since August last year, asset values have been under pressure First, an uncertain future outlook for revenues and earnings is weighing on valuations; and second, the investment activities of many private equity houses have been curtailed “A bit of froth has come out of the valuation,” points out Mr Clokey “There’s now a return to trying to understand where the value lies.” While the time may be ripe for trade buyers to make selective acquisitions, Mr Clokey sounds a note of caution For one thing, he says, valuation has become more difficult “The one-year multiple [such as a multiple of EBITDA] becomes a blunter tool at a time when valuations are falling and there is a threat to short-term profits.” Moreover, once an investment has been made, it is now more difficult to retreat “If you make an [ill-advised] investment when the market is hot, you can always exit it to remedy any errors you make – perhaps even at a profit Now, it’s more difficult to this.” Feeling the pressure? The challenge of enhancing return on equity Conclusion CFOs in the US and beyond are now beginning to feel – or anticipate – the effects of the credit crisis that started in August 2007 For many executives, delivering improved return on equity is a growing challenge At the same time, pressure on executives to enhance return on equity is intensifying But few executives are making significant changes to their long-term financial strategy For the time being, executives are adopting a cautious approach to balance sheet restructuring and leverage, in anticipation of a possible worsening of economic conditions Rather than using the balance sheet to drive return on equity, executives appear to be turning to the bottom line in an effort to increase returns For many, driving organic revenue growth – for example by diversification – is key; most executives are also planning cost efficiency measures For some companies with solid balance sheets and strong cash flow, the current environment is a time of opportunities for acquisitions that may drive returns Executives report that asset valuations are under pressure, in part due to reduced competition for assets from private equity operators Still, discipline is key in ensuring that acquisitions make a valuable contribution to return on equity © The Economist Intelligence Unit 200813 Appendix Feeling the pressure? The challenge of enhancing return on equity Appendix How significant has the adverse impact of the credit crisis been on the following aspects of your business? Please rate on a scale from to 5, where 1=Very significant and 5=Not significant (% respondents) Very significant Not significant Don’t know/Not applicable Share price 15 17 15 18 27 Cost of borrowing 15 33 16 12 18 Availability of bank credit 12 28 19 15 21 Availability of capital markets debt 11 23 21 13 12 21 Value of assets 20 23 18 26 Capital expenditure plans 10 22 23 22 21 Business confidence 15 30 28 14 13 Ability to execute strategy 25 24 23 19 Ability to increase return on equity 11 26 27 19 15 Strength of balance sheet 19 28 18 25 Ability to fund pension liabilities 10 18 15 26 27 11 Over the next year, which of the following steps you expect your company to take in response to the credit crisis? Select all that apply 11 (% respondents) Reduce levels of debt 38 Cancel, scale back or postpone capital expenditure plans 34 Refinance debt or bank credit 26 Cancel or postpone acquisition plans 25 Cancel, scale back or postpone debt issuance plans 13 Cancel, scale back or postpone equity issuance plans 12 Cancel or postpone sale or divestiture plans 12 None of the above 23 14 © The Economist Intelligence Unit 2008 Appendix Feeling the pressure? The challenge of enhancing return on equity Has the current credit crisis had a positive impact for your company in any of the following ways? Please select all that apply (% respondents) Impact already felt Anticipating this impact Less competition from private equity firms for assets 26 49 Less pressure from private equity/activist hedge funds to increase levels of leverage 28 43 More attractive valuations of assets for acquisition 37 45 Reduced likelihood of takeover by private equity 28 45 Which of the following structures have been most successful at helping your company to achieve its required financing objectives? Select up to five Which of the following financing structures does your company intend to use in the next three years? Select all that apply (% respondents) (% respondents) Equity Equity 42 46 Private placement Private placement 36 31 Syndicated loans Syndicated loans 33 29 Equity linked financing Securitisation of assets 21 17 Securitisation of assets Asset sale and leaseback 21 17 Derivatives to hedge interest rates Equity linked financing 17 15 Asset sale and leaseback Public bonds 16 13 Public bonds Subordinated debt / hybrid capital 14 11 Non-recourse project finance Non-recourse project finance 14 11 Subordinated debt / hybrid capital Derivatives to hedge interest rates 14 10 Derivatives to hedge commodities Derivatives to hedge commodities Carbon trading instruments Index-linked bonds Index-linked bonds Covered bonds Derivatives to hedge inflation Derivatives to hedge inflation Equity derivatives Carbon trading instruments Covered bonds Equity derivatives 3 © The Economist Intelligence Unit 200815 Appendix Feeling the pressure? The challenge of enhancing return on equity Please indicate current measures for the following performance ratios (% respondents) Current ratio (current assets divided by current liabilities) 25 22 16 0.0 0.5 1.0 1.5 2.0 2.5 3.0 5 3.5 3 4.0 4.5 5.0 5.5 1 1 1 6.0 6.5 7.0 7.5 8.0 8.5 0 9.0 9.5 10.0 Cash to debt ratio 25 14 12 11 0.0 0.5 1.0 1.5 2.0 2.5 3.0 2 3.5 4.0 4.5 5.0 5.5 6.0 1 6.5 7.0 1 8.0 8.5 7.5 0 9.0 9.5 10.0 What change has there been to these measures over the past year? (% respondents) Significant increase Slight increase No change Slight decrease Significant decrease Current ratio 11 33 42 11 Cash to debt ratio 11 24 43 17 What is your current debt/equity ratio and what you expect this to be in one year's time? (% respondents) Between and 0.5 Between 0.5 and Between and Between and Between and 10 More than 10 Currently 32 21 22 14 In one year's time 29 16 © The Economist Intelligence Unit 2008 23 24 15 Appendix Feeling the pressure? The challenge of enhancing return on equity In the past three years, how has your company's debt to equity ratio changed in relation to your industry average? What changes have you made to levels of debt and equity in your company over the past three years? (% respondents) (% respondents) Increased ratio of debt to equity Increased compared with industry average 30 20 Increased ratio of equity to debt No change 36 38 No change Decreased compared with industry average 34 26 Don’t know 17 In deciding how much cash to hold on the balance sheet, which of the following are the most important considerations? Please select up to three What is your view of the amount of cash that you currently hold on the balance sheet? (% respondents) (% respondents) Too much 17 Holding a "war chest" to protect against future downturns About right 42 Uncertainty about future investment opportunities 63 Too little 31 21 The cost of raising additional funds 25 Interest rate considerations Which of the following have you used to return cash to shareholders in the past three years? 24 The time it takes to raise funds (% respondents) 23 Ability to return cash to shareholders Paid a regular dividend 23 62 Preference of shareholders Paid an extraordinary dividend 20 21 Tax considerations Repurchased shares 17 26 Regulatory considerations 11 Potential liabilities (eg, possible litigation exposures in the future) 10 Which of the following you intend to use to return cash to shareholders in the next three years? (% respondents) Paid a regular dividend 55 Paid an extraordinary dividend 26 Repurchased shares 27 © The Economist Intelligence Unit 200817 Appendix Feeling the pressure? The challenge of enhancing return on equity How satisfied are you with the following aspects of your financial management? Please rate on a scale of to 5, where 1=Very satisfied and 5=Not satisfied (% respondents) Very satisfied Not satisfied Don’t know/Not applicable Overall capital structure 16 42 25 11 Return on equity 13 32 28 14 11 Debt issuance and management 13 30 29 10 14 Equity issuance and management 10 26 33 20 Dividend and share buyback policy 12 27 27 21 Cash management 15 42 24 12 Management of assets 16 36 34 11 Financial risk management 12 35 32 13 Please indicate whether you agree or disagree with the following statements (% respondents) Agree Neither agree nor disagree Disagree An asset-light business model is currently attractive to us 39 35 26 The tax advantages of debt are a strong incentive for us to increase leverage 28 42 30 We have put plans to optimise our capital structure on hold until there is greater clarity about how the current market downturn will develop 34 42 23 We would consider partnering with private equity firms to acquire assets 33 32 36 We would welcome an attempt by a sovereign wealth fund to take a stake in our company 24 31 45 The current environment has made conditions more favourable for the strategic acquisition of assets 51 37 12 We have been thwarted in our attempts to acquire assets in the past by private equity firms that use more aggressive balance sheet structures 27 46 27 We believe that our equity is currently undervalued by the market 45 47 11 11 11 11 11 18 © The Economist Intelligence Unit 2008 Appendix Feeling the pressure? The challenge of enhancing return on equity In deciding how much cash to hold on the balance sheet, which of the following are the most important considerations? Please select up to three Which of the following are currently exerting pressure on your company to boost its return on equity? Please select all that apply (% respondents) (% respondents) Executive management 61 Holding a "war chest" to protect against future downturns 42 Competitive pressure 37 Uncertainty about future investment opportunities 31 Shareholders (institutional) 31 The cost of raising additional funds Non-executive management 25 25 Interest rate considerations 24 Shareholders (activist) 22 The time it takes to raise funds 23 Private equity suitors 23 Other, please specify 13 Ability to return cash to shareholders Preference of shareholders 20 Tax considerations 17 Regulatory considerations 11 Potential liabilities (eg, possible litigation exposures in the future) 10 Which of the following have exerted pressure on your company to boost its return on equity in the past three years? Please select all that apply What change has there been to overall levels of pressure since the credit crisis began in August 2007? (% respondents) (% respondents) Significant increase Executive management 13 53 Slight increase Shareholders (institutional) 45 40 No change Competitive pressure 34 36 Slight decrease Shareholders (activist) 22 Significant decrease Non-executive management 17 Private equity suitors 13 Other, please specify © The Economist Intelligence Unit 200819 Appendix Feeling the pressure? The challenge of enhancing return on equity Which of the following have played an important role in enabling your company to boost its return on equity in the past three years? Please select up to three If you have increased leverage in the past three years, what have been the main objectives for this approach? Please select all that apply (% respondents) (% respondents) Enabling more capital investments 32 Increasing revenues 66 Returning cash to shareholders 16 Reducing costs 51 Satisfying activist investors Increasing operational efficiency (eg, working capital) Defending against takeover 38 Refinancing assets 16 Other, please specify Increasing ratio of debt to equity Not applicable; we have not increased leverage 15 41 Divestment 15 Which of the following you expect to be important in enabling your company to boost its return on equity in the next three years? Please select up to three What you see as the main drawbacks of increasing leverage at your company? (% respondents) Increase in borrowing costs Increasing revenues Issuing debt would lead to reduced financial flexibility in the future (% respondents) 26 19 68 Difficulty servicing debt in the event of a downturn Increasing operational efficiency (eg, working capital) 59 16 Negative impact on company's appeal to investors Reducing costs 11 56 Potential for lower credit rating Divestment 17 11 Potential for increase in interest rates Increasing ratio of debt to equity 11 15 High transaction costs of issuing debt Refinancing assets 14 If you intend to increase leverage in the next year, what will be the main objectives for this approach? Please select all that apply (% respondents) Enabling more capital investments 35 Returning cash to shareholders 18 Satisfying activist investors 10 Defending against takeover Other, please specify Not applicable; we not expect to increase leverage 39 20 © The Economist Intelligence Unit 2008 Appendix Feeling the pressure? The challenge of enhancing return on equity About the respondents What is your primary industry? In which region are you personally located? (% respondents) (% respondents) Western Europe Financial services 31 20 Asia-Pacific Manufacturing 31 10 North America Professional services 28 10 Eastern Europe IT and technology Middle East Consumer goods Latin America Construction and real estate Africa Energy and natural resources Entertainment, media and publishing Healthcare, pharmaceuticals and biotechnology Which of the following best describes your title? Automotive (% respondents) Board member Chemicals CEO/President/Managing director Logistics and distribution 24 3 COO Telecoms 2 CFO/Treasurer/Comptroller/Finance director Transportation 52 Other C-level executive Education 15 Agriculture and agribusiness Aerospace and defence Government/public sector What is the ownership structure of your company? (% respondents) Privately owned 53 Publicly listed 38 Private equity owned © The Economist Intelligence Unit 2008 21 Appendix Feeling the pressure? The challenge of enhancing return on equity Does your company currently have a credit rating? Select all that apply What are your company's annual global revenues in US dollars? (% respondents) (% respondents) $500m or less AAA (or equivalent) 49 $500m to $1bn $1bn to $5bn AA+ 15 AA 17 $5bn to $10bn AA- $10bn or more A+ 12 A A3 BBB+ BBB BBB1 BB+ BB BB1 B+ B B0 CCC Not rated 55 22 © The Economist Intelligence Unit 2008 LONDON 26 Red Lion Square London WC1R 4HQ United Kingdom Tel: +44 (0) 20 7576 8181 Fax: +44 (0) 20 7576 8476 E-mail: london@eiu.com NEW YORK 111 West 57th Street New York NY 10019 United States Tel: +1 212 698 9745 Fax: +1 212 586 0248 E-mail: newyork@eiu.com HONG KONG 60/F, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: +852 2802 7288 Fax: +852 2802 7638 E-mail: hongkong@eiu.com [...]... Unit 2008 Feeling the pressure? The challenge of enhancing return on equity A time for disciplined acquisitions While some senior executives are cautiously bracing themselves for a possible worsening of economic conditions ahead, others see opportunities in the current environment In one of the clearest-cut indications from executives polled for this report, 82% of executives say that they are feeling. .. 2008 Appendix Feeling the pressure? The challenge of enhancing return on equity In deciding how much cash to hold on the balance sheet, which of the following are the most important considerations? Please select up to three Which of the following are currently exerting pressure on your company to boost its return on equity? Please select all that apply (% respondents) (% respondents) Executive management... competition from private equity firms for assets 26 49 Less pressure from private equity/ activist hedge funds to increase levels of leverage 28 43 More attractive valuations of assets for acquisition 37 45 Reduced likelihood of takeover by private equity 28 45 © The Economist Intelligence Unit 200811 Feeling the pressure? The challenge of enhancing return on equity you have to earn a return on that... postpone sale or divestiture plans 12 None of the above 23 14 © The Economist Intelligence Unit 2008 Appendix Feeling the pressure? The challenge of enhancing return on equity Has the current credit crisis had a positive impact for your company in any of the following ways? Please select all that apply (% respondents) Impact already felt Anticipating this impact Less competition from private equity. .. 6 4 In one year's time 29 16 © The Economist Intelligence Unit 2008 23 24 15 6 3 Appendix Feeling the pressure? The challenge of enhancing return on equity In the past three years, how has your company's debt to equity ratio changed in relation to your industry average? What changes have you made to levels of debt and equity in your company over the past three years? (% respondents) (% respondents)... flow, the current environment is a time of opportunities for acquisitions that may drive returns Executives report that asset valuations are under pressure, in part due to reduced competition for assets from private equity operators Still, discipline is key in ensuring that acquisitions make a valuable contribution to return on equity © The Economist Intelligence Unit 200813 Appendix Feeling the pressure? ... choosier,” says Mr Wilks Of five acquisitions that we would have been completed previously, perhaps now we may only buy the three most synergistic ones.” 12 © The Economist Intelligence Unit 2008 A note of caution Peter Clokey, head of the valuation practice at PricewaterhouseCoopers in the UK, is all too aware of the effect of the credit crisis on asset valuations “Before the credit crunch, we were... expect to increase leverage 39 20 © The Economist Intelligence Unit 2008 Appendix Feeling the pressure? The challenge of enhancing return on equity About the respondents What is your primary industry? In which region are you personally located? (% respondents) (% respondents) Western Europe Financial services 31 20 Asia-Pacific Manufacturing 31 10 North America Professional services 28 10 Eastern Europe... © The Economist Intelligence Unit 200817 Appendix Feeling the pressure? The challenge of enhancing return on equity How satisfied are you with the following aspects of your financial management? Please rate on a scale of 1 to 5, where 1=Very satisfied and 5=Not satisfied (% respondents) 1 Very satisfied 2 3 4 5 Not satisfied Don’t know/Not applicable Overall capital structure 16 42 25 11 5 1 Return. .. Derivatives to hedge inflation Derivatives to hedge inflation 5 3 Equity derivatives Carbon trading instruments 4 3 Covered bonds Equity derivatives 3 3 © The Economist Intelligence Unit 200815 Appendix Feeling the pressure? The challenge of enhancing return on equity Please indicate current measures for the following performance ratios (% respondents) Current ratio (current assets divided by current ... Feeling the pressure? The challenge of enhancing return on equity Executive summary l Return on equity is increasingly at risk As the effects of the tightened credit environment spread from the. .. that acquisitions make a valuable contribution to return on equity © The Economist Intelligence Unit 200813 Appendix Feeling the pressure? The challenge of enhancing return on equity Appendix... on the balance sheet, the most widespread motivation cited by Feeling the pressure? The challenge of enhancing return on equity In deciding how much cash to hold on the balance sheet, which of