Financial Restructuring in Asia: Issues and Opportunities
Tom Pepper and Ian Giddy
Asian financial crisis beginning in 1997 has left most Asian companies
in need of financial restructuring.
of the crisis
crisis stemmed primarily from excessive or otherwise inappropriate borrowing
to finance continued high growth.
1997, high growth had come to seem "only natural," as one after another
Asian company developed systems for profitably exporting lower cost manufactured
products to Western, and in recent years, Japanese markets.Concurrently,
the emergence of new consumer groups in every Asian country seemed to confirm
the "natural" condition of high growth and continuing prosperity.
use of debt to finance business expansion also seemed "only natural," as
newly-established companies lacked an equity base and business-friendly
governments were supplying low-cost debt that, on the one hand, appeared
easy to service in an overall environment of high growth and, on the other
hand, could also be rolled over relatively easily.Problems
would obviously arise if the above conditions no longer applied, but till
then company owners felt no pressure to change to a less expansionist approach.
equity as appeared to be required was typically generated "internally,"
from reinvested earnings, related companies, or individual relatives.This
"minimal" level of equity enabled the dominant owners of a company or group
of related companies to retain management control over their businesses,
but imposed no cost-of-capital constraints on the amount or type of business
expansion.As long as sales growth
exceeded growth in expenses, business expansion appeared cost "free" and
became, in turn, the main measure of business success.
this environment, family-dominated business owners -- or, as in Japan,
surrogate family business executives -- saw no need to share information
or control with outsiders, foreign or domestic.Moreover,
with no apparent cost-of-capital constraints, company owners and executives
also saw no need to monitor how efficiently they were using their capital.
Assets that elsewhere might have been sold off or at least securitized,
thereby freeing up capital to be deployable in higher return businesses,
remained less-than-optimally utilized in existing businesses and on existing
companies' balance sheets regardless of their underlying worth if they
had been subjected to independent valuation.
export-oriented manufacturing firms, whose foreign currency earnings gave
supportive policy makers a rationale for minimizing concerns about over-borrowing,
various non-exporting borrowers also took on high debt levels.If,
as often happened, these borrowings were in foreign currencies, the borrowing
firms -- and, as events later showed, even national treasuries -- were
left disproportionately exposed to adverse exchange rate movements.
particular, property developers in Thailand, Indonesia, and Korea, whose
currencies were pegged to the U.S. dollar, found it advantageous to undertake
arbitrage plays, borrowing in dollars at lower interest rates than in their
home markets, converting these dollars into local currencies, and simply
assuming they could rely on their countries' pegged exchange rates to be
able to service dollar-denominated debt in later years.Such
interest arbitrage plays generated attractive short-term profits (in some
cases stimulating further borrowing to finance still more speculative property
foreign-based currency traders outside Asia noticed this borrowing pattern
emerging, some reasoned that they, too, could undertake arbitrage plays,
and short sell what they considered vulnerable Asian currencies in an expectation
the exchange values of these currencies would fall.Beginning
with the collapse of Thai baht in July 1997, and spreading during the course
of the year to the Indonesian rupiah, Korean won, and Malaysian ringgit,
this in varying degrees is what happened.
local currency values depreciated, local companies that had borrowed in
foreign currencies could no longer service debt payments.As
confidence fell, so did domestic demand, then employment, then overall
growth.Strapped companies could
no longer service even domestic currency debt.
spending by governments, supported in Thailand, Indonesia, and Korea by
IMF loans, sought to stimulate recovery.
line with now standard macroeconomic theory, these stimulative efforts
have worked fairly well, though economists remain typically more cautious
than business leaders, officials, or politicians on grounds the affected
economies still need extensive microeconomic reform to insure against repeated
instances of excessive borrowing.
Corporate Finance Issues:Increased
Need for Equity
as overall growth among Asian economies recovered during the ensuing two
years -- a result of both government stimulus and fortuitous export growth
based on extraordinary growth in the U.S. economy -- most individual companies
in Asia are still left with over-leveraged balance sheets.
such companies to achieve self-sustaining financial strength, they need
increased equity to reduce debt levels.This
need for increased equity raises important issues not previously faced
is such equity to be found?
existing owners accept new equity providers?
will be the effects on corporate control of raising new equity?
issue of growth vs. control arises not only in Asia, but anywhere:Increased
equity is needed to enable a business to grow beyond the limits set by
its debt servicing capabilities and/or retained earnings; yet increased
equity is often anathema in family-owned businesses that are a prevalent
pattern for new ventures and especially prevalent in Asia.Thus,
while well-known traditions of arms-length business relationships in the
U.S., U.K., and associated Commonwealth countries make publicly available
equity (and/or financing from private equity funds) easier to raise and
accept in these countries than in most Asian countries, the underlying
business issues are identical.
in light of the "base case" reliance on debt rather than equity in the
financing of business expansion in Asia, equity may now be in increasing
demand in markets in which traditional financial institutions are reluctant
to continue lending at the same pace and/or using the same "friendly" criteria
as before.Faced with a stark choice
between accepting outside equity or being unable to obtain debt financing
to support expansion, Asian business owners are likely to show "flexibility"
andaccept new equity.Correspondingly,
financial institutions that can identify and sponsor equity investors willing
to accept minority positions in Asia-based companies will themselves be
in great demand.Hence, the sudden
and recent appearance in Asian markets of Western-based private equity
Pressures for Increased Use of Equity
by-products of globalization are also increasing the importance of equity
in Asian corporate finance.
directed or subsidized debt financing -- effectively a system of credit
allocation -- requires protectionism, both from foreign-based lenders,
lest the previously stronger capital structures of these "outsiders" enable
them to offer local borrowers even better terms than the government permits,
and from bankruptcy, lest borrowers take on more debt than they prudently
should and run into trouble servicing this debt.But
such protectionism is now tolerated by other countries less than before.As
Asian countries have grown richer, they can no longer claim to be so poor
as to deserve special treatment.On
an opportunity cost basis, such protectionism is also increasingly expensive,
i.e., relative to alternative uses of public funds or lower taxes as a
percent of GDP; too much subsidization produces a crowding-out effect and/or
higher interest rates.
government-directed credit allocation system also effectively pre-empts
development of a risk-based credit culture:Lacking
systems of credit analysis and price differentiation, banks over-lend;
in the absence of market-determined interest rates, neither borrowers nor
lenders catch signals to slow down existing expansion; a Japanese-type
situation arises, in which the borrowing companies keep seeking sales growth
to the point of over-capacity (and resulting low or negative profitability),
while the lending banks are stuck with under-performing loans they typically
roll-over to maintain nominal asset values.Escaping
from or avoiding altogether such over-lending implies a need to employ
more equity-based financing than traditionally used in Asia.
previous systems of government-subsidized and/or government-allocated credit
come under increasing pressure, the weight of excessive debt levels is
felt by both borrowing companies and governments.As
in Japan for the past decade, a downward spiral ensues:Companies
can no longer service their debt (or find new debt to pay off the old);
as loan repayments decline, banks' liabilities exceed their assets; temporarily,
some banks "survive" through direct government support, as in recent nationalizations
in Japan, Korea, Thailand, Indonesia, and Malaysia; but government finances
themselves also come under strain and the nationalized banks are put up
for sale in a privatization process (in which, in many recent cases, foreign-based
buyers have taken control, as only they have the available equity to purchase
assets at prices the selling governments and their publics consider fair
or at least defensible).
global market in equity returns has limited the segmentation that Asian
financial markets had previously considered "natural."The
relentless search by equity providers for ever-higher returns, coupled
with Asian companies' need for increased equity, leads to an increased
emphasis on profitability (i.e., return on equity), vs. the previous emphasis
among Asia-based companies on sales growth, market share, or net profit
long as subsidized debt financing made the cost-of-capital unimportant,
Asian companies could afford to ignore it.Once
increased equity is needed, however, savvy equity investors will insist
that proposed uses of their money earn a net-positive return – and a return
higher than known alternative uses.In
these circumstances, equity is no longer "free."In
effect, such arms length-supplied equity has a cost that Asia's traditional
"equity" financing didn't have.This
change in the criteria through which equity is supplied in turn changes
the basis of corporate governance, as well as requiring Asian companies
to build considerations of cost-of- capital into business planning.
Market for Corporate Control
demand for arms-length/third-party equity financing gradually takes shape
in Asia -- at least complementing and in due course replacing the traditional
family- or surrogate family-based providers of equity -- an arms-length
market for corporate control will also take shape.
is not yet an immediate issue, in the sense of such a market's becoming
"hot."For cultural reasons, mergers
and acquisitions in Asia will remain predominantly "within the family."Divestitures,
particularly in the form of management buy-outs, will occur more frequently,
however, as companies seeking to raise their returns on equity will look
for ways to divest slow growing sub-divisions and subsidiaries.
a proliferation of divestiture proposals will come a necessary response
in terms of merger and acquisition possibilities.
"un-heard of" proposals to buy or sell companies will in due course appear
March 14, 2000