November 29, 2012, 1:03am
FACED with the most severe downturn since the 1930s, corporate confidence has declined. Recent research from Ernst and Young revealed that company executives are more pessimistic about the current state of the global economy now than they were a year ago. But more interestingly, given the Bank of England’s recent growth forecast, over 78 per cent of respondents still expect a recovery within two years.
This combination of short-term pessimism and longer-term optimism is leading UK businesses to sit and wait for things to improve, creating a bias towards risk avoidance and inertia. UK corporates are sitting on over £700bn in cash, equivalent to around 50 per cent of GDP, but despite these cash stock piles and adequate access to capital, executives are waiting for a sustained recovery before engaging in business investment and mergers and acquisitions (M&A).
There will be a recovery, but the world is not going to return to the boom of 2005 to 2008. In the pre-crisis decade, emerging markets grew faster than their long-term sustainable growth rates, driving up commodity prices and inflation. Excess savings in emerging markets were exported to western economies, contributing to the explosion in credit that fuelled developed market growth. The world will be working off this excess for the next decade and economic growth will be below trend, particularly in Europe.
Ernst and Young is concerned that, in waiting for the upturn, corporates have not recognised that they will be facing a very different environment. The harsh reality is that low growth is the new normal. Some businesses are using historic decision criteria, developed in the pre-crisis decade, to plan for the future and this means they are at risk of inefficiently using their capital.
Take, for example, asset values. Quantitative easing (QE) is distorting values by pushing down government bond yields and increasing the demand for other asset classes like equities, raising their prices. Our research suggests that current UK transactions levels are 30-40 per cent off where current stock market values suggest they should be, as value and the underlying business economics have seemingly become disconnected. As the impact of QE fades over time, the values of these assets could fall. So rather than waiting to realise unrealistic value expectations, divesting today would free up cash to acquire other assets, opening up opportunities for growth.
Similarly, businesses considering acquisitions need to act now to identify and integrate those assets, to strategically position themselves in their chosen markets. Failure to act could lead to businesses playing second fiddle to their competitors.
Now is the time to undertake a review of business models. Is the cost structure and operating model sufficiently flexible for a low growth world with more pressure on margins and price aware customers? Portfolio rationalisation must be considered, both in terms of geographic footprint and product lines, to assess whether the market offers sufficient growth opportunities. If not, then conducting M&A or investing into a higher growth market and jurisdiction should be a focus for the business to ensure it is placed exactly where the optimum growth opportunities exist.
Jon Hughes is head of Ernst & Young’s transaction advisory services practice.
head of Ernst & Young’s Transaction Advisory Services practice,
Critically, companies must adjust their strategies and decision criteria to reflect the future economic reality, not that of the past. In a market like this, where good opportunities exist for those corporates with an eye for a deal, fortune will favour the brave. Value and growth are not going to be created by waiting for a major upturn that is a long way off.