TWENTY years ago, I sat on Wall Street as an expectant, newly-hired investment banker, being trained in the arts (although there was some science involved) of corporate finance, bond maths, and company valuations. One phrase from a shouty lecturer remains imprinted on my mind to this day. “Life’s just a stream of cashflows,” he bellowed repeatedly, punctuating his otherwise unmemorable presentation with this recital.
Twenty years later, sitting in a very different environment, I am reminded of this mantra as I read and listen to the various and voluminous comments about Islamic State being “tremendously well-funded” and President Obama’s intention to “degrade, and ultimately destroy” the organisation. As numerous commentators have finally grasped, Islamic State is the very embodiment of my lecturer’s catchphrase. It has moved effectively and efficiently from startup to maturity, from reliance on seed capital to a balance sheet stuffed with cash. Life for Islamic State is a stream of cashflows, and the key to degrading and destroying the group is to undermine those cashflows and turn them negative by direct or indirect means.
The Islamic State model comes straight from the pages of a classic corporate finance text book or a Harvard Business School case study. The similarities are remarkable. The group emerged as a “disruptor”, with an enticing product and brand, that initially raised seed funding from rich backers and attracted foreign expertise in the jihadi “war for talent”. Despite setbacks, it strengthened its position until, in the true style of a “barbarian at the gate”, it launched an audacious raid on much larger rivals (the Syrian and Iraqi states), financed by the targets’ own cash-rich balance sheets (namely centres of commerce and oil fields).
To bring about its downfall, we must also turn to lessons from the financial world. As the internet boom of the late twentieth century taught us, the life (and death) of a company is entirely linked to its ability to generate cash from its business or to attract funds from investors at a rate that exceeds the pace at which it burns its cash. Witness the spectacular demise of boo.com, which crashed to earth as a result of an unsustainable cash burn rate, or the rise of lastminute.com, which attracted a stampede of retail investment when it floated on the stock market. These companies flew or failed on the basis of access to the oxygen of corporate finance, cash.
Consider too a more contemporary example such as the rise of Facebook. Had the social network been deprived of cash in its early years, it would have simply been another garage-based idea that failed to stand up. Today, barely ten years later, no one-off financial loss is ever likely to sink the company or any other mature, well-established, profitable firm – observe the ability of large banks to absorb the multi-billion dollar fines applied to them in recent years.
But well-established companies do fail and they fail for a handful of related reasons. Either they overstretch themselves or misjudge their client base, changes in attitudes, fashion or demand. Or, as was famously the case when Gerald Ratner declared the jewellery sold by his eponymous store to be “total crap” and “cheaper than an M&S prawn sandwich but probably wouldn’t last as long”, they undermine themselves by giving customers and clients good reason to desert them.
Thus, while drones, F-16s, and a “coalition of partners” may successfully restrict Islamic State’s advance, we should not expect this approach to “ultimately destroy” the organisation. Islamic State will most likely be the architect of its own demise as its predecessor al-Qaeda in Iraq was too. It will overstretch, it will misread its client base, it will push those that it claims to represent or those whose towns and cities it has seized too far, thus undermining the support and, most importantly, sources of cashflow on which it relies.
The international community’s best chance of destroying Islamic State is to expose the group’s violence and barbaric actions while ensuring there is a better social and economic alternative for its supporters. Islamic State is sufficiently well-established for its future to be in its own hands, and its life will depend on its stream of cashflows. What the international community needs to do is create the environment that leads the group to be the architect of its own downfall, turn cashflow negative, and “do a Ratner”.
Tom Keatinge is an associate fellow at the Royal United Services Institute and a former investment banker at JP Morgan. @keatingetom