Arranging almost $3 billion in financing for two different deals in emerging markets, simultaneously, would never be a cakewalk. But during the fourth-quarter of 1998, the financial markets were unusually tremulous. The state of affairs, in fact, was described by thenTreasury Secretary Robert Rubin as “the most serious international financial disruption of the last 50 years.”
Nonetheless, Andrew S. Fastow, CFO of $31.3 billion Houston-based Enron Corp., the world’s largest private developer of energy-related infrastructure, was able to close on $3 billion in borrowings between July 1998 and May 1999–$1.8 billion to build the second phase of a power plant in India and $1.3 billion for an acquisition in Brazil. And key to his success, he says, were Enron’s “profitable and mutually beneficial relationships with the 29 international banks that make up our Tier 1 and Tier 2 group”–the large lenders that have repeatedly participated in Enron’s efforts.
That, however, is not the full story. Enron’s ability to put together these two lending syndicates during tumultuous times illustrates several “musts” for corporate borrowers in emerging markets. For one thing, says Fastow, you must distinguish between countries in which it makes sense to invest capital and those in which you do business. In the latter category, for example, is Russia. “There’s lots of business to do, but it’s hard to invest there,” he explains. Beyond that, he says, you must protect yourself against worst- case scenarios. In Enron’s case, that means “building all underlying businesses to be dollar-denominated. Sometimes, we are actually paid in dollars; at other times, our contracts adjust and settle on a monthly basis, indexed to the dollar.”
Such tactics reflect lessons learned by U.S.- based corporate borrowers during two years of convulsions in the emerging-market countries. Those convulsions were precipitated by the Thai central bank’s decision in July 1997 to float the baht, which rapidly led to currency devaluations in Indonesia and Korea. Asia’s pneumonia quickly became Latin America’s influenza in January 1999, with the devaluation of the Brazilian currency (the real). And sandwiched between those events was the Russian default on its sovereign debt in August 1998. Complicating matters was that “no one foresaw the sudden massive erosion of loan values once market sentiment changed and exchange rates collapsed,” says a late September report by the International Monetary Fund (IMF).
And while positive macroeconomic growth has returned to Asia and Latin America, the hangover from 1998 reinforces the need to assess what worked and what did not for multinational borrowers during the crisis. In such unstable environments, says David Schoenberger, CFO of Compania Anonima Nacional Telefonos de Venezuela (better known by its acronym, CANTV), “You have to be in tune with the markets,” he says, “and keep a finger on their pulse.” If not, “companies can find themselves in a position in which it is either impossible or extremely costly to raise needed funds.”
It’s little wonder that many borrowers were not prepared for the currency crises. Until 1997, the allure of the emerging markets had been overwhelming. From 1965 through 1995, in fact, the economies of Japan, Hong Kong, Republic of Korea, Singapore, Taiwan, Indonesia, Malaysia, and Thailand together logged an average annual growth in gross domestic product (GDP) per capita of close to 6 percent. Add China to this crew–the behemoth economy of 1.3 billion people–and you get the dazzle of enormous potential with the underpinnings of a sturdy work ethic, burgeoning middle classes, and the possibility of compressing several stages of industrial development.
But the “long-running success of those economies,” according to the IMF report, obscured structural shortcomings in the region- -high levels of corporate indebtedness, lending based on cronyism rather than sound credit analysis, and generally weak regulatory authorities. In June 1997, for example, a matter of days before unpegging its currency, the Thai central bank reported $33 billion in international reserves, omitting its commitment of about $25 billion in forward contracts.
Not surprisingly, many of these structural issues are slow to fix. For example, the new bankruptcy codes in Thailand, Indonesia, and South Korea are not as effective as expected. Loan workouts are hobbled by weak disclosure laws, as well as by the social stigma attached to bankruptcy. Because of that, “corporate debt restructuring has been lagging, and now is delaying the bank restructuring process,” says the IMF. That’s less true in South Korea, where government support is pushing the banks to lead corporate restructurings. But the sheer volume of nonperforming loans in “the three crisis countries [Thailand, Indonesia, and Korea] and Malaysia…is massive,” the IMF report continues. It estimates the gross costs of bank restructurings in these four countries to be anywhere from 15 percent to 45 percent of GDP.
Having a solvent banking system, however, is one of the preconditions Fastow cites for investing in or entering a country in any way. The others he insists on are a well-developed system of contract law, an independent judiciary, and compliance with the Foreign Corrupt Practices Act. While Fastow admits that the likelihood of all emerging-market countries meeting these criteria anytime soon is slim, his attitude is “don’t compromise.”
Eastman Kodak treasurer David Pollock agrees that meeting certain thresholds for doing business is vital. But so is making contingency plans just in case, he says. Pollock, who joined Rochester, New Yorkbased Kodak in 1995, after 27 years primarily in international finance with IBM, was given a mandate by colleagues Jesse Greene Jr., currently the acting CFO, and Greene’s predecessor, Harry Kavetas, who died suddenly last May, “to strengthen the treasury’s international operations, especially for the emerging markets, which they identified as a major opportunity.”
Central to this globalization effort was developing personal relationships with key lenders. “In the architecture of our key relationship banks–a group of 35 global banks that we put together in 1996 — we made sure that we had good reach into the developing countries where we do business,” reports Pollock. “We have somewhere between two and four global banks in each region, sometimes in a given country, in which we are well acquainted with their executive-level managers for that locality.” Pollock can lay out his needs to that executive, and after that, “it’s simple: ‘Please get your local people to deal with ours.'”
In several instances, those relationships proved crucial to resolving an impasse in a troubled country within 24 hours. “In the Philippines, for example, in the middle of the crisis, when the flight from the peso to the dollar was precipitous,” recalls Pollock about the late summer of 1997, “our local affiliate was trying to buy dollars to pay for intercompany goods. [The Kodak enterprise in the Philippines is a wholly-owned subsidiary that imports film and paper to sell to dealers and distributors.] It took one phone call to our relationship executive in a multinational bank to get access to those dollars,” says the Kodak treasurer.
Similarly, in Russia, in late August 1998, “we ran into a payroll issue. Our local bank did not show up with rubles on payday about one week into the crisis,” recounts Pollock. “But three of our bank group work with us in Russia, and once again, we reconfirmed the importance of our contacts with senior executives in those banks,” says Pollock, adding, “We had an agreement the same day with banks in adjacent time zones.” The following day, Kodak’s Russian affiliate met its payroll.
A Delicate Balance
Kodak’s experiences in the Philippines and Russia point out a basic precept. The balance between multinational corporations’ reliance on their international banks and on their local-market banks tips periodically, and to some extent that rebalancing is cyclical. During the crisis, in fact, a few multinational banks–for example, Citibank, Chase Manhattan, Bank of America, J.P. Morgan, Deutsche Bank, ABN Amro, ING, Société Generale, and Banque Nationale de Paris– gained market share. Since July 1997, for example, Citibank has increased its market share in just about every country in Asia, a fact that the bank confirms without supplying specifics.
But in general, lenders’ appetites have contracted in emerging markets, among both multinationals and the local banks. A recent Barclays Capital report estimated that some $93 billion in international bank funds had been withdrawn from Asia between July 1997 and July 1999. And local banks are reeling from the inability of their local borrowers to meet their obligations. In July, Merrill Lynch surveyed 166 major companies in Thailand; among them, 67 were not paying interest on their loans. In Latin America, “I’ve seen wholesale swings in market share for consumer banking in the double digits,” says Thayer Jack, a partner in KPMG LLP’s consulting practice who specializes in global banking.
Bearing in mind the caution that such frailties warrant, for certain services– payroll, for example–local banks are still essential. In Latin America, the consulting firm Tillinghast Towers Perrin moved its banking relationships away from its local banks in Latin America to its multinational banks during the peso crisis of 1994 and early 1995. “But now we are back with some of our local banks,” reports John Nigh, a principal with the Stamford, Connecticut-based firm and the financial services practice director for Latin America. The locals, he adds, in general have been retail bankers in their communities far longer than the multinationals.
Malcolm McAuley, CFO of Caltex Corp., a Singapore-based joint venture between Chevron and Texaco, echoes a different facet of that opinion: “The national banks here [in Asia] have valuable insights into the economies.” While insisting on certain standards of quality, McAuley adds: “We have to manage long- term relationships. There cannot be a permanent skewing away from the local banks.”
Ironically, the crisis has actually improved some local market banking practices. “It’s been tough to hedge the risk of foreign- exchange swings effectively when the local lenders have taken 60 to 90 days to let you know what your exposure is,” says KPMG’s Jack, referring to the paucity of basic data and analytical ability in Latin American local banks. In the United States, he notes, the banking industry made incremental progress on this front–developing its information technology infrastructure–over the past 15 years. In Latin America, local bankers are being pressured to make these transitional leaps in a matter of months. A wave of mergers and acquisitions, particularly purchases by foreign banks, hit Latin America in late 1996 and early 1997, infusing the system with capital and the opportunity for wholesale change.
When Politics and Banking Mix
No matter what the balance between local and foreign bankers, executives have to be prepared to deal with local politics. In Enron’s $1.8 billion financing in India, the second phase of its Dahbol co-generation plant in Maharashtra province, local banks provided two-thirds of the capital. Still, the first phase of constructing the 1,624 megawatt producer of electricity was stalled for two years because of local political shifts. The party in power at the state level changed not long after the deal’s initial agreement. “Meanwhile more than 20 lawsuits were filed against Enron, alleging everything from fraud to criminal activity. All of which have been dismissed or ruled in the project’s favor,” says Fastow.
“We finally had BJP’s full support,” he adds, referring to the litigious party that had opposed building the plant at the outset. Winning the confidence of the Indians, who had used the project as their political football, was also critical to another constituency. Fastow is convinced that Enron’s perseverance with Dahbol’s first phase is a “great example of what bankers are looking for: we did not cut and run.”
But persistence can also run into dead ends. In September 1997, when the financial crisis was first hitting Southeast Asia, then- Indonesian President Suharto suspended an Enron project in East Java, the building of a 500-megawatt gas-fired power plant. Enron had lined up political risk insurance through the World Bank, and for several months, has been trying to collect on its claim.
Emerging Motto: Be Prepared
Political uncertainty is only one pressure that continues to dog multinational borrowers in emerging markets, however. Despite the good news about macroeconomic growth rates, for example, the region remains volatile. Indonesia’s banking system, for example, is going through another frisson of uncertainty. A new layer of corruption is being unveiled in the relationships between Bank Bali and the year-old government of Premier B.J. Habibie. And in late September, Ecuador defaulted on its sovereign debt payments, another reminder of fragility in Latin America.
Nonetheless, Enron’s Fastow is brimming with confidence. Unforeseeable problems arise, he says, but the rewards more than warrant the risks. Besides, he points out, finance executives can design the structure of currency and liquidity exposures–for ongoing cash needs, for debt payments, and for the bottom line. In Brazil, as in all markets with wild currency fluctuations, “you simply cannot buy a 15-year hedge of the real,” he asserts. But the company’s dollar-denominated, 15-year contracts serve that purpose.
And perhaps most important for managing financings in these uncertain markets are a cool head and a long-term view. In describing the ups and downs of the first phase of Enron’s Indian power project, Fastow says, “many managers would have been too bewildered. But for both the Indians and Enron,” he continues, staying the course brought “a grand-slam home run.”
———————————————– ——————————— Managing Political Uncertainty
For CANTV, in Venezuela, financing turmoil is the norm. In 1997, optimism reigned at CANTV, the telephone company formally known as Compania Anonima Nacional Telefonos de Venezuela. Positive market and political conditions allowed the company to raise $200 million in a Yankee bond offering in February of that year.
The deal couldn’t have worked out better for CANTV, which is operated by a GTE-led consortium (including AT&T, Telefonica de Espana, the Venezuelan bank Banco Mercantil, and Electricidad de Caracas). The bond issue had a weighted average cost of 9.05 percent, and was used to pay off previous debt, which had an average cost of 11.78 percent. One month later, March 1997, the market for bonds had risen to 9.50 percent.
The timing of CANTV’s next major financing–a $150 million bank loan from the International Finance Corp, a subsidiary of the World Bank– was equally fortuitous. The floating rate note deal was completed in March 1998, before the cost to raise funds increased to the prohibitive levels of late 1998.
But CFO David Schoenberger insists that luck was not a factor. “Twelve to 18 months ago, we evaluated the uncertain macroeconomic and political horizon, and took several steps to prepare for difficult conditions,” he reports. Those steps included shelving plans for new debt and beefing up the company’s collection of receivables. In spite of a recessionary economy with 20 percent unemployment forecast for year-end 1999, uncollectible receivables were down to 6 percent this past June, from 13 percent at year-end 1998.
Prompting Schoenberger’s actions were not only the turmoil in the financial markets, but also the December 1998 election of President Hugo Chavez, a former army colonel who led a coup attempt in 1992. While it is unclear whether President Chavez will alter the calendar for telecommunication deregulation (CANTV’s exclusive right to offer phone services in the country expires in November 2000), he has already called a constitutional assembly to rewrite Venezuela’s magna carta.
But Schoenberger remains optimistic. He points out that CANTV has solid long-term relationships with foreign and Venezuelan banks to fall back on. In addition, the company has been reducing its net foreign- exchange liability position during 1999, moving from $547 million on December 31, 1998, to $411 million by March 31, 1999, and $265 million by June 30.
Besides, Schoenberger also has experience with political uncertainty. When the venture was first formed, in late 1991, for example, the country was headed by Carlos Andres Perez, a noted advocate of free markets, who was forced to resign from office in 1993. In 1994, intense economic turmoil began when 34 percent of the country’s banks, representing 50 percent of the system’s deposits, passed over to government control.
A change in government followed in 1994, and soon after, price and exchange controls were enacted. The result: CANTV defaulted on millions of dollars in overseas loans due to the inability to obtain U.S. dollars. (The subsequently restructured debt was paid in full through several transactions, the last being the February 1997 Yankee bond issue.)
Finally, in 1996, the government lifted foreign-exchange and domestic price controls, and later that year the government sold its one-third interest in CANTV to the public in an IPO. GTE increased its stake to 26.4 percent during the IPO and in another transaction in 1998.
Given such experience, Schoenberger is cautiously optimistic about the latest macroeconomic and political environment. “The proposed constitution has the same basic protections and guarantees as the old one,” he says.