What Goes Around

Customer financing seemed like a smart move when times were good. Now, it's wreaking havoc on corporate balance sheets.

It’s no secret that customer financing has backfired badly on telecommunications-equipment suppliers. By the end of 2000, according to McKinsey & Co., nine suppliers — Alcatel, Cisco, Ericsson, Lucent, Motorola, Nokia, Nortel, Qualcomm, and Siemens — had extended an estimated $25.6 billion to service providers. Today, 24 of the 30 largest publicly traded telecom service providers are bankrupt, and write-offs for loans by suppliers to those companies are soaring as a consequence. Anywhere from a third to 80 percent of their loan portfolios is estimated to have gone down the drain; Lucent Technologies and Nortel Networks, for instance, are on the brink of insolvency, while many if not all of the other suppliers struggle to retain their footing.

We, along with others, predicted as much more than two years ago. But with trouble now spreading throughout the economy, the nasty hangover of customer financing is by no means limited to victims of the Internet bubble’s deflation. Boeing Capital Corp., for example, is now caught in the downdraft of United Airlines’s bankruptcy after financing a significant proportion of United’s aircraft. Liquidity concerns confront Ford Motor Co. and Sears, Roebuck and Co. because of the huge short-term liabilities they’ve taken on to finance sales in the face of sagging demand. Even General Electric Co., a master of financial services, is finding that lending to others is far more of a burden than almost anyone imagined it would be during the roaring 1990s. (See “Whither GE?” later in this article.”)

To be sure, these companies take a wide variety of approaches in their financing activities, reflecting fundamentally different objectives. For New Economy companies such as telecom suppliers, financing is (or was) a tactical means of developing markets for new technology. It remains that for Dell Computer Corp. and Microsoft Corp. as they seek to support more small and midsize businesses. For more-mature companies, such as Deere & Co., Ford, and Sears, lending to customers helps sustain growth during periods of economic difficulty. And for more-diversified companies, though none as much GE, financing represents a strategic foray with indirect bearing at best on much of the rest of their operations.

Overall, corporate reliance on financial services is pervasive. A study of the Standard & Poor’s 500 by Morgan Stanley in June 2001 showed that even without taking into account leasing and vendor financing — or, for that matter, equity and pension investments — financial services accounted for roughly 25 percent of the index’s total earnings. Morgan Stanley says the percentage has increased since then, to 28 percent.

And all companies involved in customer financing face the same basic challenge: how to manage both the leverage and credit risk that lending, leasing, and the like pile onto balance sheets, or spill into intricate but questionable off-balance-sheet transactions. “Whether it is selling underwear, jet engines, or routers,” observes Steve Galbraith, chief equity strategist at Morgan Stanley, “when a company begins to rely on the financing part of its operations to generate earnings, its risk profile almost by definition becomes more complex.”


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