Until the credit markets froze up, the conventional thinking was that capital markets around the globe were so integrated and efficient that borrowers would discover the same interest rate wherever they sought to find it—this is the analogue in financial markets to the “flat world” thesis of Thomas Friedman and others. I don’t embrace that thesis—as a recent blog posting of mine (“A Curved World”) suggests. Indeed, a recent research article by some colleagues and me finds that equity markets remain rather segmented along country lines. The implication of segmented financial markets is that it will always pay to have a CFO who goes shopping for money around the world the way a consumer goes shopping around town for lettuce: find the greengrocer with the best deal.
A former student who is now living in Santiago, Chile, makes my point. He is Manuel Irarrazaval (MBA ’00), CFO of Endesa Chile, a subsidiary of the big Spanish power company, Endesa SA. He writes (I quote with his permission) “A couple of weeks ago we (Endesa Chile EOC, BBB+) raised US$ 350m in the local bond market at UF (a Chilean inflation index) +4.8%, if we were to swap this to US$ it would come out to +/- 6%. This is extremely cheap for us, our US$ bonds are trading in the secondary market (in the US) at 8.5%.”
He continues with several “Lessons learned:
- Cash is king, and the market rewards you for having it. We did not “need” the money, … However investors welcomed us and praised our prudence in raising an additional 350m. We are ending the year with 850m in cash! …
- You don’t want to risk “testing” your banks. It is true that we have revolving facilities for 400m, the documentation was carefully drafted excluding Material Adverse Effects clauses, the banks are all solid (all European, some quasi state-owned now), but still I told the board that I would rather issue bonds at a higher financial expense than try to draw on those facilities. The bankers involved call me weekly to discuss my plans regarding these facilities and once in a while I will draw some 10 to 20m from them just to keep them “active”, but I don’t trust them for the real thing!
- Lenders are being extremely selective. It is a binary process now, you are a “good” credit, there is financing available; you are not, zero financing available (non negotiable!). I did a very intense road-show with the pension funds and insurance companies in Chile, and the discussion was never about pricing but about credit. Once investors decide they will participate, price is set by the market!
- There are “niche” arbitrage opportunities for borrowers. The world may be falling apart, but pension funds in Chile need to invest, and they have limitations to where they can invest. It is also important that in this crisis of confidence, they feel more comfortable investing in the generation group down the street, where they know the CFO (I went to school with a number of the Investment Managers and my kids go to the same school as theirs!). After we issued the bond, I got a call from the CFO of Endesa Spain (our parent company, AA rated) and he told me that today he could NOT raise $350m in Spain at a rate close to ours!
- Finally, focus on financial expenses, not spread. Unfortunately our investment bankers all talk about spreads, and we end up playing the same game. …[but] this was the lowest coupon bond issued in our history.”
Some years ago, Tip O’Neill, the Speaker of the U.S. House of Representatives, said, “All politics is local.” By this, he meant that someone trying to understand Washington politics would do better to listen to the concerns of people in places like the town halls, diners, and fire stations around the country, than by listening to pundits within the Washington beltway. Manuel’s note tells a similar story: financing and the financial crisis are ultimately local phenomena. The relevance of all this to B-schools is that learning by case studies is a good approach. To be sure, you must learn the grand theories and the tools on which they are based. But it is by studying cases that you learn to seize the opportunities you face in any specific situation. Ultimately, all business is local. To become a master of business, you must prepare to “think local.”
Posted by Robert Bruner at 12/31/2008 05:41:50 PM