Stock markets in the US, UK and other markets around the world are hitting record highs. Loss-making Technology companies are raising hundreds of millions of dollars. The top 5 publicly traded companies by market cap (ca $2.3 trillion total) are all cash rich, growing Technology companies (Apple, Google, Microsoft, Amazon and Facebook).
Everything is OK, right?
It’s easy to be fooled by rising stock markets.
Markets are rising because they’re inflated by a world bathed in low and negative interest rates, which are a symptom of our fragile, uncertain world.
But are these “symptoms” now also becoming a “cause” for what comes next? What does all this mean for CEOs and business leaders?
A few years ago the term “negative interest rate” probably wasn’t even in the dictionary. Now we don’t even think twice about it. Negative rates almost seem normal.
Global bond yields are at the lowest levels in 500 years of recorded history. The value of negative yielding bonds in the world has grown to $13.5 trillion – it’s the biggest bond bubble ever.
Yes Brexit is a problem but let’s put that to the side. Europe ex-Germany is flirting with recession, indebted beyond any hope of growing out of the problem.
As an example, Italy has just exited the European budgetary agreement to face ever-higher deficits and ever-greater debt, threatening to rival Greece. Italian debt is 132% of GDP today, and if the country enacts its announced tax and spending policies, it will likely soon be facing 150% debt to GDP. And rising.
What if the ECB stops buying Italian bonds and allows Italian interest rates to go to market rates? It would likely blow Italy out (like Greece) and force Italy to leave the European Monetary Union. Does this mean the ECB might have to keep buying Italy’s debt, no matter what Italy does?
Japan has been lost in 20 years of growth paralysis. The Japanese have tried using negative interest rates and massive deficits as a magic trick to bring the Japanese economy back after 20 years, to no avail.
In the US the Fed’s ultra-easy monetary environment has produced a wimpy 1% GDP growth over the last six months (the last seven years has been the weakest US “recovery” since WWII), almost no productivity growth, and an employment reality in which seven million men between the ages of 25 and 54 – prime working age – are no longer even looking for work.
It would seem the only way one can possibly think the Fed’s monetary policy is working is if you are measuring it only by the Dow Jones average (which is not what most people in the real world actually think about when one thinks of a thriving economy).
This isn’t normal, folks. This is serious.
Why do we talk now about the economy and debt and interest rates rather than about Technology company valuations and M&A deal trends?
Because something has clearly gone horribly wrong in the world and it matters – not just to investors and lenders but to business leaders too.
It’s been 8 long years since the last crisis. We are due for another one soon, whether we like it or not.
The current bond bubble is massive – it’s the “mother” of all bubbles. One day, this bubble, like all bubbles, is going to burst.
Instead of worrying about what has caused this bubble to grow, and instead of trying to fix it or, hell, even ride it, we as company leaders are worried about being prepared for when it bursts.
It’s easy to be lulled into thinking that everything is ok.
It’s almost automatic to assume in our business planning that the market environment will always be as it is now.
But that would be a mistake. The only constant is change.
As a company leader, it is the “what you don’t know / what you can’t control / what you’re not prepared for” that will kill you – kill you more than your competition, more than your disgruntled poor performing staff, more than losing a law suit or even more than unhappy customers – more than almost anything else you can think of.
And it can happen very quickly.
In the 2008/9 most Technology companies lost 40-50% of their enterprise value in just a few months.
Our Recent Survey – Most UK / European CEOs Just Aren’t That Worried
Just after the Brexit vote we decided to find out if our core audience and client base – CEOs of UK and European Technology, Media/Internet and Telecoms companies – were concerned or not about market uncertainty, and whether or not they had a “Plan B” in place to execute in a crisis or market crash.
Our team, in conjunction with The Tech CEO Roundtable, conducted a survey in which 150 Technology company CEOs in the UK and Europe replied. We asked them two questions:
- Do you believe uncertainty in the markets will negatively affect your company’s orders or revenue in the next 12 months?
- Do you have a “Plan B” in place to act on immediately as soon as you see the next market crisis or crash potentially severely affecting your business?
The results surprised us.
72% of CEOs said they are not concerned by market uncertainty and didn’t believe that market uncertainty would negatively affect their company’s revenue in the next 12 months.
In the UK, even after the Brexit vote, 61% of CEOs say they are not concerned about market uncertainty affecting their revenue in the next 12 months.
Even more surprising was the fact that 41% of the CEOs say they have no “Plan B” to act on in the next market crisis or crash.
In the UK, even after the Brexit vote, 43% of CEOs say they do not have a “Plan B”. Only 50% of Spanish CEOs say they have a “Plan B”.
In contrast, 74% of Dutch CEOs say they do have a “Plan B.”
The Consequences? Ouch!
Now you might ask, why does any of this matter if you’re running a healthy business, ie you’re growing revenue, you’re growing profits, you’re growing EBIT margins and boosting ROIC? You’re focused on your business – your customers, products, services, staff, suppliers, shareholders, regulatory bodies, competition and future industry developments. You’ve got it all in hand. Yes?
Well, let’s do a check on that. Let’s say you’re an SME with a relatively steady $100m in revenue, a 50% GM and a comfortable $10m in EBIT.
But then a global market crash hits (“where did this come from?!”). Capital and confidence withdraw from the market. Stock prices fall. Companies terminate contracts, cut staff, reduce budgets. Banks stop lending. Investors hold on to their cash.
Within a matter of six to nine months your company’s revenue falls by 30% to $70m. Your gross profit falls by $15m to $35m. Without cutting opex your “comfortable” profits have just been wiped out and now you’re looking at a $5m loss.
You can cut opex to try to reduce your losses but it might be too little and too late. Cutting opex also has nasty side effects such as reduced sales, poor customer service, angry suppliers, more complaints on social media, poor staff morale, and so on, especially when you cut into the meat.
So you ask “wait, what do you mean 30% revenue loss? Our revenue is solid – we have long-term contracts in place with customers who have been with us for years. They’re not going away.”
You might be right, but in a market crash environment, contracts have a terrible habit of getting terminated. Your customers will terminate their contracts with you if theircustomers have terminated their contracts with them. And so on. This vicious circle includes banks terminating credit lines. The wider and deeper the crisis, the wider and deeper your problem becomes.
Moreover, if the losses you experience in a market crisis are cash losses, then from where are you going to source the cash to fund the losses and the turnaround / recovery?
If in a market crash you cannot raise any cash because the banks have stopped lending and investors have stopped investing (and they will stop lending and investing), then you have a big problem, unless you have a large net cash balance.
Don’t expect your PE or venture capital investor(s) to automatically bail you out with rainy day cash. You have no idea what they are going to do. They don’t even know what they are going to do.
And by the way even if you do have a large net cash balance your company valuation is still likely to fall 30-50% in a market crash. This matters because it affects the value of management share options, which can hamper staff recruitment and retention. A lower valuation also means down rounds, limits your ability to do acquisitions for shares and reduces your prospects for an exit.
And in general it can make you pretty damn miserable person, which doesn’t do anyone any good.
Of course not every company faces such a bleak scenario in a market crash.
But many will.
No matter what type of company you run and no matter what sector you’re in, your company is at risk.
We don’t know when the next market crash will hit.
We don’t know which of the many possible causes will cause it.
But we do know one thing – a crisis will hit.
Sometime. Probably sometime soon.
And it could be ugly – deeper, and longer, than the crisis of 2008/9.
Bottom line – if you’re the leader or CEO of a company who
- wants to be prepared
- wants to be able to preserve your company’s performance in a market crash or crisis
- welcomes a market crash just so you can crush your competitors who begin failing because they were not as prepared as you were,
Then there is one thing you need to have.
You need to have a “Plan B”.
To Your Success in Good Times and Bad,
- Paul Cuatrecasas, Founder and CEO