Restructuring cure two-dimensional

Restructuring cure two-dimensional

By Inghie Kwik

JAKARTA (JP): Bernd Waltermann, president of PT Boston
Consulting Group wrote an article titled Corporate restructuring
toward growth: 'C' curve, which was published on Jan. 6.

Next to the article, Waltermann produced a graph showing the
trajectory of 58 U.S. companies that underwent restructuring
efforts in the 1990s. The trajectory was plotted along two
variables, with profitability on the vertical axis and investment
on the horizontal axis.

Successful restructuring efforts were shown to move left
(reduced investment), up (increased profitability) then right
(increased investment).

Unsuccessful companies, starting from the same point, were
shown to increase investment with little improvement in
profitability. The total graph depicted the letter "C", hence the
title of the article.

On the basis of this graph, Waltermann suggested that
Indonesian companies follow the C curve in order to emerge from
the crisis with higher profitability and better capital
allocation.

The title and the graph of the article were attractive,
especially since the article was authored by a senior member of a
well-known firm. After careful reading, however, it was clear
that the article was statistically misleading, and that the
advice provided by Waltermann could be wrong for Indonesian
companies to follow.

First of all, for Waltermann to make a general conclusion on a
sample of 58 U.S. companies is simply appalling. Take the
population of companies undergoing restructuring in the U.S. in
the 1990s, and it is reasonably certain that each draw of 58
random samples would provide a different trajectory -- possibly
even representing different letters in the alphabet. With several
million firms operating in the U.S., how can Waltermann provide
any advice merely based on the performance of 58 companies?

From his profession, Waltermann should know that the nature of
a company in distress is simply too complex to be depicted along
two axes. Restructuring alternatives could not be force-fitted
along a two dimensional curve. For distressed companies in
Indonesia, if there were any common underlining symptoms, they
would be excessive debt to equity ratios and dismal productivity
levels, when compared to international standards.

These are not problems that can be solved by simply "doing the
C-curve". In fact, in many current cases of distressed Indonesian
firms, management does not even have the leverage to think along
investment versus profit trade-offs. Their problems are often far
more severe than suboptimal portfolio/resource allocation.

Another flaw in Waltermann's article is the underlying
assertion that for companies under distress, profitability and
investment are mutually exclusive choices.

To provide a simple example, suppose that a widget company is
undergoing financial distress because its manual labor simply no
longer produces products that are cost/quality competitive with
its automated competitors.

The company produces only one variety of widgets, and its
market share is rapidly being eroded by its better competitors.
Suppose that the only way for this company to maintain its share
(and profit) would be to get a bank loan to purchase automated
widget machines and replace its manual labor.

Waltermann's article suggested that such a widget company
should not increase its capital base (e.g. don't get the loan)
but instead find a way to become more profitable before further
investment. Yet in this case, profitability and survivability of
the company depends on further investment.

This may be a simple example, but if Waltermann has been in
Indonesia long enough, he should know that many companies here
face similar conditions as this example shows.

Waltermann's article seems to assume that most companies have
portfolios of businesses that could be easily purged by
management. This is certainly not the case in Indonesia and it is
doubtful that this would be the case in the U.S.

There are many companies that produce single products through
single business units. These companies do not have the freedom to
"clean-up" their portfolios as suggested. Even with companies
that do have portfolios, "cleaning-up" by selling assets in
Indonesia today is probably one of the worse things to do given
the depressed asset values and an illiquid market for assets. Of
course, some companies may be forced to do so in order to pay
back debt, but this is an entirely different issue.

Finally, the nature of company distress should never be
generalized. Of course, as a rule of thumb, the pursuit of
profitability before additional investment is always a good
thing.

Nevertheless, most restructuring cases are far too complex to
follow simple profit/investment trade-off. Problems within
distressed companies could stem from a multitude of internal and
external factors.

Internally, they could stem from weaknesses in human
resources, organization, product development, strategy and
marketing. Externally, they could be caused by changing
technology, changing demand patterns and macroeconomic shocks.

Suppose a company has an excellent product, but is dying
because it simply has no money for a major advertising campaign
during a down cycle in the market. Should such a company refuse
to increase its capital base and opt for profitability. How?

For most unsuccessful turnarounds, corporate distress follows
a spectrum of symptoms that ends with financial disaster. The
beginning of distress is normally characterized by a
deterioration in product, customer and/or distribution channel
profitability.

The next level of distress is a deterioration in productivity
marked by increases in labor/material unit cost, increases in
sales/marketing expenses and/or increases in
finance/administration expenses.

As the company moves closer to financial disaster, its revenue
generating capabilities would deteriorate as characterized by
falling unit sales by customer, product line or distribution
channel. This normally leads to decreasing capacity utilization.

Deterioration in balance sheet structure normally follows.
Debt/equity ratios balloon and current ratios collapse. Without a
turnaround at this level, a firm would eventually face the
inability to pay secondary cash flow commitments such as purchase
commitments and fringe benefits.

Finally, the death blow would arrive when the firm was no
longer able to pay primary contractual cash flow commitments such
as interest payments, taxes, accounts payable and salaries.

Each of the aforementioned symptoms need different solutions
and require careful balancing of complex decisions along many
important variables. At times, it may even become necessary to
increase the capital base (e.g. get a new loan) simply to
continue the payroll, especially when the cost of liquidation
would be higher than the cost of a going concern, even with
additional investment.

Granted, there are times when companies could face a C-curve
decision, but this is only one among a myriad of decisions that a
distressed company faces. Doing the C curve is certainly not the
kind of panacea that Waltermann was trying to portray.

The writer is a businessman with previous experience in
consulting and corporate restructuring.