Monday, July 02, 2007

Asian Financial Crisis – Lessons Learnt 10 Years On

The Straits Times recently wrote some articles on the Asian Financial Criis 10 years on, to review on how the Asian countries are doing after the infamous crisis back in 1997. They also highlighted examples of people who had gone through that difficult period and survived, as well as some who did not manage to pull themselves through. In terms of companies and the stock market, some articles were written on Thakral, Goldtron and the CLOB debacle as well as the crashing of the stock market to below 1,000 points. Below is a review of the significant learning points (summarized and analyzed from the articles written):-

Companies with high leverage (debt)

Many companies had borrowed heavily during the boom years when interest rates were attractive and banks were courting companies for more loans in order to increase their business. When the currency crisis hit, the Central Banks in many countries raised interest rates in order to protect their currency from being de-valued. This resulted in massively high interest costs for companies which were over-leveraged, and many of them had to make provisions as well for loans given out to associates and subsidiaries located in crisis-hit areas as the debts became uncollectible. These huge write-downs and write-offs hit these companies hard and many struggled to stay afloat as even their ability to generate cash was in question. Lesson Learnt: Beware of companies which borrow heavily in order to finance their expansion. High gearing is never a good sign as it shows that the company may not have sufficient FCF (Free Cash Flow) to sustain its operations, thus it has to resort to borrowings.

Living Within Your Means

It’s important to start building your wealth at a young age as Warren Buffett always stresses on the incredible effects of compounding. During good times, irrational exuberance and complacency tend to take over rationality, and people have a tendency to take more risks (as they do not want to miss out) and spend more too (as the good times never seem to end, fat bonuses are being paid). Of course, the fatter pay checks and higher bonuses also make people spend more, in the sense that they increase their fixed expenses much more than they would have in normal times (e.g. more instalment payments, more expensive car). This increased fixed expense is a financial commitment which many people don’t realize until the bad times come along. When the economy goes into a slump and jobs are shaky, it gets very difficult to cut out these higher fixed expenses as they are already part of your life. Lesson Learnt: Always compute your tolerable fixed costs assuming the WORST (e.g. losing your job or getting a pay cut) and to be able to explain why you are increasing your fixed expenses. This keeps one’s head on the ground (instead of in the clouds) and allows for accountability.

CLOB Shares

The market meltdown also spread to the CLOB (Central Limit Order Book) shares in Malaysia, causing the government to freeze all trading in CLOB as a form of protection against the devaluation of Malaysia’s currency. About 170,000 investors were “stuck” and had their monies locked up for a long period of time, without much recourse (at the time). This episode shows the risk of investing in stock markets, especially one which was an informal and loosely regulated over-the-counter (OTC) exchange. If one counts on liquidity as a reason for investing in equities, then all I can say is liquidity can dry up almost instantly without reason (as it did in the CLOB debacle). Lesson Learnt: Always be mindful of the risks involved in investing in equities. Extreme volatility is commonplace and should be expected (remember the allegory of Mr. Market ?), and liquidity could dry up very quickly as well (especially if a counter is suddenly halted or suspended for whatever reasons). Learn to keep a spare cash fund for emergencies and don’t sink 100% of your net worth into the market.

With markets trading at all-time highs now, it is easy to forget the hardship suffered by many during that turbulent and tumultuous period in 1997. It is always prudent to keep oneself aware of the overall health of the economy and to follow business news closely in order to anticipate a possible relapse of this financial disaster. One should buffer against this by keeping spare funds and understanding the nature of the human psyche. If successful, you will be on your way to building long-term wealth.


Anonymous said...

Hi musicwhiz, as far as debt is concerned, what are the differences when companies borrow direct from bank, through share placements, through CB? Can their all considered equally bad when business expansion required $?

musicwhiz said...

I think the main difference is the interest rate ! Haha nah kidding. Actually, your question is harder to answer than most as it really requires a dissection of each method of financing.

Suffice to say that all debt instruments come with interest expense components, and these affect the P&L and thus profit. For equity issues, they go directly to share capital and affect EPS. Thus, a company should have a good mixture of both in order to even out their interest expenses and prevent too much shareholder dilution.

Debt is never strictly good or bad, it's just how you make use of it. Hope this helps !

Anonymous said...

It certainly do, musicwhiz. I was wondering if higher gearing for pacandes is a concern given that its business expansion require funding, mainly through shareholders pouring in more cash. In a way, it require more conviction from the part of the shareholders that its future businesses will continue to perform as in the past. Can I request you do a estimate of its intrinsic value having taken the bigger percentile of CFG?

musicwhiz said...

Hi Anonymous,

That's a very good idea ! In fact I was thinking of doing an intrinsic value analysis for PAH assuming the 63.9%, but decided to wait till they released their 1Q 2008 results in order to get a better indication of revenue growth, earnings growth and margins. Just be patient and check back often, I will definitely be doing an analysis some time in future !