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The Declining Dollar

How companies are coping.
Kate O'Sullivan, CFO Magazine
February 1, 2008

For every penny the euro increases against the dollar, United Technologies Corp. records an additional $10 million in earnings. A diversified manufacturing behemoth that earns more than 60 percent of its revenues outside the United States, UTC received an earnings boost of about $100 million last year as the dollar slid against the euro — and slid, and slid a little more. Despite its far-flung revenue streams, the company has never done any financial hedging, says vice president of accounting and finance Greg Hayes. Instead, UTC relies on what are essentially operational hedges: ensuring that it manufactures its products in the markets where they are sold. "The key is to manufacture locally and not put yourself into situations where you're affected by things you can't control, like foreign exchange," says Hayes.

With the dollar at its weakest point in a decade, protection against currency risk looms ever larger on the CFO's agenda. For U.S. manufacturers selling into Europe, the dollar's decline has been a boon, allowing them to accelerate overseas growth and boost earnings by 5 or 10 percent. But for other companies, particularly those based in Europe, the prospect of a permanently weaker dollar has heightened the need to diversify their operations, causing some to consider moving manufacturing facilities to a suddenly lower-cost United States. In Asia, rapidly rising currency values have CFOs thinking about ways to protect the margins on their extensive U.S. sales.

While companies have long used financial hedges for short-term currency problems, the fact that businesses are changing their operations in response to the dollar's fall suggests they suspect that the greenback's weakness may be a long-term phenomenon. According to the most recent Duke University/CFO magazine Global Business Outlook Survey, a stunning 50 percent of Europe's CFOs and 60 percent of Asia's think the decline in the dollar represents a permanent devaluation. A third of their U.S. counterparts agree.

"I think it's a fundamental adjustment," says Charles Kane, CFO of investment firm Global BPO Services and a lecturer on international finance at the MIT Sloan School of Management. "There are a lot of factors driving the dollar down." And it could fall still further, for example, if the oil-exporting countries decide to peg oil prices to another currency or to a basket of currencies.

Even those who say the dollar will bounce back are moving to protect themselves from the downside or to take advantage of its current underdog status. "The dollar has fallen too far too fast, at least relative to the euro," says Scot Carlson, former CFO of Black Diamond Equipment, a small climbing- and ski-equipment manufacturer based in Salt Lake City that sells one-third of its product in Europe but manufactures in the United States and China. Still, he says, "to be a global player, it has become increasingly important to hedge your bets."

Seizing the Day
Not that a sagging dollar is altogether bad news. The earnings benefit for companies with overseas sales is undeniable. According to the Duke/CFO survey, half of U.S. CFOs with significant international sales have seen a benefit from the dollar's decline.

For Compact Power, a small manufacturer of landscaping and construction equipment based in South Carolina, the falling dollar has meant a rapid rise in the company's overseas sales. The $100 million company began selling internationally two years ago, has doubled its international sales in the past year, and plans to double them again in 2008. "We've absolutely accelerated our international growth because of the exchange rate," says CFO Norman Boling. "The falling dollar has made us competitive in markets where we're up against established competition."

Compact Power quickly developed two diesel units to distribute in England this year, and has entered into a distribution agreement with an Italian manufacturer to sell that company's product — tractors — in the United States. To address currency fluctuations, the two companies agreed on a rate in their contract, a strategy Compact Power plans to continue with other partners going forward. While the manufacturer does not do financial hedging, "by locking down the exchange rate at which we purchase, we can take out some of the risk," says Boling. Trade partners have been willing to agree on rates in their contracts because the practice removes uncertainty for them as well. "We might feel a pinch here if the dollar goes back the other way," says chief operating officer Michael Edwards. "We're developing sources out of Europe and other regions so that we can play the other side when that happens."

U.S. companies are also seeing a boost from the dollar's weakness at home, as tourists from overseas flock to stateside shopping centers. Stephen Sterrett, finance chief at Simon Property Group, the largest shopping-mall owner in the United States, says foreign travelers have provided a big boost to the company's malls and outlet centers in the past year. "We have seen a disproportionate impact on sales in centers where there are a significant number of international tourists," says Sterrett. "The foreign tourist's purchasing power is greater than it has ever been before." While European tourists have packed Simon's East Coast locations, the company's shopping centers in Houston have welcomed an influx of travelers from Mexico and South America. Shoppers from Canada have bolstered sales at malls on the northern border as the Canadian dollar has reached near-parity with its U.S. counterpart.


Like UTC, Simon is largely operationally hedged. Although most of its business is in the United States, it operates 50 properties in Europe, where it reinvests profits in its local operations. "Our leases are in local currency, we borrow in local currency, and we're using our profits to reinvest locally," says Sterrett. "We have a natural hedge."

Making Adjustments
For companies that have significant costs outside the United States but recognize much of their revenue in dollars, the picture is not as rosy. In a striking change, many are considering moving manufacturing operations to the United States to reduce costs. European carmakers like Fiat, BMW, and Volkswagen are looking to establish or expand their stateside production to strengthen ties to U.S. consumers and reduce their euro exposure. BMW executives have said that they plan to increase U.S. production by more than 70 percent in response to the dollar's decline. The French manufacturer Alstom announced plans last December to build a $200 million facility in Tennessee, in part to mitigate the impact of the weak dollar on its margins. And in perhaps the highest-profile rumored defection from the eurozone, the CEO of EADS, the parent company of Airbus, has said the airplane manufacturer will consider moving some production to the States, much to the dismay of French government officials.

Novo Nordisk, a Danish pharmaceutical company, derives more than 30 percent of its sales from North America and an additional 30 percent from other locations outside the eurozone, but produces nearly all of its product in Denmark. The insulin maker also conducts most of its research and development just outside Copenhagen. CFO Jesper Brandgaard says the company has taken a number of steps to reduce its exposure to the weakened dollar. In addition to increasing its financial hedging, Novo Nordisk has expanded its production facilities around the world, opening a new facility in Brazil and planning to expand production in China this year. The company also opened an R&D office in New Brunswick, New Jersey, in 2006 and has established a 50-person research team in China. "We are looking for a better balance between our production cost base and our income base," says Brandgaard.

In Asia, outsourcing firms like India's Infosys Technologies Ltd. are facing currencies that are strengthening against the dollar even as local wage rates rise, squeezing their margins and forcing them to consider operational changes. "Indian companies are very exposed. About 98 percent of our revenue comes from overseas and about 63 percent comes from North America," says Infosys CFO V. Balakrishnan. "A one percent change in the rupee affects our margin by around 50 basis points." As a result, the company is pursuing higher-margin consulting work, instead of more-routine application-development projects, to buffer margins. Balakrishnan says he is also focused on containing costs.

Infosys rival Tata Consulting Services is also seeking higher-end work, and the company is trying to steer clients toward projects that are based at its own facilities in India, rather than at the client's location — again, to boost margins. All these changes may not be enough, says CFO S. Mahalingam. "If the exchange rate drops to 35 [rupees to the dollar], that's a different matter. Then we will have to look at creating more delivery centers overseas." At the end of 2007, the rupee clocked in at 39.2 to the dollar.

In contrast, at companies headquartered in the United States, some CFOs are looking hard at investments overseas. "New investments could become less justifiable because of higher local costs," says Pablo Edelstein, CFO of Dow Latin America. Because many of Dow's raw materials — such as ethylene, which is derived from oil — are linked to the dollar, margins will shrink internationally unless the company raises prices. "We do transfer those increases to our selling prices, but sometimes there is a lag, particularly when oil prices shoot up rapidly," Edelstein says. If the dollar's weakness lingers, the company might even reconsider the economics of new investments, he adds. Edelstein stresses that the company would not scrap a project due to currency fluctuation alone.

Simon Property's Sterrett says his company will also proceed with caution as it pursues international acquisitions or new international developments with local partners. "The weak dollar has made it increasingly difficult for us to look at a large-scale acquisition that would require a significant commitment in U.S. dollars," he says. "It has gotten harder to look for viable growth alternatives outside the U.S."

Looking Ahead
For many CFOs, there is a sense of inevitability about the dollar's current plight. "The U.S. economy is growing slower than much of the rest of the world, which puts continuing pressure on the dollar," says UTC's Hayes. "The deficits we are ringing up to fund the wars in Iraq and Afghanistan add to that pressure."

"My concern is not that the dollar's decline is cyclical, but that it's a long cycle," says Scott Goble, finance chief at Alliance Flooring, a private company with more than $1 billion in annual sales. Although Alliance does business only domestically, the company has been affected by rising raw-materials costs. "We need to keep interest rates low to keep the housing situation from getting out of hand, but we need to maintain high enough rates to keep foreign investment coming in," Goble says. "I don't see a way to do that without a devalued currency."


Indeed, according to economic theory, currency devaluation is the natural response to outsized budget and trade deficits, says John Graham, a professor of finance at Duke University's Fuqua School of Business and director of the Duke/CFO Global Business Outlook Survey. "If as a country you don't save, and you spend, spend, spend, ultimately your currency will devalue," he says. Given the lack of savings in the United States and the growth in the Chinese and Indian economies, "it's possible that the United States is in the beginning of a decline," says Graham. "It could be that we've lost our way a little bit."

Still, most CFOs are hesitant to count the dollar out. "There are some radical imbalances in the U.S. economy that are pushing for this kind of depreciation," says Edelstein. "But the economic dynamics are such that the situation will correct itself." The weaker dollar will attract capital to the United States and drive exports, he says. David Elkins, North American finance chief at AstraZeneca International, the British pharmaceutical company, also anticipates an increase in cross-border merger activity. "U.S. assets are becoming cheaper for foreign investors. We will start to see more foreign investment in the U.S. market," he says (see "Attention, Shoppers!" at the end of this article). In one example, Dow itself just announced a U.S.-based joint venture with Petrochemical Industries Co. of Kuwait to manufacture and market plastics.

In fact, another reason the dollar's fall may not be such a bad thing is that the very processes that restore economic equilibrium — like foreign investment and increasing exports — are currently buoying the U.S. economy. "If the dollar had stayed steady in our current economy, I think we'd be in a recession," says Global BPO Services's Kane. "As much as the Federal Reserve and governmental agencies knock the dollar's decline, I think they're secretly applauding it."

While there are elements to the dollar's weakness that indicate a longer-term shift in its value relative to other global monies, many doubt that the euro — much touted of late — will necessarily become the world's leading currency. "If you look at the prospects in Europe versus the U.S. from an economic-growth standpoint, I would put my money on the U.S.," says Hayes. Graham agrees: "Europe faces high tax rates, huge social programs, and promises to future retirees. I don't think the U.S. will be worse off than Europe 20 years from now. But we might well be worse off relative to the Asian economies."

For now, the change in the dollar's value relative to other currencies is forcing many businesses to become truly global. "It's becoming more and more the standard for corporations to match the location of their expenses to the location of their revenue flow," says Kane. United Technologies offers one example of how such a strategy provides an effective buffer against foreign-exchange fluctuations and serves as the ultimate hedge. But CFOs stress that while the dollar's fall may be accelerating such operational changes, foreign-exchange concerns are not the only reason to make a move.

"The business logic is the primary driver for any new initiative, but we have been acutely aware of the impact of currency changes, and we've been trying to bring that into our decision process," says Brandgaard. Given the general uncertainty about where the dollar is headed, that strategy seems wise.

Kate O'Sullivan is a senior writer at CFO. Additional reporting was provided by CFO Europe editor-in-chief Janet Kersnar, CFO Asia managing editor Don Durfee, and CFO Asia editor-in-chief Tom Leander.


Attention, Shoppers!

Discount fashions aren't the only lure to foreign shoppers seeking bargains in the United States. "The weaker dollar is going to attract a lot of capital as foreign buyers start to see U.S. assets as undervalued," says Pablo Edelstein, CFO of Dow Latin America.

Indeed, foreign direct investment in the United States was up by 11 percent in 2007. In one recent example, last December, the German airline Deutsche Lufthansa paid $300 million to buy a 19 percent stake in JetBlue Airways Corp., with Lufthansa executives citing the weakness of the dollar as one reason for the deal.

Foreign investors have targeted U.S. financial firms in particular, with Canada's TD Banknorth Inc. purchasing Commerce Bancorp for $8.5 billion; China Investment Corp., an investment arm of the Chinese government, sinking $5 billion into Morgan Stanley; the Abu Dhabi Investment Authority investing $7.5 billion in Citigroup; and China's Citic Securities taking a $1 billion stake in Bear Stearns. (The U.S. investment bank put $1 billion into Citic, too.) And in one of last year's final deals, Singapore's Temasek Holdings bought a 9.5 percent share of Merrill Lynch.

The subprime-mortgage meltdown has made the financial sector a particular hot spot, but other areas will likely see more foreign interest if the dollar stays soft. In late 2007, international buyers purchased U.S. companies in the health-care and consumer-products sectors as well. — K.O'S.


CFOs in Europe, Asia, and the United States predict the future of the U.S. dollar, January 2008


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