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Go with the Flow

A new scorecard highlights Europe's top companies when it comes to generating cash.
Jason Karaian, CFO Europe Magazine
October 1, 2007

Read the complete results of the 2007 Cash Masters survey, or review just those results that appeared in print.

Life often imitates art. Given the recent twists and turns at his company, Lothar Lanz, for example, can easily relate to the soap operas broadcast on television channels owned by ProSiebenSat.1, the German media group where he is CFO.

A string of impressive results drove the company's share price from around €5 in early 2003 to €30 this summer. The shares have since fallen nearly 20% though, after the company's controlling shareholders, private equity firms KKR and Permira, engineered the €3.3 billion takeover of Luxembourg-based SBS in June. The debt-financed deal will transform Munich-based ProSiebenSat.1, boosting revenue by 50% and dramatically altering its capital structure. For this reason, Lanz explains, "cash flow was important before, but not as much as it is now."

Cashing In
"Cash is king" is a popular, often overused, refrain among CFOs, but some take the mantra more seriously than others. To gauge which companies are most adept at generating and managing cash, REL, a research and consulting firm, ranked the 1,000 largest listed companies with headquarters in Europe by their "cash conversion efficiency" (CCE), measured as cash flow from operations divided by sales. Combing through these companies' most recent annual financial statements, the inaugural REL/CFO Europe Cash Masters Scorecard also highlights the metrics underlying CCE, including gross margins, SG&A costs and net working capital, among others. (See the rankings that appeared in print.)

At first glance, 2006 was a great year for business. Sales and profits at large European companies grew by double-digit percentages, while working capital and SG&A costs fell in relation to revenues. However, companies "weren't able to fully reap the rewards that could be expected," according to Stephen Payne, president of REL. That's because CCE declined for the second year in a row, resulting in "fewer euros, relatively speaking, completing the journey through a company's cost structure and onto the balance sheet," says Payne. In 2006, average CCE fell to 11.7%, from 12.4% in 2005. (See "Flow of Funds" at the end of this article.)

Less than half of the 1,000 companies in the sample improved CCE last year, with only a third posting improvements in both 2005 and 2006. If laggards improved their CCE in line with the top quartile of their sectors, REL reckons some €400 billion in additional cash flow could be generated, increasing the scope for capital spending, dealmaking, share buybacks and debt repayment.

It's always easier to improve "efficiency and effectiveness" when times are good, notes Payne, though complacency is difficult to overcome, as the recent deterioration in CCE shows. More often than not, as with ProSiebenSat.1, it takes an external shock to move cash management up the corporate agenda.

The German media group already generated a lot of cash, leading its sector with a CCE of 60% last year, compared with a 14% sector average. In 2006, operating cash flow rose by 9%, to €1.3 billion, as sales grew by 6%, to €2.1 billion. That sort of robust cash generation allowed the firm to cut net debt to €122m at the end of last year, down sharply from €665m three years earlier.

Last December, when KKR and Permira first acquired their majority stake in ProSiebenSat.1, the private equity firms said they would consider combining the company with SBS, which the same duo took private in 2005. The plan came to fruition this July, financed by €3.6 billion in term loans and a €600m revolving credit facility, secured just before the debt markets seized up. ("Thank God for that," says CFO Lanz.)

The German company "can learn some things" from its new acquisition, Lanz notes, given SBS's experience of operating under much higher leverage. While it wouldn't make sense to "centralise everything," the CFO adds, he is planning to exert stronger top-down control on areas such as capex at the enlarged group. This reflects the shuffling of priorities among the three "central financial control variables" that executives use to steer the company, Lanz explains. Previously at the bottom of the list, cash flow now takes precedence over Ebitda and Ebitda margin. The CFO hopes this will sharpen employees' focus amid the integration work, proving to the markets that the company can maintain its previous momentum on cash and profit generation despite markedly different financing conditions.

Hitting Turbulence
One company that owes its current cash flow success to a previous external shock is Unique Flughafen Zürich, the SFr737m (€448m) holding company that operates Zurich airport. "2001 was a really bad year for us," Beat Spalinger, the CFO, says with great understatement. That year, in the midst of a SFr2 billion expansion programme, traffic levels at the airport collapsed after the terrorist attacks on September 11th, which drove flag carrier Swissair into bankruptcy shortly after. Investments were quickly cut to the "absolute minimum," staff were laid off and salaries were slashed, Spalinger recalls.


"It took quite some time to survive the crisis, and it had a huge impact on the culture of the company," the CFO says. "Even today, when we are highly profitable again, everyone is still very conscious of costs."

Since the crisis, sales, profits and cash flow at the company have all risen strongly. Despite nearly doubling investments last year, cash flow rose by 7%, to SFr252m. The airport operator's 2006 CCE of 50% lifted it into the top three of the transport infrastructure sector.

Since its near-death experience in 2001, the airport has taken subsequent shocks in its stride. Consider the decision prohibiting passengers from carrying liquids on to aeroplanes last summer. Given only a couple of weeks to implement the new security measures, it was up to the airport to "ensure smooth passenger flow at any cost," says Spalinger. "An absolute headache from a CFO's point of view," it took nine months before the airport could recoup the heavier cost of security screening via increased passenger charges. The company's ability to protect budgets and plans, and conserve cash, in the face of such events is its key strength, the CFO maintains. The markets seem to agree. Having fallen below SFr20 in early 2003, the company's share price recently reached above SFr500, setting record highs.

Though the shift in business conditions for Telenor, a NKr80 billion (€10.3 billion) Norwegian telecom, weren't as abrupt, it is also more mindful of cash flow these days nonetheless. Mobile and web-based alternatives to fixed-line telephony are relentlessly eroding sales in Telenor's Nordic home markets. In response, the company launched a three-year, NKr1.5 billion cost-cutting programme at its Norwegian fixed-line unit in 2004. In May, executives said that the Nordic unit will generate more than NKr10 billion in annual operating cash flow within two to three years, up from NKr9.6 billion in 2006.

Many analysts doubt this is achievable, but "that doesn't mean we will lower our ambitions," says Trond Westlie, Telenor's CFO. After all, the group followed an 11% rise in operating cash flow last year — giving it a CCE of 34%, one of the highest in its sector — with a 22% rise in the first half of this year.

A key reason for the company's resilience, especially at under-siege divisions such as fixed-line telephony, is that employees "wear more than one hat every day," Westlie explains. And rather than launching cost cuts dictated by rigid financial timetables, employees across all functions are asked to manage a "delicate balance" of short-term financial targets and long-term customer relationship goals. These shared, wide-ranging incentives encourage "a common understanding of each other's jobs," says Westlie. "Everyone contributes to decisions, and there is a lot of local autonomy."

Another important step in "tearing down silos," he explains, is to abandon the budgeting process. Next year Telenor will introduce a rolling five-quarter forecast covering both financial and non-financial metrics updated each quarter, in addition to a three-year outlook that's revised annually. Doing so, he predicts, will bolster the company's agility and shorten time-to-market. By "going dynamic" — the term used around Telenor — employees will be able to react faster to changes in the market, both in terms of chasing new opportunities and adjusting spending and other costs in response to business conditions. The goal is to capture as much cash as possible.

The Plot Thickens
For one reason or another, CCE leaders such as Telenor, Unique and ProSiebenSat.1 were forced to think more seriously about generating and managing cash because of external events beyond their control. For others, attention from private equity suitors or agitation from impatient shareholder activists may have provided a similar spur. More recently, turmoil in the credit markets is sure to put highly leveraged, lower rated corporates on notice.

Judging by the performance of the average company in the scorecard's sample, however, cash isn't necessarily king. The question is whether firms will voluntarily make cash a priority, or whether they will need change forced upon them before that happens. Stay tuned to watch the drama unfold.

Jason Karaian is a senior editor at CFO Europe.


Rainy Day Funds

For years, analysts and investors berated companies for being too conservative when it came to cash on their balance sheets. Last year, companies started to take heed, and cash as a percentage of sales at the 1,000 largest listed companies in Europe fell to 8% from 9% in 2005. Good opportunities for growth, shareholder demands for buybacks and dividends, and frenzied dealmaking driven by private equity all helped lift the old clouds that lingered from the dotcom downturn.

Historically speaking, though, corporate cash balances remain high. (See "Hoarders" at the end of this article.) Many companies say that they are keeping large piles of cash for the proverbial rainy day. "But why is that rainy day more substantial now than it was ten or 20 years ago?" asks Henri Servaes, a professor of finance at the London Business School who is currently studying the merits and dangers of idle cash on corporate balance sheets. Despite the recent credit market turmoil, "one could argue that it's easier to raise money now that capital markets are so much more developed, so companies should hold less cash," he adds.


REL, which crunched the numbers on cash holdings for our new scorecard, agrees with Servaes. According to the research and consulting firm, European companies are carrying more than €260 billion in "excess" cash that could be put to better use. If every company in the sample pared down its cash in line with the leanest quartile of its industry, the average company's ROCE would rise from 16.5% to 17.6%, putting the critics in a sunnier mood.





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