For companies that do business in other countries, the best way to mitigate the risk of fluctuating currency rates is to lock in contracts and work with foreign-exchange experts rather than try to become one.
John Brittain, managing director at Accordion Partners, a corporate financial-services firm, advises companies to “understand [their] risks first, spend time focusing on where the true transactional cash-based exposures are, and utilize the foreign-exchange markets, particularly the forward and options markets for hedging those risks.” It sounds straightforward, yet companies sometimes take their eye off the ball, adopt an improvised approach to hedging, or convince themselves that their exposure is inconsequential.
Companies that lack firm contracts with their international suppliers or customers can find it difficult to mitigate currency risk, Brittain points out. They “have no effective way to hedge that exposure [because of ] the variable nature and timing of the underlying cash payments,” he says. Under a long-term contract, companies “can lock in that revenue or cost, and they can do that efficiently through the FX markets,” says Brittain.
Juniper Networks, a technology company that provides high-performance network infrastructure, sells its products and services primarily in U.S. dollars. But Catherine Portman, vice president of treasury, says that with a presence in 46 countries, her company is exposed to fluctuations in currency exchange rates to the extent that a weaker U.S. dollar increases the cost of foreign operating expenses. The company currently hedges this exposure with forward contracts, but it has used currency options in the past.
The Risk of Inaction
Despite the sophisticated tools available, some companies become complacent about hedging. During the past three years (essentially covering the euro crisis), payments firm AFEX has seen a 25%-plus uptick in forward-contract volume. But when the dollar strengthened in the United States last summer, AFEX saw “a general reluctance to hedge too far out,” says Guido Schulz, executive vice president of strategic management. “There was definitely a wait-and-see attitude, and most of the CFOs were taking a somewhat relaxed view.”
Although there were more “knee-jerk reactions initially when [the] Greece [crisis] started to heat up,” says Schulz, that relaxed view has become “the new normal” with respect to U.S. companies’ exposure in Greece and other parts of the euro zone.
AFEX’s clients, mostly importers, are getting short-term gains from buying goods at discounted prices in some areas of the euro zone. However, “it’s definitely looming in people’s minds what the impact will be if the euro zone partially collapses or if there is an orderly exit by Greece,” Schulz says. “We have seen some companies looking for alternative sourcing from more-stable markets.”
The companies just standing by, in the euro zone or elsewhere, are taking on a big risk. “If you know what FX conversion rate you will be paying ahead of time, then you can budget with that and strategize accordingly,” says Schulz. By waiting to see what the market is doing, companies open themselves up to surprise shortfalls and surpluses in their budgets, he says.
Currency-risk hedges can be built into a business model. Roger Moody, finance chief at Nanosphere, a molecular-diagnostics company that conducts genetic testing, favors employing distributors to mitigate currency risk. The company considers other factors when deciding how to market its products internationally, Moody says, but “it just so happens that these considerations result in a distribution-partner model, and this model also happens to allow us to achieve the currency-risk benefit.”
Since Nanosphere sells its products to distributors in U.S. dollars, currency risk “has not been nearly as large an issue for us as for many other companies that operate with foreign subsidiaries,” says Moody.
The company recently entered into a distribution deal with ThermoFisher and also works with Grifols in other parts of Europe. Since these large, multinational distributors sell many different products from other companies as well, they are in a good position to aggregate their various currency exposures. “This makes it easier for them to hedge or take whatever other actions they feel are necessary to mitigate their risk,” says Moody.
There is a downside to this approach, however. Nanosphere surrenders direct control of marketing its product in those international markets, explains Moody. “We also give up margin for the costs associated with their sales and marketing expense. So we don’t collect as much and the margins are not as high for the products we sell internationally as they are in the U.S.”