Big Spender

Long on the sidelines, SM Investments in the Philippines is making big bets on the future. Is the finance function up to the challenge?
Cesar BacaniDecember 1, 2007

Inside the ornately vaulted church beside Manila Bay, the
children could be forgiven their fidgeting. Sunday mass was ending
and they were already thinking of the food and fun to come.
At last, the mass came to an end, and the 200 or so worshippers
dutifully filed out of the Shrine of Jesus, the Way, the Truth and
the Life — to head to the mammoth SM Mall of Asia just a few
minutes’ walk away. The 19.5-hectare temple to shopping, dining,
and entertainment, which also hosts a 1,500-seat Dell call center,
is owned and operated by SM Investments, the same company
that built and donated the church to the Archdiocese of Manila.

Among the worshippers is Felisa Domingo, 54, who attended
the 10:30 a.m. mass because she needed to visit the mall to
exchange U.S. dollars for pesos and buy school supplies for her
two grandchildren. Their parents, Domingo’s son and daughterin-
law, are medical workers in Saudi Arabia. SM’s foreign
exchange centers offer the best rates, she explains, and everything
else is there. The kids will buy school supplies at SM
Department Store, eat lunch at Jollibee, a homegrown burger
chain that leases space at the mall, go skating at the Olympicsized
ice rink, and perhaps see Harry Potter on an eight-story
IMAX screen if they are not too tired.

Only in the Philippines, as the locals would say. But it makes
perfect sense in this overwhelmingly Roman Catholic country for
a place of worship to be just a stone’s throw away from a church
of commerce. Flush with record remittances of more than US$1
billion a month from some eight million Filipinos abroad, the
economy is seeing a resurgence on the back of spending by consumers
like Mrs. Domingo. Helped by a period of relative fiscal
and political stability, GDP growth in the first half of 2007 topped
7 percent, the fastest expansion in three decades. The rise in personal
consumption in those six months reached 6 percent.

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Consumer-oriented firms are reporting stellar results. Profits
are growing fast at companies ranging from Jollibee to dominant
telecom provider PLDT and property developer Ayala
Land. But it is SM Investments that looks like the best-placed
consumer play — and also the most vulnerable. What began as a
humble shoe store in 1948 (SM stands for “Shoe Mart”) has
become a conglomerate built in part around the vision of serving
overseas workers and their families at home.

Spending by overseas workers and their dependents now
accounts for half of all sales in the company’s 29 shopping malls.
SM’s banking arm, Banco de Oro-EPCI, the country’s secondlargest
lender by assets, has a global network of remittance centers
that has about a quarter share of the US$14 billion business.
These centers are being tapped to sell mortgages and service
payments on SM-built homes in property projects connected to
the malls, which are hugely attractive in the mall-crazy Philippines.
The success of the strategy is allowing SM to branch out
to related sectors like tourism and BPO (business process outsourcing),
two of the country’s sunrise industries.

SM Investments is doing well indeed. Sales in the first half of
this year nearly doubled to 55.3 billion pesos (US$1.3 billion at
the current exchange rate) after the opening of 28 new SM Supermarkets
and nine SM Hypermarkets. In three years’ time, says
CFO Jose Sio, “we’re looking at a compound annual growth of 12
percent” — meaning a turnover of about 125 billion pesos (US$2.8
billion) by 2009. For the same period, Sio projects a much heftier
30-40 percent compound annual growth in net income to
around 23 to 29 billion pesos (US$523 to US$660 million).

Hitting such targets will call for spending on a scale unheard
of at the company. As a group, SM firms — which comprise more
than 25 major enterprises — will invest 95 billion pesos (US$2.2
billion) over five years. At the 60-hectare SM BayCity, home to the
Mall of Asia, the group will build a convention center, hotels, and
office towers for BPO and call-center firms. The company also has
plans for tourist resorts, condominiums and master-planned communities,
and more shopping malls across the country.

It’s all getting a bit hectic for the 67-year-old Sio, who — like
other CFOs in the Philippines — has grown used to nursing cash
rather than spending it as the country lurched from one crisis to
another. Is finance up to the task? For now, the company appears
to have no trouble raising funds. But Sio will need all his skills
and decades of experience to navigate today’s treacherous financial
waters. Even if SM gets all the money it needs, it could
founder if, as a newly bulked up enterprise, it loses the agility to
maneuver in a volatile marketplace.

Risk and Remittances

There’s no shortage of risks that could derail Sio’s efforts. While
buoyant today, remittances are highly sensitive to the economies
of the host countries where overseas Filipinos work. During a
downturn, domestic helpers, personal drivers, and factory workers
are among the first to lose their jobs. That’s no small worry,
considering that SM’s exposure to remittances is still growing,
particularly in its property and banking businesses.

The two other legs of SM’s expansion, tourism and BPO, are
predicated on economic and political stability. But sadly, volatility has stalked the Philippines in recent
years (see “Looking Up” at the end of this article). The
series of unfortunate events include the
ouster of President Joseph Estrada in 2001
and the ongoing attempts to impeach his
successor, President Gloria Macapagal
Arroyo, over allegations she cheated in the
2004 elections. New scandals erupted this
year over a US$330 million national infrastructure
contract with Chinese telecom
gear maker ZTE. And anxiety about terrorism
intensified in October after an explosion
at a Manila mall (not SM’s) killed 11
people and wounded scores more.

SM itself is in transition. Founder and
SM chairman Henry Sy, Sr. is 83 and his six
children now effectively run the enterprise.
The two eldest siblings, Teresita Sy-Coson and Henry Sy, Jr. are
co-vice chairmen at SM Investments, while another son, Harley
Sy, is president and board director. Herbert Sy heads retail merchandising,
Hans Sy oversees mall operations, and Elizabeth Sy
is senior vice president for marketing at SM Prime, which owns
and operates the shopping malls.

The family appears harmonious now, but there is no saying
how things will look when the patriarch is gone. The children have
their own ideas of how to run the burgeoning empire, including an
increasing reliance on professional managers. Henry Sr. is known
to favor family and kin over outsiders. The second generation is
also seen as the driving force behind the investing spree. “Henry
Sy had been averse to projects with large capex,” notes Alfred Dy,
head of research at the Philippine unit of investment bank CLSA.
Unlike other Filipino tycoons, the SM founder stayed away from
big-ticket ventures like airlines and telecoms, even when the politicians
of the day were open to giving him the franchises.

Sio says SM continues to adhere to Henry Sr.’s dictum that the
company should get involved only in businesses that it knows well,
meaning retail, banking, and real estate. But the Sy children are not
shying away from scale and complexity. Sy-Coson, for example, had
been dogged in her three-year pursuit of a difficult merger between
Banco de Oro and Equitable PCI Bank, which finally came through
earlier this year. For his part, Henry Jr. is in a hurry to make SM a
major property player. He’s launched five projects in less than three
years, with the 1.4 billion peso (US$31 million) Chateau Elysée
master-planned community due for completion this year.

The new generation is also eyeing China, Henry Sr.’s birthplace
and home until he emigrated to the Philippines at age 12. Hans Sy
spearheaded the construction in 2005 of the SM Jinjiang shopping
center, located in the patriarch’s hometown of Jinjiang. SM Prime
plans to acquire SM Jinjiang and two other Chinese malls currently
owned by the family’s private companies. The strategy is to focus
on small cities rather than a metropolis like Shanghai, on the
theory that SM’s experience is easier to transplant to smaller urban
areas that are closer to the Philippines in stage of development.

Finance in the Hot Seat

SM’s warehouse-like receiving area is almost as bustling as the Mall
of Asia in front of it. Job applicants, suppliers, messengers, and
potential property buyers fill rows of plastic chairs and sit around
little side tables. Models of SM’s housing projects line the wall.

Sio takes a seat in a cramped meeting room. “This is our temporary
headquarters,” he explains. The corporate offices will eventually
move to OneE-ComCenter, an eight-story
building under construction next door to the
mall. The vacated strip of prime real estate may
be redeveloped into condominium towers. A
spare man who shows no signs of slowing down
two years past the usual retirement age, Sio is a
CPA who earned his MBA from New York University.
Recruited in 1990 from the prestigious
Manila accounting firm SGV, where he was senior partner, he is one
of the first non-family members to be named to a key post at SM.

When CFO Asia spoke to Sio in 2005, newly listed SM Investments
was in wait-and-see mode as Arroyo fought off impeachment,
the stock market and the peso were on a downward spiral,
and newly enacted tax increases threatened corporate profits. “We’ll
just try to manage the consequences of these daily events,” Sio said
at the time, “but we should not lose track of our long-term goal,
which is to expand so that when things stabilize, we’re already there.”

That time has come. The economy and stock market are performing
well (click here to see a timeline of the Philippines’ recent political and economic history). The peso has
appreciated 21 percent against the U.S. dollar since the end of
2005. International reserves stand at a record US$30.7 billion,
up 66 percent from 2005, while unemployment has fallen to 7.4
percent from 11.3 percent in the same period. And with the budget deficit now below one percent of GDP, government
spending and revenues may be in balance by 2008.

Sio has been joined in the finance function by other professional
managers, among them Jose Amantoy, a CPA with international
experience who was recruited in 2005 as controller at
property arm SM Development and vice president at SM Investments,
and Corazon Guidote, who became vice president for
investor relations last year after four years as Arroyo’s presidential
consultant for investor relations.

“Our work has become more challenging,” says Jeffrey Lim,
executive vice president for finance at SM Prime. “When our
president [Hans Sy] wants something, it’s automatic — he would
pass it on to our area and we look into it not only from the perspective
of finance, but also strategy, operations, and others.” Sio
is pushing for more. “While the traditional definition of a CFO
is related more to the treasury,” he says, “we would like the
[finance function] in each subsidiary to also get involved in risk
management, policy decisions, investment decisions, and so on.”

Find Them the Money

Not surprisingly, finance spends much of its time these days
helping fund the expansion. Net debt at SM Investments has
shot up 120 percent to 42.3 billion pesos (US$960 million) as of
June 30, 2007, compared with 19.2 billion pesos (US$435 million)
in the same period last year. Sio says the net debt-to-equity
ratio is still a comfortable 27 percent, up from 19 percent in
June 2006. Even so, the intensified leveraging of the balance sheet
is new at SM, which has been more inclined to rely on internally
generated funds and the stock market.

In this SM has not been much different from other Philippine
companies, particularly after the 1997 Asian financial crisis. That year, Sio orchestrated a US$100 million floating rate note — three
months before the Thai baht crumbled against the dollar. The ensuing
panic saw the peso fall from 26 to 40 against the greenback. Fortunately,
the obligations were fully hedged, a practice that SM follows
to this day.

“It means additional cost, but our discipline is not to speculate,”
says Sio. About 55 percent of the SM group’s total longterm
debt is denominated in dollars, including a US$300 million
convertible bond issued in March this year.

Given the peso’s continuing strength and the dwindling differential
between peso and dollar interest rates, SM is now turning
more to the local currency. In October, SM Prime completed
a 4 billion peso (US$90 million) five-year floating rate issue
after the central bank cut interest rates by 25 basis points. This
followed a similar 3.5 billion peso (US$79 million) issue in June.

More borrowings may be needed, so Sio is strengthening his
department’s coordinating role. “At SM Prime, for example, I don’t
know what the property and retail groups are doing,” explains Lim.
“But Mr. Sio knows all our banking relationships, so he can tell us
when and how we can work together and get better rates.”

Also being strengthened is finance’s ability to provide expertise
and advice on issues related to accounting, treasury, financial
management, and corporate governance, as well as to monitor and
benchmark business performance across the enterprise. To this
end, the company is considering an upgrade of financial management
and business performance software, which is currently a tapestry
of in-house programs, Oracle, and SAP. “We do get the information
that we want, but right now it is not the fastest way I would
like,” says Sio. An efficient flow of information will be essential for
keeping the US$2.2 billion expansion program on track.

Art of Cross-Selling

SM Investments’s expansion plans rest on the hope that the new
businesses will complement the old. Nona Reyes, assistant mall
manager, takes visitors on guided tours of SM BayCity. The
three-story SMX Convention Center is nearly complete, she
says, pointing to the mall’s north side. It will have a gross floor
area of 46,074 square meters, comprising an exhibition area on
the first floor, a commercial area connected by a pedestrian
walkway to the mall on the second, and meeting halls and function
rooms on the third. OneE-ComCenter is being built to the
south of the mall; it will be leased to call-center and BPO firms.

Three hotels, serviced apartments, and a sports arena are in
the planning stages. “If the first BPO center is successful, we will
build more,” says Guidote, the investor relations manager. “That
will create more foot traffic for the mall. That’s where the synergy
is.” Further synergy is expected from the US$144 million
Hamilo resort complex in Batangas province on the other side of
Manila Bay, which will be linked to SM BayCity by ferry. A fourtimes-
a-day ferry service from the mall to prospering Cavite
province (population: 2 million) was recently launched, cutting
travel time from two hours by land to just 40 minutes by sea and
thus expanding the mall’s catchment area.

There are any number of cross-selling possibilities. At
Chateau Elysée in Paranaque City, about an hour’s drive from the
Mall of Asia, SM Development marketing officer Jose Ma. Jens.
Zamora III shows off three showroom units. They are furnished
with refrigerators, washing machines, and ovens from SM Appliances,
sofas and beds from SM Our Home, and decorative items
from handicrafts unit Kultura. “We can arrange discounts with
these sister companies for our home buyers,” says Zamora. Scale
models of the project are on display in SM malls and promotional
materials are available in Banco de Oro-EPCI bank branches.

A shuttle bus carries Chateau Elysée residents to the nearest
SM mall. The company will apply the same concept to other residential

SM is also tapping its overseas remittances network. After a
marketing team visited London in July, says Zamora, “almost 50 percent
of sales that month came from nurses there. They found the
prices very affordable.” Units at Chateau Elysée start at 940,000 pesos
(US$21,400) for a 20-square-meter, one-bedroom apartment. The
Banco de Oro-EPCI remittance centers serve as sales venues, facilitators
of mortgage applications, and conduits for monthly amortization
payments to the Philippines. “Many of the people living here
are dependents of overseas workers,” says Zamora, pointing to children
splashing in Chateau Elysée’s clubhouse swimming pool.

SM’s key targets for its property projects are overseas Filipino
workers in the medical field and other professions in Europe and
the United States, rather than the lower-paid domestic helpers in
Hong Kong, Singapore, and the Middle East. That’s one reason
why SM isn’t worried that an economic slowdown in the West
will hurt its property business. “Doctors and nurses are not likely
to lose their jobs in a downturn,” says Ismael Pili, an analyst at
Macquarie Securities in Singapore. “You can say that the medical
sector is almost recession-proof.”

But property accounts for just 13 percent of the SM empire’s net income. Together, retail merchandising and shopping malls
contribute 56 percent, and those operations are vulnerable to a
slowdown in remittances. Sio argues, however, that a big fall is less
likely than it was because the proportion of Filipinos taking overseas
posts in hospitals and nursing homes is rising. “The United
States alone needs more than 60,000 nurses,” adds Lim.
Philippine demographics also suggest that the flow of workers
to aging Western societies can continue for decades. Some 46 percent
of the population of 88 million is younger than 20, and children
under four are the largest age group — at 10.4 million. By 2025,
CLSA’s Dy says, the vast majority of the population will be 44 years
and younger. Even if they all stay at home — which is
highly unlikely — “the demographics will remain in
favor of mass-based consumer-related companies.”

Consumers Plus

In any case, SM’s diversification into tourism and
BPO leasing could provide a bit of cushion if
remittances and personal consumption slow. Its banking and
financial services arm also provides balance with exposure to
trade and manufacturing, bancassurance, agriculture, and other
non-consumer sectors, in addition to mortgages and consumer
loans. It already accounts for 31 percent of net profits.

But does a retailing giant like SM have the expertise and experience
to run tourism resorts, BPO buildings, and convention centers?
“People forget that we have long been in the tourism business,”
Sio responds. “Mr. Sy bought Taal Vista Hotel 20 years ago, and he
has always said that tourism is the next big thing for SM after retailing.”
The key to understanding SM, he adds, is to look at the group
as the sum of its parts. “It’s all part of a plan,” says Sio. “Before we
make any major acquisition or expansion, everything
is analyzed. What’s the synergy, what’s the cost,
what’s the benefit? How would it help grow the
entire enterprise?”

This is why SM turned down an opportunity
to take over an airline and why it sold a cement
plant a few years ago — the group decided that the
synergies weren’t there. But the judgment is that
resorts, convention centers, hotels, BPO, and
housing developments add value to the existing
businesses. “We already own the land, so it’s a
matter of building structures on them,” says Sio.

Moneyed BPO agents, convention goers,
tourists and SM condo dwellers are expected to
increase foot traffic to the malls, joining the
dependents of overseas workers and other Filipinos
who hopefully will be participating more
and more in economic growth.

The Next Generation

It’s a self-sustaining business model that Henry Sy,
Sr. has long had in mind, says Sio, and one that
the second generation is expected to nurture. “It
is fortunate that all the children are active in their own area of
expertise,” says the CFO. “Mr. Sy is of course still consulted on
major decisions, but the initial discussions are conducted by the
family members among themselves.”

The succession appears to have been internally decided as well.
The expectation had been that Henry Jr. would take over, being
the eldest son, but SM’s 2006 annual report described Sy-Coson,
57, matter of factly as “the chosen successor at SM Investments.”

The patriarch Sy involved his children in every aspect of the
business from a young age, to the point that none was allowed to
study abroad. The children themselves are more relaxed with their own offspring, some of whom are in school overseas. They
also remain open to hiring more professional manages to handle
day-to-day operations so “we can sit back and relax,” as Sy-Coson
once told Time magazine.

SM, in other words, is not only transforming its business, but
also its culture as a family empire. “We emphasize transparency
and corporate governance, and we know that we have obligations
to our stockholders, to our creditors and to our people,”
says Sio. Minority shareholders, among them foreign shareholders
and lenders, will hold him and the Sy family to that.

Cesar Bacani is a contributing editor of CFO Asia.

Looking Up?

Something must be going right in the Philipines.if a venerable company like Ayala Land is on a spending spree.
“The last two years have been all-time highs in terms of our capex
spending,” says Jaime Ysmael, CFO of the US$581-million-a-year
property developer known for its ultra conservative financial management.
In 2006, the company spent 13.8 billion pesos (US$281
million), compared with the years before when it was spending
between 5 to 8 billion pesos.

Then, on October 19 an explosion ripped through Ayala Land’s
upscale Glorietta 2 shopping mall, killing at least 11 people and
injuring more than 100. The blast was initially blamed on a terrorist
attack by separatist Muslims in the south, but investigators
now say it may have been an accident.

It’s too early to say how deeply this will dent business confidence,
but the tragedy underscores the fragility of the country’s
economic and political environment. For now, Ysmael is upbeat.
“A lot of reforms have been instituted,” he says. “We have never
seen interest rates come down this low. The peso has appreciated
against the U.S. dollar, and with it a significant debt service
burden on the government has eased. OFW [overseas Filipino
worker] inflows have significantly increased and the business
process outsourcing phenomenon is generating not only a lot of
investment but also purchasing power among the 20-to-30 age

Many economists agree. When CFO Asia spoke to him in 2005,
Agost Benard, credit analyst at rating firm Standard & Poor’s,
fretted that political uncertainty was distracting the government
from its reform program. “Much has changedÂÂÂ… and these
changes are almost all positive,” Benard now says. S&P forecasts
2007 GDP growth at 5.8 percent, accelerating to 6.2 percent in
2008 and 2009.

HSBC economist Fred Neumann credits Arroyo, who remains
president, for what he describes as the country’s “impressive
strides towards the reduction of the fiscal deficit.” The budget
gap, which equaled 3.8 percent of GDP in 2004, was trimmed to
1.1 percent last year. But Neumann thinks the 7.3 percent GDP
expansion in the first half of the year will moderate because of the
global credit squeeze, which may slow growth in the United
States, trimming demand for Philippine exports as well as remittances
from overseas Filipinos there.

Tom Crouch, Philippine country officer for the Asian Development
Bank, is more bullish. “We see signs that GDP growth is
breaking out of the 5-6 percent trap in which the Philippines has
been caught since 2003,” he says, citing continuing strong OFW
remittances and big-ticket foreign investments such as a US$1 billion
electronics plant to be built by Texas Instruments and a US$1.5
billion shipyard under construction by Hanjin of Korea. Anthony
Nafte, economist at investment bank CLSA, agrees that an acceleration
in foreign investment will be key to maintaining a higher
growth rate.

Cielito Habito, a professor at Ateneo de Manila University,
urges the government to focus on tourism and agriculture. “These
are the sectors that will readily employ almost three million unemployed,”
he says. “Almost two-thirds are only high school graduates
or did not finish high school, so the call centers and BPOs are
not going to be the answer to their problems.”

There are deeper issues, though. “The problem is the crisis in
domestic business confidence, and that is because of the political
uncertainty,” asserts Habito. “The president should demonstrate
a dramatic change in her style of leadership. Her appointments
should be made on competence and not on political considerations;
policy decisions should be based on the greater good, rather
than vested interests.” Arroyo’s opponents say she is not doing
any of these things, and have filed fresh impeachment charges
based on alleged bribery in connection with a broadband infrastructure
contract with Chinese telecom equipment maker ZTE.

Ysmael and Ayala Land remain optimistic. But like everyone
else, the company will be watching the economic numbers and
political and security developments to decide whether to stay the
course — or return to the somnolence of 2005. — C. B.

How SM Investments performed in 2006–2007 and its income sources

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