DELOITTE
Rethinking business MODELS during an economic recovery
Q: With a focus on raising capital, what strategies do you recommend for corporates looking to strengthen their financial position in the prevailing economic climate?
A: Corporates should strategically focus on key growth areas within their businesses. Their core businesses may provide good returns and therefore, it is best to focus on strengthening that core and giving up non-core activities where their capability and competitive advantage is less.
What we see is that over time, many successful businesses have invested their surplus capital in non-core assets such as land and real estate as a store of value. But these surplus assets may not be generating good returns. Successful corporations may consider monetising these non-operational assets to strengthen their balance sheets and reinvesting them in growing their core businesses. By doing so, they redirect the released capital towards essential investments that are aligned with their core business objectives.
Some corporates have also diversified into new businesses, which they thought looked promising over the years. Unless they have a strong advantage in such businesses, it is best for such non-core activities to be divested to conserve not only cash but also manage time and effort that goes into monitoring them and ensuring compliance with regulations.
It is important to be able to get into ventures, and grow them to a scale and size that generates a healthy return on investment. In a small market such as Sri Lanka, doing scalable businesses is important. We often see that industries with many small fragmented players are inefficient and suboptimal, other than of course for SMEs that are localised and personalised.
Q: What challenges do corporates face in executing capital raising initiatives – and how can they be mitigated?
A: At present, when companies embark on capital raising endeavours, particularly for debt capital with a long-term horizon, they may encounter higher costs, given the prevailing economic environment.
It’s advisable for companies to adopt a phased approach to raising capital in alignment with the prospects of an economic revival. By doing so, they can potentially capitalise on lower interest rates in the future, mitigating the impact of existing challenges.
Another crucial aspect for companies to consider is aligning the tenor of the facilities they hold with their project life cycles. This involves careful consideration to avoid borrowing short-term funds for long-term projects or vice versa.
Ensuring that the tenor of financing aligns with anticipated cash flows from such projects is essential to ensure prudent financial management. Variable interest rates help capitalise on anticipated improvements in interest rates over time, with interest rate ceilings and floors helping to maintain costs at manageable levels.
Moreover, companies – and financial institutions in particular – shouldn’t focus solely on raising capital but explore alternative strategies. In instances where a company possesses distinct business advantages but faces a capital shortfall, exploring merger options could be a viable solution.
Merging with an entity that has a more robust capital position can be mutually beneficial. This strategic move enables companies to leverage each other’s strengths with one entity perhaps offering business advantages and the other providing the necessary capital.
In the prevailing economic landscape, companies are encouraged to evaluate merger opportunities within their sector or industry. Such mergers can yield synergies and efficiencies, allowing entities to utilise excess or additional capital from a consolidated standpoint.
For corporates seeking to raise capital, recognising the current challenges in mobilising foreign capital is most important. Given Sri Lanka’s credit rating concerns following the default on sovereign debt, foreign investors perceive the country as a riskier and challenging environment despite the attractive opportunities
Accordingly, foreign investors may apply a higher risk premium to Sri Lanka than in the past. An economic recovery is pivotal for restoring a favourable credit rating and enhancing foreign investor sentiment. More than that, policy consistency by way of a stable tax regime, currency and interest rates is vital for creating a predictable investment climate.
If we manage our economic fundamentals well, we would have overcome one of the biggest concerns that investors have had in the past. Investors don’t want wild fluctuations in tax, and interest and exchange rates, which put their business plans in complete disarray.
In the context of foreign capital, the emerging trends emphasise environmental, social and governance (ESG) compliance. We should be conscious of these trends when we seek new capital.
Corporates must prioritise their ESG compliance efforts as foreign investors are increasingly evaluating such endeavours. Establishing robust programmes not only garners favourable assessments from foreign investors but also mitigates some of the associated risks that are of concern to foreign investors.
Q: In the context of an economic recovery, how do you anticipate valuations to evolve for organisations considering mergers and acquisitions?
A: While the fundamental approaches to valuation methodologies remain unchanged, the current volatile and uncertain times call for incorporating sensitivities and scenarios into this process.
In this environment, evaluating projects over multiple time horizons becomes crucial.
When applying discount rates for business valuations, it’s advisable to use transition discount rates; and for multiples-based valuation approaches, considering stable market multiples with adjustments for uncertainty and volatility would be prudent.
The basic approaches remain intact but the heightened subjectivity and reliance on judgement become more pronounced – especially when drawing insights from other markets that have navigated similar economic cycles.
Q: In what ways is investing in infrastructure important at this juncture and can public-private partnerships (PPPs) be leveraged to expedite infrastructure development?
A: It is crucial to prioritise infrastructure development in sectors that directly boost the economy.
Social infrastructure – particularly in schools and hospitals – takes precedence along with other forms of infrastructure that generate employment opportunities such as the development of technology parks and industrial zones. The importance of a good system of public transport cannot be over-emphasised in a fuel import dependent economy – because an efficient public transport system will reduce fuel consumption and costly imports of private vehicles.
The shortage of industrial zones in the country is a notable concern and where we’re promoting information and communications technology (ICT) led exports, we also need good technology parks where tech companies can house their offices and create ecosystems for their workforces.
Foreign investors seeking to establish factories in Sri Lanka often face challenges due to the lack of land banks and essential resources such as power, water supply and waste disposal facilities to be able to readily set up factories. Since the government has a lot of surplus land, diverting some of it to develop well managed, investor friendly industrial zones as PPPs can be explored. This is not a model we are unfamiliar with; these models have been tried and tested elsewhere. Rather than turning away foreign direct investment (FDI) led projects due to the lack of adequate infrastructure, the private sector can be mobilised to develop and run these zones.
The same goes for local companies in the technology sector that require high quality cost effective real estate and communication infrastructure to make their businesses more competitive.
ICT will be a good export sector for the country, which can create employment opportunities for skilled youth. When such industrial and technology parks are developed, a whole new neighbourhood and eco system develops around it, creating more employment opportunities for service providers supporting the zones.
Therefore, future PPP initiatives should strategically target key areas that improve productivity and directly contribute to the country’s growth and employment creation, as opposed to focussing on glamour projects without economic benefits.
Ventures such as cold storage facilities can play a pivotal role in adding value to the agriculture sector. Sri Lanka is grappling with agricultural wastage and cultivators are challenged to command fair prices for their produce.
Establishing high quality storage facilities including cold storage through PPPs can expedite solutions to these concerns. We see good examples in the private sector where retailers purchase directly from producers, thus benefitting both parties. And good infrastructure by way of processing, storage and transport can help create economic value.
The focus should be on initiatives that promptly and tangibly benefit both the economy and citizens.
Q: How do you view the role of the private sector in collaborating with the government to ensure that projects that become PPPs are executed efficiently?
A: The private sector is more focussed on cost efficiency and timeliness in executing projects, primarily due to its inherent management practices and profit driven motivation. Its efficiency lies in a heightened awareness of costs and timelines, which is driven by the pursuit of profitability.
Consequently, private sector entities ensure that projects aren’t only completed within allocated budgets but adhere to stipulated timelines as well. However, the caution is that throughout the construction and operational phases, rigorous oversight is necessary to ensure that the private sector consistently meets the required quality standards and fulfils the expectations of the government when carrying out PPP projects.
This comprehensive monitoring approach serves as a catalyst for the private sector to maintain the necessary quality standards and adhere to regulations while expediting project implementation. Proactive measures are essential to engage the private sector in PPPs, starting with the establishment of a conducive regulatory environment.
Addressing outdated regulations, ensuring policy consistency, and having economically viable pricing policies and strong monitoring frameworks are important considerations for harnessing the private sector in executing PPPs.
