Montrose Journal Summer 10
THEN AND NOW: THE CHANGING LANDSCAPE OF CORPORATE RISK -
MARTIN VANDER WEYER
The capping in mid-July of the ruptured oil well in the Gulf of Mexico offered a moment to reflect on a period of extraordinary upheaval in the landscape of corporate risk not just for BP and the wider energy industry, but for every kind of multinational business, and for everyone who invests in them. When the saga of the Deepwater Horizon disaster is finally declared over, it will no doubt become a celebrated business-school case study; it already stands as the most vivid parable of our troubled times.
BP, let us recall, was so blue-chip that its shares were frequently the largest single holding in cautious pension-fund and charity investment portfolios. Though it had suffered other setbacks in the recent past notably the Texas City refinery explosion in 2005 its business model was based on long experience of managing operational risk in a multiplicity of conditions and territories. Its then Chief Executive, Tony Hayward, was a well-regarded scientist turned manager, chosen to strengthen the company's safety culture.
Yet within hours of the first explosion on Deepwater Horizon on 20 April 2010, all that had gone before for this corporate giant counted for almost nothing. BP's shares plunged, losing 55 per cent of their value by the lowest point in June, wiping tens of billions of pounds off the value of pension fund holdings. A range of takeover and break-up scenarios were mooted for the increasingly embattled company. Hayward himself came under relentless personal attack, led by President Barack Obama, that helped to bring a premature end to his career at BP. As the oil slick spread, the future of deepwater drilling a hugely important potential source of carbon energy was thrown into confusion. A decade of multi-billion-dollar litigation loomed.
Whatever technical lessons will eventually be learned, there is a more immediate moral to be drawn from this catastrophe, just as there was from the collapses of Lehman Brothers, American Insurance Group and Royal Bank of Scotland, and there is from the rumbling crisis of eurozone debt. We live in times so volatile that no company, bank or even country can be labelled 'blue-chip' without close re-examination. In fact, nothing in the economic world is as certain as it looked five years ago. And the globalisation of trade, finance and investment means that unlooked-for shifts and events in the real world have far-reaching and amplified consequences in the financial world, and vice versa.
That last observation perhaps needs some explaining. The ultimate cost of the Gulf oil spill to Louisiana's coastal shrimp farmers and tourism businesses may run into the low billions of dollars, but the long-term cost to pensioners and savers around the world who are indirect investors in BP (which, before its dividend was suspended, provided £1 in every £7 of income for UK pension funds) is far more insidious. A rig blow-out that resulted from the momentary interaction of nature with fallible on-the-spot decision-making will have uncountable financial consequences for years to come.
Likewise, the Icelandic ash cloud in insurance parlance, 'an act of God' was an immediate threat on the airline industry, but its economic impact was far wider, touching even Kenyan rose growers and vegetable farmers whose livelihoods depend on daily air freighting of their perishable produce to customers of Waitrose. Crop failures, floods and droughts too are acts of God which seem (perhaps assisted by acts of man) to have become more frequent in recent years, and have direct effects on the supply and price of basic foodstuffs. But again there is a new element of amplification, through the actions of hedge funds and investment banks which treat soft commodities as an asset class whose volatility can offer high trading returns. Thus in the summer of 2008, spikes in wheat and rice prices driven by speculators in response to rumours or genuine concerns about crop levels, provoked shortages on supermarket shelves and rioting in the streets from south east Asia to Latin America. In recent days a single London-based hedge fund was reported to have cornered the market in cocoa beans, pushing its price to a 33-year high with who knows what impact to come for the livelihoods of third-world cocoa farmers.
These uncertainties connected to the natural world exist alongside parallel uncertainties in the financial world. Before the crisis of Northern Rock in 2007, there had not been a 'run on a bank' (a depositor panic) since the failure of Overend Gurney in the City of London in 1866. Before October 2008, it was unthinkable that any major British bank would suffer such a collapse of confidence that it would have to be taken overnight into public ownership, but suddenly it happened to two of them. And all round the world, governments had to intervene to prop up their own domestic banks against the threat of a domino collapse. Before 2010, only a sceptical minority of economists thought it possible that the structure of the European single currency could be tested to breaking point by the fiscal delinquency of its southern member states, led by Greece. But that is happening now, and the whole euro edifice has arguably only been held together by a giant bail-out at the expense of German taxpayers, and with the backing of the IMF.
For those who run international businesses, therefore, the rules have changed: in some respects, there are no rules any more. Prices of raw commodities are subject to huge and sudden swings. Logistics can be dramatically interrupted. Important areas of business development can suddenly become politicised and subject to new regulatory scrutiny. Banks can suddenly totter and perhaps more importantly, can suddenly become reluctant to lend even to longstanding and normally creditworthy corporate customers. European countries can suddenly become unsafe to do business in. Entire financial markets can seize up. For investors, shares that had for decades occupied the 'safe but dull' sector of the portfolio can suddenly plummet. It really is a tricky new world out there.
And this means that the skills required of chief executives and public-company boards have changed just as markedly. Back in what we can now see as the halcyon middle years of the last decade, it was all about grand strategy, financial sophistication and the ability to talk a good game. Strategy needed to encompass the opportunities offered by China or India or Brazil or all three, as well as the former Soviet bloc. On the financial front, kudos was accorded to those who found the smartest ways to use leverage, cheap money and fancy capital-market devices to achieve 'tranformational' deals. And talking the talk meant giving eloquent answers to questions that included the word 'sustainability', whether that meant green-consciousness, a hollowed-out management cost base, or consistently high rewards for shareholders.
If there was an archetype, a corporate superhero of the era, it was Lord Browne, Hayward's expansionist predecessor at BP. Repeatedly voted the world's most admired business chief, a top-table political operator par excellence, Browne transformed his company into a global leader through the acquisitions of Amoco and ARCO in the US, and the massive TNK-BP joint venture in Russia, and at the same time sought to transform its negative 'big oil' image with the suggestion that its initials now stood for 'Beyond Petroleum'. It was a remarkable set of business achievements, and his fall from grace in 2007 came for entirely personal reasons; but Deepwater Horizon is now seen by some analysts as symptomatic of the unforeseen pattern of risk that he and his generation left behind.
Those risks require a quite different set of management skills. The attributes admired today are first and foremost to do with resilience in the face of shocks, together with a presentational ability to strike the right tone at moments of crisis. 'Sustainability' still means all the things it used to mean, but most importantly now it means a degree of financial robustness and caution that can sustain blows ranging from industrial accidents to sovereign defaults. Today's executives also have to demonstrate a willingness to 'share your pain' whether that means emoting appropriately after a disaster, or accepting lower bonuses as executive pay becomes increasingly controversial issue.
One chief executive who seemed to have spectacularly misjudged several aspects of this new mood was Tidjane Thiam, of Prudential, whose 'transformational' $35 billion offer for the Asian arm of American Insurance Group would have taken the Pru in one giant leap to become a major force in high-growth insurance markets on the other side of the planet. A French-educated engineer and former McKinsey consultant, Thiam took an objective view of the traditional British life assurer which had headhunted him and decided to turn it into a completely different business. But his shareholders were not having anything to do with such a radical shift certainly not at a price that looked too high for comfort after a bout of Asian market jitters in the spring, and perhaps not at any price. And AIG, effectively 80 per cent owned by the US taxpayer after its collapse in 2008, was not prepared to haggle. This was a deal that might have flown at another time, and might have attracted global applause for its strategic boldness, but not now. Thiam's future, following Hayward's professional demise, hangs in the balance.
How the chief executive's agenda has changed
- Talk the talk on sustainability and the green agenda
- Maximise opportunities in BRIC countries and the eurozone
- Look for transformational M&A/joint ventures
- Be lean and smart in management and operating structures
- Use capital markets and leverage boldly and creatively
- Above all, seek competitive returns for shareholders
- Brace for shocks out of the blue
- Beware transformational deals that shareholders won't back
- Beware eurozone turmoil
- Don't be too lean, too smart or too big:
- remember BP, BA and RBS
- Be sure your bankers will survive
- Be prepared to share the pain
- Above all, beware capital destruction for shareholders
So which business leaders have truly grasped the new Zeitgeist? Some observers might cite Willie Walsh, the combative Irish chief executive of British Airways who has been battling for two years against slump in the notoriously cyclical international airline market. In recent months he has had to cope with two additional challenges: striking cabin crew, and the ash cloud which grounded European air traffic for a week in April and sporadically thereafter. Walsh's decision to order BA long-haul pilots to fly towards London (with himself as a passenger) in order to force air-traffic controllers to reopen Heathrow and Gatwick looked both resolute and, in risk terms, shrewdly calculated: he has come through his crisis pretty well so far, and is still firmly in command.
Yet BA is itself an example of something else that no longer seems well fitted to the times: the hierarchical mega-corporation exposed to multiple risks at the same time, in contrast to the tighter-focused, leaner competitor. That observation invites an obvious comparison between BA and the low-cost operator Ryanair, with its even more combative Irish chief executive Michael O'Leary. Ryanair's stripped-down service, single-model fleet and highly flexible route map makes it as well suited to the times as any airline can be and to prove the point, it has surpassed BA in market capitalisation, profitability and (by a factor of four) UK and European passenger numbers. So perhaps O'Leary is our ultimate new role model.
The BA versus Ryanair analysis of the value of diversified exposure versus narrowness and tightness of management approach can be applied much more widely, however. It is especially relevant to the financial sector. Sheer bigness and broadness did not provide protection to the likes of Royal Bank of Scotland or Citigroup at a time when world markets went into a synchronised dive. Some conglomerate banks (HSBC for one, Santander rather distinctively another) came through relatively unscathed, but they were exceptions. On the whole, it turned out to be safer to focus cautiously and expertly focused on a relatively small number of business lines than to spread your risks across the entire spectrum of financial activity. In the British high street, the institution that came through the crisis best of all was the Nationwide, the only major mortgage lender still operating as a traditional and highly conservative mutual building society.
But let us turn back for a moment to the example of Santander, a Spanish regional bank that has expanded under the 25-year leadership of Emilio Botin to become the biggest banking conglomerate in Europe; having absorbed Abbey, the Bradford & Bingley branch network and Alliance & Leicester in the UK, it is now bidding for former Lloyds branches as well as adding new outlets in Germany. The group claims to have exceptional strengths in global risk management, but what is startling about its risk profile today is that the biggest worry it presents to analysts is its prominent market position in its own domestic marketplace, Spain, which still generates around a quarter of its profits.
In all 'normal' circumstances in the developed world, a business's home market is also its safest market: now that is no longer the case. And within its home market, the state would normally be the safest customer; but that too may no longer be the case in many countries, either because the flow of public-sector orders and contracts is about to dry up as spending is cut, or simply because the state itself is no longer a decent credit risk.
So much has changed, and so little of it was predicted by anyone five years ago. How fascinating it will be to see which businesses do best in such a turbulent and unexpected landscape, and which great names fail.
The writer is editor of Spectator Business.