Booz & Company
27 February 2009
Seeking the Phoenix – meltdown,
recovery and strategic response
Suvojoy Sengupta
Partner, Booz & Co
Suvojoy.sengupta@booz.com
This document is confidential and is intended solely for
the use and information of the client to whom it is addressed.
We have had downturns before – this one is different
Drivers
1973 Oil Crisis
1973 - 1975
 OPEC cut and embargo - oil
price quadrupled
 High government spending
1980 Energy Crisis
1980 - 1982
 Iranian revolution resulted in
higher oil prices in 1979
 Fed increased rates to cut
inflation
1990 Downturn
1990 - 1991
 Defense spending cut
down
 Cost reduction and
restructuring
2001 Tech Bubble
2001 - 2003
 Dot-com bubble burst
 9/11 attacks
 Accounting scandals
Why is the current crisis different?
• Pervasive, across geographies, across sectors
• Unprecedented volatility : commodities, fx rates, equities
• Squeeze on credit/liquidity –greater and more immediate impact
• Systemic/structural solutions needed, not just policy responses
• Responses to have impact on major global issues
2
Focus of today’s discussion
 How did the crisis unfold?
 What will recovery patterns look like?
 What are ‘smart’ companies doing?
3
Genesis of the crisis
The Great Moderation
 Long period of stable market, low
inflation, cheap money, lots of
liquidity
 Rising asset prices – the ‘asset
bubble’
 Massive overleveraging by financial
institutions
 Ballooning of consumer credit to
primarily fund consumption (buy now
pay tomorrow) – often against
inflating assets
 Injudicious (subprime) lending
especially in US and UK housing
markets…
 Repackaging, slicing and trading of
the debt in form of derivatives
–
Debt securitisation (CDOs)
–
Default risk isolation (CDSs)
Turn of the tide
 US housing market peaked mid
-2007, and house prices started
falling
 Higher foreclosures and credit
defaults by borrowers – further
depressed market
 Value of securitised debt instruments
and derivatives started falling…
 …putting pressure on balance sheets
of highly leveraged FIs
Full blown crisis
 Momentous events of Sept 2008
–
Collapse : Lehman, WaMu
–
Takeovers : Merrill Lynch, Wachovia,
HBOS
–
Government bailouts : AIG, Fortis,
Dexia, RBS
–
Country crises : Iceland, Pakistan…
 Collapse of confidence, rapid deleveraging, asset deflation and credit
contraction
 Commodity price collapse
 First distress signs – Northern Rock,
Countrywide… Bear Stearns…
 Concern over ‘toxic assets’
developed into alarm over FIs’ overall
creditworthiness…
 … resulting in credit and liquidity
crunch at all levels
 Liquidity crisis spreads to ‘real’
economy; US, Europe and Japan slip
into recession
 Unprecedented coordinated and radical
moves by governments and central
banks
 Massive bailout/financial stimulus
packages;
4
Our take : How did we end up here?
 Irrational exuberance – belief that assets will continue to rise, money will continue to be
cheap and plentiful, risk/volatility will remain low
 Measurement, pricing and transparency of risk got distorted – credit ratings, CDS
 Regulation loopholes – use of non regulated OTC trades, off balance sheet vehicles
 Short term incentives – mega bonuses for FIs based on in-year profits
 Failure of accountability and governance
In summary, financial markets failed their role in channelling capital to the most
attractive risk adjusted investment opportunities – and no one cried wolf!
5
This is forcing radical changes in the way Western
developed economies are operating – starting in the
financial sector
 Assuming control of failed institutions
 Providing capital directly to banks and other financial institutions
 Pumping liquidity into the system through lowering interest rates, reducing reserve requirements,
open market operations etc
 Insuring deposits and money market funds
 Providing first loss insurance on doubtful assets
 Purchasing or backstopping securitized assets
 Pushing mergers and consolidations of weaker institutions
 Freezing assets of failing foreign institutions
 Providing commercial loans (US commercial paper market: Fed is the major lender)
6
Lots of challenges for Western governments in their
new roles – and uncertainty on how (effectively) they
will use them
 Massive shift back to a “statist model”, away from a market model, and Western governments don't have
experience to guide their countries as some of the world's largest economies
 Governments and regulators may lack the specific skills to guide both the systemic and specific interventions
 Government intervention in lending, deposit and investment markets may create severe moral hazard
whereby participants assume that their specific risks are reduced and take on excessive new risks;
 Government investment and guarantees in key financial markets may be extremely difficult to unwind
without reigniting market and public concerns about risk
 Governments and regulators may have their own, non-economic, interests in over-extending the degree and
duration of their direct intervention
 Financial executives may be in denial about the sweeping nature of the changes in control and inadvertently
irritate key constituencies
 Financial executives may lack the public relations and political skills to anticipate society's concerns and
respond effectively
 Voters may have unrealistic expectations of the ability of regulators and politicians to reestablish stability
in financial markets and use financial interventions to support other sectors of the economy
7
To provide some context and pointers for these
decisions, we reviewed academic studies of past
financial crises andTimeline
recessions
of Previous Recessions
 US Recession of
1948-1949
 11 months
Non-financial
Crises
 US Recession of 1945
 8 months
 US Recession of
1937-38
 13 months
 US Recession of
1969-1970
 11 months
 US Recession of
1953
 10 months
 World Recession of
1957-1958
 8 months
 Global Oil
Crisis
 16 months
Financial
Crises
Recession longer than 12 months
Recession within 12 months
 Gulf war, oil price hike
 8 months
1990-1995
1957
 Dot-com bubble burst
 8 months
 US Recession 1982 to 1983
 6 months
1929
1937
1945 1948 1953
 “Great Depression” of 1929-1933
 43 months
 US Recession of 1980, Iran crisis,
oil price hike
 16 months
1969
1973
1980 1990
 Japan Financial Crisis
 12 years
 Norway Crisis
 1 year
 Sweden Crisis
 3 years
 Finland Crisis
 4 years
 Mexico Crisis
 1 year
1997 2000




2001
2008
Argentine Economic Crisis
4 years
Asian Financial Crisis of 1997-98
1 year
 Sub-prime triggered
global financial crisis
 Duration to date: over
one year
Note:
(1) Financial crisis is defined as a situation where financial assets suddenly lose a large part of their values accompanied with rapidly tightening liquidity. Typically speculative bubbles and crashes,
banking crises, or currency crises are the triggers for long-term economic recession
(2) Recession is a usually negative downturn in economic growth lasting several quarters
Source: Recession Definition Organization; Booz & Company analysis
8
Starting from 2008: a year of extremes
Long term
interest rate
Equity market
performance
Inflation
Commodity
prices
 Highest level for 20 years AND lowest levels for 50 years
 Worst performance for 70 years AND six of the ten best-performing days
in past 70 years
 Fear of inflation getting out of control at the beginning of 2008 AND
fear of deflation getting out of control now
 Highest levels in July 2008 AND significant lows by year-end
Source: International Herald Tribute Dec.19 2008; Booz & Company analysis
9
Recessions and the ensuing recovery typically take
one of three shapes
Three Recession “Models”
L Shape
U Shape
GDP
V Shape
GDP
GDP
Time
 No recovery
– Serious financial problems
usually accompanied by global
economy recession
– Governments ignore/misjudge
problems
– Poor implementations of effective
policy
– Example: Japan Financial Crisis,
over 10 years of recession
Time
 Slow recovery
– Serious financial problems
– Governments recognize
problems and take actions
accordingly
– Slow pace of improvement in all
three elements (demand,
financing, and confidence)
 Example: The Great Depression,
about 4 years of recession
Time
 Rapid recovery
– No serious financial problems
– Governments recognize
problems early in the crisis…
– …and take proper actions that
fully address all these three
elements (demand, financing,
and confidence)
 Example: Sweden Banking Crisis,
about 2 years of recession
Source: Booz & Company analysis
10
And the shape of the recession depends on the scale
of the underlying problems and the effectiveness of
Japan
Oil Crisis
US
Sweden
“Great Depression”
the policy response
1990s
1990s
1980s
1990s
1930s
Root cause
 US increased interest
rates, leading to
massive debt burden
in emerging markets
 More than 5%
 4.4%
GDP change
 Peaked at 10.8% in
Unemployment  Rose about 3.5%
 Peaked at 5.5%
impact
late 1982
 S&P index fell more
Equity market fall  Stock market index  Insignificant
fell by 54% from peak
than 15% from 1982 1984
 Tight monetary policy
Policy response  Gradual interest rate  Interest rate cut
 Increasing money
cut
to fight inflation
 Increasing money
supply
supply
 Fiscal stimulus plan
 Misjudgment of
government actions
on domestic and
foreign borrowings
 More than 5%
 Peaked at 11.1% in
1993
 Stock market index
fell by 25%
 Collapse of stock and
housing bubble
 Bailout banks’ bad
assets
 Increasing money
supply
 Promoting exports
 Initially contractionary
monetary and fiscal
policies
 Interest rate cuts,
Increasing money
supply, the “New Deal”
Shape of curve
Length of
downturn
 V shape
 3 years
 U shape
 43 months
Implications /
Lessons
 Speculation in the
stock market and in
real estate
 L shape
 13 years
Adjustments in
monetary and fiscal
policies played a
key role in boosting
corporate
investments
 Oil supply
shortages to the
West led to oil
price surge
 3.1%
 Peaked at 9.0%
 V shape
 16 months
 V shape
 22 months
Supply price shock
required
readjustment of
economic structure
to cope with a new
level of oil price
Government’s
graduated policies
increased banking
reserves and
restored a healthy
banking system
Combined effort of
maintaining bank
liquidity, boosting
demand and
building confidence
 29%
 Peaked at 25%
 Over 50% in cities
 Dow Jones Index fell by
89%
Expansion of
government spend
stimulated economic
growth and rebuilt
confidence
11
Throughout all these crises we see three key factors
driving recovery: demand, financing and confidence
Confidence
& Leadership
What changes and
actions boost
confidence? - e.g.
political leadership, new
breakthroughs
Confidence
increases
willingness to lend
and availability of
credit increases
confidence
Confidence boosts demand
and signs of increased
demand boost confidence
Adjustment
Which sectors,
geographies offer new
demand? - e.g. Govt
spending,
consumption
Sources of
Demand
Access to
Financing
Access to financing increases
demand and increases in demand
make financing less risky
What financing is
available to support
demand and enable
investment in future
opportunities? - e.g.
bank credit, capital
markets
12
A “Recovery Scorecard” can assist management in
monitoring key drivers and gaining foresight into
recovery signals“Recovery Scorecard” for the World Economy
Demand
 Private consumption
– Retail sales
– Savings ratio
– Real estate demand, pricing
 Investment
– Capital goods orders
– New / disruptive technologies
– Inventory growth
 Exports
– Import barriers
– Emerging market imports
 Government expenditure
– Fiscal policy
Note:
Financing
 Bank financing
– Bank lending
– Money supply growth
– TED spread
– Long term / short term interest
rate spread
 Capital market
– Market volatility
– ECM / DCM issuance volumes
 Other sources
– Availability of alternative funds
Confidence
 Government action
– Focus of stimulus
– Range of tools deployed
– Detail of plan
– Effectiveness of execution
 Consumer confidence
– Confidence indicators
 International collaboration
– Trade policies
– Coherence of action
The TED spread is the difference between the interest rates on interbank loans and short-term U.S. government debt ("T-bills").
ECM/DCM: Equity Capital Market / Debt Capital Market
13
Our Recovery Scorecard will look different across
countries – early analysis indicates that India/China
are likely to recover
sooner
Reading the Recovery Scorecard
GDP
A rapid recovery
 Government action stimulates
consumer confidence
 Banking rescues restore
financing
 …and a positive spiral results
US, W Europe
India, China
A long time coming
 Mixed success of govt. action
 Consumers caution continues
 …and a ‘wait and see’ attitude
prevails
Economic relapse
 Stimulus plans go awry
 Consumers panic
 …and vicious circle ensues
E Europe?
Time
14
Can BRIC countries compensate for contraction in
developed economies?
Composition
Japanof World GDP 2007
8.4%
US
26.3%
 BRIC cumulatively account for 12% of world
GDP, compared to 67% from US+W Eur+
Japan
 Capital flows to emerging markets predicted
to fall by 33% in 2009 (Economist)
RoW
20.6%
 Internal challenges to sustain growth, e.g.
Russia
 Impact of export contraction to BRIC from
developed economies
Brazil
2.5%
Russia
2.5%
India
2.2%
W Europe
31.5%
China
6.2%
Source : Economist Intelligence Unit
Emerging economies would
have done well to sustain their
growth, unlikely to compensate
for OECD shrinkage
15
Implications for Corporates : recessions become
'moments of truth' that further separate industry
leaders
from weaker competitors
 Performance of firms in an industry gets more polarized - strong performers outdo weak
(1)
performers compared to good times when everybody achieves close to industry average
 More similarity in results of strong performers across sectors than across firms within a sector
 Reshuffle in the industry order - new winners emerge; examples include:
1)
–
Honda made inroads into US car industry during the 70s oil shock
–
AMD bridged the performance gap with Intel chips during the last recession and thus was able
to steal share from Intel
–
In the wake of 9/11, Ryanair bought Buzz, a low cost airline from KLM, and added 30 new
aircraft to its fleet.
–
Southwest came out much stronger and profitable from the last recession compared to the
giants of United and American airlines
–
Born around the recession time Google redefined the on-line media market
Source: Coping with Recession, UK Company Performance in Adversity by Paul Geroski and Paul Gregg
16
Our recent survey indicates that majority of
companies still consider themselves ‘stable’ or
‘strong’ Size of each cluster
What actions should cluster be taking?
Relative to total respondents
Financial strength
Stable
22%
Strong
54%
Failing
8%
Struggling
15%
High
Financial strength
High
(In line with “Rethink Your Strategy”)
Stable
 Invest for growth (this is
chance to become
“Strong”)
 Be careful with cash
Strong
 Invest for growth
 Be careful with cash
Failing
 Conserve cash to buy
time to find right buyer
 Polish and look for exit
Struggling
 Conserve cash and hold
on for better times
 Consider merger with
“Strong” or “Stable”
company
Low
Low
Low
Competitive Advantage
(Perform better on
2 or fewer dimensions)
High
(Perform better on
3 or more dimensions)
Low
Competitive Advantage
(Perform better on
2 or fewer dimensions)
High
(Perform better on
3 or more dimensions)
17
%
The survey indicates that many companies have not
started taking appropriate action
Short-term Cash Generation
Decelerate
Strong
Disposing Stable
assets Struggling
Failing
Securing Strong
sources
Stable
of
Struggling
external
Failing
funding
Same as before
6%
20%
28%
62%
9%
58%
17%
33%
43%
39%
12%
63%
10%
7%
Accelerate
74%
10%
7%
Growth Initiatives
24%
22%
68%
30%
46%
63%
46%
Decelerate
Expansion
in emerging
markets
Investment
in new
products
Investment
in people /
talent
Acquiring
assets /
companies
Strong
Stable
Struggling
15%
Stable
Stable
Struggling
2
40%
35%
45%
21%
44%
29%
39%
35%
16%
33%
2
42%
43%
32%
36%
43%
21%
Stable
21%
42%
30%
38%
27%
Strong
Failing
41%
15%
Failing
Struggling
52%
33%
Failing
Strong
34%
32%
48%
28%
Struggling
Accelerate
51%
21%
Failing
Strong
Same as before
37%
42%
45%
34%
36%
48%
37%
2
30%
40%
2
33%
18
%
However, most sectors expect structural changes as
a result of the downturn
“The structure of my industry will change dramatically as a result of the
economic crisis (e.g., consolidation, new business models, etc.”
Financial
-17%
74%
Energy & utilities
-24%
55%
Prof Services
-23%
54%
Industrial goods
-23%
Healthcare & pharma
Transport &
communication service
•
Telecom & media
Consumer
-27%
-24%
-27%
-26%
51%
49%
49%
42%
41%
Disagree
Agree
(Neutral answers not shown)
19
What do leading corporates do in a recession?
Strategic Intent 1
Survive and Preserve Value
Strategically
Manage Costs
Improve Balance
Sheet
Tighten Controls
 No across the board head count
reduction at the beginning of
recession
 Careful cost reduction
 Reduce SG&A costs
 Continued reinvestment in business
and focused R&D to prepare for
upturn
 Decrease working capital
 Write down excess inventory
 Identify where payments would be late
and try to negotiate extended
payment terms
 Defer non essential purchases
 Refinance debt schedules to take
advantage of cheap financing




Tighter controls
Reduce discretionary spending
Apply sound financial management
Use the right metrics
Strategic Intent 2
Leverage Recession to Emerge Much Stronger
Rethink Strategy
 Focus more on growth than
costs
 Plan for 12-24 months out
 Use the recession to preserve
value and build the future
 Focus on core - shed
unprofitable businesses/assets
Grow Market Share /
Enter New Markets/
Build Capabilities
 Leapfrog through M&A
 Assets and companies are
cheap during downturn
 Leverage discounted financing
 Enter new markets and
segments
 Build new differentiating
capabilities
Focus On High
Value Products and
Customers
 Introduce products for most
profitable customer segments
 Customer centric innovations to
improve volume without
discounting prices
 Focused advertising targeting
high value customers
20
Separating men from boys.. our recommendations for
India Inc
Pursue operational fitness
agenda, get closer to
customers
Handle volatility – not just
through financial hedging
Winners from this
crisis will…
Refocus portfolios, look for
value adding acquisitions
Refresh talent pool, acquire
new capabilities
Innovate : products,
propositions, business
models
21
A closing thought : balance of power shifting on
many dimensions…will a new world order emerge?
Governments
Markets
Regulators
Businesses
Developed economies
Emerging economies
Globalisation
National agenda
22
Thank You
23