Sweden- Moving against the flow

Today while I was reading on other headlines in the economics sections, one article particularly caught my attention. "Sweden Shows Central Bankers How to Fight Next Asset Bubble" By Kati Pohjanpalo. This article highlights the steps taken by central bank of Sweden to fight the rising asset prices. At a time when the banks in the US, Europe and Japan are keeping their borrowing cost low, the increase in repo rate by the central bank in Sweden comes as a surprise.

Most of the central banks had kept the rates low to encourage borrowing and fuel economic growth. And most of the banks have used inflation target as a benchmark to gauge the effectiveness of this step. In USA the inflation has decreased over past many months and the CPI stands at 0.1% in November 2010 ( source US Bureau of Labor Statistics). This has made FED worried and they plan to infuse more than $600 billion funds in quantitative easing to stop the US from moving in a deflation mode. So on the face of it, the steps look reasonable as infusing of more funds in market with reduce the borrowing cost which ultimately make people to spend and help achieve the inflation target that the FED has set.

Now lets compare the parameters to whats happening in Sweden. The inflation in Sweden has been under the target of 2% for past few months but the central banks has increased the repo rate four times. If we apply simple principles of economics, this step should reduce the demand for funding and further reduce the inflation. Now at a time when most of the countries in world are trying to accelerate their growth, why is Sweden doing totally opposite. The comments of other economists provide some very valuable insights in this. Johnny Akerholm, president of the Helsinki-based Nordic Investment Bank, says that "The financial crisis that started more than two years ago was exacerbated by central banks holding rates too low as inflation gauges failed to capture asset-price growth". This essentially means that even when inflation across major countries remained low, the prices of commodities other than prices of consumer goods are increasing. So keeping the borrowing rates low is just further fueling this prices to higher level.

This contrasts with Feds approach who prefer higher inflation and rising asset prices to less than target inflation and weaker growth. Which is the best approach? well only time will tell that but it does raise few questions. Is inflation target alone a most optimum parameter? Does infusion of liquidity and keeping the rates lower really help growth in long term or it may actually have a negative impact( case in point Japan) ?

Any ideas highly appreciated..

M&A- the right strategy

I was reading a new article in Reuters about M&A in 2010. And I was surprised to read that M&A globally reached its highest level of $2.25 trillion in 2010(in spite of approximately $100 billion of M&A deals by BHP which didn't go through) since 2007. I had suspected that companies get conservative in recessionary times and concentrate more on cutting costs and not on making future investments.

On the one hand the bad market conditions force companies to adopt a conservative approach and increase the amount of cash they hold while forcing them to reduce capital investments such as opening new factories as demand get unpredictable. Also to consider various discounts company offers to its consumers to spike the demand. Considering all this factors it makes one wonder, what are the strategic and operational benefits that companies consider to justify M&A in 2010.

The first reason that is attributed to increase in the M&A in 2010 is the availability of cheap credit. As the world entered recession, many countries, the US in particular, infused high liquidity in the market. This helped companies reduce their borrowing cost. And this motivated them to invest this money borrowed at low interest in avenues of higher returns. But the global markets had been performing badly and the higher volatility increased the risk associated with making any investment in equities.

Than one may ask why did companies make investments in such a market? Well, the answer to this question was also the volatility in the market. The overall performance of equities in the world had been negative in previous two years and most of the companies were trading at a discount to their future earnings. This motivated most of the companies to make the investment as they thought it to be a big bargain.

So these were the reasons, but that makes on think, which is the best way to go about it? Should the company make many small acquisitions or go for one very large acquisition. A discussion on the website of Deloitte provides some valuable insights into the topic. They argue the pros and cons of both approaches. Mr. Steve Joiner, Partner, M&A Transaction Services, Deloitte & Touché LLP shares his valuable insights on the topic. He shares his experience while leading a panel discussion at Deloitte CFO Conference. He brings contrast in approaches followed by two CFOs of two major companies. The first CFO mentioned about a multibillion dollar acquisition his firm did few years back. The CFO mentioned that they kept a tight focus on integration and execution of the deal which allowed them to do well even in bad economy. However the CFO mentioned that even though they have the cash and experience, they follow a strict guideline of only going for deal that provides them at least 15% after tax returns.

To compare this approach with the other CFO whose firm did more than 60 deals in past five years? This company follows the approach of finding small and mid size companies which produce quality products with broad appeal but lack the marketing skills. The company doesn’t look for a short term expectation on the return but look for longer term value creation. Mr. Joiner concludes the view saying that both the CFO insisted on sticking with their strategy.

When I was reading the views of both the CFOs, I get a feeling that the firm CFO is working for a company in a mature industry with low differentiation in products such as metals& mining and oil and gas. In that case it makes sense to have a strict guideline for return expectation. This helps the company stick to its growth strategy and avoid unnecessary risks. While in case of second CFO, it looks like his company operates in an industry with high growth potential and highly differentiated products. In that case it makes it pertinent to go for companies with products with high potential of future growth. Also as they products are highly differentiated, it’s not easy to gain new customers which leave M&A as the only option.

So to conclude, I think the choice of M&A strategy is more dependent on the industry the company is operating. But if one has to choose between one big acquisition and many small acquisitions, I think going for many small acquisitions is less risky approach. However I opinion may be short sighted as I am not sure about the following areas.

If a company does many deals, does it get easier for the company to integrate the new company with each deal?

Also is the fee paid to advisors of the deal fixed irrespective of the deal value?

Is the time required to integrate the acquired company directly proportional with size of both the companies?

Links to articles quoted in the blog

http://www.reuters.com/article/idUSTRE6BG00D20101217?pageNumber=1

http://www.deloitte.com/view/en_US/us/Insights/Browse-by-Content-Type/deloitte-debates/6fd3c32332c9c210VgnVCM1000001a56f00aRCRD.htm