Saturday, 30 April 2011

Think Globally, Act Locally

This week I almost did not write a blog post. I have spent time instead on writing to a building contractor about safety problems at a nearby roadworks site. I’m not a prolific ‘letter-writing’ individual, but I observed a lack of safety procedures which I could see was putting cyclists at risk, and I felt the need to tell the company about it. Thankfully the contractor has now corrected the main safety problem, and has written on their website about an updated safety policy to avoid the same problem recurring.

The reason for me relating this, is that it reminded me of maxim that I first came across about 6 years ago: “Think globally, act locally.”*

I read this when (aged 17) I was trying to find out what ‘postmodernism’ means**. It was used in the context of the struggle of the individual to have an impact on the world. We all learn about the world and wish there were ways we could change it, but only a very few ever accumulate the power required to have a significant impact on ‘the world stage.’

This is where the imperative “act locally” becomes so powerful. If we do what we can to improve our communities, to hold our leaders to account, and to generate positive change on a local level, we can live in hope that others elsewhere in the world will do the same. It is important to “think globally” to develop an idea of what our society ought to be like, and that is one of the aims of this blog. But it is equally important not to neglect to act, when we get the chance, and to try and make our local realities a bit closer to the ideals we aspire to.

*A quick google search reveals that the phrase has its own Wikipedia page, and is attributed originally to the Town Planning profession. Since then it has become a recurring theme in discussions about globalisation.

**for the record, I’m still trying

Wednesday, 20 April 2011

Should employees provide financing to their employers?

John Lewis recently made the headlines by raising £50m from offering savings bonds to their own staff and the general public. In exchange for investments of between £1k and £10k, bondholders will receive 4.5% p.a. cash interest, and 2.0% p.a. in shopping vouchers.

There is a clear rationale for borrowing from customers. Last year I wrote a post applauding Hotel Chocolat’s financial innovation when they raised capital using ‘chocolate bonds.’ The razor blade manufacturer King of Shaves employed a similar method to raise finance, offering bondholders free shipments of razors in addition to interest payments. As long as customers realise that these are (somewhat) speculative investments with a high return on capital, they bring benefits to both parties.

The John Lewis bond is a good opportunity for regular customers to get extra value out of their savings. However I am less sure of the wisdom of raising capital from your own staff. The very first topics I chose to write about when I started this blog last year was the collapse of Enron, which was brought down by widespread accounting fraud. A large number of Enron employees had invested their life savings in Enron shares (encouraged by its CEO Jeff Skilling) and when it went bust they were left with nothing: no income and no savings.

For senior executives, tying up large amounts of their savings in company shares is the norm, as it gives other investors confidence that they are incentivised to maximise the value of the company. If the business fails, they lose a lot, but they will typically have a some of their (high) net worth in cash, and will reasonably be able to ‘start over.’ For regular employees, this is not necessarily the case. The link between their personal performance and the company’s performance is weak-to-non-existent, so the ‘incentive’ effect of investing does not hold. If the business fails, they have everything to lose. My last post on the retail sector explains just how easy it is for some companies to run into financial difficulties.

One of the first rules of investing is to diversify your holdings to spread the risk. An employee is already heavily exposed to their employer’s growth or decline. Perhaps investing their savings as well just puts too much risk in one place?

Monday, 11 April 2011

Retail woes and the 'Working Capital Trap'

The retail sector has made the headlines for all the wrong reasons in the past month. Sainsbury’s has missed sales forecasts, HMV in trouble with its banks, and Oddbins has gone into administration.

Wondering what is behind these kinds of problems, I decided to take a look at HMV’s financial statements. An inspection of HMV’s capital structure at April 2010 is quite revealing:
Total Equity: £100m
Total Liabilities: £605m
-------Of which: Interest bearing debt: £96m
--------------------Trade payables:£442m
-------------------------Other liabilities: £67m

The capital that sits behind a company is like the structural support holding up a skycraper. Equity capital is like the foundations on which the company is based; debt finance the reinforced steel beams allowing the tower to reach for the sky. The balance between equity and debt is critical. If you build too high without solid foundations there’s a risk the whole building could collapse – especially if the wind blows too strongly.

Retail businesses are unusual as their largest source of capital financing is their suppliers (‘trade payables’ above). Big retailers don’t pay their suppliers for 60 to 90 days after receiving goods, but when customers buy products they often get the money immediately. In effect, the suppliers are providing interest free loans. It is a form of ‘leverage’ which allows management to build a company on a thin slice of equity capital.

This business model works perfectly well as long as sales volumes are growing. The cash coming in from sales in any given month is higher than the amounts owed to suppliers for sales in the previous month. Sales can grow without the need for any additional equity investment. However, if sales stop growing, suddenly the amounts owed to suppliers exceeds the cash received from sales. The company finds itself in a ‘working capital trap’ where it suddenly needs to find a lot of extra cash, either in the form of an equity injection or a bank loan.

In its Annual report in April 2010, HMV was still showing revenue growth. But in its interim report in October 2010 it reported an 11.5% drop in like-for-like sales. The urgent need to find more working capital is what's thrown doubt on its ability to meet banking covenants, and caused it to seek further financing from its suppliers. I will be watching with interest to see how this story progresses - but I don’t plan on investing in HMV shares any time soon.