Published October 20, 2008

Shareholders' return hurtles downhill at speed of crisis

Detailed study sketches the pain, but turmoil may throw up lucrative M&A opportunities

By LYNETTE KHOO

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(SINGAPORE) The global slowdown is eroding value from companies and broad market sell-offs are eating into shareholders' return.

In the first nine months of this year, the total shareholder return (TSR) of companies globally has fallen by 26 per cent along with the slump in the global MSCI index, according to The 2008 Value Creators Report by Boston Consulting Group (BCG).

The short-term outlook for TSR across industries and markets worldwide has turned bearish and points to a downturn ahead, the BCG report says.

'As the events of the last nine months and specifically the last quarter have shown, the TSR performance for all markets including South-east Asia is under tremendous pressure,' said Dinesh Khanna, a principal at BCG Singapore and head of the BCG Corporate Development Practice in South-east Asia.

TSR generally takes into account a company's capital gains and cash flow yield over a period of time. Companies can raise their TSR by improving EBITDA (earnings before interest, tax, depreciation and amortisation), valuation multiples or cash flow yield.

But businesses could see further declines in shareholder return as they face tight credit amid slower demand, while their valuations get beaten down in jittery stock markets.

After several years of strong growth, EBITDA growth across markets and industries is declining, with some pockets expected to turn negative, while valuation multiples have also slumped, according to the BCG forecasts.

And recent events have shown that the knock-on effect of the current economic crisis is global in nature, Mr Khanna added. 'If the current economic conditions persist, the combination of less available (and more expensive) credit with stagnant or even declining demand will hurt even healthy companies.'

With the risk of corporate earnings globally on the downside, analysts have trimmed their earnings forecasts for 2008 and 2009. As it becomes increasingly difficult to sustain TSR by holding up their revenues, companies may focus on cost efficiency, preserving their cash flows and paying down debts to enhance their TSR.

But Mr Khanna cautioned that opportunities, including M&As, tossed up by the current downturn should not be overlooked. In an earlier study by BCG this year, M&As done in downturns have a higher chance of creating shareholder value and delivering greater returns on average.

He recommends companies cherry-pick M&As, and increase their likelihood of returns by acquiring relatively smaller targets and paying lower valuation multiples. Those with stronger cash flows will be in a better position to do so.

The BCG study also found that South-east Asian companies have held up better than their global counterparts across all industries, particularly for financial services and banks. Value erosion in SEA businesses has also been less severe than in emerging markets such as India and China so far.

The average TSR among SEA companies slipped 32 per cent in the first nine months of this year, dragged by losses in their benchmark indices. This compares with 40 per cent and 58 per cent decline of lead indices in India and China respectively.

Thanks to the healthy growth of regional economies over the past five years, the average annual TSR of a SEA company between 2003 and 2007 was 32 per cent, higher than the global average of 17 per cent for the top 650 companies in the world.

Mr Khanna believes South-east Asian companies are better positioned than their global peers to weather the storm, given their lower leverage and stronger cash balances.

Other analysts agreed. DMG & Partners Securities co-head of research Terence Wong believes SEA companies will probably continue to outperform the rest of the world in generating shareholder returns.

'Since the Asian financial crisis, a lot of these companies have already bucked up. They have concentrated not only on their profit and loss but also on their balance sheets,' Mr Wong said. 'We also see them generating very strong free cash flow over the last few years.'

The BCG study found Singapore blue chips such as Singapore Exchange, CapitaLand, Keppel Corp and SembCorp Industries as well as other second-liner stocks, among the top South-east Asian value creators - a reflection of their positions as regional powerhouses.

Revenue growth has been the strongest driver for value creation among South-east Asian players, contributing 21 per cent of the average annual TSR, followed by cash flow returns - in the form of dividend and debt repayment - which made up one-third of their average annual TSR.

SEA companies paid out higher dividends to shareholders over the last five years, which increased by over 29 per cent compounded annual growth rate (CAGR). They also reduced their gearing by 6 per cent over the same period.

Reinvestments were not stifled, the BCG report says. These firms reinvested and grew their asset base by a CAGR of over 14 per cent, which was funded mainly through retained earnings rather than debt.

The study suggests that such corporate practice of returning cash to shareholders via dividends or share buybacks will be more sought after by investors in downturns.