7.Financing ? focus on the company?s extensive involvement in local currency exposures (non-US $). What were the financial implications of the generation of revenues in many Asian currencies? What were the implications of debt in those currencies?

8.Financing ? evaluate the decision to rely on U.S. $ debt. Comment on the tradeoffs between lower financing costs on foreign exchange exposure.

9. Asia Crisis ? financial management is especially important in periods of economic difficulty. The company?s exposure in many markets made it sensitive to more crisis situations. Examine the negative impacts of the Asian crisis on the company?s financial position from the viewpoints of investment, operational and translation perspectives. Comment on the company?s reaction to these negative impacts.

case study The Far East Trading Company Michael Moffett \"We have worked 30 to 40 years to develop our countries to this level, but along comes a man with a few billion dollars, and who in a period of just two weeks, has undone most of the work we have done. As a result, the people of our countries suffer. You talk about human rights and protecting people. But they must be protected from people like Soros who has so much money and so much power and totally thoughtless because he is not only hurting the people of Myanmar, but the poor people in Indonesia, Malaysia, the Philippines and Thailand.\" Prime Minister Datuk Seri Dr. Mahathir Mohamad of Malaysia. New Straits Times, Kuala Lumpur, July 27, 1997 For Thailand to blame Mr. Soros for its plight is rather like condemning an undertaker for burying a suicide. The Economist, August 2, 1997, p. 57. Jan Karl Karlsen, CFO of The Far East Trading Company Ltd. A/B, hurried down the Kuala Lumpur hotel corridor to his meeting with the financial controllers of many of the company's regional operating units. His task this morning was to explain personally the profit warning reported by the company in a press release the Copyright 1999 Thunderbird, The American Graduate School of International Management. All rights reserved. This case was prepared by Professor Michael Moffett for the purpose of classroom discussion only, and not to indicate either effective or ineffective management. Thunderbird International Business Review, Vol. 42(1) 113-125 January-February 2000 CCC 1096-4762/00/010113-13 Published 2000 John Wiley & Sons, Inc. 113 Michael Moffett previous Friday, November 21, 1997, in Stockholm. This had been the second official profit warning of the year, and FETC's shares on the Stockholm Stock Exchange had once again fallen. The questions from shareholders, creditors, and analysts were increasingly numerous and pointed. Karlsen's thoughts on the flight from Stockholm to Kuala Lumpur had been dominated by what he considered the three critical factors facing FETC's management: cash flow, confidence, and control. FETC was expected to suffer significant losses from the current Asian currency crisis. Operating units throughout East Asia were already reeling from currency exposures, working capital financing shortfalls, and the general economic slowdown spreading out from the currency crisis which had begun in July in Thailand. These growing losses were now causing downward revisions in forecasted cash flows for the second half of 1997 and would most certainly continue into 1998. This in turn caused declining confidence in management as FETC was once again in the headlines of the business press in Sweden, FETC's home country. With losses came increasing criticism of management and increasing influence of the company's creditors. Ultimately, 114 control of the company could be at stake if management did not take action. The Company The Far East Trading Company Ltd. A/B was incorporated in Stockholm, Sweden, on March 27, 1897, by H.N. Johansson. Johansson, an experienced sea captain, had established a trading house in Bangkok, Thailand, in 1884 and wished to establish a trading company in Sweden which could serve as a financial base for continuous trade between the Far East and Europe. In the early years, the Far East Company made markets in rice, oilseed, spice, and timber. As the company expanded with the turn of the century, FETC opened trade routes to Africa, the Indies, North America, and Australia, eventually making shipping itself a major part of its business. What differentiated the Far East Trading Company in 1897 was still significant in 1997. FETC was a global trading company which had no real domestic business base but, instead, served to provide a cultural and corporate center for the conduct of global trade. For the next century, no matter what market or business it was involved in, the continuity of Swedish management was the only constant. Throughout the twentieth cen- Thunderbird International Business Review January-February 2000 The Far East Trading Company tury, the company prospered and faltered, like so many others, but persevered and maintained its corporate charter in Stockholm. Due to the immense distances in time and space for the conduct of trade, the firm was a loosely knit collection of independent country units from its very beginnings. The individual business lines conducted by FETC were under the direct and active management of the country manager assigned from the Swedish home office, and the decentralized organizational structure produced what many came to call country kingdoms. The individual country-based operating units were inherently entrepreneurial, entering into any area of trading or distribution which offered profit potential. The result was an amazingly diverse set of global businesses. The recent history of FETC had been dominated by a major reorganization and management change in 1992. After sustaining growing losses throughout its European and Asian country businesses, a new management group took control in 1992 headed by the new Managing Director, Jesper Erickson, and the new CFO, Jan Karl Karlsen. Although FETC was a Swedish corporation, Erickson focused on the fact that nearly 75% of its earnings were in the Far East. Erickson immediately moved to assert central control over the loosely linked worldwide operations, sell off much of the Group's remaining European business units, and reorganize the FETC Group along two different lines, FETC Core Businesses and FETC Businesses (Exhibit 1). Erickson's longterm strategy was to concentrate FETC's activities in fewer business areas in order to pursue growth prospects in line with FETC's expertise. FETC Core Businesses FETC's strengthand future prospects in the eyes of managementwas in three core areas of identified competence: Consumer Products, Foods, and Graphics. These three areas were expected to make up over 70% of FETC's turnover in the coming decade. The company's plan was to organize activities around these business areas across countries, rather than by country as under the historical organizational structure. Each of the core businesses would be managed independently from an identified business center of its activities: Consumer ProductsKuala Lumpur, Malaysia; GraphicsSingapore; FoodsBogot, Colombia. The Consumer Products segment was made up of two major subsegments: marketing services and nutritional products. The Marketing Services Thunderbird International Business Review January-February 2000 115 Michael Moffett Exhibit 1. The Far East Trading Company Group provided marketing, sales, distribution, and merchandising services to consumer product firms without significant in-country operations in the ASEAN1 countries and Greater China. Name-brand clients utilizing the marketing services segment included Philip Morris, Lego, and Sara Lee. The Nutritions Group was largely composed of 1 ASEAN, the Association of Southeast Asian Nations, is a regional economic and trade organization with original membership including Brunei, Indonesia, Malaysia, Philippines, Singapore, and Thailand. 116 a newly operational state-ofthe-art dairy plant in Shanghai, China. The Shanghai plant produced dry and liquid infant and baby nutritional products, but was not yet operating at full capacity. The second core business, the Foods segment, was the newest of the three core business segments. Unique for FETC, Foods was purely South American in composition, and headquartered in Bogot, Colombia. Serving the Andean Thunderbird International Business Review January-February 2000 The Far East Trading Company Region, the Foods Group focused on meats and meat products, including manufacture of concentrated animal feed, pig farming, slaughterhouses, meat-processing plants, and their associated distribution networks. It had been quite successful to date. Foods made up only 9% of FETC Core Business sales in 1996, but created over 30% of operating profits. The Graphics business segment, the third of the FETC core businesses, provided material and service solutions to the graphic arts industry in East Asia. This included the importation and distribution of equipment, services, and solution consumables to this rapidly growing sector of the Asian economy. Although historically the unit had served as the local representative of a number of major European manufacturers of graphic arts equipment, the product line had received a Exhibit 2. FETC Turnover & Operating Profit Margins, 1995-1996 (millions of Swedish krona) Thunderbird International Business Review January-February 2000 117 Michael Moffett significant boost in 1996 with the signing of an agreement to represent Eastman Kodak's graphic arts products throughout its service region. Operations in the region had been recently reorganized under one management roof in Singapore. FETC Businesses When Jesper Erickson reorganized much of FETC in 1992, all of those Group interests which did not fall into the three FETC Core Businesses were collected under FETC Businesses. Erickson believed these businesses were the leftovers of the earlier era in which country managers were allowed to follow entrepreneurial instincts, not the proven competency of the organization. The result was a steady liquidation of non-core businesses. FETC Businesses included timber (procured in Southeast Asia, Ghana, and Brazil, and traded through a central trading unit in London); wool under the trading name Stanford & Wilson (a buyer, processor, and seller of combed-wool products in Europe); shipping and technical services. All shipping unit businesses were scheduled for divestment and liquidation. The Chemicals Group, part of Technical Services, was a marketer and distributor of specialty chemicals to a variety of 118 manufacturing industries. In addition to distributing thirdparty products, Chemicals produced and distributed via a number of joint ventures in Thailand. The long-standing success of Chemicals in Thailand had built a base for expansion of the segment to a number of other Asian country markets, with entries into Vietnam, Myanmar, and most recently, Indonesia. Other activities included in FETC Businesses' results included plantations in Malaysia which were recently liquidated, and unallocated expenses related to the Corporate Center in Stockholm and other regional centers in Asia. 1997 Half-Year Results With FETC's half-year report (for the January-June period) published in August (Exhibit 3), problems were apparent. Although sales were up by 12% in Swedish krona terms, operating income was down by a full 26%. Sales were up in all three Core Businesses and four of the seven FETC Businesses, but the operating results of Consumer Products (-144%), Foods (-77%), Wool (-82%), and Other Activities (-30%) were down. The causes, as best as Jan Karlsen could determine, combined both operating and financing cost problems. Thunderbird International Business Review January-February 2000 The Far East Trading Company Exhibit 3. FETC Net Sales and Operating Results, Half-Year Report, 1997 (millions of Swedish krona) Operations The report noted specifically that cost control and utilization issues in Asian market segments were largely to blame. The core business units in Thailand had experienced significant inventory pilferage and accounting fraud (postponed orders had continued to be booked as current sales) since the first of the year. Unit management had been quickly replaced, but the declining Thai market continued to put pressure on management performance. Days sales out- standing on receivables were stretching out, and many suppliers had simultaneously begun drawing in their credit terms. Both sales and costs had grown. The Chinese powdered milk plant, a major capital project, was still operating at less than 70% capacity, adding to the continuing operating burden on the Chinese subsidiary. This state-of-the-art factory, recently brought online in Shanghai for the production of infant nutritional products, Thunderbird International Business Review January-February 2000 119 Michael Moffett was continuing to suffer high per-unit costs. A recent stockholder briefing had summarized management's outlook on the Chinese investment: It is our strong belief that these commitments to and investments in China, despite the difficulties and risks in the near term, will provide attractive future profits and worthwhile long-term returns. It must be underlined, however, that China will require prolonged nurturing, and that substantial expenses and investments will be required in 1997 and 1998. Financing Financing expenses were significantly higher than in the previous year. The individual subsidiaries were largely responsible for their own funding. The parent company had provided minimal equity investment in the beginning, and additional funding needs were supplied over time through retained earnings and debt. The majority of the debt acquired by individual units was from outside the organization, typically from local and regional banks, not from the parent company. As opposed to many multinational firms which had only recently entered Asia, FETC's long history in the region had allowed it to build bank relations over time. The reliance on debt had risen throughout the 1990s as profits had declined. 120 In 1995 and 1996, many of the Asian units had moved to reduce financing expenses by financing both long-term debt and short-term working capital financing needs offshore in U.S. dollars. The stable currencies of the region allowed the firm to borrow dollars offshore at an average interest rate of 9% in 1996, as opposed to 14% for Malaysian ringgit or 18% for Thai baht. The parent company had also encouraged the individual units to decrease capital needs through improved inventory turns and reduced cycle times, as well as capital costs through more aggressive financial management. But in June 1997, the dollar had strengthened, leading to rising debt service expenses and foreign exchange losses. FETC had concluded its halfyear report to stockholders in August with a profit warning that \"... it is expected that 1997 full-year operating profits will be lower than in 1996.\" FETC's share price suffered another setback, and Jan Karlsen was spending more and more of his time meeting with both institutional investors and the major creditors of the company. The Asian Currency Crisis The roots of the Asian currency crisis extended from a funda- Thunderbird International Business Review January-February 2000 The Far East Trading Company mental change in the economics of the region, the transition of many Asian nations from net exporters to net importers. Starting as early as 1990 in Thailand, the rapidly expanding economies of the Far East began importing more than they exported, requiring major net capital inflows to support their currencies. As long as the capital continued to flow incapital for manufacturing plants, dam projects, infrastructure development, and even real estate speculationthe pegged exchange rates of the region could be maintained. When the investment capital inflows stopped, however, crisis was inevitable. The most visible roots of the crisis were in the excesses in capital flows into Thailand in 1996 and early 1997. With rapid economic growth and rising profits forming the backdrop, Thai firms, banks, and finance companies found they had ready access to capital on the international markets, finding U.S. dollar debt cheap offshore. Thai banks continued to raise capital internationally, extending credits to a variety of domestic investments and enterprises beyond that which the Thai economy could support. As capital flows into the Thai market hit record rates, financial flows poured into investments of all kinds, including manufacturing, real estate, and even equity market margin-lending. As the investment bubble expanded, some participants raised questions about the economy's ability to repay the rising debt. The baht came under sudden and severe pressure. As the Thai government and central bank intervened in the foreign exchange markets directly (using up precious hard currency reserves) and indirectly (by raising interest rates to attempt to stop the continual outflow), the Thai investment markets ground to a halt. This caused massive currency losses and bank failures. On July 2, 1997, the Thai central bank, which had been expending massive amounts of its limited foreign exchange reserves to defend the baht's value, finally allowed the baht to float (or sink in this case). The baht fell 17% against the U.S. dollar and over 12% against the Japanese yen in a matter of hours. By November, the baht had fallen from Baht25/US$ to Baht40/US$, a fall of about 38%. In the aftermath, the international speculator and philanthropist George Soros was the object of much criticism, primarily by the Prime Minister of Malaysia, Dr. Mahathir Mohamad, for being the cause of the crisis. Soros, however, was likely only the messenger. Within days, in Asia's own version of the tequila effect, a number of neighboring Asian nations, some with and some Thunderbird International Business Review January-February 2000 121 Michael Moffett Exhibit 4. The Economies and Currencies of Asia, July-November 1997 without similar characteristics to Thailand, came under speculative attack by currency traders and capital markets.2 The Philippine peso, the Malaysian ringgit, and the Indonesian rupiah all fell within months (see Exhibit 4). In late October, Taiwan caught the markets offbalance with a surprise competitive devaluation of 15%. The Taiwanese devaluation only seemed to renew the momentum of the crisis. Although the 2 The tequila effect is the term used to describe how the Mexican peso crisis of December 1994 quickly spread to other Latin American currency and equity markets, a form of financial panic termed contagion. 122 Hong Kong dollar survived (at great expense to the central bank's foreign exchange reserves), the Korean won was not so lucky. In November the historically stable Korean won also fell victim, falling from Won900/US$ to more than Won1100/US$. By the end of November, the Korean government was in the process of negotiating a US$50 billion bailout of its financial sector with the International Monetary Fund (IMF). The only currency which had not fallen besides the Hong Kong dollar was the Chinese renminbi (Rmb), which Thunderbird International Business Review January-February 2000 The Far East Trading Company was not freely convertible. Although the renminbi had not been devalued, there was rising speculation that the Chinese government would devalue soon for competitive reasons. Asian Crisis Impact The falling value of Asian currencies was reflected in a series of impacts on the FETC Group's financial results. First, business units across Asia individually suffered currency transaction losses associated with exposures to nondomestic currencies (most frequently, either accounts payable or debt obligations in U.S. dollars). Local management in these business units, however, argued that although their Swedish krona value was diminished, these units were in many instances continuing to make significant progress and take growing market shares in local currency termswhich was what mattered. Secondly, the FETC Group would suffer currency translation losses in both earnings and asset values on a consolidated basis. These translation losses would include not only the reduced Swedish krona value of Asian currency financial results, but also the reduced equity value of the Asian businesses themselves. This was the reduced Swedish krona value of the firm's original equity investments in its Asian businesses as recorded in consolidated equity. (In anticipation of the potential fall of the Thai baht, FETC had declared dividends from Thai units in 1996 which surpassed their total income for the period.) FETC had pursued a relatively common practice of hedging its (corporate) net equity investment in its subsidiaries (an asset) by borrowing in the currency of the subsidiary (a liability). But FETC had borrowed U.S. dollars, not Thai baht or Malaysian ringgit, in the belief that these currencies would maintain their pegs to the U.S. dollar. However, with the devaluations of the Asian currencies, FETC was now realizing substantial equity losses with no corresponding fall in the value of the dollar liabilities. Third, the operating exposure of the firm, the firm's changing long-term competitiveness as a result of the currency changes, was yet to be determined. The currency crisis had already caused the World Bank and IMF to intervene in the region in the hopes of preventing a general recession as a result of failing financial institutions and general economic collapse. Regardless, it appeared East Asia was headed for an extended recession. Thunderbird International Business Review January-February 2000 123 Michael Moffett The consumer product and graphics units were already finding themselves squeezed as a result of importing increasingly expensive dollar-denominated merchandise requiring higher retail prices than the market would support. And local competitors were gaining lost market share. Of immediate need in the eyes of Karlsen was the firming-up of the Group's many working capital lines with banks. The banks were repeatedly denying expanded working capital lines, even for units with growing sales. The Kuala Lumpur and Singapore units had both recently begun lagging intrafirm payments, including debt service, due to capital shortfalls. Currency charges were also rising as all intrafirm payments were required to be in U.S. dollars. More and more scheduled payments were not occurring as promised. FETC's Second Profit Warning: November 21, 1997 Jan Karlsen concluded that, with the continually declining earnings in the Core Business segments, there was little choice but to go public with a second profit warning. FETC's Management and Supervisory Board have evaluated the consequences of the cri124 sis in a number of Asian financial markets, and the impact the recession in several Asian countries has on FETC's businesses and earnings. On the assumption that conditions in our main markets are unchanged for the balance of the year, FETC expects a loss after tax of about SKK 300 million in 1997 after a number of non-recurring costs and provisions ... It now appeared that management had no choice but to take rather drastic measures if FETC was to have hopes of returning to profitability within the near term. Erickson and Karlsen returned to a topic of constant debate between them: the potential liquidation of FETC's non-core businesses. Erickson wanted to liquidate them immediately, at any price. This would generate additional capital for the reduction of corporate debt loads and signal shareholders that management was taking positive actions in the crisis. Karlsen was more reluctant to sell off these other units quite yet, arguing that if they waited they would be able to find buyers who would pay at least 20% more. In the meantime, the businesses would continue to generate cash flows which were critically needed. An emergency meeting between the senior management team and institutional investors had concluded with the agreed expectation that the Group Thunderbird International Business Review January-February 2000 The Far East Trading Company would return positive results by the second half of 1998. The first profit warning of the year had left the share price at about SKK80. It was still unclear what this second profit warning would do to it. As Jan Karl Karlsen entered the Kuala Lumpur hotel meeting room, still focusing on the three C's of cash flow, confidence, and control, he consciously changed his thoughts from Swedish to English. He knew there were two sets of questions he had to answer: (1) what FETC's corporate outlook was from the Stockholm perspective; and (2) what actions were needed immediately in the regional business units. Thunderbird International Business Review January-February 2000 125