SOPHISTICATED FINANCE

CWI Strategic Reorganization

CWI, the historically dominant fixed line and wireless telephone service provider in the Caribbean, announced their financial results last week. With EBITDA margins of over 30 percent on $2.4 billion in revenue, the results look pretty good. However, the company announced a strategic reorganization in the face of increased competition from Digicel in both the Caribbean and in Panama (CWI's fastest growing market). Digicel was awarded a cellular license in Panama earlier this year.

CWI's reorganization is along geographic lines with the entire Caribbean as one region, Panama as a stand alone region and operations outside the western Hemisphere also grouped geographically. By managing the entire Caribbean as a single market, CWI believes they can utilize pan-Caribbean products to take back market share from Digicel. Such an approach is expected to reduce the cost of new product development and reduce operating costs in marketing and administration. The headquarters for Caribbean operations will be in Barbados, wherein lies the problem. (Patience--we will get to the management point in a few more paragraphs.)

Barbados is a small island with a population of only approximately 280 thousand, which makes it a small market for CWI. The major markets for CWI in the Caribbean are Jamaica and Trinidad, which have a combined population of over 3.8 million. Barbados has little air service to other Caribbean islands except by changing planes in Miami, which will naturally reduce management's desire to visit other markets. As a small market, Barbados will not be the initial market for any new product offerings from competitors such as Digicel.

So why did CWI pick Barbados for its headquarters. I think the only reason is that expatriate staff will live in Barbados. It is very difficult to get expatriates to relocate their families to Jamaica or Trinidad, the more logical locations. You might ask why CWI, who has been operating in the Caribbean for over 150 years, is still relying on expatriates, but this post is not about British colonialism. (CWI used to be called Cable & Wireless and they had the telephone monopoly in every British colony.)

In this day and age of high tech telecommunications, rss news feeds and other information technology, you might be tempted to say that it is no longer necessary to headquarter in a major market. I would disagree because I think it leads to losing touch with your most important customers. Driving to work, watching local television and after work socializing provide much richer information about the changing needs and economic well being of customers than rss feeds and sterile demographic information. CWI appears to have missed this important point when they decided to headquarter in Barbados.

Where would I have located my Caribbean headquarters? I probably would have put administration and customer service in Trinidad and put marketing and network operations in Jamaica, thereby achieving senior management in both the major markets. Alternatively, I would have located headquarters in Panama. The fight between CWI, Digicel and America Movil in Panama will be very insightful to any manager for application across all the markets where CWI and Digicel go head to head. Also, Panama has good air service to the major Caribbean markets, a bi-lingual management pool and is in the heart of the fight for control of the Central American cellular market--where product innovation is imminent.

I spent years in Japan doing organization work to support new strategies. It always amazes me when companies adopt good strategies (CWI) and then implement the wrong organization structure (CWI). Organization structures have to follow strategies and not be tainted by personal or personnel issues. This is the most common mistake in developing an organization structure and CWI appears to have made it.

The Consequences of Technology Adoption

Two Harvard Business School professors, Diego A. Comin and Bart Hobijn, have just published an interesting paper entitled An Exploration of Technology Diffusion. The paper basically looks at the rate at which fifteen technologies have been adopted by 166 countries over the period from 1820 to 2003 and the resultant affect on economic development. The main conclusion of the paper is that the time to adopt a new technology is the leading factor to explain economic development.

Two examples illustrate the point that shortening the period between invention and adoption of a new technology accelerates economic development. The first example cited by the authors is the Meiji Restoration in Japan (circa 1860) where one of the major objectives was to industrialize Japan by using western technology (and thereby shrinking the time frame to adopt new technologies). As a result of these efforts begun in the Meiji restoration per capita income increased 33 percent. The second example is the Four Tigers (Hong Kong, Singapore, Taiwan and Korea) who in the period from 1960 to 1995 each averaged 6 percent annual economic growth. The data shows that it was the speed to adopt new technologies that explains in large part their phenomenal growth. The data also shows that Latin America is comparatively slow to adopt new technologies and consequently has had much slower economic growth than many other regions.

The paper provides the data to draw some other interesting conclusions about globalization, government policy, new business development, and business management.

Globalization The rapid diffusion of technologies in recent years is probably not due to globalization or the Internet revolution. Over the nearly two hundred year period studied, newer technologies are adopted faster than older technologies. As we consider the free trade dialog, rather than focusing on jobs going off shore the better discussion would be about how to encourage U.S. companies to adopt new technologies faster.

Government Policy The shorter the lag in the adoption of a new technology the greater the economic benefit. Government interference in the development and particularly in the time to adopt a new technology has dramatic negative consequences for economic growth. Government policy on stem cell research and global warming, to cite two examples, could severely slow adoption of these technologies in the U.S. and put economic development at a severe disadvantage.

New Business Development When the number of technologies available for a production method are small an increase in production methods, i.e. a new technology, have a very large effect on economic productivity. Given the limited number of communications methods available pre-Internet (Telephone, radio, television, newspapers) it should not be a surprise the profound effect the Internet has had. More importantly, when looking for new business ideas, look at industries or needs where there are a limited number of technologies for production; energy generation comes to mind.

Business Management A widely held view is that one does not invest in new technology when the cost of using people at low salaries is cheaper. This view is particularly prevalent in emerging markets. The key factor to explain the lack of development in emerging markets is their slowness to adopt the new technologies. Invest in new technology, even if you can not afford it.

While much is said about globalization, economic development and third world governments, it all comes down to how fast can you adopt new technologies--assuming that the goal is economic development.

If you are interested in following the thought leaders at Harvard Business School their new work is here.

Cost Cutting?-Update

Yesterday's most popular search that brought readers to this blog was "Deutsche Bank Brothels". Google is not yet sophisticated enough to tell me whether searchers were looking for a list of the brothels or just more details on the story.

For those of you who wrote or commented to say that the bank never took you to a brothel I can only say that you should have proposed a bigger loan.

For those of you looking for a new business idea, I think a guide called "Brothels of the Leading International Banks" would be very popular. Of course, you would first need to document whether any other leading international banks allow expense reimbursement for such activities.

For those of you actually interested in cost cutting I apologize, but some stories are just too funny.

If you missed yesterday's breaking news story on Deutsche Bank it is here.

I will return to more serious posting as soon as I get that 10Q done, but until that time I may ....

Colombia Free Trade Agreement

Last week it was announced that Democrats in the House of Representatives are going to block a vote on the treaty for a free trade agreement with Colombia. The New York Times quotes Nancy Pelosi, "We’re first and foremost here to look out for the concerns of America’s working families". The NYT then goes on to quote Condoleezza Rice on behalf of the Bush administration, saying that the U.S. needs Colombia's support to stand up to "very hostile anti-American states and forces in Latin America".

These quotes explain why the U.S. reputation internationally is in a tailspin. Ms. Pelosi puts partisan politics ahead of a good trade agreement with one of the two or three remaining U.S. allies in South America. Ms. Rice responds with "national security" issues related to Venezuela. The Boy Scouts of America could handle Chavez in Venezuela if he became "very hostile". Idiots Politicians on both sides use arguments that a toddler would see as specious.

On a positive note, Peru has invited Central America to enter into negotiations for a free trade agreement. Maybe Peru will replace the U.S. as the world leader in free trade, democracy, human rights etc.

Guatemala's Emerging Middle Class

In a recent post I talked about the business opportunities in serving the needs of the emerging middle class in Central America, and in particular in El Salvador. In Guatemala the lead story yesterday in a local newspaper, Siglo XXI, talks about the impending shortage of electricity in the country. (If you read Spanish, the full story is here.) The key information from the story is summarized below.

The most interesting number for me was the 43 percent increase in electricity subscribers. While part of the increase can be attributed to government efforts to expand electrification, the other important reason is the increase in the number of people with the disposable income to pay for electricity. I would suggest that this is further evidence of the emerging middle class in Central America, in this case in Guatemala.

Am I recommending that we build a power plant in Guatemala? Not exactly, unless you run a hedge fund and you are looking for less credit risk than mortgage-backed securities or want to diversify the portfolio out of the U.S. or China. I am, however, recommending that there are ample opportunities in Guatemala to serve these customers who only recently got electricity. Perhaps a concept that combined consumer credit with consumer electronics would work well. Maybe a cooperative that built wind powered electricity generation is feasible. Maybe simply a store that offered a very large selection of lamps at popular prices would work. The opportunities are there.

One note on the competitive landscape. Wal-Mart is expanding aggressively in Central America and already has six hypermarket stores just in Guatemala. The good news is that this investment is further proof of the emerging middle class. The bad news (maybe)is you do not want to take on Wal-mart head on, but fashion and trendiness are always Wal-Mart's weaknesses and trendiness extends well beyond just clothing to consumer electronics :)

Next post I will have more Excel tips.

New Business Ideas-A Different Approach

I have been working in El Salvador this week. The annual per capita income here is about US$ 2500 and the minimum wage per month is US$ 170. For a variety of reasons including political stability, historically lower borrowing rates and the CAFTA treaty, the middle class is emerging here. You see it in the development of new inexpensive town home projects and the more fashionable dress of the women, to cite two examples. I lived through the emergence of the middle class in Indonesia in the 1990s and have some experience in understanding how the customer needs of relatively poorer people change as their income increases to the level of real discretionary income.

The people I was working with were pushing me pretty hard for new business ideas. Housing development and fashion retail stores did not really match up well with their business competencies and available capital. Finally, I gave them a framework for how to find their new business idea. I told them to look for opportunities where the newly emerging customer needs can be met by technology as opposed to bricks and mortar. The technology to focus on is the cellular phone. Despite a comparatively low per capita income, cell phone penetration is approaching fifty percent. I used two examples to illustrate my point.

1. El Salvador is in some ways an inconvenient place to live because many monthly payments are made in person in cash. People without bank accounts are the majority and spend a lot of time standing in lines to pay bills.The new business I told them to consider was to establish a banking system using electronic payments via cell phone. In South Africa such a system has achieved over twenty percent of all deposits in the country.
2. Online social networks have become very popular all over the world, but in some countries the principal access to the Internet has been through the cell phone as opposed to DSL, cable or fiber. Perhaps the opportunity exists to start a cellular-based social network in El Salvador.

I had a third example which my associates in El Salvador really liked, but that idea will remain confidential.

While the examples cited above utilize the internet access/network functionality of the cell phone, there are many other functionalities in the cell phone that can be used to satisfy the emerging needs of the new members of the middle class in El Salvador...and many other countries.

In closing, I would caution you to define and understand the customer need and estimate the size of the business opportunity first. Then look for the applicable technology, whether it be wireless, medical, cleantech, etc.  Remember that unless you are part of this emerging middle class you may not really understand their new needs and the timing of their emergence.

Digicel Wins Honduras License

Back in October I posted on the auction taking place in Honduras for the fourth cellular license in that country. I predicted that either Telefonica or Digicel would be the winning bidder and the winning bid for the license would be at least $20 million. Yesterday several sources announced that Digicel had been awarded the license with a winning bid of $80 million or about $10 per capita.

The magnitude of the winning bid for the license prompted me to do a short analysis, which is shown below. Digicel's total investment in Honduras will probably total $300 million based on their previous strategy in similar countries. The initial network buildout will cost $100 million and with success in the market they will expand their network in phase two at an additional cost of $120 million to provide the best network coverage in the country. The license fee brings total investment to $300 million. Assuming that Digicel is targeting a return of 15-25 percent per annum in 5 years, their target exit value for Honduras is $600-900 million. Based on an assumed value per subscriber at exit of $1500-2000 (50-60 percent of a U.S. subscriber), Digicel needs between 300-600,000 subscribers in year 5 to achieve its return target at exit. This level of subscribers is quite realistic given Digicel's performance in markets similar to Honduras.

Digicel's willingness to invest $300 million in a market that already has two strong competitors shows just how attractive the cellular market is in Latin America. It is proof we can expect continued growth in subscribers and new investment in this sector in Latin America.

Customer-centric Management

Yesterday I spoke (in Spanish) at a conference hosted by the Summit of the Americas Center. The conference theme was microfinance in Latin America. I presented on how to develop a business plan for microfinance. Microfinance is, for example, the concept that you give a poor person a small loan (less than $1500) and they can start a business, feed their family and improve their life. It has been very successful in several countries and earned Mahammad Yunus a Nobel prize in 2006 for his microfinance work in Bangladesh.

In the course of preparing my speech I came across a 2005 Conference on Global Poverty. One presentation was by two professors, one from HBS and one from MIT. Their presentation focuses on consumer-centric marketing as a means to solve third world health problems Download 6rohitchancepresentation.pdf . Their thinking on how to solve health problems in the third world closely matched the conclusions I developed independently for how to build a microfinance business in Latin America. Then I realized the general applicability of what was being said and the importance of the concepts to early stage companies.  However, to properly understand what is said below, ignore the notion of "marketing" and think of it as a theory of management. The main points from the Boston professors are summarized below:

The points I find most valuable are:

1. Focus on the customer's needs (translate needs to product development)
2. Establish a social network with your clients (to build trust and confidence)
3. Maximize long term sustainable revenues (recurring revenues, repeat customers)
4. Innovate through business process (lower risk)
5. Reduce controllable risks (minimize the factors that can negatively affect the business)

Too often early stage companies lose sight of their customer, caught up in everyday "emergencies". To check the focus on customers, when was the last time you met with a customer not to make a sale or fix a problem?  The need for a social relationship with the customer gets easier every day with all the Web 2.0 tools (enough said). Early adopter customers are always exciting opportunities but average customers build businesses with repeat sales. (The cheapest customer to get is a repeat sale from an existing customer.) "Innovate through business process" should be on every business school diploma in order to popularize this concept. It is much lower risk to change the way somebody already does business than to try and sell them something new. Reducing controllable risk is the least appreciated of the five concepts I highlighted above. For example, interest rates may rise and put cash flow at risk. Switch to fixed rate loans. Consciously manage away risks, which of course assumes you have taken the time to identify the risks in the business.

One conclusion to draw is that sound management theory applies whether you are working in a startup on Rt 128 near Boston or on a microfinance project in Bolivia. The other conclusion to draw is that the world's social problems, whether it be AIDS or poverty, when considered as issues of providing a service to a client can be managed using the same sound management theories we should use in our businesses.

Strategy in the Wireless Industry

I have followed the wireless industry for many years, raised capital for cellular companies and done several feasibility studies for greenfield projects. An announcement this morning caught my attention. The government of Honduras is auctioning off the fourth wireless license for the country. Honduras has a population of 6.8 million, a per capita income of about US$ 1,000 and three operating cellular service providers. The minimum bid for the license is US$ 10 million and the network build out will cost approximately US$ 100 million based on similar projects. One other fact, two of the best cellular operators in Latin America, America Moviles and Millicom, already have operating service in the country. So in summary, you write a check for US$ 110 million, go up against two formidable competitors and the total available market is probably 3-4 million subscribers.

Despite this daunting scenario, four very qualified companies are bidding:

1. Telefonica, the second largest provider of cellular services in Latin America
2. Cable & Wireless, a leading provider of cellular services in the Caribbean who is going after their first new market in many years
3. Iusacell, a second tier Mexican cellular operator (everybody is second tier in Mexico behind America Moviles, Carlos Slim's company)
4. Digicel, now with nearly 5 million subscribers in the Caribbean and Central America

So why is everybody looking to jump into Honduras:

1. The unserved market probably totals at least two million (sufficient to pay off the US$ 100+ million investment)
2. All of the bidders get certain economies of scale in head end systems and network
3. The absence of local number portability means that you get the customer probably for life
4. Significant growth in cellular services in Latin America is only available from entering new markets
5. The amount of investment is insignificant to all of the bidders (with the possible exception of Iusacell)
6. All the bidders have experience and strategies for the markets of Central America.

My fearless forecast is that either Digicel or Telefonica will be the winning bidder, that the license will go for US$20+ million and that the price of cellular service in Honduras is about to come down. Who says you can not make money in poor countries!

New Business Ideas--III

Periodically I write about ideas for new businesses. The last post is here.

Michael Porter, the HBS professor and leading authority on business strategy, believes that a competitive advantage can be achieved through cost advantage, differentiation (providing greater benefits) and competitive scope. Competitive scope addresses what industry segment the business targets and the choices are a broad or narrow segment focus.

With the proliferation of the web and in particular user generated content, more and more information is being created and the pace is increasing. This has lead many analysts to realize that markets can now be segmented more and more finely. The result of this segmentation will be a tendency toward more narrowly defined vertical markets and a proliferation of strategies based on scope (Hint: you will still need cost advantage or differentiation but it will be in more narrowly defined segments.) As markets become more finely segmented, competition will increase as competitors intentionally or inadvertently test the boundaries of their competitors' segments.

This analysis is of course only true in the developed world of internet access, computers and ample disposable income. To avoid this increasingly competitive marketplace in the developed world, I think the best market opportunity in the 21st century may be the "poor" in the markets of Africa, Latin America and South Asia. If you already think I am crazy, consider the success of Wal-Mart in Latin America and GE Credit in motorcycle finance in Southeast Asia. Another data point may be the US$1 billion retail company I built in Indonesia where annual per capita income never exceeded US$1000. Lastly, look at the high penetration rates for cellular phone service in Latin America and Asia. Carlos Slim, now reportedly the richest man in the world, built his fortune by providing telephone services first in Mexico and later throughout Latin America. Yes--he had a near monopoly in Mexico but over 35 million comparatively poor customers still had to buy the cellular service.

These successes in poor, emerging markets all have certain common characteristics:

1. Large markets (possible to achieve economies of scale and cost advantage)
2. Provide basic consumer needs (consumer products, telephone service, consumer finance)
3. Generally the markets were neglected by local providers

Why did the local businesses neglect the market and create the opportunity for new (foreign) entrepreneurs? Local businessmen were already rich and satisfied. Basically the locals were focused on their existing customers and a lack of competition in these markets had not prepared them to identify new, emerging consumers with sufficient disposable income. The scope of the market was changing and the local providers did not recognize it early enough to prevent new competitors. (There is also a tendency to under estimate the income of the poor because so many are part of the "informal" economy.)

Emerging markets are not for the timid, but the "poor" are still under served in most of the world. The "poor" is a viable segment and therein lies the opportunity.

(This post is based in part on discussions with Dr. Gilbert Morris.)

Latin American Startups Entering U.S.

I get quite a few inquiries from early stage companies in Latin America asking for help to raise U.S. venture capital money for entry to the U.S. market. The inquiries usually come from Brazil and Argentina, which is a little surprising given the vibrant VC community particularly in Brazil. The companies usually profile as follows:

1. Family or angel backed
2. Sales of US$3-4 million
3. No sales outside their home country
4. Seeking outside capital because of concerns about the cost to enter the U.S. market
5. No obvious product link to the U.S. (unlike some of the VOIP services)

I usually give the following advice:

1. First expand into a market in Latin America to demonstrate new market entry expertise and that there is a market outside the home country
2. Consider an aggressive expansion in Latin America; it may be more capital efficient than the U.S. and easier to manage because of distance, culture and customer knowledge
3. If you insist on entering the U.S. market, start with either a distributor or a sales rep network to prove in a cost effective way that the product can be sold here
4. You have to have a real presence in the U.S. and senior management committed to working in the U.S. before any VC will consider your opportunity

The real strategic error is that these companies are too small to be considering international expansion. No market in Latin America is sufficiently penetrated when sales are only US$ 3 million. In a previous post on the stages of business development I discussed that breaking through $3 million in sales is a critical hurdle in demonstrating that a company can scale. Most of these companies are considering international expansion because they have not figured out how to scale in their home markets. They have commercialized the product but have not figured out how to scale the business.

If you have not figured it out yet, early stage U.S. companies should not be considering international expansion when annual revenues are $3-4 million. You too should be focused on scaling your business in the U.S. At this stage foreign markets are an expensive distraction that will probably guarantee that you never achieve any meaningful market share in the U.S.

VCs-They are Not all Monsters

Yesterday I met with an executive at a company where I had helped arrange their A round of venture capital. I was interested to hear about their dealings with their two VC firms one year after funding. Contrary to what you read on many blogs, this executive was very positive about his two VC firms. The VCs had not been overly intrusive, had not required excessive reporting and only met with the company periodically. Of course, it probably helps that the company is on plan and the CEO is clearly focused on new business development. In my experience VCs become excessively "intrusive" when companies fall behind plan and the CEO is fighting the changes that need to be made. The more the CEO fails to recognize the need for a new direction, the more pressure the VCs assert.

One thing the company I visited is doing is using programmers and developers based in Latin America. Off shore programming staff now totals fifty full time people. While India is the fashion in offshore programming, this company chose Latin America because of its geographic proximity, the greater cultural similarities which facilitate better communications and the programmers personal familiarity with the U.S. market. The company uses once a month, on-site visits to keep everything on track. (Who wants to go to India once a month?) I have dealt with a lot of technical people in Latin America and I have found them to be the equal and often better than what I see in Miami. Outsourcing technical work in Latin America makes a lot of sense to me, and for those who do not speak Spanish, a lot of people now speak English well.

Guatemalan Banks: What Signal are They Sending

I have just returned from a business trip to Guatemala. The economy appears robust with many discussions of mergers and acquisitions and cross border business development. The benefits of CAFTA (the Central America Free Trade Agreement) have definitely spurred the local economies and general high levels of global liquidity are benefiting the region.

While everything looks comparatively rosy I am concerned by one development. Local banks are offering 10 year term loans to local corporate borrowers at a fixed rate of 7.5 percent. This yield looks severely underpriced. US corporate high yield (S&P BBB, Moodys Baa3) 10 year bonds are now yielding about 8.95 percent. The U.S. junk bonds would look comparatively attractive given the country risk, the ability to diversify the portfolio and the ease with which one can sell a position. The Guatemalan banks either have a unique perspective on risk and return vis-a-vis their local corporate customers or they are desperate to generate loan volume. Both possibilities concern me and one may want to monitor the local banking sector more closely.

When I was a young banker at Chase Manhattan in the late 1970s, the leading international banks put on large volumes of ten year loans to Latin American corporates at 50 basis points over LIBOR. The first half of the next decade was spent doing workouts and collections on these underpriced loans. When loans are priced "artificially" low, borrowers take on marginal projects that do not work at typical interest rates. Any bump in the road and these marginal projects get in trouble. Let's hope there is no bump in the road for Guatemala.

Brightstar:Is there an IPO in its Future?

Brightstar Corp., the Miami-based cellular handset distributor and one of the largest Latin-owned companies in the U.S., announced recently that it has raised $238 million in equity through an investment from Lindsay Goldberg. Analyzing the deal suggests that the new investor may be relying on an IPO as the means to achieve their target investment returns.

Cellular and wireless distribution is a very low margin business with EBITDA margins in the 2-3 percent range. With Brightstar's annual revenues reported to be in excess of $3.5 billion, their margins should be at the high end of the range. Brightpoint Inc., a publically-traded competitor, has margins of approximately 2.4 percent. For a mature company like Brightstar, a private equity firm would be looking for a 6X return. However, to achieve that return level, as shown below, Brightstar  would need annual compounded growth (CAGR) in revenues of approximately 33 percent. (The assumption is that Lindsay Goldberg owns 35-45 percent of Brightstar.) Despite Brightstar's almost meteoric growth, I do not believe that a private equity firm made the investment expecting annual growth in sales of over 30 percent.

In the scenario above I assumed at exit the company would be valued at eight times EBITDA (and had no significant debt). If we look at Brightpoint's valuation as a publically traded company, the company is valued at about 11 times 2006 EBITDA. If we apply an exit multiple of 11 to Brightstar, the revenue growth requirement becomes a more reasonable 25 percent.

While the analysis is based on many assumptions, I think we can expect an IPO at Brightstar within five years and probably sooner.