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Why you need a cash lab

Industry observers say that India Inc. is in much worse shape than it currently appears. Bloated with debt and hobbled by a severe slowdown, Indian firms need rapid cash generation.

Rajiv Rao        Print Edition: January 11, 2009

For the past four years, A whole range of Indian companies—from automakers to aluminium miners—embarked on a feeding frenzy at the trough of global debt so they could rapidly expand their businesses. Acquisitions of foreign companies were trumpeted by the country’s newspapers as a sign of a tectonic shift in the global business order.

All of that seems a cruel joke for many of the same companies, now gasping to survive in the current frigid air of the global credit squeeze. “The ‘India Story’ was followed by a false sense of immunity from a western recession,” says Vivek Pandit, partner at consulting firm McKinsey & Co. Still, this means lots more business for Pandit and McKinsey, whose global corporate finance practice— of which ‘Cash Lab’ is an important component—tries to help companies focus on doing the one thing that just might save them from sinking: generating cash.

Industry observers say that India Inc. is in much worse shape than it currently appears. Lax risk management policies by banks whose reluctance to recognise bad loans means that the domestic business landscape—comprising firms unable to meet their debt obligations— is going to witness an avalanche of bankruptcies in the next few years. How did things get so bad, so quickly?

For the past three years, Indian companies took on a mountain of debt—a staggering $450 billion worth—in order to fund acquisitions and other growth plans. Moreover, while the liquidity crisis and an impending economic slowdown was a much debated affair in countries like the US for the past three years, in India, a host of business fundamentals went awry—all at roughly the same time—and with astonishing speed. Upwards of 60 per cent of the Sensex vaporised in just nine months. Around $14 billion of foreign capital was sucked out. Cost of debt increased by as much as 700 basis points. The global credit crisis began to starve businesses and stall growth. “Even retail loans have seen increasing delinquencies across asset classes,” says Raman Uberoi, senior director of Crisil Ratings. Naturally, all of this has had its impact on corporate India.

Today, in the absence of equity or new loans for survival or expansion, cash has become the new lifeblood of Indian firms— indeed, the only way in which many Indian companies can stave off going out of business. Cash doesn’t quite equate to profits on a company’s financial statement— as a company, you can experience the ignominy of being profitable and insolvent at the same time. How so? Cash from operations might be nonexistent, but recent debt financing may have padded profit figures to reflect an inaccurate state of the company’s health.

Industries that could use a ‘cash lab’ fix

  • Oversupplied: Chemicals, Iron & Steel, Metals and Mining, Auto

  • Capital-starved: Petroleum, Power, Infrastructure, Fertilisers

  • Manpower-heavy: Health Services, Pharma, FMCG, Telecom
Monitoring a company’s cash position entails deftly managing liquidity while ensuring that the company’s liabilities are fully met— something that many Indian corporates are struggling with. Working capital becomes a crucial component: Bills need to be sent out on time and collected speedily, early payments for goods—if you can imagine such a thing—need to stop, and inventory build-up has to be reduced. Basically, the ultimate goal of managing working capital is to make sure that the company is able to perform its operations and that it has enough cash flow to satisfy both maturing short-term debt and operational expenses in the future.

Many companies that McKinsey has dealt with have been simply unaware that they were running out of cash. Others have found out a little too late in the game. Therefore, the consulting firm’s Cash Lab initiative focusses on rigorous cash monitoring and forecasting capabilities which can then target specific initiatives to generate cash. This entails the daily and weekly monitoring of a company’s cash positions led by a competent CFO who operates in a crisis management mode.

Managing working capital is key to the Cash Labs process, as is the constant reviewing of capital expenditures— often linked to a company’s expansion plans. Generating cash could also entail flogging a non-core asset of a company, and rejiggering hiring or compensation plans. The capital structure of the company should also be placed under close scrutiny. All this might sound like common sense to most business owners. Fact is, “when business is profitable, other issues take priority, leaving cash and inventory management to become less disciplined over time,” says Interchange, Ernst & Young’s newsletter published by its Transaction Advisory Services practice.

Does Cash Lab work? McKinsey states that if properly applied, this kind of solution can “free up cash of 10-20 per cent of sales from reductions in working capital, 10-15 per cent savings of addressable spending from procurement, and 15-25 per cent reduction or up to 50 per cent deferred in Capex”— potentially enough to save many Indian businesses a trip to the corporate graveyard.

Using some of these strategies, BT decided to independently evaluate the health of a few Indian firms that are suffocating from a variety of financial ailments—from severe debt obligations (a recurrent theme) to other global slowdown-related economic shocks— and offer some solutions.

Hindalco, India’s largest producer of aluminium and copper, is in trouble. The company took on a mountain of debt—its debt ratio went from .7 per cent in 2007 to 111 per cent in 2008—largely because of its acquisition of Novelis. Then spot prices for copper and aluminium went into a free fall this year—dropping as much as 21 per cent in last month alone, according to Merrill Lynch. Morgan Stanley thinks that these “prices are unlikely to rebound meaningfully in the next six months.” Plus, its considerable interest debt has begun to pile up.

Hindalco is in a tough spot. On one hand, it needs to continue to run at full capacity in order to generate revenue. On the other, it needs to cut back production in order to decrease its post-production inventory build-up. Industry observers feel that the company needs to strike deals with customers and dispose off inventory at distressed levels if necessary. They say that it also must lay off a certain amount of workers and produce just enough to meet demand. The firm also needs to try hard to hawk off any non-core assets. Selling off some of its distribution and capital equipment to generate cash, and then leasing them back, is also an option the company must consider. Finally— and this involves pain—selling off Novelis at half its acquisition price, or selling its Australian mines might enable it to service its debt and keep it afloat. Approaching Alcan— which withdrew from a JV agreement last year—or another deeppocketed investor for a possible JV deal is also something worth considering, provided the terms are not too unfavourable.

 “Companies should manage cash, not EBITDA”


Fredrik Lind
Fredrik Lind
Cash generation has become vital for many Indian companies hit by high debt costs as well as the economic slowdown. In an interview with BT, McKinsey partners Vivek Pandit, Fredrik Lind and Kuldeep Jain explain how their ‘Cash Labs’ initiative could help alleviate many of India Inc’s recent troubles.

What is so different about troubled Indian companies today that doesn’t exist in most other parts of the world?
In the last two-three years, we’ve seen greater than 50 per cent increase in Indian corporate debt —from around $260 billion to $400 billion. This does not include external commercial borrowings. During the first two years of this period, as equity values rose over 100 per cent, fuelled by FIIs and hedge funds, many firms saw debt as a cheaper alternative. Most felt they could retire their loans within 3-4 years and borrowed with equity-linked covenants. However, over the past year equity values fell by 70 per cent, internal accruals dropped, and borrowing costs increased, resulting in a relatively rapid weakening of cash flows and balance sheets. We’re coming off a period where rewarding optimism was considered less costly than questioning it.

Vivek Pandit
Vivek Pandit
Can the McKinsey Cash Lab approach help Indian companies that are getting snowed under because of large debt obligations?
Most companies, but not all. Cash Lab can materially boost cash position over a 2-3 month period. This helps retire debt, buys time to restructure operations, and renegotiate obligations. But, if you are a company in severe financial distress, especially if you have already broken covenants or have a spiralling debt problem, it is an insufficient intervention.

What are the different kinds of companies that McKinsey encounters in the current business climate?
We see three categories of companies:

a) The first category has strong business models but are over leveraged vis a vis the current economic outlook. This is because the growth and pricing environment for their products or services has changed rapidly. They have significant nearterm challenges in their ability to service current medium to longterm debt or pay down short-term working capital revolvers that are not being renewed.

b) The second category knows they have six to nine months of cash on hand. They are looking at aggressive measures to reduce working capital needs, asset disposals and eliminating or delaying capital expenditures.

c) The last category does not have a handle on their cash situation and several have not made the transition from managing for earning to managing for cash. They may not have significant debt obligations, but have not projected the impact of a weakening market scenario or the true impact of their operating initiatives, or both. Few of these are funded by deep pocket ‘parents’. Some of these companies will realise their predicament late, leaving little time for material restructuring.

Kuldeep Jain
Kuldeep Jain
How do Indian companies address these problems?
Companies should manage cash, not EBITDA. Our process requires companies to focus on how much cash they generated last month, last week, and yesterday. Cash Lab focusses on three major levers—(i) capital turnover and productivity that looks at cash, working capital, capex management, non-core disposals, and financial structuring; (ii) opex management that looks at expense management, procurement, personnel costs and right sizing; and (iii) company’s capital structure which focusses on finding nearterm credit facilities, debt-equity optimisation and revisiting dividend and share buy-back policies.

Who, in your opinion, becomes responsible for overseeing a company’s resuscitation during such wrenching times?
The CFO’s role is heightened in this environment. He or she is the person with the ability to monitor and project cash and should drive cash generation initiatives. As risk managers, CFOs play a critical role in assessing the impact of new shocks and changes in the external environment.


Tata Motors is in even more of a tight spot. Its chief nightmare— no fault of its own—is the sharply slowing auto industry, both domestically and abroad. The company has sold 30 per cent fewer vehicles in November compared to the previous month and Enam Securities says that the firm’s inventory is building up rapidly.

In other areas, it has no one else to blame. Its purchase of Jaguar-Land Rover (JLR) is bleeding it badly: Out of the $3 billion loan it took out for the purchase, it has paid off $1 billion, but is struggling to clear the rest, including related interest payments. Meanwhile, JLR has lost $500 million in the first half of this year. And we haven’t even begun to talk about the Nano. S&P downgraded its rating to BB-. That’s not even considering the bad retail loans it probably has on its books due to defaulting customers, say industry analysts.

Ratan Tata’s vow to not fire his employees is a magnanimous gesture, but might cost the company in the long run. The firm simply has to swallow the bitter pill of retrenchment and lay off a chunk of its workers in order to avoid bankruptcy, say restructuring experts.

This will ease some of the pressures on operating expenses for the company. It also has to go into significant re-negotiations with suppliers, both within Tata Motors and also with Corus, Tata’s other pricy buy. Enam Securities reports that banks remain reluctant to lend to Tata Motors, so its only chance of decreasing its debt loads are to investigate the possible sale of chronically underperforming JLR at a distressed price.

Other options: hiving off other assets such as spare part units and other ancillary businesses in order to generate much-needed cash. On the surface of it, retail giant Pantaloons seems to be doing much better than the previous two companies, considering that it too, is highly leveraged. The company registered a 78 per cent sales growth in the month of October (over the same period last year), plans to unveil distribution of products in the rural arena and telecom and is all set to add 4 million square feet by June 2009. Here’s the problem: It could face a severe liquidity crunch and run out of cash by then, say industry observers. HSBC’s Global Research team says that it is concerned about losses in several subsidiaries—comprising a huge 83 per cent of the ’08 profits of the stand-alone business—and is also worried about its focus on growth rather than quarterly performance.

 India Inc’s rising debt

If that’s not bad enough, analysts say that its home retail division, already loosing money, will be hit badly by a drop in home sales and rentals. Where can Pantaloons go to fund its growth—which it needs to pay down its debt? Not from sales since consumer spending has slowed.

Nor from debt—it has a debt to equity ratio of over 100 per cent. Its warrants worth Rs 600 crore may not be converted as its current stock price is now half of the conversion price, says HSBC. Restructuring experts say that Pantaloons needs to sell stakes in its various companies for a much needed cash injection. It also needs to pay careful attention to its working capital—ensuring that its retail inventory is managed to minimise costs. Finally, the firm needs to put the brakes on all its expansion plans so that it can focus on generating much-needed cash to keep profitable business lines going.

When will this apparent bloodbath affecting many Indian companies end? “We are in an era where cyclical upturns and downturns are compressed. Next year, we just might be on our way back once there’s liquidity in the system,” says Darius Pandole, Partner at private equity outfit New Silk Route Advisors. Till that point— and hopefully well after—companies would do themselves a favour by developing the habit of keeping a steady eye on cash generation and management instead of being swept up by the stratified worlds of high finance. So they can be better positioned to weather rough economic seas in the next few decades.

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