Rising Debt to Total Assets: A Tech CIO's Guide During Turbulent Times
A recent Alvarez & Marsal analysis of mid-market tech companies showsratio of debt to assets rising from 2010 to 2018 by almost 400% for Internet services and infrastructure providers. Companies that rely on credit to fund current operations are more exposed to interest rate and market fluctuations. Such companies can face more serious consequences if market disruptions tip the balance of an already precarious position.
In our recent A&M survey of 100 U.S. based technology executives, nearly 72% of companies have adjusted their financial plan of record this year due to headwinds such as U.S. recession, tariff/trade wars, and geo-political instabilities. However, are they making the right adjustments?
It’s a long-held belief that tech companies can “adjust on the fly” in a downturn by placing a freeze on hiring, instituting layoffs, cutting travel, and doing more with less. That approach may have worked well in the dot-com crash, and to some extent in the Great Recession when supply chains were less global and businesses did less outsourcing. However, fundamentals have changed drastically in recent years.
Despite rising populism and nationalism, companies are serving customers globally and operating globally. Most importantly, an extended period of low interest rates motivated companies to accumulate significant debt. The debt itself does not necessarily mean trouble; however, the reason that a company acquired debt really matters. For example, if debt was acquired to take advantage of low interest rates, it can improve the company’s capital structure by lowering its total cost of capital. But companies that are not generating enough operating cash flow and are relying on cheap credit to cover their costs could find themselves struggling to service their debt when faced with market headwinds. The worst case scenario is when companies cannot wean themselves off debt when the credit market is no longer favorable.
CIOs have the opportunity to claim a valued seat at the table and meaningfully influence business agility in the face of increased debt
Though balance sheets might not have mattered as much in the past, the increased level of debt makes reviewing balance sheets critical. Unfortunately, many companies are still accustomed to managing their income statement, as opposed to managing both the income statement and the balance sheet. Continuing this practice is not sustainable, however. It is imperative for companies that have taken on considerable debt to think about what that means to their balance sheet and the implications of suddenly facing market events that disrupt to operating cash flow.
In the months ahead, tech leaders and their investors should reconsider balance sheet items such as working capital and debt ,and be particularly mindful of their implications on cash flow. In fact, tech leaders who review their financial plans within the context of headwinds may see that adjustments of more than 10% in balance sheet and cash flow items are needed. In addition, it’s important to note that companies have fewer levers to pull than they once did, which means their planning now needs to be more precise, detailed and thorough.
All this means that CIOs will play an even more critical role in partnering with the C-Suite in navigating potential headwinds, as well as in using this opportunity to drive greater IT productivity. CIOs have the opportunity to claim a valued seat at the table and meaningfully influence business agility in the face of increased debt.
To make the best of this opportunity entails:
• Partnering with the CFO and CEO to provide forward-looking data and insights that help the company analyze financial scenarios, its exposure, and what it can do to navigate through uncertain times. In these tough times, the CIO must enable the CEO and CFO with the right data, and any other tool they might need to effectively analyze the company’s debt and market conditions.
• Working with the CRO and CCO to provide insight and related reporting/analytics to help predict early warning signals on changes in customer demand to help direct sales and marketing tactics and operational changes, from adjusting forecasts to inventory levels. In tech companies, CIOs are often with customers helping them to evaluate their companies’ solutions and have a unique viewpoint on customer demand that they can bring to the table.
• Partnering across functions on opportunities to deploy automation and other digital technologies to manage cost structures. Many companies have been testing capabilities such as Robotic Process Automation and Artificial Intelligence at some scale, and now may be the right time to execute pragmatic, action-ready plans to expand those pilots, particularly in functions like Finance, HR, IT and Customer Service.
• Continue to emphasize productivity and cost focus within the IT function itself. This is the right time to look at right-sizing IT to be ready to release 10-20% in savings. This may entail adjustments to planned and in progress projects, the IT service catalogue, and service level agreements. In addition, looking to selectively rationalize applications, infrastructure and services, and consolidate and renegotiate IT service contracts can yield rapid value.
Now is the time for value-seeking CIOs to help their companies prepare for turbulent times. The good news is that they have a broad range of solutions and capabilities to realize greater value from technology across the business.