From Computer Business Review, a sister publication
Are companies right to limit their disclosure of the extent that Forex markets affect their revenues, asks our sister publication. Apparently so………
No results announcement from any international computer equipment manufacturer is complete without some reference to the impact of the exchange rate. The effect of currency shifts – predominantly the US dollar and the Japanese yen – is generally presented as limited to 2 or 3% of revenues a year. Currency variations and the roulette of the foreign exchange (Forex) markets is played down to the extent that these activities appear to be barely relevant. The truth is quite different. In its fourth quarter results warning statement, Digital Equipment (DEC) admitted that adverse currency fluctuation had wiped $50 million off its books. Far from playing a marginal, ‘house-keeping’ role, the Forex teams of the major computer manufacturers represent a critical string in the competitive bow. For the computer industry, currency fluctuations are unusually problematic. US dollars make up most North American manufacturers’ revenues, while a large part of their costs are denominated in Japanese yen. In between lies an ocean of currencies from Europe, the occasionally hyper-inflationary South America, the Middle East, Asia, Africa and Australia. In addition, while the world’s currency markets are based on parity relationships which link expected interest rates, inflation and exchange rates, such relatively stable relationships crumble in an industry which experiences nothing but rapid deflation. Companies are not obliged to refer to the impact of currency fluctuations on their results, but many do although the details are rarely comparable. But revenues are only half the story. Expenses are also incurred in different denominations, the most obvious of which is the Japanese yen. None of the companies disclose the currency mix for costs, but some broad assumptions can be made. DEC, for example, had sales of $13.8 billion in 1995, half of which came from products, the remainder from services. If assumptions are made of the split between materials’ costs (50% of product cost-of-sales and 10% of services cost-of-sales), wages (50% of product cost-of-sales and 90% of services cost-of-sales) and overheads, if these costs are allocated according to the regional revenue split shown in the graph, a set of assumptions about the currencies in which DEC spends its money can quickly be made. Even by allowing for the fact that its overheads and R&D will be heavily skewed toward the US, by this analysis 60% of DEC’s expenditure is denominated in non-US currencies. To some extent, there is an off-setting effect between sales and costs in dollar and non-dollar denominations. If the dollar rises against European currencies, DEC will receive less dollars for European sales, but European costs will fall too. But this natural hedge is limited in its effect, because neither the scale nor the timing of cost and revenue flows necessarily correlate strongly. The scale of exchange rate fluctuation in periods as short as a year are phenomenal. For example, the yen, from mid April 1995 until the present, has revalued by 34% against the US dollar, meaning components bought by DEC in Japan cost 34% more than a year ago. With Japanese sourced components representing as much as 30% of the sales value of a DEC Alpha, it is clear that this appreciation of the yen could easily have consumed 10% of an Alpha’s sale value – probably equivalent to each machine’s pre-tax profit contribution. David Holland, the man in charge of Apple’s foreign exchange activities worldwide, confirms the basic case for hedging currencies, but argues that there is much more to the story: Currencies have a very significant impact on our operating profitability. Exchange rates are highly volatile and very erratic so we have to look at local currency cash flows in each of our markets around the world and then hedge them. But why all the secrecy? Why don’t the computer manufacturers specifically disclose the gains and losses on Forex? That is the really important point. If we started disclosing our Forex gains and losses, the competition would be able to calculate our hedging positions and from that they could work out our pricing policies. That would be, literally, disastrous for any one of us. Suppose, as an example, that we find out that Company A has hedged its European currencies six months out. Imagine then that the foreign currency moves in their favour but, because they have forward contracts which lock them into the old rate, they can’t react. We would be able to move into that market and price very aggressively to take advantage of Company A’s situation and steal market share. For that reason there is tremendous secrecy.
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