The Crisis Timing Strategic Moves

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The crisis:

Timing strategicmoves

Timing is key as companies weigh whether to make strategic investmentsnow or wait for clear signs of recovery. Scenario analysis can exposethe risks of moving too quickly or slowly.

Timing such moves is bound to be dicult.How quickly the world economy returns tonormal—and indeed, what “normal” isgoing to be—will depend on hard-to-predictactors such as the fuctuations o consumerand business condence, the actions o governments, and the volatility o globalcapital markets. Identiying market troughswill be particularly hard because stockindexes can rally and decline several timesbeore the general direction becomes clear. Inprevious recessions, as many as six rallieswere ollowed by market declines beore theeventual troughs were reached.

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During thecurrent downturn, market indexes fuctuatedby an average o 20 percent each monthrom November 2008 to March 2009.Given the uncertainty, executives may easilygive up in rustration, hunker down, andawait irreutable evidence that the economyis turning around. But this approach couldIt may be a nice problem to have, but even companies with healthy nances ace a quandary:should they pursue acquisitions and invest in new projects now or wait or clear signs o alasting recovery? On the one hand, the growing range o attractive—even once-in-a-lietime—acquisitions and other investment opportunities not only seems hard to pass upbut also includes some that weren’t possible just a ew years ago. Back then, buyers acedcompetition rom private-equity rms fush with cash, governments applied antitrustregulations more strictly, and owners were less willing to sell. What’s more, investments incapital projects,

R&D

, talent, or marketing are now tantalizingly cheaper than they havebeen, on average, over the economic cycle. On the other hand, many indicators suggest thatthe economy has yet to hit bottom. Companies that move too soon risk catching theproverbial alling knie, in the orm o share prices that continue to plummet, or spendingthe cash they’ll need to weather a long downturn.

Richard Dobbs andTimothy M. Koller

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As o the end o March 2009, the presentdownturn has seen ive so-called bear marketrallies. This downturn could be dierent rompast ones, so there could be more than theearlier maximum o six such rallies. As o March 2009, the market was about 18 monthspast its peak. The time to trough was32 months in the 2000 recession, 21 months inthe recession o the 1980s, 21 months inthe recession o the 1970s, and 35 months inthe Great Depression.

McKinsey on Finance

Spring 2009

be a recklessly cautious one. Instead,executives must make educated decisionsnow by weighing the risks o waiting or o moving too early. And while better timing o acquisitions, and thereore the prices paidor them, can make a big dierence in theirability to create value, the best way tominimize risk is to ensure that investmentshave a strong strategic rationale.Executives considering whether to jumpback into

M&A

or to make other strategicinvestments now must understand what liesbehind earnings and valuations. To illustratethe risks, we conducted an analysis o ahypothetical acquisition. Real

US

marketand economic data allowed us to build arange o scenarios embodying dierentassumptions about uture

US

economicperormance.

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We ound that even scenariosassuming conservative levels o marketperormance (as indicated by the experienceo past recessions) suggest that manyindustries may be reaching the point whenacting sooner would be as appropriate as—i not better than—acting later. Managers whowait may be ailing to maximize the creationo value.

Analyzing scenarios

The primary drivers o capital markets arelevels o long-term prots and growth, so wedene our scenarios in those terms. Long-term prots are tightly linked to theeconomy’s overall perormance: over thepast 40 years, they have fuctuated around astable 5 percent o

GDP

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(Exhibit 1). It’sthereore reasonable to assume that a returnto normal or corporate prots would meana return to their long-term level relative to

GDP

and that long-term growth in corporateearnings will also be in line with long-term

GDP

. For our scenarios, we assume that

US

corporate prots will revert to some 5 per-cent o

US GDP

, although that estimatecould be a conservative one i the trend tohigher prots in the years leading up to thecrisis resulted rom a structural change inthe economy. One can tailor this analysis tothe circumstances o individual industries by

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Managers using this approach or actualstrategic decisions would need to reine it bycountry, economic sector, or both, or to relectthe peculiarities o investments such as capital,R&D, or marketing expenditures, as well ascompetitors’ moves and regulators’ changes.

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We’ve excluded inancial institutions rom thisanalysis because their recent proits havebeen highly volatile—way above average in2005–06 and way below average in 2007–08.The inclusion o these companies would notchange the results but would make itharder to interpret the long-term trends.

7654321019681971197419771980198319861989199219951998200120042007Ratio of nonﬁnancial corporate proﬁts to GDP,

1

%2008Median = 4.9



Includes all US-based nonnancial companies with real revenues greater than  million. Prots are earnings beforeinterest, taxes, and amortization (EBITA), less estimated taxes.

Exhibit 1

Profts revert to the mean

Corporate prots fuctuate around astable percentage o GDP over the long term.

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McKinsey on Finance

Spring 2009

Scenario,

%Assuming this level ofpermanent GDP lossPlus this level of long-termreal growth

02.5–3.002.0–2.552.5–3.052.0–2.5102.0–2.5

Normal level,

S&P 500 indexequivalent1,200–1,3501,100–1,2501,100–1,2501,050–1,2001,000–1,150

Market discount,

from normal level,

%30–4025–3525–3520–3015–25

Discount from stock market trough to normal value, %

RecessionRange of discounts

1980–8239–511990–9121–252000–0220–251929–3259–681973–7428–30

Pace of recovery,

cumulative totalreturns to shareholders (TRS), %

1 year2 years3 years

Recession

1973–744685791980–8266791131990–913448722000–023650631929–32129123176

Exhibit 2

Estimating stockmarket value

The market today is trading at a discountusing even conservative scenarios o GDP lossand growth.Exhibit 3

Discounts in earlierrecessions

The current discount o the market is consistentwith those during past recessions.Exhibit 4

Speedy recovery

Historically, the market returns rom itstrough very quickly.

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