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Wednesday, 29 October 2014

KLM probably won’t layoff 7500 employees… yet, but still seems on a flight, ‘leaving with destination unknown’.

First to fall over when the atmosphere is less than perfect
Your sensibilities are shaken by the slightest defect

The massive strike at Air France made the financial problems of Air France-KLM more imminent for the general public, but might distract airline watchers from the structural, hard-to-overcome problems of this ‘in between’-airliner. To these eyes, the shaky financial position of Air France-KLM is more than a ‘temporary inconvenience’.

Today was the day of the quarterly data for KLM, the Dutch branch of Dutch/French airliner AirFrance-KLM. In spite of the fact that there was still an operational profit of approximately €250 million for this Dutch airliner, in contrary to French branch of the company, Air France, the data were yet generally disappointing.

The following snippets come from Het Financieele Dagblad:

Airline company Air France-KLM is trailing in Europe.This was stated by CFO Pierre-François Riolacci, during his statement at the presentation of the Q3 data. He tried to mitigate the unrest surrounding the challenged airliner, by stating that the stories regarding a technical bankruptcy of the company are fairytales.

In spite of the loss of €416 million at Air France, as a consequence of the pilot strike in September, the airline combination sticks to the earlier submitted targets for 2014. The operational results (ebitda), corrected for – among others – a share of the lease obligations, should hit the €2.4 billion mark at the end this year. However, after the first nine months of this year, there is only €1.3 billion on the counter. Traditionally, Q3 should be the best quarter of the year.

Riolacci did not offer a more detailed draft of the additional austerity measures, which are required now in order to keep the bi-national airliner afloat. According to him, that was not necessary, in spite of the commotion that emerged around KLM during the past days. ’Numbers, like the 7500 required lay-offs at KLM, came totally out of the blue’.  

The financial executive maintains his story that Air France-KLM is well on course with its current austerity programs. More clarity will be offered in February, during the presentation of the annual data.

This indifferent attitude of Riolacci is heavily contrasting with the negative equity of the airliner combination. Yet, Riolacci is not bothered. ‘Analysts and financiers always look at the operational cashflow. This cashflow is still satisfactory within the company.

Negative equity is like a dead canary in a coalmine for Air France-KLM: an undisputed signal that there is something seriously wrong with the company. It means that the consolidated assets of Air France-KLM have less value than the total amount of debt of the airliner.

Yet, as long as the analysts and the financiers of Air France-KLM recognize the satisfactory operational cashflows as the ‘clothes of this emperor’, the company will remain in business. And perhaps Transavia’s transition – from a Dutch, national low-cost carrier into a pan-European low-cost carrier – will succeed in such a way that the company can indeed run the gauntlett against Easyjet and Ryanair. I have serious doubts about the probability of this scenario, but sometimes miracles do happen.

I also guess (and hope) that Riolacci did not lie to the press, when he stated that the story of the 7500 required lay-offs at KLM, which was brought by the AD and De Telegraaf yesterday, was a ‘canard’ (i.e. a hoax).

Still, you might wonder where the future, structural profits of Air France-KLM will come from after all?!

At this moment, Transavia is absolutely not able to offer fierce competition to Easyjet and Ryanair, due to its current, small size and to the fact that Transavia has not been a genuine pricefighter from the beginning of its existence. The latter means that Transavia does not have the concept of price-fighting, as well as the required killer instinct, in its genes like the other two airliners do.

To name an example: if it would be possible to fit chairs on the wings of a plane and subsequently fly it on water, Ryanair would probably manage to put 40 chairs there and settle for only 500 gallons of water for the whole flight, while asking its customers additional payments for the wing-view.

This is the main reason that Transavia will trail its biggest two competitors by years at best and will probably never surpass them in revenues and profitability.

On top of that, the chance that the French pilots will soon fully embrace the Transavia business model and settle for a much lower reward, in exchange for keeping their job, is that of a snowball in hell. Unless Transavia will start to hire pilots from low-wage countries, through opaque labour constructs and off-shore employment agencies, the company will remain too small, too poorly funded and yet too expensive to become a true competitor for Easyjet and Ryanair. One could call this Transavia plan ‘dead on arrival’ for this very reason.

At the other end of the airliner scale (i.e. the high end scale), there is fierce competition for Air France-KLM from Turkish Airlines and other Middle-Eastern airliners.

Turkey is currently developing a mega airfield near Istanbul, which should pale Heathrow in comparison. Besides that, the country is trying to turn Turkish Airlines into ‘the world’s favorite airline’, through generous sponsor contracts and commercials featuring some of the biggest sport celebrities in the world. To achieve this goal, the country offers government grants, regarding taxes and investment subsidies; probably to the tune of millions and millions of Euro’s.

Countries like Dubai, the United Arab Emirates and Qatar on their behalf, have invested heavily in their cities, as well as in their airliners and air infrastructure. In order to earn this money back and warrant future employment for their populations, these countries do litterally everything to lure visitors and transitory travelers to their freshly built tinseltowns-in-the-desert. Money is not an issue for them, due to their nearly infinite, oil-based resources.  Consequently, money isn’t either an issue for the airliners and airports that these countries support, although these countries themselves categorically deny handing out forbidden government grants.

If Air France-KLM wants to fight its battle against the pricefighters at one end of the spectrum and the high end airliners at the other end, it seems to be a fight, which is impossible to win.

In The Netherlands we have the beautiful expression that ‘a company – in this case Air France-KLM – is too big for the napkin (i.e. the price fighters), but too small for the table cloth (i.e. the high end airliners)’. Air France-KLM is stuck somewhere in the middle between these two, very contrary targets and still seems to be on a flight, ‘leaving with destination unknown’. 

Although the required lay-offs at KLM – to the tune of 7500 employees – have fortunately been recognized as a canard at this very moment, the bitter truth is that such an event still could come any moment: rather sooner than later in my humble opinion. Until then, future profitability remains a mirage at the horizon.

Sunday, 26 October 2014

Are British animals more equal in Europe than animals from the Baltic States, Bulgaria, Poland and Rumania? If it is up to David Cameron, in his new role as straw man for UKIP and the really conservative conservatives, they are!

“All animals are equal, but some animals are more equal than others.”
George Orwell – Animal Farm

British (i.e. in most cases English) knowledge workers are yet indispensable within most Western countries in the European Union.

With their specific and thorough knowledge from f.i. developments in ICT (information and communication technology), business services and the financial industry, as well as their unbeatable, native knowledge of English, these skilled professionals are very sought after by various larger and smaller companies all over Europe. British people can ‘blend in’ in any modern team of programmers, marketing people and financial wizards. They do so, without causing any commotion, as a consequence of mutual misunderstanding (“being lost in translation”) or due to having a different culture with uncommon habits. The British do what they do and we all do what the British do.

Often these British people wander about from one country to another country, as business, financial or ICT 'nomads': they work at a certain place or in a certain country for a number of years and then move on to the next country and employer, before eventually moving back to Great Britain.

Where knowledge workers from (for instance) Eastern Europe or India often do their best to learn the native language in their new host countries after a number of years, the British don't even bother to do so. “We're British and we speak the ‘Lingua Franca’ of the 21st Century. Why should WE learn another language then our own, for God’s sake. Don’t be ridiculous!” And everybody in – at least – The Netherlands accepts this without protests. To quote George Orwell in this matter: some animals are indeed more equal than others!

And so it can be, that in a common meeting at a financial institution in The Netherlands, with nineteen Dutch people present and one Englishman, the whole meeting is held in… English (some would call it ‘Double Dutch’ in The Netherlands) and nobody even blinks with an eye.

Still, these British ICT, financial and business ‘nomads’ get their chances to work abroad and earn their wages there, without the slighest hassle for permits and ‘green cards’, due to the free traffic of workers in the whole European Union.

Every day tens of thousands of Brittons take advantage of this fundamental right, derived from Great Britain’s membership of the European Union.When this is such a fundamental and utterly important attainment, you would think that even the most Europhobic Brittons would respect this fundamental right, as one of the foundations of the European Union.

Well, you might be wrong about that… If you listen closely, you can almost hear the British PM David Cameron sawing the legs from under this fundamental right in the European Union. Not because he wants to do so, deep in his heart, but rather under the electoral pressure of UKIP’s Nigel Farage and the really conservative Tory MP’s and grassroots. In other words: David Cameron is turning into the straw man of the British anti-EU lobby.

The following snippets come from the Financial Times of 20 October:

Urged by members of his own Conservative party to curb immigration and harried by the anti-EU UK Independence party, David Cameron is under pressure to formulate a policy to tackle the issue – and fast. But with the rest of Europe in no mood to rip up the rules allowing freedom of movement within the union, the British prime minister risks angering everyone while pleasing no one.

The prime minister’s aides claim he will set out his position on immigration before Christmas. Whatever he says, he is unlikely to satisfy the eurosceptic bloc of Conservative MPs, let alone quieten Ukip, which wants Britain to leave the EU completely.
At the same time, the rest of Europe has no appetite for abolishing the EU’s founding treaty, which covers freedom of movement for citizens of the union. Angela Merkel, German chancellor, wants to curb benefits for migrants but has no thought of limiting their right to travel for work in the first place.

Speaking on a visit to Ford’s factory at Dagenham on Monday, Mr Cameron said: “We need to address people’s concerns about immigration. I’m very clear about who the boss is, about who I answer to and it is the British people. They want this issue fixed, they are not being unreasonable about it. I will fix it.”

He now wants to limit the movement of workers from existing EU members – but even his own colleagues admit he has yet to work out exactly how. José Manuel Barroso, outgoing president of the European Commission, on Monday repeated his warning that a cap on migrants would be against the EU treaty. For once, he found common ground with Nigel Farage, Ukip leader.

“You cannot do what Mr Cameron is pretending to do and remain a member of the European Union,” Mr Farage said. “It is one of the fundamental cornerstones of the European Union that you have the free movement of people.”

Britain used to be an ardent advocate of the principle, recognising that a single market in goods, services and capital required a fluid labour market. As in the US, Europe’s workers had to be able to go where the jobs were. One European Commission source said: “[The UK government is] driven by an idiotic attempt to out-Ukip Ukip.”
In depth

Vince Cable, Lib Dem business secretary, said Mr Cameron’s warning on immigration could hit jobs and investment: “Once you start putting up barriers to free movement of workers within the European Union you destroy its whole essence – which is why the rest of the European Union is not going to allow it.”

The most powerful quote about Cameron’s “misbehaviour” in this discussion about the free traffic of workers within the EU, is the anonymous EU source, who states that Cameron tries to behave more UKIP-ish than Nigel Farage himself (see first red and bold text).

In earlier years, the discussion in Great Britain with respect to immigration had mainly been about the ‘floods of low-wage immigrants from former Eastern Europe’, who would be claiming the jobs of the lower-class British workers in the not too distant future. Yet, this didn’t happen.

Besides that, there have also been fears in the UK (and also in The Netherlands) that herds of East-European immigrants would visit ‘our’ shores to pick up ‘our’ welfare payments and unemployment benefits, after a few months of working (or after not working at all). Apart from a view relatively small scandals, I am still waiting for those herds to show up.

Frankly, we hear more often stories about extortion of East-European workers by Dutch (and probably British too) companies and bosses, than that we hear stories about East-European “workers” sponging on our societies. Most workers from Poland, Romania and Bulgaria are very hard-working people and they often do the work, for which the Dutch are either too expensive, too clumsy or too unfit and spoilt.

As an example: can you imagine a Dutch unemployed person, standing for eight hours in a row behind a flower packaging machine, bundling roses or Gerberas? Or do you see that same unemployed guy or girl picking asparagus, strawberries, tomatoes, cucumbers or paprikas for six to eight hours a day? Most Dutch unemployed people don’t see that either. The East-Europeans are more than happy to fill up the void and earn those Dutch luxury salaries, even though they often get paid less than a genuine Dutch worker would.

So in my humble opinion, the repression of domestic workers by workers from the East-European low wage countries, for which so many Dutch and British people fear, is a smaller problem than most anti-EU parties let you think. It is not that I try to downplay the problem, but I really think it is a containable problem.

Of course, we need to be cautious about the excesses, caused by the free traffic of workers, for our domestic workers, as well as for the foreign workers themselves.

When we suspect abuse of labour protection regulation by obscure temporary labour agencies or witness breaches of collective labour agreements and minimum wage arrangements through opaque fiscal/legal constructs, we should warn the government about that. (Local) government officials should interfere and they should severely punish deliberate (multiple) offenders.

Nevertheless, the free traffic of workers is one of the most treasured attainments of the EU and it will never be put under jeopardy by the rest of the EU member states. Vince Cable of the Liberal Democrats (see second red and bold text) was 100% right about that. And when the British are indeed so senseless to fumble with the European immigration laws in their own country after all or even plan to leave the EU, they should think about the consequences for their own British nomad workers all over the European Union.

They should consider that this could even become the end for ‘British workers being more equal than all other workers’ in Europe, as they are hard, but not impossible to replace. These British knowledge workers now receive a warm welcome all over Europe and most of them do truly deserve that.
However, when the UK indeed abolishes the European immigration laws and turns into an ‘inpenetrable island in the European sea’, like even Switzerland has never dared to be, these British workers all over continental Europe could possibly be replaced with knowledge workers from Southern and Eastern Europe or Asia. 

In retrospect, these South European, East-European and Indian knowledge workers are willing to learn the language of their host country after all. And at least they don’t pride themselves on perfectly speaking the ‘Lingua Franca’ of the 21st Century, which allegedly “discharges them for eternity” from learning another language!

Wednesday, 22 October 2014

“Why so many government projects fail”. Ernst in discussion with Jeroen Gietema, co-author of the book series “The Project Saboteur”

Last Saturday,  I have written about the Dutch, parliamentary Ton Elias Committee and its investigation into the failure of numerous governmental ICT projects.

This extremely sloppy and superficial investigation only seemed to push paper around and did hopelessly fail at looking for the real reasons, why so many governmental ICT projects fail.

After I finished my article last weekend, I had on Monday a very interesting discussion with my colleague Jeroen Gietema; except for being an excellent and amiable ICT consultant with expert knowledge in financial business, he is co-author of the small, but interesting management book series The Project Saboteur. On top of that, he has years and years of experience with change processes at the government and in the financial industry.

Jeroen Gietema, Co-author of
The Project Saboteur series of management books
Click to enlarge
Today, I asked Jeroen to speak out frankly about the topic of change and explain why so many goverment (ICT) projects failed hopelessly in achieving their main goals.

The following article is an integral representation of our ‘interview’, for which I thank Jeroen very much.

Jeroen: In governmental ICT projects, you need to look at the context in which a software supplier is acting. That is always a personal context – for instance where the account manager of the supplier is involved – but also a corporate context.  

The main corporate context is always that a commercial company wants to make profits and wants to achieve continuity for a longer period.

Depending on how the national ICT market is, at the time of the assignment, the company will try to extend or not to extend the assignment. That has to do with direct yields from the project and other opportunities beside the current project, which could yield more money possibly.

State officials, civil servants and employees of commercial companies often go through organisational change projects. And then certain eternal truths are highlighted: the change project should almost always lead to diminished numbers of personnel. In nine out of ten times, the business case for a change project is personnel reduction.

Irrespective of whether you take McKinsey, PWC or KPNG, they all sing the same ole’ tune. Personnel reduction is the only real business case that these companies have. But as a matter of fact, this is exactly the business case which almost never gets realized.

These companies argue, however, that their business case does get realized in a profitable way indeed. Still, at the bottom line, one will see that the expenses of the McKinsey consultants and the costs of outsourcing of employees have almost never been added to the final financial result of the project. The reason is that the costs of outsourcing and firing personnel are dramatically high.

There is a simple calculation for that, to prove my point.

I suggest that we have two companies, which want to go through a merger. Both these companies have an ICT-department. One ICT-department has a 60 year old manager and the other department has a 35 year old manager. It makes sense that these ICT departments will be merged together and that one of the two managers has to step down, for the point of being superfluous.

The manager that probably will be forced to step down is the 60 year old manager, who has about five years to go before his retirement. How much money will this man cost the merged company, when it pays him until his retirement, do you think? This is what many companies do these days.

Say, that it will cost you a total amount of about €500,000 during five years. The cash value of this is about €480,000 (at the current interest rates).

However, when I want to lay off this man, I need a consultant from an outsourcing company. This guy will probably cost me €250,000 annually and this kind of guys always manages to get themselves a contract for a whole year: €250,000!

So I have to pay this 250 grand now and when I say goodbye to my 60 year old ICT manager, I have to bring a large bag of money too: perhaps 20 to 30 times his monthly salary. Including the fees of the outsourcing consultant, this lay off will at least cost me also 500 grand and probably a bit more..

When the ICT manager has worked at the company for a long time (more than 20 years for instance), his resignation will cost me between €500,000 and €1 million. This already happens to be a very poor business case, as it costs more money to fire the man than to keep him at the job for five more years, until his retirement.

And there is more: when I fire this man, quite a lot of knowledge walks away from the company.

Ernst: Perhaps you should hire him back as a freelancer then, after he has been fired?!

Jeroen: That could very well be. The second thing that happens, is that these people start their resistance against the project in the days that they have left, as genuine project saboteurs.

They resist against everything and silently refuse to share their vast knowledge – which is always very useful knowledge, gathered in years and years of experience – among their colleagues. This is a double whammy, which makes the merger inefficient, as you cannot disclose all available knowledge, in this situation.

In other words: the added value of the merger diminishes strongly, even when the merger itself is a success. Such success, however, is definitely not a no-brainer, as a merger of two departments often leads to the situation that the ICT systems of both departments all remain operational. Then you have a merger without merging the available computer systems. This costs double the money.

The solution for this conundrum starts with not hiring McKinsey, KPMG or PWC, as these people always come with an unachieveable business case.

The second thing that you should do, is to keep the “superfluous” manager (or personnel) in service. Instead of firing them, you use these people to prepare and train the other people at the department, through a master / student relation for knowledge transfering.

In the example of our ICT manager, you let him coach the other workers, making him important in the process, instead of futile. You could even make him projectmanager for the transition, with a guarantee that he can stay the full five year period until his retirement or that he can go with a solid early retirement arrangement, at the moment that his knowledge has been transfered successfully.

What will happen? The process of the transition will actually accelerate, as this experienced ICT manager with 20+ working years, from the example, had always been the most qualified guy to hamper the transition process.

By making him important, he will stop doing so. This has to do with the Pyramid of Maslow. This Pyramid actually goes very deep in explaining the motivations of people.

Pyramid of Maslow
Chart courtesy of
Click to enlarge
People in the lower stages of the Pyramid have interests, like making money to feed themselves and their families and to let their children go to college. The upper stages of Maslow focus at self-esteem and self-achievement.

When you make someone important, by letting him transfer his knowledge to his colleagues, you add to his self-esteem. So I save serious money in the process by keeping this guy and actually making him important!

Summarizing: when you have a business case for change, you need to get the human factor out of it (i.e. personnel reduction), as making a profit on this is exactly the thing that you won’t achieve… ever!

However, you should take the human factor into consideration, in order to force yourself to investigate how you can mobilize these people in a positive way. Positive people are enthusiastic to participate in the change project. This is the conundrum that you need to solve.

Every change project where executives fail to do so, is dead-on-arrival. You see that happen at almost every merger and at all systems and departments which should be merged together.

This is my statement and this is where things go horribly wrong, nine out of ten times, at government change programs and large ICT projects. Employees have great interest in their jobs being continued. Executive managers should never forget about that.

I thank Jeroen for his elucidating insights in change processes.

Monday, 20 October 2014

“There is nothing cheap about penny stocks, when you lose your money on it”; telephone conversation with a reader

This weekend I had the pleasure of having a telephone conversation with one of my latest readers, who had recently discovered my website and the information on it. Let’s call him ‘John’ (not his real name).

Without disclosing much about his background, it suffices to say that John became one of the ‘victims’ of the Dutch technical service provider Imtech. He lost quite a lot of his own savings’ money on this tech fund under jeopardy.

While his personal background, as well as his shareholders ‘comfort zone’ lay in the oil and gas industry, he was attracted both by the extremely low price of Imtech stock and the earlier reputation of this technical service provider. He decided to give it a shot and invested heavily in Imtech stock, without doing proper research into this company. It was a choice John would deeply regret soon.

As so many other people, John thought that Imtech’s drawbacks, with respect to its loss-bearing subsidiaries in Poland and Germany, would be of a temporary nature.

The good reputation and specialized knowledge of the company with respect to their different service areas, as well as the healthy order portfolio, would deliver the necessary cash-flows to pay back most of the enormous debt position of Imtech. The sale of a few company parts would smooth down the remaining edges and supply the necessary working capital.

Eventually, the remaining parts of Imtech would become a healthy and mostly debt-free company again, he thought, with a good order portfolio and sufficient new opportunities. In that case, he would have hit the jackpot, as the stock rate could have exploded then. And hey, how much money can you lose on a stock of less than €1 per share, right?!

Unfortunately, this was not going to happen. When John would have checked the balance sheet and P&L of Imtech and would have followed the news, he would have found out that the enormous debt of well over €1 billion, in combination with the skyhigh interest rates of more than 8%, made debt reduction almost a ‘mission impossible’.

And then we are not even speaking about the obligation of the company to gather a working capital of €400 million in 2014, in order to meet the bank covenants to this respect.

Other worrisome factors were the large amounts of goodwill on the balance sheet of Imtech and the circumstance, that it is very hard to sell parts of a company for a decent price, of which the people and the knowledge base are the main (and almost only) asset.

In such companies, the net worth is almost equal to the reputation of the company. And Imtech’s reputation lay in tatters at that very moment.

What happened with Imtech, since my March 2014 article (see the aforementioned link), is history. Imtech had indeed mounting liquidity problems, due to the heavy debt burden, the huge 8+% interest and the ‘impossible’ goals in the bank covenants.

And after every presentation of quarterly data since March, the investors and shareholders felt that “the worst had yet to come” with Imtech: problems got bigger, losses increased and there seemed to be no light at the end of the tunnel, in spite of the soothing words of CEO Gerard van der Aast at every presentation.

Royal Imtech's year-to-date price development
Chart courtesy of
Click to enlarge
In order to stay afloat, the company tried to sell some company parts, but it nevertheless had to turn to its shareholders repeatedly. These took a few heavy blows on the chin, in spite of the recent news that Imtech got slightly more favourable interest rates from its syndicated lenders.

One month ago, the company created total confusion when it offered 60 billion additional shares, at €0.01 a piece, in a limited access primary offering (called a “claim emissie” in Dutch).

Shareholders had to decide between cutting their losses, while their share in Imtech would vaporize under this tsunami of new stock, and buying many more shares in it, in order to keep their interest in the company intact. It was truly like ‘being stuck between a rock and a hard place’. You could also justifiably call it a lose-lose situation.

Royal Imtech's last month's chart
Chart courtesy of
Click to enlarge
A trading day like a roller coaster ride followed, in which the price for Imtech shares and claims seemed to go through the roof. This was a consequence of the complicated price calculations, which nobody understood properly.

That trading day brought a mixture of old stock, new stock and tradeable claims for sale and it was virtually impossible to set the correct prices; for traders as well as for the stock exchange itself. However, in the end – when the gunsmoke had lifted – the shareholders ended with virtually nothing in hand.

The lessons that many people and especially John learned with Imtech, are also very much applicable to other penny stocks:
  • A penny stock with a rate of less than €1 can still go down 99 times: one cent at the time. And please don’t think that this won’t happen, because the stock price is already very low;
  • The circumstances that turned a company into a penny stock, are the same circumstances that could kill the company eventually;
  • Throwing good money at bad money – with Imtech this happened during the claim emission – is the worst thing that can happen for an investor. So sometimes it is better to cut one’s losses, than to endure the full ride down the drain;
  • When someone invests heavily in a losing penny stock, he doesn’t lose pennies, but loads of hard-earned pounds.

So the next time when you want to invest in a penny stock for the sake of it, without doing your homework properly, please think about John. Then his losses could save you some serious heartache.

Sunday, 19 October 2014

Is hybrid financing indeed “the new lubricant in the M&A market”? Or is it yet another symptom of the dangerous influence of “virtually free money” in the European economies?!

This week, Het Financieele Dagblad printed a very interesting article with respect to a ‘new’ form of company financing, called ‘mezzanine’ or hybrid financing. Here are the pertinent snips.

Subordinated loans work miracles at the Merger and Acquisitions market (M&A). Deals that scare away the traditional banks, are brought to a successful ending with it.

Take for instance the merger of two offshore companies, initiated by Amsterdam-based investment company Value Enhancement Partners (VEP). Traditional financing is virtually impossible to get, as there is too much risk involved in the multi million euro deal. No problemo: the London-based credit fund Beechbrook Capital, funded with capital from institutional investors, comes to the rescue.
The contribution of the British company was essential”,according to VEP-partner Bob de Lange. The role of the bank is now limited to the financing of working capital.  

In the business, hybrid loans are known as mezzanine financing. It is an ‘sub-level’ form of financing between equity and debt. The receiver of the funds gets subordinated debt in hands, which only has to be redeemed in the mid to long run.

And very important: in contrary to the offering of preferent and common stock at the exchanges, the executive control of the company does not change by it. The owners of the company remain in charge themselves.

The mezzanine loan is gaining importance. In the London City, billions of euro’s have been reserved for this form of financing. Private Equity houses of repute have established separate funds for mezzanine loans. With $4 bln in cash, Blackstone Group created in 2012 the largest debt fund in the world, closely followed by ICG, KKR and Greyrock Capital.

Mezzanine seems ideal for companies, which cannot (sufficiently) finance their growing ambitions at regular banks. Mezzanine is meant to fill up the void.

This whole article is a must-read, in my opinion, as it offers an excellent insight in this relatively new, but very risk way of financing.

I can imagine that mezzanine seems like the goose with the golden eggs for founders and CEO’s of innovative and fast-growing companies, which have enormous ambitions, but still suffer from financial growing pains.

Yet, a little voice in my head whispers:
When these companies are indeed so promising and seem to be a reduced risk; why don’t the renowned business and general banks want to finance these companies themselves?!

And a second voice whispers:
“When this kind of financing is too risky for business and general banks, why isn’t it for British and American private equity funds and the institutional investors that supply their funding?!

Does that have to do with the fact that banks have very strict capital ratios (solvability and liquidity), which are required and regularly assessed by the national banks and the European Central Bank, while institutional investors and private equity funds don’t have those ratios?

And is this perhaps a new kind of gambling with ‘other people’s money’?!

The skyhigh interest rates of 10% - 12%, plus additinal profit-based arrangements, definitely seem to point in that direction.”

And how many companies will eventually be successful enough and will indeed be able to earn sufficient cash flows, in order to pay back the substantial interest payments of 10% per year on their subordinated loans?

Losses and defaults of borrowing companies must be substantial; especially as a consequence of these skyhigh interest rates and the amount of risk involved. It is a very expensive kind of financing and also very risky; both for the money supplier and the debtor.”

I cannot help but think, that this new and extremely risky kind of financing – it looks, feels and smells a lot like the junkbond investments from the eighties, which went horribly wrong in the end – is only caused by the perversely low interest rates of this moment.

The institutional investors are desperately looking for ways to get more “bang for their buck”, than would be possible with sovereign and corporate bonds and shares.

On the other hand, the private equity funds are feasting on the ubiquitous availability of litterally shiploads of cheap money, which can be borrowed against only 2% or 3% interest. When the difference between the yields and the funding costs of loans is almost 10%, it rewards the risk of taking a gamble. Because that what it is, to these eyes. 

These kinds of investments will probably yield excellent results, until one day they won’t anymore. That will be the day that a lot of common people can wave a substantial share of their invested pension and insurance money goodbye!

Saturday, 18 October 2014

‘Governmental departments allegedly lose €1 to €5 billion per year on ICT projects gone awry’. Sloppy parliamentary investigation shows sloppy results and offers little more than open door solutions at too many occasions.

You can’t push an elephant through a needle
hole, irrespective of how hard you try it…

If you don’t know what you want,
You will get what you asked for…

A few days ago, a Dutch parliamentary committee presented its conclusions, with respect to the investigation that the committee performed, into governmental ICT projects gone awry during the last decade. As some of you might know, this topic has my undivided attention, as it is connected with my daily work as a very experienced ICT testing consultant.

The conclusions of the committee, chaired by a liberal-conservative MP from the VVD party,Ton Elias, never transcended from being a list of open doors and advices, which were often simply ‘too obvious’. The report seemed to fight the symptoms, instead of the disease.

Besides that, the committee has been too eager, at occasions, to point the finger at the ICT suppliers, instead of looking at the government itself as a roused and impatient principal, which offers unclear requirements, desires and demands as a starting point for large, open-ended ICT projects.

The report is yet another testimony of generally clueless politicians, who are genuinely shocked by the number of governmental ICT-projects gone awry and the financial damage that these failed projects caused. And now these clueless politicians are desperately looking for easy solutions, which they won’t find as they seemingly fail to look at the root cause of most problems.

Does this sound too harsh?

Well, imagine that your teenage son approaches you and says: “Dad, yesterday I went to a discotheque with my girlfriend and I spent there between €100 and €500. Yet, I don’t know how much money I spent exactly, because I didn’t count it, when I took your wallet with me”.

Would you be a happy camper, when your son would do that?!

Still, this is what the Elias Committee did in its report “Conclusions and Recommendations of the Dutch temporary committee on government

Since no comprehensive report on the national public finances has been drawn up after 1995, nobody knows how much money the Dutch public sector is really spending on ICT. Nor how much is being wasted on failed projects. A conservative estimate based on information from a variety of experts suggests that the figure may be anywhere between €1 billion and €5 billion euros each year. Whatever the true amount, the Committee believes it to be unacceptably high.

I cannot understand why the committee got away with this amount of sloppiness, in its predictions regarding the bandwidth of the ICT losses. Besides that, the main recommendation of the report is filled with an incomprehensible self-confidence, clearly not based on substantive prowess of the committee with the matter on hand:

Nevertheless, the committee feels that a few robust organizational measures – provided they are implemented consistently and coherently – will be sufficient to prevent a repeat of a large proportion of the problems identified. The Committee’s recommendations are closely interrelated and should be viewed as a total package of measures for the Cabinet to adopt.

Much will be gained simply by involving not only ICT specialists in government projects of this kind, but also users and those responsible for monitoring government spending. On this point the Committee is strongly critical of the House of Representatives itself, as up until now it has not made sufficient efforts to scrutinize public expenditure in this area.

Do the creators of the report really think that these measures will help them to prevent the central and local governments from suffering big losses on future ICT projects?! Really??!!

The suppliers in the ICT industry get taunted by the following, slightly villainous statement:

On the rare occasions when a supplier does point out avoidable problems, these warnings are all too often not taken seriously.

I have spent 16 years, working as an ICT consultant and specialist at functional testing.

I dare to say that most ICT suppliers – small as well as large ones – are honest, hardworking and respectable firms, which try very hard to find the best solutions for their customers. 

Consequently, most companies are indeed willing to point out possible problems ahead when they see and grasp them, as these might and probably will backfire at them as suppliers, when a government project fails and the ‘blame game’ starts.

Nevertheless, these ICT companies are in it for the money. So simple is that… They need their staff to make sufficient billable hours and thus earn money for the company; this is their raison d’etre and you can’t blame them for doing so, mostly with the best intentions for the customer.

So – in the end – when their customers/principals (i.e. the central and local governments and/or governmental bodies) want to execute large projects, in spite of many foreseeable problems ahead and an uncertain outcome, most companies do start developing the project!

When their customers demand certain services through a tight time-schedule, in spite of warnings regarding impossible deadlines and opaque specifications and requirements, they try to deliver such services. When these companies would not do that, their competition will and consequently they will lose the assignment to their competitors.

“You demand. We deliver…! No questions asked”.

You could blame these companies for doing such, but that would not be fair, in my opinion.

Some conclusions of the report, however, are spot on:

On the one hand there is unbridled enthusiasm for ICT, with proponents
viewing it as the solution to every problem. On the other hand the House of Representatives regularly demands policy measures, without realising that ICT is almost always needed in order to implement them.

The minister in question promises delivery, without first checking whether the
measures required are technically possible in ICT terms.

Even when they know that the promises being made to Parliament cannot be fulfilled, officials do not challenge the political leadership enough. When they do voice their concerns, the necessary information does not reach the top political level. This results in ministries issuing tenders for, as they were called during the hearings, “cars without steering wheels”: something, which, by its very nature, cannot work.

The first red and bold paragraph shows exactly why so many ICT projects at the government are doomed to fail. Unfounded enthusiasm for ICT and lacking insights in the possibilities and impossibilities of it, in combination with unclear and politicized requirements and unachievable deadlines, predict havoc on any ICT project.

Here is the summary, containing the ‘most important’ conclusions:

1. Establish a temporary ICT authority to act as a project gatekeeper: the BIT (Bureau for ICT assessments).

3. The House should increase its ICT awareness, for example by including ICT in the induction programme for new MPs and maintaining regular contact with the BIT.

5. From now on the Cabinet should explicitly consider ICT in its decision-making processes, in a structural manner, weighing up the possible consequences and risks of its decisions from that perspective.

6. The government should introduce more central management of its ICT policy, among other things by appointing a single minister responsible for policy concerning ICT project

7. The national government CIO should be given more authority, including decisive powers over the implementation of general ICT policy.

8. The cost savings and societal benefits of ICT policy in general must be made visible.

10. Continue the centralization of ICT procurement and government-wide ICT facilities.

11. Clearly define roles and responsibilities within all government ICT projects, including those at executive agencies. A single minister should always be responsible for any ICT project in which there is a major public interest.

17. Introduce a compulsory initial test for projects worth more than €5 million with a significant ICT component.

21. Make ICT a permanent component in the internal training for all civil servants.

22. The ministerial CIO should ensure that roles and responsibilities are clearly understood.

24. Those implementing the project and every layer of management should provide their senior officials and managers with realistic information concerning its progress.

28. From now on, a supplier’s past performance should be taken into account when evaluating tenders.

32. The government should avoid additional work and the use of hourly rates, turning any perverse incentives into positive incentives.

This (reduced) list of obligatory, open door-statements actually contained the most significant and important conclusions of the report – in my humble, but nevertheless experienced opinion.

This means that the other conclusions were even more trivial and neglectable. I will focus, however, on the red and bold conclusions, as these stood out even more negatively than the others and miss the point by lightyears.

Conclusion 1. 

This BIT bureau, as an official, governmental gatekeeper for ICT projects, will probably develop into a Soviet style ‘Polit Bureau’, as it gets much power. Too much power, according to me.

Their ability to endorse one project or halt another can lead to stagnation at one hand (i.e. a bureau “saying nyet to any project”) and corruption at the other hand, especially when such a bureau turns into a ‘private kingdom’, without sufficient political control and transparency. Their final verdict could decide on the sheer future of governmental ICT projects and that opens all options for bribery, corruption and nepotism.

Besides that, it ignores one of the most important conclusions from the report, that almost any government decision requires a change in the ICT infrastructure. Just saying ‘nyet’ to a project does not solve the political needs or fulfills the requirements.

Conclusion 10.

Central  procurement is something that has created havoc in the ICT industry and it bears the same problems as the BIT bureau.

First, it makes it virtually impossible for small, ‘lean and mean’ ICT companies, with eager employees and smart solutions, to make a tender offer on government projects in any kind. The only companies that could offer to such government tenders are the same ‘big ten’ companies that “messed up” so many other government projects.

Second, such an extremely powerful procurement organisation has the power to make and break ICT suppliers with a simple strike of a pen. This will have a downward effect on the price of ICT services and hourly fees. Services and fees, which already received blow after blow in the past six years.

And – to the contrary – when the demand for ICT services would increase dramatically in the future, there are only few ICT suppliers that are able to meet the demands of this procurement bureau. Hence, the costs of government projects would soar again, as the procurement agency has only a few suppliers to choose from: suppliers that could also deploy their employees at other companies.

Conclusion 32

This statement is so naive.

As principals, central and local governments and semi-governmental organizations are notoriously capricious and restless and – consequently –unreliable.

Many central and local politicians have – next to an extremely short attention span – an undying tendency to respond to any event with more and different legislation. Too often, short term political gains and short-sighted responses to crisis situations are favored at the expense of developing a consistent long-term vision on political and governmental subjects.

Mixed with inconsiderate policies and the eternal and ubiquitous desire for additional austerity measures at the central government, this makes that tax legislation, healthcare regulations, social security arrangements and other ICT-intensive governmental areas virtually change with the speed of light.

The whole ICT-infrastructure at the local and central governments and the governmental bodies should change accordingly to keep up with all the political changes.

However, this is often impossible, as a consequence of the often very old and non-scalable hardware and the obsolete and static structure of the software, which was often developed by people who are currently retired or have even died from old age(!).

Much governmental software exists from a (litterally) decades-old foundation, extended with numerous layers, caused by dozens of changes. This turned the whole software complex in an incomprehensible and unstable entity.  

This particular circumstance makes it virtually impossible for ICT suppliers to offer fixed price projects, without running a substantial risk at enduring financial disasters, due to drawbacks and unforeseen circumstances .

In the past, too many ICT suppliers saw fixed contract projects turn into a financial cataclysm for their company, due to reality biting at one time and allegedly clear requirements being suddenly unclear, flawed or obsolete after all, due to a changing environment. Penalty clauses,  and other financial sticks in hands of the principals did the rest to scare these companies sh*tless.

The only way in which a fixed price contract can be safely executed by suppliers of software and hardware services, is by having extensively elaborated, ironclad contracts of 150 pages, which tell to a T what the supplier will and will not do during the project. No exceptions and no flexibility possible!

On top of that, they charge large (read: exuberant) premiums for unforeseen circumstances to the customers, amalgamated in the project price, which.

I know by heart that the results of such ironclad contracts are always disappointing and almost never bring the desired software and hardware infrastructure. It is simply much too hard to catch reality in a contract.

This is the main reason that most ICT suppliers only offer labour at an hourly rate and at ‘best effort’  basis: an obligation to deliver certain efforts, instead of an obligation to deliver fixed results (!). Many ICT companies can simply not offer more than their best effort to their government customers.

Because that is the simple elephant in the room: ICT projects often fail due to unclear and changing requirements, in combination with an obsolete existing infrastructure.

And the stricter the deadline is for such projects, the bigger is the chance that a project fails totally or – at best – yields only half of the desired functionality, against twice or triple the original contract price. Very little in the report of the Elias Committee will prevent that from happening in the future.

The government itself should focus on developing a long-term ICT strategy and it should reserve vast budgets for replacing obsolete software and hardware at governmental bodies with modern, better scalable solutions. This replacement should happen, without combining it with numerous software changes.

And most important: the leading politicians in The Netherlands should abolish their restless and short-winded vision on things, leading to legislation-for-the-sake-of-legislation.

Instead, they should offer the central and local government and governmental bodies a chance to reattach to the reality as-is with improved software and hardware, instead of forcing these parties to pursue their own tail with endless rounds of new legislation and governmental arrangements. 

That lesson is so dearly missed in the report of the Elias Committee.

Sunday, 12 October 2014

The climate for retail stores in The Netherlands is still killing. Perhaps surprisingly, however, it are not only the small, independent stores that perish.

This was a typical bread-and-butter week in 2014. Nothing out of the ordinary happened….

At least, except for the fact, that two of the largest retail store chains in The Netherlands – with both well over hundred brick-and-mortar stores – were tarnished as being in deep, deep trouble.

Travel agency D-Reizen – a traveling behemoth with over 500 stores – which took over a few hundred stores after the OAD bankruptcy, came deeply into the red figures itself and is now forced to close down approximately 150 stores within the next three years, in order to survive.

And Halfords, a massive bike and car parts retailer with 130 stores, went bankrupt and is now only hoping to make a second beginning soon, with a minimal amount of spilt blood, in the form of mass lay-offs. 

Their chances, however, seem dim. Het Financieele Dagblad wrote about Halfords:

Retail store chain Halfords has been declared bankrupt, by the Court of Justice of Midden-Nederland. About 535 people work at the company.

The bankruptcy is applicable to 102 stores, as well as the head office in Veenendaal. Apart from this, Halfords has 28 stores, which are operated by independent entrepreneurs. 

The company mentions ‘changing market circumstances and an economic climate, which improves very slowly’ as main reasons for the bankruptcy. A spokesperson declares that Halfords is suffering from the circumstance that more and more people order their goods online, instead of in a brick-and-mortar store.

On June 30, 2013, the store had been sold to Peter Jan Stormmesand – already the CEO of Halfords at the time – by its former owner Macintosh Retail Group, for the token amount of €1. Macintosh already wanted to abandon the company for years and offered Halfords a €9.5 million loan to enable the necessary management buy-out.

The remainder of the article dealt with the chances for survical of Halfords. Although there is still optimism among the executive management and they see ample opportunities to continue the store chain, which allegedly has ’12.5 million visitors per year’, I personally consider the chances of Halfords surviving this shakeout quite dim.

The stores are (in)famous for their cheap, Chinese bikes and further they are not specialized bike stores, not specialized car-part and car detailing stores and not specialized… in anything. It is a little bit of this and a little bit of that, but nothing special at all. 

To put it bluntly: the store sells nothing that numerous other store (chain)s don’t sell at the same or better prices.

Besides that, the formula has probably suffered from exhaustion, like many other store chains: simply too many stores at too many poor(?) locations.

The second store chain in dire straits is the aforementioned D-Reizen. 

Travel agency D-reizen is currently in dire straits. The retail organisation will write deeply red figures this year and is forced to shut down dozens of stores. CEO Will van den Hoogen confirmed this to De Telegraaf.

According to Van den Hoogen, the chain's headwinds have been caused by the malaise in the traveling industry, as probably at least half of the current 1200 brick-and-mortar traveling stores in The Netherlands will disappear, due to the rise-to-power of online traveling shops. In earlier years, there had been 2500 brick-and-mortar travel agencies.

“Besides that, we suffer from considerable reorganisation expenses, due to the merger of D-reizen with VakantieXperts and Thomas Cook Travel shops. We want to amortize these expenses within this year and that yields a loss. All bonuses for the store personnel – more than 1000  workers –have been withdrawn. We must get the picture straight, in order to move into the future healthily”.

Van den Hoogen announced to abandon loss-bearing travel stores without hesitation. “Together with our partners, we still have approximately 500 stores in The Netherlands. In about 3 years, 350 of these stores – only the ones that earn money – will be left”.   

Of course, the internet has been a particularly massive factor in the traveling industry and in many more parts of the retail industry. Why would you f.i. visit a traveling agency, when you can order almost any trip from the comfort of your own chair.

Still, I consider myself to be a sucker for the services rendered by a travel agency:
  • the good and useful advices about interesting travels and beautiful destinations;
  • the possibility to hear exactly those offers that I like and;
  • the possibility to book my travel immediately, without any hassle and surprises and without the chance of ‘sending my money into oblivion’, when I order my trip at just the wrong site.

Nevertheless, since the Mrs. started to live together with me, I totally stopped visiting travel agencies. My wife books our travels online and she always manages to get the best trip for the best price. She never failed at that yet.

And also for many other products and services, the internet and internet shopping seem to become the answer to all questions. 

Nevertheless, the internet is not the only reason for the lasting, general malaise in the retail industry. Not for D-reizen and not for many, many more store chains. 

The biggest reasons, in my humble opinion, have been the suicidal expansion of many of these store chains in recent years and other flawed strategies of these store chains themselves. These flawed strategies are visible through the following two symptoms:

Just too many of the same chain stores at too many poor locations:

Since a few years, it seems that the combination of too many of the same chain stores at too many poor locations, is starting to eat away the margins of the famous Dutch and foreign store chains. 

It seems that the Dutch consumer, still numb after six years of crisis, has enough of the ubiquitous overkill in retail stores and particularly of the overkill in the same boring chain stores. You could call this ‘chain store fatigue’.

There are simply too many C&A branches, too many V&D stores, too many Blokker stores, too many HEMA-stores and too many of all these other renowned chain stores. Only a few stores, like Primark, seem to be the goose with the golden eggs nowadays, but this effect won’t be lasting, in my humble opinion.

In stead of shopping enthusiastically, the Dutch consumers still go through the motions and wait further for the sales periods, which are ever more frequent and longer in size. Why would you buy something for the full price, when you can get it for half the price in a few weeks.

And there is more…

Devastating loss of margin through price erosion:

One of the worst causes for loss of margin at all these store chains, is a phenomena called ‘price erosion’:

When you have a number of competing store chains, which sell the same lines of articles, deliver the same service level, have roughly the same expenses and cover about the same geographical areas, then they have to distinguish themselves through the price of their articles. And you know what that means: discounts, discounts and even more discounts…  

These store chains are often stunting with their prices so fiercely, that their margin totally evaporates and they hardly keep their heads above water. This continues, until the strongest and 'baddest' store chain is the last store chain standing. This is the store chain with the deepest pockets and the best purchase prices and discounts from its ransacked suppliers.

Some of these store chains see their cheap ‘stunt’ articles as a means to lure in interested buyers, hoping that these will also buy normally priced articles. However, in most cases this is a fallacy, as this behaviour by customers does not happen automatically and often does not happen at all. Period.

Many people buy only the stunt article and leave, waiting for the next stunting period, which inevitably appears a few months later in the same shop or a day later at the next store chain.

The results of this kamikaze strategy have been devastating for many of these store chains. Megapool, a large store chain of household appliances and consumer electronics bankrupted in the past and quite recently, the same happened with other large store chains, like Block, Harense Smid, E-Plaza and Apple reseller iCentre.

MediaMarkt, the Germany company of megastores in household appliances and consumer electronics (“I am not crazy” is their aggressive (translated) punchline in virtually every country, where they appeared), seems the next victim to lose the ‘battle for the bottom price’, due to price erosion. 

Winners can seemingly become losers at lightning speed in The Netherlands.

Personally, I think that many more chain stores will perish, as people are tired of the mediocre quality, ordinary and indistinctive articles and the ubiquitous price stunting of many of these chains.

I personally think that the future could look particularly bright for small, specialized shops with goods of exceptional quality, exceptional service and really exclusive brands and articles: so-called niche stores and state-of-the-art shops.

My brother Rob is optician with an independent optics shop, who is a sucker for quality and style. 

Besides that, he is a genuine innovator in his line of business, incorporating his groundbreaking ideas regarding modern spectacle frame design and production and contact lense measurement in his business, to the benefit of his customers. 

He does not even bother to compete with the massive optics store chains, like Pearle, EyeWish Groeneveld or SpecSavers.

Rob often tells me when we talk: “Shops that give away their main products for free – like glasses and spectacle frames  are utterly crazy. It is a rat race…

In earlier times you got one pair of specs for free, while buying one pair. Nowadays, you get two pair of specs for free at Pearle, when you buy one pair. Are these guys out of their darn minds?

And what good are three sets of specs, when they are not measured correctly and have a poor fit or an incorrect strenght of glasses?! 

I sell my customers one pair of specs at a fair price. The glasses are measured perfectly, the frame is fitted to a T and my customers can always come back for service or a refit, when they need it.

My customers appreciate that and know the quality for which I stand. They not only come back to my shop, but tell their friends and relatives about it too! They pay a few bucks more in my shop, but get the best quality and service in return for it!”

And so there are many more independent shops, who gave up the rat race to the bottom price and instead go for the best quality and service. I think that such shops ultimately have the future, although this is more a gut-feeling than sheer science. 

Specialization and exceptional quality could become the key-words in years to come.