March 27, 2020
By Dennis Kaiser
What business leaders should be doing in a downturn? Though the market has yet to clearly establish a new trajectory, the COVID-19 pandemic has introduced a harsh new reality into what was shaping up to be another banner year for CRE.
CEO and performance measurement expert Greg Milano, author of Curing Corporate Short-Termism: Future Growth vs. Current Earnings, has some ideas that he shared with Connect Media about what leaders should do now that the market is facing serious challenges because of the impact from the coronavirus. Milano is the founder and CEO of Fortuna Advisors LLC, a leading expert in capital allocation, behavioral finance, and incentive compensation design. He has nearly 30 years’ experience in management consulting, and prior to Fortuna, he was a partner at Stern Stewart and a managing director at Credit Suisse.
Q: What is the first order of business for company leaders as they face the unknown challenges of the COVID-19 pandemic?
A: Survive: First priority is protecting the business, so be sure to carefully manage cash flow and liquidity, and for companies that have heavy debt burdens this could require full attention. Along these same lines, be sure to stay in close communication with employees, customers and suppliers so they know what is happening, how it affects them and what they can do.
Although real estate is often thought of as “low risk”, the current environment is proving very difficult for many real estate companies. As of right now, the median real estate company in the S&P 500 has experienced a stock price decline of over 40% since February 19. This places the sector eighth of the 11 sectors – only financials, consumer discretionary and energy are doing worse in the stock market.
Many real estate companies carry way too much debt for this type of economic scenario, and this will call into question whether such entities will survive. I split the S&P 500 real estate companies into those with above average or below average debt as of February 19, and those with more debt have performed worse than those carrying less debt.
Some will need to sell properties in order to pay down debt and meet other obligations, and the prices these properties get will be way lower than what would have been expected very recently.
Q: Assuming a company properly addresses the initial challenges, what is next, in terms of strategies to emerge on solid footing?
A: Improve: Next priority, for those not consumed with item one, is identifying opportunities that the downturn creates. Within the business, this can be a great time to reset strategy, consider bold business changes and rationalize operations that need it, while the warts of poor performance are extra visible. As I believe Winston Churchill said, “Never let a good crisis go to waste.”
With vacancies increasing in many properties, this will offer an opportunity to upgrade the quality of tenants as the crisis passes.
This also could be an ideal time for upgrading and refurbishing, while space is empty.
Q: Lastly, what steps should leaders look at taking from an optimistic viewpoint?
A: Be Opportunistic: For those companies that have truly nothing negative happening to their business, which is the case for many healthcare companies, for example, but where the share prices for the company and its peers have declined, there can be opportunistic value creation situations.
As I wrote in Curing Corporate Short-Termism, “From the 2007 peak to the trough of the market in the 2009 financial crisis, the median utility company suffered TSR of –41%. Utilities are not viewed as being cyclical. Indeed, the median utility, Exelon, saw its EPS increase slightly from $4.03 to $4.09 from 2007 to 2009, a period when its EBITDA increased 9.5%. So, why was its TSR –41%? Market fear. Exelon acquired no competitors that year, but perhaps it could have improved its long-run performance by buying a very stable competitor that would have essentially been on sale.”
For those that don’t see any decent acquisition opportunities, and have available debt capacity, buybacks may be good at this time as well.
There will be a lot of real estate that becomes available because of financial difficulties being experienced by the current owners, and these may be available at very attractive prices. For those with adequate financing capacity (low current debt), this could be a very important time for growing the real estate portfolio.
For comments, questions or concerns, please contact Dennis Kaiser