Global markets. Global trading. Global portfolios. And global comparisons by analysts.
Er, no, well not quite, anyway. Peer group comparisons across borders remain a bit of a sticky issue amidst all of this globalisation talk. Even in the sectors, such as chemicals and paper, which by their very nature lend themselves to such analysis, the financial community runs into obstacles in evaluating say, a German company, in relation to a US competitor.
So, what’s the problem? Surely, with a little bit of accounting jiggery-pokery, reconstituting the numbers to US Gaap or whatever, you’re able to put two or more companies side by side on the same level. Problem solved. No, no, no. A collective, exasperated sigh goes up from analysts and fund managers around the world at the naivety of the solution.
‘No matter what you do, making comparisons is a problem when you cross borders,’ says Gary Schieneman, at Merrill Lynch in New York. And this from a guy who spends a great deal of his time doing just that. Schieneman argues that using Dutch financial information is fine if you’re just looking at the Dutch market and Dutch companies. But try bringing those figures into the US market to compare with a US competitor and you’re going to run into trouble.
Just take a look at what happened to Daimler-Benz, if you want further proof. One minute it was toddling along at a nice, safe net income level of DM615 mn. Next minute it makes a ground-breaking ADR listing on the New York Stock Exchange and recasts its figures according to US Gaap. Whoosh. There goes its income cushion. Instead Daimler was now apparently making a net loss of DM1.83 bn for the same financial year. Not only that, but the company also incurred the wrath of its German peers for breaking ranks.
The difference in the figures was largely a reflection of the differences in appropriated retained earnings. By this year Daimler-Benz had had enough of living with the dual position. Starting with the publication of its half-year results in August, the German giant will only publish its results according to US Gaap. Industries which, according to UK accounting principles, reported a net income of 188 mn in 1994. Wave the US Gaap magic wand and 132 mn of that net income went up in smoke. ‘Which of those figures is the true one?’ asks Schieneman. ‘The answer is both of them.’
Not much help there, then.
‘No single bit of data is the key to meaningful evaluation across borders,’ Schieneman continues with an air of resignation. ‘That depends on the sector and on the composition of that sector. The more global the sector, the more comparability you will find in the reporting.’
But that’s not always the case, either. Schieneman points to the automobile industry, a sector which, as he says, one might expect to be global in its outlook. ‘You’d think you can compare Volkswagen with General Motors,’ he says. ‘But Volkswagen considers itself to be a German company and General Motors considers itself to be a US company.’ He adds that it is only in sectors where there is global raw material input, such as chemicals, that figures are becoming more global in nature.
Other commentators are inclined to go along with that assessment. Brian Rafferty, founding partner of IR agency Taylor Rafferty Associates in New York, points to chemicals and paper. As does Roger Hornett, at Socit Generale Strauss Turnbull in London, who also mentions telecoms as increasingly being drawn in to the global comparison equation.
‘In general terms, each market has its own idiosyncracies with different p/es and different cultures,’ adds Hornett, who heads up sales and research at SGST. ‘Although there is an increasing trend to a common market p/e and common sector p/e. But that’s only in the genuinely international sectors and not necessarily true of retailers and other sectors.’
Rafferty argues that in the paper and chemicals sectors those trying to make comparisons across borders are probably less concerned with accounting differences than with trying to judge the overall capacity of the companies they are looking at. He believes that conversion to US Gaap numbers is probably not as important as it is made out to be.
A consistent framework for reporting performance is what is required rather than necessarily having the same accounting standards. Rafferty goes on to qualify that argument by stressing that US Gaap conversions are more significant in markets which are ‘less understood’ – such as in Asia – and where there might be more difficulty in obtaining other information.
What Rafferty is getting at is that putting two companies into the same accounting standard does not make them directly comparable. You need more. A French company reporting in US Gaap still cannot be viewed side by side with an American competitor – it is not reporting as it would if it were born and bred in the States. The stricter US standards may well get rid of understated earnings or the like in other countries, but they won’t take into account that a company is being managed for its own domestic accounting arrangements or its cultural background. In effect, reconstituting to other accounting standards makes it a lot easier to compare differences in accounting standards, not differences in the companies themselves.
Enter the International Accounting Standards Committee. Under pressure from companies eager to tap the US markets but reluctant to report in US Gaap, the IASC announced earlier this year that it was speeding up its work programme to draw up a complete set of generally accepted core international standards by March 1998.
The announcement followed last year’s agreement between the IASC and the International Organisation of Securities Commissions in which Iosco said that a core set of standards would ‘clear the way for it to endorse IAS for the purposes of cross-border offerings and listings in all global capital markets.’
Liesel Knorr, technical director at the IASC, is upbeat about the accelerated programme but recognises that it won’t solve all the world’s accounting differences at a stroke. Continental European accounting is a particular bug-bear. Knorr says the IASC is on a ‘crusade’ to make things more comparable but that its constitution limits its approach. The constitution keeps the IASC’s work on the straight and narrow of looking at financial statements, not financial reporting in general.
A wider remit would allow it to look at bringing standards between, for example, the UK’s Operating and Financial Review and the Management Discussion and Analysis in the States closer together. That is, managements’ explanation of what’s going on behind the figures which analysts find so useful. No joy there, but at least things are on the same road on the financial statements front, says Knorr.
Does the end of that road mean that the golden day of international comparisons is just around the corner? Not a bit of it. Sure, things are probably going to get a lot easier but, bearing in mind some of the problems alluded to above, things aren’t going to change that much.
Not according to Roger Davis, head of audit at Coopers & Lybrand in London, anyway. He questions whether, at the end of the day, the US SEC will be prepared to accept international standards which are far less rigorous than its own. Davis believes there will be considerable opposition from US companies to foreign companies listing in the US on ‘lower’ standards. He asks if an Exxon, for example, would be prepared to see a Shell or BP list on different criteria.
‘There has to be an element of lowest common denominator in international standards,’ says Davis. And, he believes, there can not be an absolute comparability across borders even with international standards. Having said that, he acknowledges that ‘they will be much more comparable than they are at the moment’ – with the substantial differences between continental Europe and the Anglo-Saxon jurisdictions.
The ‘things can only get better’ attitude echoes around the analyst and fund management community. Jim Wilbur, chemicals analyst at Smith Barney in New York: ‘The problem at the moment is that we’ve got too much data and not enough information. To the extent that international accounting standards may pull towards what’s actually happening, then that can only be a good thing.’
With too much data and not enough information in the accounts, Wilbur uses a whole raft of measures and ratios to get behind the figures on the balance sheet when comparing companies across borders. He starts from the basic premise that if it isn’t a US corporation he’s not likely to get all the information he needs handed to him on a plate. It’s more likely to be a continual struggle for information.
And that goes for Canadian companies, too. Indeed, having just visited Nova in Canada he had a recent example to quote. To look at management efficiency, Wilbur takes general sales and administration costs and compares that to total gross profit. He complains that he couldn’t get those basic figures from Nova even though he thinks they’re quite efficient in that regard. In the US those figures are generally available from the P&L statement.
Wilbur also complains about being frustrated by how ‘international’ companies go about incorporating their pensions assets into the balance sheet. He recalls asking the management of one large German chemical company where their pensions were in the figures. The executive pointed in the direction of a nearby chemical tank and intimated that they were encapsulated within it. Wilbur reports that there was an element of shock when he dared to ask him what would happen if the company went bankrupt.
‘How would you feel if you worked at Burberry’s and asked how they were going to pay your pension and they said it’s over there in that stack of shirts?’ asks Wilbur. ‘I want to see real money in a real place. You’ve got to know what the balance sheet would look like if the company actually charged the right amount to pensions.’
So if the traditional balance sheet is fairly useless in making international comparisons – regardless of the accounting standard being applied – what figures are analysts and fund managers using? Most of them refer back to some form of cashflow measurement or Ebitda (earnings before interest, tax, depreciation and amortisation). But there are problems there, too.
Brian Rafferty believes that the move towards cashflow as a measurement in the UK is a ‘major philosophical change’ in the right direction. That being said, he points out that cashflow is defined in many different ways, which leads to further obstacles in making comparisons.
Likewise, Roger Hornett at SGST favours the trend to looking at Ebitda as a measurement, believing it to be the most realistic and total view of where a company is going compared with another. Gary Schienemann at Merrill is not so convinced, arguing that it favours those companies which grow by acquisition and that any measurement which ignores different tax regimes is asking for trouble.
Rita Ogun, technical consultant at Datastream, wryly sums up the advantages of Ebitda by defining it as a measurement of where a company is at before the professions (for that read accountants) have done anything with earnings. She adds that the determination of the charge for depreciation and amortisation is highly subjective – but that only takes away one of the subjective elements in the measurement of profit. Many others remain.
Datastream gets round the problem of inconsistencies in international information as far as it can by at least trying to calculate the statistics it provides to the financial community in a consistent fashion. Easier said than done, though, says Ogun. The data required to make the necessary adjustments is not always disclosed in the annual reports. And it is all very well looking at the different treatment of exceptional, extraordinary and unusual items across borders but that still doesn’t take into account valuation differences. Start bringing currencies into the equation and you enter a whole new – much more confusing – ball game.
‘Everyone is still far, far away from making truly accurate international comparisons,’ says Ogun. And we’ve just been talking about retrospective figures. Don’t begin to talk to analysts about what they want in forward-looking information.
