Eyes Wide Shut - Ho Kwon Ping

I hv to say I hv utmost admiration for this guy ~ for the way he runs his biz and his ethics. I could never sell a CDO.... Hmm... I am a banker and so I am a Bargirl. Hehe...

DISTRACTIONS OF AN ECONOMIC BOOM - Eyes wide shut

Mr Ho Kwon Ping, executive chairman of Banyan Tree Holdings, spoke at the BlueSky finance fair on Thursday, 19 July 2007. This is an extract from his speech.

THIS symposium's focus on capital - how to find it, how to spend it, maybe lose it, and then how to find it again - is particularly timely. For small and medium-sized enterprises (SMEs) in particular, it is gratifying that banks have finally discovered that they are the real drivers of Asia's economic growth. SMEs account for more than 90 per cent of Asia's companies, around 60 per cent of employment and some 40 per cent of exports.

Yet four years ago, fewer than 20 per cent could get bank funding. But with a prolonged economic boom in the region, many SMEs are not so small any more. Banks are now rushing to provide them with not just plain-vanilla cash, trade, or overseas accounts, project loans and foreign exchange hedging, but also with more complex and exotic wealth management products as well as corporate finance for mergers and acquisitions and initial public offerings (IPOs).

This is a commendable and long overdue attention to the needs of the SME sector. But there are also grounds for some caution.

We are in the midst of a liquidity-driven boom which started very positively, became euphoric, and is now causing some unease as to whether - or when - the music will come to a stop. This unease is no doubt accentuated by the uncanny coincidence that the last two crashes were exactly 10 years apart, in late 1987 and mid-1997. By this reckoning, something big and nasty should happen within the next six months.

For the past decade, the world has been awash in liquidity. Over this long period of low interest rates, cheap money was available for anyone to access. Since prudent individuals and companies were inherently conservative about their debt and investments, this cheap money found homes elsewhere. Some of it went to high-risk borrowers like sub-prime mortgages or junk bonds. Much of it fuelled a global boom in property, commodity, equity and other asset markets. A much larger amount went to hedge and private equity funds, which then, in collusion with banks, further leveraged themselves to make acquisitions built entirely on debt.

We are now entering an unknown territory in capital market cycles. All asset classes are experiencing historic highs. The sense of euphoria in all markets is palpable. The more seasoned observers are already warning of froth and bubbles. But respectable people are also saying - like people used to say before every crash - that this time it's different.

Perhaps it will indeed be different and water can flow uphill, and fish have wings. But I would be surprised.

It is in times of euphoria that businessmen must be particularly vigilant and disciplined. Sophisticated financial institutions can handle high degrees of risk because they slice off pieces of high risk subprime mortgages or junk bonds and repackage them into high yield products with impressive names like collateralised debt obligations or CDOs, and pass the risk to unsuspecting investors like you and me (also known as 'high net-worth individuals' to flatter us).

Use of other euphemisms like 'sub-prime' to describe barely solvent homeowners, or 'leverage lending' to describe piling debt on top of debt, certainly helped to mask the increasingly risky activity.

My experience is that our faculties are most sharp and logical during a crisis, like a recession. But when we are inebriated by prosperity, our vision becomes blurred, our logic and discipline weaken and the gambler's motto - 'one more time' - takes over. Normally conservative businessmen who avoid casinos find themselves heavily speculating in the equities and property markets, or pile debt onto debt to acquire expensive companies, or to diversify into unrelated businesses like property development.

It is during the good times - like now - that entrepreneurs are more likely to become excessively exuberant about borrowing or investing.

It is not impossible that the spectre of 1997 may come back to haunt us. While Singapore and Malaysia emerged relatively unscathed, any of you with friends in say, Thailand or Indonesia, will know the intensity, duration and depth of the trauma which the then very successful businessmen of Asia plunged into, and which they are only now beginning to emerge from. I would hate to see that happen to any of you.

*Sweet prospects*

ON THE other hand, prosperous times also opens the door for the sale of your company, in part or whole, to the public or private equity markets. Having found large and lucrative deals increasingly rare in the US and Europe, private equity deal frenzy is now turning towards smaller deals in Asia. And that means some of you have probably been targeted by investment bankers for an IPO, or by venture capitalists and private equity fund managers for a private sale.

The prospect of finally being rich after years of slogging, of being able to buy that yacht or Ferrari, or second home in Shanghai or London, or indulging in other forms of conspicuous consumption, is certainly sweet.

So what should you do?

Having just gone through our latest IPO a year ago, many of the questions are still fresh in my mind. You will surely ask: Is this the best time to bring my business to market, whether by IPO or private equity? Or is it premature, because within a few years my business will really take off and I will get a better value then? Should I seek mezzanine investors from the venture capital industry to tide over my capital needs till my IPO? Or should I sell out completely to the tempting offers from private equity funds because valuations won't get any better. And, how much should I dilute down? Do I need majority control in order to achieve my vision, or should I sell out and enter into a service contract?

In my own case, an IPO was a foregone conclusion because I had minority investors for whom I had promised an exit, but I did not sell down my equity at IPO because I felt that the best was yet to come. Our IPO was quite nerve-wracking. Delayed twice already because of Sars and then the tsunami,we thought we finally had perfect weather ahead. We started preparations under ideal market conditions but finally listed smack in the middle of a severe market correction. Companies queuing to list behind us actually cancelled their listing. But we were too late to cancel, and our share price collapsed on the first minute of trading. So much for an auspicious start.

Fortunately, investors did see value in Banyan Tree after a while. In the past one year our share price has gone up 300 per cent and Banyan Tree's market capitalisation is now about $2 billion.

*A healthy cynicism*

LOOKING back over my 25 years in business, I sometimes ask myself, did I actually learn anything at all? It's certainly not for lack of learning opportunities.

I've accessed public equity markets four times, with two listings in the Bangkok stock market and two in the Singapore stock market. In the process, I've gone on countless roadshows and rubber chicken lunches, trying to convince sceptical 25-year-old analysts that I was worth five minutes of their time.

I've hand-held venture capital investors in my companies from their entry till their exit through an IPO, and kept faith with them. I've also had many discussions with private equity funds who want to buy over completely Banyan Tree and some of my other companies.

I've signed loan covenants with fair-weather banks who court you when you don't need them, and pull the plug just when you do need them. I've tangled with vulture funds who buy distressed debt for a few cents on the dollar and then try to strip the borrower's assets.

I've nearly lost a few million dollars through buying complex derivatives from glib investment bankers who made me feel stupid that I didn't really understand how the hell the derivatives worked but was too intimidated to say so. And I've ignored advice and borrowed so much for an oil rig project which, when it collapsed, nearly sank our company.

I've also seen the view from the other side. After nine years on the board of Standard Chartered Bank, I have developed a respect for the men and women who pursue their vocation with integrity, professionalism, and even some compassion. I've worked with many excellent bankers who have since become friends.

From my expensive lessons, is there any single over-riding take-away, some shining pearl of wisdom I can give to you?

Very simply, it is this: You need to have a healthy cynicism about money - how we always are scrambling for it, and when we finally have it, how we can easily squander it. How the people who want to lend to us or invest in us,or for us to buy their financial instruments, are often less altruistic than their glibly articulate appearance.

A robust scepticism about all the players in the money game, including ourselves, is necessary if we are to be street-smart enough to survive and flourish in a world where things are not always what they appear to be.

Besides healthy scepticism about others, we should also be equally cynical about human nature as it applies to ourselves. My father, and probably each of yours also, used to always drum into me: There is no easy way to make money, and distrust anyone who tells you otherwise. But we usually remember this only until an easy-money proposition comes along.

Before the Thai baht devaluation 10 years ago, it was common practice for wealthy individuals and companies to borrow in low-interest US dollars and then invest in baht-denominated equities, bonds, or even loans. Double-digit returns on investment could be had for no risk because the baht had been pegged to the dollar for longer than anyone could remember. It was a no-brainer. Our companies also engaged in this lucrative trade, and we made good, easy money. My father's caution seemed so out-of-touch, so old-fashioned and conservative.

Well, as we all know, the baht did devalue and suddenly my liabilities doubled and my investments halved in value.

The amazing thing is that 10 years later, this same business has re-emerged with a vengeance, but it is interest rate arbitrage on the Japanese yen. And again, companies which would normally balk at speculative foreign exchange trading are happily engaged in the yen carry trade because it is such easy money to make. I hope you all listen to your fathers more than I did.

*Banyan Tree's early years*

WHEN the Asian crisis hit, Banyan Tree was a three-yearold start up, much less an SME. When I first started out to build our resort business, I did not have our family business as backing. I had already lost millions of my father's money through a disastrous oil drilling rig project in China.

I had access to less than $3 million to buy the land and build the first hotel, on what is now Laguna Phuket. We could not find investors or bankers, and even hotel management companies refused to manage our first hotel. My brother and I designed the first hotel literally on his kitchen table.

But as all of you know, the first step is always the hardest, and after several missteps and many doors rudely shut in our faces, the first hotel was built. After that, I was lucky to climb onto and ride a tourism boom in Thailand in the early 90s, and was therefore able to leverage the rising value of our land bank in Phuket to partner with outside investors. By eventually listing the Thai company, I managed to monetise some of my efforts, and re-invested that in a Singapore company, which later became Banyan Tree Holdings. This was to be our platform for international expansion.

Throughout all these years, we have been financially quite conservative. I have a fondness for plain-vanilla, traditional term loans rather than complicated facilities, for low gearing, and for not mis-matching short term loans with long term projects, or borrowing in one currency to fund a project in another - no matter how attractive it may be to do so.

Because of my own past mistakes, I've taken to heart another of my father's sayings: When you borrow money, think not of the huge profits you'll make but whether, in a worst case scenario, can the bank end up owning you.

And so we have conservative borrowing guidelines which we call the 1-2-3 formula. We will not exceed a 1:1 debt equity ratio, a 2:1 debt service ratio, or a 3:1 interest coverage ratio. Currently, even with our expansion plans and relatively easy access to credit, we are nowhere near these levels. I would suggest that each SME also set its own internal borrowing guidelines - especially in good times.

Because of this conservatism, I have funded some of our expansion not with excessive debt, but with venture capital. I invited a few venture capital firms to take up 30 per cent in a restructured company which became Banyan Tree Holdings, then gave them a verbal promise of an IPO exit - which I've kept.

*Bankers and bargirls*

AS AN entrepreneur, your dilemma is not whether to access the capital markets or not. It is how to optimise the use of each of the four sources of capital - internal cashflow, bank debt, public equity market, and private equity market.

And the corollary of that dilemma is how to maintain your independence while satisfying the demands of the various capital providers.

You have built up enviable businesses, many from scratch. You are ready for the next phase of growth, whether by using debt or equity capital. Whichever way you choose, and the resultant capital structure, will have a great impact on the next phase of your company. Have confidence in your own instincts, be aggressive in your thinking but conservative in your actions,and be not intimidated by bankers nor seduced by your own greed.

Above all, never fall prey to flattery and hubris. Bargirls and bankers have something in common: They are the most persuasive flatterers you'll meet. Both can persuade you to part with your money, and both can make you wake up one day regretting everything you've done. But only the banker can make you owe him even more after the deed than before.

But even more dangerous than flattery is your own hubris, the notion that you are somehow above business cycles, above unexpected risks, above competitive pressures; that because you have been successful once, you will always repeat that success.

To avoid hubris, never take yourself too seriously. Struggling entrepreneurs are pretty tough and resilient, but successful entrepreneurs often get soft and complacent. They are infected by a once-healthy confidence which has started to fester. They become bloated, full of themselves and wedded to possibly outdated formulas for success. They start to fear change and cling onto business models which no longer work, and then resort to debt to keep a failing business afloat.

Regard your work very seriously, but not yourself and your own infallibility. Recognise the need to be nimble and flexible in a global marketplace, and to change business models when necessary.

My own solution to hubris is simple: Whenever I feel like a master of the universe who can do no wrong, I go home and face my wife and children, and ask them who I am, and their honesty brings me down to earth pretty quickly.