Portuguese companies must consolidate and gain scale or disappear!
It is widely known that Portugal lacks own capital and relies on overseas investment to grow its companies, without which it is difficult to grow Portugal’s economy. But with 90% of companies being classed as micro or small enterprises, mergers and acquisitions are the only way that its companies can gain scale and compete in International markets. But what options are open to get investment? A panel of experts debated the shape of the capital markets at an event organised by the American Chamber of Commerce in Portugal (AmCham) on Thursday in Lisbon.
Text: Chris Graeme
It is a startling and incredible fact that just 1% of Portugal’s companies represent 57% of the Gross Value Added of the Portuguese economy, 71% of taxes, 48% of salaries, and 62% of Portugal’s exports.
“We have a economic-enterprise landscape in Portugal of very few companies that unfortunately manage the lion’s share of wealth in the Portuguese economy,” said the President of AmCham, António Martins da Costa at the event ‘Financing Systems – Investment in Portugal’, held at the Sheraton Lisboa & Spa.
This, he said, would naturally lead to reflections on the need for Portugal’s companies to consolidate to gain scale through mergers and acquisitions, against the current situation of high inflation, high overheads, rising raw materials and transport costs all of which make it difficult for many micro-companies to survive.
Therefore, financing for these acquisitions and mergers, and for companies to grow, can come from a combination of debt and equity, third party debt, owners equity, venture capital, and lines of credit.
And right now this has too be done in challenging times of high inflation and interest rates, the tail of the Covid-19 pandemic, and the uncertainties of the war in Ukraine and not knowing when it will end.
“All of these have an impact on society, companies and an appetite for investment and financing”, said Martins da Costa, so what are the prospects and perspectives for company financing and investment in Portugal in the mid-term?
The outlook from Portugal’s banks
Norberto Sequeira da Rosa, the Secretary-General of the Portuguese Banking Association (APB) outlined how Portugal had arrived at the point in which it finds itself today by retracing the steps of Portugal’s economic fortunes and performance 20 years and focusing on the last great financial crisis which unfolded in the US from 2007 and culminated in Portugal’s Sovereign Debt Crisis in 2011 which led to Portugal seeking a €78Bn bailout from international institutions to avoid a default.
From 2016, he recounted, there had been a recovery in companies’ capital stock*. (*Capital stock is issued by companies to raise capital. It is usually issued when companies are trying to fund their growth. They are made up of a combination of preferred and common stock. These are often sold to investors, who may benefit from dividend payments and strong appreciation as the business grows.)
However, the level of the capital stock of public entities is continuing to fall because public investment is currently at only 2%, falling from 5% pre financial crisis. Family investment too has fallen by around 50% to about 4%, however, fundamentally company capital stock has increased.
This is relevant, he said, because company capital is more active and important for the creation of value.
“Since 2016, there has been an increase in investment of around 19%, with companies gaining value of 13% — the highest it has been for 20 years — but with an additional advantage in that all this investment has been financed by national savings and without increasing external debt.
This is even more relevant when the different institutional sectors have managed to drastically reduce their debt.
For example, Norberto Sequeira da Rosa said that companies had reduced their debt by 50 percentage points over that time (it had been at 120%), family debt had fallen to 60% of GDP, and Portugal’s public debt by 20 percentage points to 114% of GDP.
However, what wasn’t said was that more recently private company debt has increased by €5.5Bn in 2022 on 2021 (+1,7%), translating in an increase vis-à-vis overseas of €2.9Bn. The financial sector was responsible for €1.8Bn and companies for €1Bn of this increase.
“We are currently in a situation in which the debt of the various institutional sectors is less, gross savings are entirely financing investment, and investment is sufficient to replace capital stock”, said the banker.
In terms of the elasticity of capital to GDP and capital to employment, the annual values are at around 0.6 and 0.4 for employment.
“This is positive but on the other hand also negative. Capital stock increased on average by 1.2% over the past 20 years (per annum), but Portugal’s GDP suffered anaemic growth. (0.7% on average). Employment has stabilised but has not contributed towards GDP growth”, said the secretary-general of Portugal’s banking association.
However, in terms of technological innovation the picture is not so good, with capital remaining constant over time. In other words, there has not been an increase in productivity, partly because Portugal is made up of small and micro companies whose investment is not very productive. “We have investment at the moment, the problem is the quality of this investment”.
“The situation today is very different from 10 years ago (record public debt at 107% of GDP, unsustainable interest on 10-year sovereign bonds (7%) and the troika bailout (€78Bn)).
Today company investment is relatively high, financed by internal savings, while the banking system (which had suffered from high levels of NPLs and low capitalisation levels) with no restrictions on financing either in terms of capital or liquidity. *Between 2007 and 2011 company investment in Portugal fell from 160% to 80%.*
The banks in terms of liquidity (liquid cover ratio) has gone from 160% to 80% with conditions to increase the GDP potential.
*(The Bank of Portugal announced this week that the transfer of savings applied in bank deposits to more profitable products that has been seen in recent months is “healthy” and is unlikely to carry risks for financial stability because Portugal’s banks have robust liquidity levels, while in May, the President of the APB Vítor Bento said he did not foresee any serious problems with Portugal’s banking system).
Securities and bonds — a frightening year of losses
Miguel Athhayde Marques, president of the Portuguese Association of Issuers** (AEM) said that for issuer companies the level of uncertainty was “still huge”.
“2022 was a “frightening year” because of the war and its consequences on the wold economy, and this is reflected in the behaviour of the markets.
“If we look at the value of all the stock market listed companies in the world (MSCI All Country World Index), this index lost 20% of its value”. (US$25 million millions or US$25 trillion.)
“If to this we add the loss on the bonds markets and long term financing (US 10-year treasury notes), the cost of capital went from of 1.5% to 4% — the highest since records began in the 1960s”, said.
On the other hand, he said the fall in the value of the stocks and shares market was the largest by far since the subprime crisis between 2007-2010. The bonds market lost US$9.6 trillion.
“These are huge losses that cannot fail to have repercussions on the prospects for 2023. So far this year there has been some reposition and return to balance, with the stock markets in Europe recovering by 8-9%; in the US the Nasdaq continues to fall, while the S&P 500 has stabilised. This re-balance has given us some hope,” said Miguel Athhayde Marques.
Today, there is a better control over energy issues and a better adaptation by the currencies regarding the US dollar. In 2021/2022 for 20 months the dollar gained against the euro by 26% and has now fallen back by 14-15% with a differential now of 10% against the euro.
He said that if the economic agencies now have the capacity to manage risk; on the other hand huge uncertainty remains regarding the future.
“Companies are very aware at the moment of the need to manage risk, with more attention being paid on mitigating risk by company boards, including stress tests and scenario building, as well as the capacity a company has to defend itself and also to search out opportunities”.
All of this has implications for the functioning of the economy in Portugal. “We have a game-changing situation on markets behaviour, with the fall in the value of shares being accompanied by a fall in the value of bonds.
This in turn means that listed companies are less attractive as investment options. Then there is the issue of the decoupling of the US from Europe. The US has resolved its energy problem but the EU has not.
“For a decade Europe was talking about energy transition, and it is now doing this, but forgot something basic: energy security and the situation we have at the moment is a reflection of not resolving this,” he added.
This problem was particularly true of gas, of which 45% came from Russia, and was vital to Germany’s chemical industry. (Just one company alone – BASF (Ludwigshafen, Germany) consumes more gas, energy and raw materials than Switzerland)
“The question is how are we going to reduce our dependence on Russia and find alternative sources of supply without any infrastructure capable of meeting the difference,” asked Miguel Athhayde Marques
Miguel Athhayde Marques added that Portugal was lucky enough not to have had a very cold winter, but the problem could be next winter since fuel sources might not be so agile as they once were.
The Question of growth — “if we don’t grow we’ll disappear”
The preference in the markets could turn to private equity instead of public equity with non-listed companies. There was also the current fashion for “share buyback.”***
“This would be worrying because it sends out a signal that these companies are overvalued on the one hand ( the jargon is ‘signalling’), and on the other hand signalling that they are reducing their capital equity and therefore their size, which can only be justified if the opportunities for investment are not there.”
This all leads countries like Portugal to run the risk of losing the strategic control of its companies.
“If our companies don’t grow, we will lose the strategic control of our companies, so it is imperative that our companies do grow, gain muscle and be in the driving seats of their businesses,” Miguel Athhayde Marques warned, adding that if they don’t, they “run the risk of being swallowed up by international groups”.
On Monday the opinions on the Outlook for 2023 and the Capital markets will be shared by Luís Laginha Sousa, president of Portugal’s stock market regulator CMVM, Isabel Ucha, president of Euronext (Portuguese stock market) and Stephan Morais from the Portuguese Association of Venture Capital and Managing General Partner of Indico Capital Partners.
* Source: (Investmento e Situação Finançeira das Empresas (2011) – Luisa Farinha** | Pedro Prego**
** Issuers are legal entities/companies that develop, register, and sell securities to raise funds for their operations.
***A form of shareholder remuneration where companies buy back their own shares to reduce their capital by cancelling the repurchased stock — which works for companies that are too large for the opportunities that they have.