Alan Leesmith looks at how captive finance houses create
shareholder value
At the recent Leasing Life Vendor Finance Summit in
Paris, I raised the question as to what was leading to “the rise
and rise of the captive”. In the motor sector the captive has been
long established and more widespread than in some of the equipment
sectors I was addressing, but many of the observations remain the
same.
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First, we must define what we mean by a captive. This is
probably easier said than done, since there are many variations in
what people mean. I would suggest that there are probably two key
factors necessary: firstly, that the manufacturer/distributor
recognises the opportunity for potential profit from a captive in
its own right; and secondly, that the manufacturer establishes its
own in-house operation dedicated to handling the financing of the
provision of its equipment. Beyond that there is a whole range of
variations as to whether the captive holds the leases on its own
balance sheet, whether it takes the credit and other risks.
The challenge that faces a captive is the fact that it needs to
be a financial services company, not just another sales arm, and
yet its prime purpose is to support and increase sales, leaving it
with the very difficult task of managing the demarcation line
between “yes” and “no” on credit. However, if it can successfully
manage the portfolio in a manner which maintains, protects and
grows the parent company’s customer base, then the sensitivity over
a rejected credit can almost go away. Another challenge is working
in an environment where a different business philosophy is bound to
exist between a financial services company and a manufacturer,
particularly in the approach to human resources.
One should also overlook some of the macro issues at a strategic
level. The return on capital a manufacturer will normally be
looking for (at least in good times) will be higher than one would
normally expect to see from a finance business. The extensive
borrowings that a captive will need may impact significantly on the
parent company’s balance sheet, leading to competing for
resources.
The impact of regulatory and compliance issues across numerous
countries will introduce challenges to a parent that it will not be
used to dealing with. If the finance arm decides that it wishes to
become a bank, for what it may see as regulatory benefits (very
broadly speaking, supervision primarily coming under the one
regulatory authority), this could completely unnerve a parent board
used to dealing in a manufacturing environment; particularly now US
parents have so many concerns over Sarbanes-Oxley.
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By GlobalDataA matter more of concern for the captive rather than the parent
will be the expectation of provision of support and facilities in
many geographical markets where the volumes are small, and cannot
support a finance company infrastructure. The captive may need to
find ways to service those markets.
So why do so many manufacturers go it alone and set up their own
captives when there is no shortage of professional finance
companies to support them and provide the facilities? At the
conference, there was a view expressed by several speakers that
perhaps third-party lessors are nowadays falling short on meeting
the needs of vendors; in other words, they have not kept pace with
the changing demands of the market.
The captive is much closer to its customer base than a
third-party lessor and can sometimes see good reasons for accepting
a credit that a finance company may not. If, as a result of a
lessor only accepting part of the business, a vendor decides to
accept the odd deal or two, or three or four and the numbers
accepted grow, then the vendor ends up in the leasing business
anyway. As more get accepted then the vendor needs resources to
administer them – and, worse, it will almost certainly be taking
the poorer business and giving away the best. At that stage the
inevitable question arises as to why it is sharing the profits when
it is taking the major part of any risk.
But we have yet to reflect on the most valuable part for the
vendor and that is shareholder value. If done properly, a captive
enables a manufacturer not only to have access to a finance
provider that is more focused and ‘understanding’ of the business
and product cycle, but also to create a valuable second business
which is profitable in its own right. In turn that also generates
increased earnings per share, leading to an increased share price.
That captive, if run properly, will create a valuable standalone
business that can be sold should the desire or need arise in the
future.
In the past we have seen examples of captives go on to be full
third-party lessors of considerable value to their shareholders,
for example GE Capital, and others that have more than proven their
worth by being available to sell when the parent needed the cash,
such as GMAC. It will be interesting to see what the future holds
in store for Ford Motor Credit, Ford having already sold Jaguar and
Land Rover in order to raise cash.
In conclusion, I leave you to ponder the question: “What does
the manufacturer who uses a third-party lessor have to show in its
balance sheet at the end of the day and how does it explain the
lack of value to its shareholders?” I am sure this question will
provoke some debate.
Motor Finance Issue: 45 – July 08
Published for the web: July 25 08 12:2
Last Updated: July 25 08 12:4
