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September 1, 2008

Another twist in recession’s tale: British profits are losing value in the eyes of US bean-counters

By Peter Kirwan MM blog

Who cares about the dollar exchange rate? If you work for Newsquest, Conde Nast, IPC or News International, you probably should.

For the past five years, we Brits have been able to buy an increasing number of dollars with sterling. The phenomenon of the two-dollar pound hit the headlines in mid-2007.

The era of a strong pound and weak dollar has been accompanied by endless stories about Brits going shopping in New York for the weekend.

But the dollar’s prolonged weakness has had another effect. It has been quietly flattering the performance of UK-based subsidiaries of American media companies.

News Corporation runs its books in dollars. In mid-2002, a profit of £1m earned by its subdiary in Wapping translated into slightly less than $1.5m.

Every year since, the dollar’s decline against sterling has inflated the value of those profits to News Corp.

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By the middle of last year, £1m of profits generated by News International was worth $2m. That’s a 33% increase solely attributable to currency movements over a five year period.

Now, however, currency markets are on the turn. The dollar’s weakness appears to have climaxed last November, when sterling traded as high as $2.11.

Last week, the pound in your pocket would have bought you $1.86. Gradually, the earnings generated by foreign subsidiaries are losing their value in US dollar terms. It’s a trend that seems set to continue.

The implications of this will become clear if you put yourself in the position of a chief executive sitting in New York. Your job is to maximize the returns on the capital you invest. From this perspective, the UK and mainland Europe look like fading prospects.

Investment is one thing; short-term revenue expectations are another. Take Gannett, which recently announced that classified revenues at UK-based Newsquest fell by 24% YOY during July.

That hit was measured in British pounds. But revenue declines that already look nasty in sterling are starting to look a lot worse in dollars. And it’s dollars that matter to Gannett.

Some will tell you that currency movements don’t matter much to multinationals, because they use complex financial instruments to hedge against risks of this kind.

And surely bean-counters in the US are smart enough to understand that local managers can’t do anything about the machinations of international currency traders?

Both points hold some water. But remember: derivatives based on rocket science aren’t the province of most corporate decision-makers.

Remember, too, that when recession makes executives brutish, mitigating arguments lose their relevance quickly. All that matters is cash. If a benign exchange rate won’t provide what’s needed, cutting local costs even more aggressively becomes the obvious way of shoring up profits.

Working offshore for Uncle Sam has been a pleasant enough experience for the past five years. Now, things are starting to look a lot trickier.

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