a case study by Ian H. Giddy
(For Giddy's International Financial Management course)
In February 1996, Benny Galloway, the chief financial officer of the Austin Computer Company, based in Austin, Texas, was considering a tricky issue: what to do with the approximately 125 million of Taiwanese dollar payables that the Notebook Division had accumulated. The liabilities had built up as a result of the division's success in marketing a line of notebook computers under the Austin label in the United States. Like some other notebook computers sold in the U.S. market, Austin's were made in Taiwan, chiefly by Chicony and Arima. Ease of entry and advances in production processes had put notebook prices on a downward trend that benefitted consumers but squeezed retailers' margins, especially those that relied principally on mail order sales. The trend was expected to continue. Some Taiwanese manufacturers sold machines under their own labels, but they also supplied U.S. marketers who sold them under their own names, and Austin was one of them. Because the Taiwanese producers had become dominant players in the field, they were able to switch invoicing for many of their customers into New Taiwan dollars, while continuing to give 90 day terms.
Galloway's dilemma was in part accentuated by the conditions on the distribution side of the notebook computer business: there were a dozen or more serious direct-sale competitors active in the U.S. market, including the captive marketing companies of Taiwanese manufacturers such as Twinhead Computers. An increasing number of notebook computers were based on Intel's Pentium chip. Austin offered a full line of Pentium notebooks. As a result of intense competition, margins were razor thin. In this environment, hedging costs began to matter.
In 1995, Galloway's strategy of leaving the payables uncovered had turned out to be a brilliant tactical move. The U.S. dollar cost of buying the NT dollar had decreased, and Galloway's action saved the division a significant amount, as he was careful to point out in his annual report. But now for 1996, what was he going to do as an encore? Galloway recognized that the same colleagues who patted him on the back for his success, would be equally critical if the NT dollar turned the wrong way. A glance at the back page of The Economist magazine told him that the $90 billion of reserves that the Republic of China had accumulated made the currency potentially very strong and Galloway wondered whether this was not the time when caution was the better part of valor.
Since any hedging strategy would represent a major change in financial policy for the division, Galloway recognized that he had to do some selling inside. In particular, the people that mattered had to be told about the accounting and cash flow implications as well as the various hedging alternatives. The matter was complicated by the fact that Austin was a subsidiary of a public company whose shares traded on the Stock Exchange of Singapore.
Austin, Texas is not exactly a world financial center, and local banks could offer little help. Therefore, to get some background on the group of which his own company was a part, as well as the industry, the competitors, and the currency, Galloway decided to tap the burgeoning resources of the Internet in addition to more conventional sources.
Could you help Benny Galloway do the research needed to prepare a two-page written recommendation on hedging Austin's currency risk? Please document your sources of information.
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