Question of the mini-case below:

• How has the sovereign debt crisis in Europe, and most importantly in Greece, affected Korres's business and financial results?
• What do you think Georgios Korres should do to secure the capital he needs to grow Korres Natural Products?

Mini-case: Korres Natural Products and the Greek Crisis

(Source: Chapter 14 Mini-case (Multinational Business Finance 13th Edition)

"Bringing owls to Athens"in other words, doing something useless. In 414 b. c., when Aristophanes coined this

expression in his comedy The Birds, people commonly

referred to Athens' self-minted silver drachmas as "owls"

since they had a picture of the bird on their reverse side.

Athens' wealth at the time was legendaryand hence it was

pointless to bring any more money to the city-state. Yet,

only a few decades later, the situation had changed dramatically. Expensive wars had wrecked the budget, and 10

out of 13 Athenian communities eventually defaulted on

loans that they had taken out from the temple of Delos

the first recorded sovereign debt defaults in history.

"Sovereign Default in the Eurozone: Greece and

Beyond," UBS Research Focus, 29 September 2011, p. 14.

It was January 2012 and Georgios Korres looked out his

windowhe could literally see the Acropolis from his

office in Athens. Like the Acropolis, the Greek economy

was in dire need of capital. But Mr. Korres's immediate

challenge in this negative economic environment was not

how to fund Greece, only how to fund the growth needs of

his own firm, Korres Natural Products. Before the Greek

debt crisis, Korres had faced little trouble securing funding

for Korres's rapidly expanding global business. But financing was increasingly hard to find for Greek firms, and Korres needed new capital soon if it was going to be able to put

its business growth opportunities to work.

The Cosmetics Industry

Cosmetics is a $170 billion global industry consisting of

five major categories of products: fragrances and perfumes,

decorative cosmetics, skin care, hair care, and toiletries.

Skin care was the largest segment, followed by hair care

and decorative cosmetics. Products are distributed through

larger retail stores, specialized and branded retail stores, as

well as pharmacies, salons, and spas.

Recent years had been hard on the industry. Although

sales were down in 2008 and 2009, the market had turned

upward again in 2010 and 2011. The cosmetics market

was one which rewarded innovation, with continuous

reformulation of products and inputs the norm.

Manufacturing costs are generally higher relative to other

industries due to specialized machinery and chemical

compounds. Consumers have shown a growing willingness

to try new products in all subcategories with performance

and ingredients being the most important considerations

when making purchasing decisions. And products based on

all-natural ingredients were a true growth category.

With its emphasis on creating natural products from

organic sources, Korres was well positioned to compete in

the global market. Consumer consciousness in sustainable

products and a growing backlash against animal testing had

helped drive demand. This same consciousness stimulated

new regulations on ingredients, component and product

testing, and manufacturing. Consumers now demanded

more information about the source of ingredients used in

the products they purchased. Combined with a renewed

emphasis on healthy living, natural product producers

like Korreswere well positioned for the future.

Korres Natural Products

Georgios Korres founded Korres Natural Products in 1996.

The company focused on utilizing pharmaceutical experience

in more than 3,000 herbs to create natural products for use in

skin care, hair care, and other cosmetics. Using pharmacies

as their main means of distribution (5,600 in Greece alone),

Korres had expanded rapidly from 2003 to 2008, and now

claimed a presence in 30 countries. The company had gone

public in 2007 (Athens: Korres). In 2012, Korres had 28

dedicated stores, five in Greece and 23 throughout Europe,

North America, South America, and Asia. The company

now employed more than 300 people within Greece, and

had over 400 natural and certified organic products.

But Korres itself had been changing as illustrated by

Exhibit 1. Group sales had actually peaked in 2008 at 53.7

million, falling the next two years in-step with the Greek

economy, to 50.4 million in 2009 and 44.1 million in

2010. Profits had followed sales down, with net income

falling from 4.0 million (2008) to 3.4 million (2009) and

1.6 million (2010). All things considered, the company's

profitability had remained surprisingly healthy given the

deteriorating economic conditions in Greece, but the

company's share price still continued to slide. Now trading around 3/share, less than a third of its peak of 9.66.

But despite the growing Greek economic and financial

crisis, Korres had found a way to grow. International sales

had continued to increase as a proportion of total sales. By

2010, international sales made up more than 35% of total

sales. At the same time, Korres had entered into a key

distribution agreement with Johnson & Johnson (U.S.),

under which J&J would be the sole distributor of Korres

products throughout North and South America.

Greek Debt Crisis

The Greek government, like many governments, had been

running large budget deficits for years. Although the Greek

economy had enjoyed healthy growth for many years,

the government's finances had continued to deteriorate.

The country's two largest industrial sectors, shipping and

tourism, were highly cyclical and had been hard hit by

the financial crisis of 2008-2009. As the global economy

continued to slow, Greece's sovereign debt to GDP ratio

continued to rise.

In late 2009, Greece's slowing economy and burdensome

debt raised concern throughout the eurozone (the set of

countries within the European Union which use the euro

as their single currency). Eurozone authorities, including

the European Central Bank (ECB), worried that if Greece

were to default on its debt it could threaten the very basis of

the euro itself. EU policy makers suggested a combination

of Greek government spending restrictions (austerity

measures), as well as some form of debt reduction or

bailout. The following year, 2010, Greece received a series

of additional loans and funds that allowed it to meet its

debt service obligations. Exhibit 2 lists other key Greek

bailout events.

However, help from the IMF and EU came with strings

attached. Besides new higher rates of interest, Greece was

forced to implement a series of austerity measures. These

austerity measures included privatization of several sectors

of the economy, cuts in government spending on health

care, pensions and other social programs, and increases

in taxes. The unpopularity of these measures amongst the

Greek people was widespread, as many took to the streets

in protest, including frequent and crippling strikes. But

this had still not been nearly enough. In January 2012, the

Greek government had entered into intense negotiations

with both the private banks and EU members holding

Greek sovereign debt. Greece wanted a 70% haircut on

existing privately held debt, restructuring of the debt to

more than 20-year maturities, new lower interest rates, and

additional bailout totaling more than 100 billion.

Funding Growth

The growth and development of the company's capital

structure is illustrated in Exhibit 3. Korres had been careful and constructive in funding its rapid corporate growth. The initial public offering in 2007 had contributed significant equity capital. A more recent addition to

equity capital was made by a private Greek investor,

Alexia David, who took a 14.1% interest in the firm as a

strategic partner in June 2011 with an injection of

9.5 million. 2

Like all firms funding rapid growth, the company

had increased the amount of bank debt very rapidly

beginning in 2008. Total loan debt jumped from 13.4

million in 2007 to 46.2 million in 2008. The following

year Korres had replaced much of the short-term debt

with new long-term bank debt agreements, guaranteeing

greater control and access over debt financing further

into the future.

The cost of bank loans had also risen. Before the crisis,

Korres was borrowing long term at about 5%, and short-

term funds ranged between 3% and 4%. After the onset

of the sovereign debt crisis, the company had managed to

retain the same rate on long-term loans (an achievement

in and of itself) but short-term interest rates had risen close

to 8%. The Greek banking sector was now under severe

financial duress. With the onset of the crisis, available

credit of all maturities in Greece had declined.

It is estimated that the Greek banking industry will need

at least 30 billion to survive the widening debt crisis. Banks

are undergoing a debt haircut, i.e., writing off 50% to 70%

of the Greek debt and are being forced into accordance

with a new law, which requires banks in the EU to have a

minimum of 9% capitalization by June 2012. In order for

banks to reach this target, there has been a general freeze

in issuing new loans. Banks are also trying to terminate

some of the existing long-term loans.

Working Capital

Korres's capital needs were compounded by the net

working capital cycle of the company. As opposed to the

typical 30-day terms and 45 days in receivables one might

see in North America, Korres was holding about 200 days

sales in receivables. This meant waiting on average 200

days to receive cash settlement on sales, thus depriving

the firm of the cash flow to fund its inventory and pay

its suppliers. As illustrated by Exhibit 4, Korres typically

held over 300 days in inventory and paid its suppliers in

160 days. All told, a net working capital cycle of over

350 days in 2010 was very large, and in this capital-short

environment, costly.

The Crisis and Korres

The company's strategy is to continuously grow both

locally and globally.

• Revenue growth. The revenue goal for the next three

to four years is 30% local/70% international, a massive

shift from the current 65% local/35% international.

Georgios Korres believed that brand awareness is

key, and the company may be able to gain 15-20

million in sales in each of the big European markets

of Germany, the United Kingdom, Russia, and Spain.

• The capital needs to support growth is estimated

at 20 million. This assumes strong royalty earnings from the Americas and realized sales gains and

margins from Europe within three years to contribute

to funding demands.

• The company also has the goal of decreasing debt-toequity ratio to reach a 40-60 split. Mr. Korres believes

the company will need to reach total revenues of more

than 100 million in 2014 before pursuing any major

plans for new partnerships in new markets. That

means doubling sales in the next three years.

For the coming two years, 2012 and 2013, the recent

equity injection combined with the maintenance of existing

bank loans should provide adequate funding. However,

for 2014 the company needs to have access to additional

capitalroughly 15 million to 20 millionin order to

achieve targeted international growth. The pressure will be

less if their target for their bigger markets comes true and

the J&J royalties pay off. However, the company cannot be

reassured that these goals will be achieved in just two years

and they will seek additional funding in order to support

their growth strategy.

Financing Options

Georgios Korres was considering a number of different

financial strategies to fund the company's growth.

Cross-Listing. Korres is considering cross-listing its shares

on another exchange beyond that of Athens. Cross-listing

is when a company sources their equity capital in foreign

countries by listing their stock abroad. A company can

cross-list by issuing depository receipts (certificates) to a

bank in a given country, and the bank will in-turn issue

certificates to investors. Basically, the investors own the

shares in the home country, which are represented by the

DRs. These instruments are quoted and paid dividends

just as the underlying shares. The difference is that the

dividends are paid in the foreign currency. Normally each

DR represents a multiple of the underlying share, which

helps the instrument be priced correctly in the foreign

market. Arbitrage makes the DR and the underlying share

end up having similar prices after transfer costs are taken

into account.

By cross-listing, Korres would be looking into

decreasing its cost of capital, improving its liquidity of

existing shares, and increasing its visibility to investors outside Greece. This last advantage would help the company

gain political acceptability to its major stakeholders, being

its customers, suppliers, creditors, and investors. However,

cross-listing has its disadvantages as well. Because the

company will be selling equity abroad, it will have to adapt

to regulations in the foreign country. These regulations

can include more disclosure requirements and investor

relations programs. If Korres decides to cross-list, the

countries that the firm would most likely issue DRs would

be Germany and the U.K.

Private Equity. Korres is also considering private equity.3

In return, the private equity investor would receive a

minority share. Because of the size of the company, its

location, and with projected earnings growth of 150%

within three years, Korres believes a number of private

equity firms would be interested. The downside of private

equity, however, was high expected returns (averaging

14% in recent years) as well as some expectation of influence over management. Korres could potentially fill all its

funding needs from this one source, but at higher expected

returns (higher capital costs) and possible loss of some

control.

Bond Issuance. Instead of issuing equity, the company

could also issue debt in the form of bonds. Although this

would not require giving up ownership control, it would

seemingly add more debt to an already highly leveraged

firm. Because the company's credit rating is currently not

investment grade, the debt would have to be issued as

floating rates. Due to Greece's bad political and economic

environment, those floating rates could be extremely

burdensome.

Private Placement. Another option was private placement, possibly in the United States. Private placement

is the direct sale of securities to an individual or niche

group of investors to raise capital. Common examples of

such investors are large banks, mutual and pension funds,

and insurance companies. The investors would have very

limited ability to sell or trade their positions prior to

maturity. As a result, most markets for private placement

like that in the U.S. limited buyers to a selected and

sophisticated qualified investor audience.

A major benefit of this alternative for Korres is that

the placement would not have to be registered with the

Securities and Exchange Commission (SEC) and thus

the credit rating of the company is not a determinant to

the deal. The average investor is notified of such a placement usually after it has taken place. Since the private

placement does not require the assistance of brokers or

underwriters, and the company is also exempt from the

usual reporting requirements, this option is often faster

and more cost-effective for smaller businesses. Numerous Greek companies have chosen this financing option

in the past. Georgios Korres favored this option; there

were a number of major insurance and pension funds

which may have a strong interest. He believes that this

is a great channel for smaller companies that are doing

well that would otherwise need to pay very high interest

rates.

The continuing frustration for Korres's leadership team

was that the company was performing wellgrowing sales

globally in 2011, including Greece, despite the debt crisis

wracking Europe and Greece. Leadership believed that the

company should be rewarded for its performance, and not

punished by the struggling Greek economy or plummeting

Athens stock exchange. That meant raising equity in the

private placement markets, markets that focused more on

firm performance than credit ratings.

Korres seems like a very good candidate for a private

debt offering. However, finding the right investor with

ample funding, especially in the midst of a major financial

crisis, is difficult to say the least. Investors continue to

show a lack of trust in Greek companies, and this could

mean a deal based on an undervaluation of the firm. In that

environment, the discount demanded by private investors

may be greatly exaggerated. That meant least capital at

higher cost.

Decision

Some firms are finding ways round the stigma of being

a Greek enterprise and the credit troubles that brings.

The headquarters of Aquis, a firm that runs hotels and

resorts of Greece, was recently moved to London by its

founder, Ioannis Kent. It is now a UK holding company

with a British bank account into which the firm's revenues are paid.

"Greece and the Euro: An Economy Crumbles,"

The Economist, January 28, 2012, p. 70.

Georgios Korres sat and pondered which financing option

would be best for Korres to pursue. He hopes that the

royalties from the Johnson and Johnson deal will be

enough to fund future expansion but in order to feel safe

he will try to secure additional financing to ensure Korres's

future prosperity.