What’s good for the U.S. dollar was not good for Netflix in the second quarter, and the company’s experience (or lack thereof) with currency hedging holds lessons for other participants in the digital economy.
That was one of the main messages from a recent PYMNTS interview with Karl Schamotta, Regional Director, Risk Management Solutions at Cambridge Global Payments, a payment services and technology firm that helps digital businesses with cross-border transactions, currency exchanges and the hedging process.
The interview took place as Netflix revealed in its Q2 financial results that its failure to “hedge its revenue with derivatives,” according to Reuters, led the company to lower its 2018 operating margin expectations to the lower end of its 10 percent to 11 percent projection. “We’ve got some adjustments to make because of foreign exchange rates, and we know we’ll make those adjustments and we’ll grow into that,” said Netflix Chief Content Officer Ted Sarandos during the company’s post-earnings conference call.
The culprit? A stronger U.S. dollar.
As Schamotta pointed out, the dollar index at the start of Q2 was down 11 percent year-over-year before rising to end the quarter on a flat basis compared to the same period in 2017. The strong dollar increases the risk for companies with a robust global presence — Netflix operates in about 80 countries and continues to expand — because their foreign currency earnings are worth less when the dollar is getting stronger.
“Volatility is inherent in business,” he said during the interview, “and as soon as you are selling outside the U.S., you are exposed to the volatility” that comes with a strong dollar. The best defense against that? “Put a plan in place that takes out some of that volatility for a longer period of time.”
Cambridge Global Payments works with technology firms and other players in the digital economy to come up with plans specific to their needs. In fact, that is part of the appeal of the company, Schamotta said when asked why those companies don’t simply go to banks for hedging and foreign currency help. “Banks focus on providing something off the shelf,” he said. “We build a plan around client wishes.”
But to have wishes, companies must first be aware of why and how they can use hedging. While Netflix is likely serving as a wake-up call for many corporate executives, the digital economy as a whole — and, specifically, relatively young technology firms — has yet to achieve a level of reasonable awareness about those financial tools, Schamotta said.
“Tech is simply not a mature area,” he said.
That holds true more for those firms that focus on software and digital services than for hardware companies, which have experience with setting up manufacturing in foreign countries, and operate with a constant “tangible exposure” to the volatility inherent in such operations, he said. As well, many younger digital and tech companies are more focused on — obsessed with — such metrics as customer acquisition and user growth than hedging and other activities that are more along the margins.
Change on the Horizon
But that is sure to change, Schamotta predicted.
“A lot of large tech companies will (eventually) focus on the operation side of things” as those companies, and the markets they serve, mature, he said. “They will start looking for those smaller advantages they can pick up as opposed to targeting the big numbers as they are used to doing.”
Several factors beyond the Netflix news all but guarantee that digital and tech companies will pay more attention to the power of hedging, Schamotta said.
As the digital economy develops and spreads, it will become more challenging for the cutting-edge firms to gain and hold their first-mover advantages in the marketplace, increasing the importance of having a hedging plan that can produce more revenue and better protect from risk.
As well, eCommerce continues to grow at high rates in emerging markets and other countries (including very populous ones like Indonesia and the Philippines), and that means more companies will deal with more foreign currency — and more risk — as they expand globally.
There is also the reality that many tech-centric firms face their own form of financial uncertainty, underscoring how a company like Cambridge Global can make its services attractive to those companies, which are operating along the frontiers of commerce and other digital activity. “There is a lot more uncertainty in their growth models,” Schamotta said. “Things can change almost overnight, and that can be more challenging for their treasury people.”
Finally, there is the all-but-certain prospect of even more volatility in the coming months, and across the world economy as a whole, not just the digitally focused parts. Tariffs, potential trade wars, increasing interest rates and a growing U.S economy fueled by more consumer spending all promise to add significant drama to the world economy in the near term, resulting in more risk and also, in Schamotta’s words, “more opportunity for growth” for many companies.
“We are looking at more volatility going forward, and a shift in where growth happens, and where FX and interest rates are growing,” he said. Looking forward to a year or so from now, Schamotta anticipates reduced dollar strength as other currencies “begin to catch up,” which could also motivate more digital and tech firms to consider hedging.
A successful hedging plan involves a variety of factors, not the least of which is the company doing a reasonable amount of homework about conditions in the new markets it is targeting, and how it wants to improve its cash flow. But even before that must come a deeper awareness of hedging – and the Netflix news, along with the other factors, seems likely to promote that.