Package Deal

It is difficult enough to develop an effective working capital management strategy during a recession, let alone when you are integrating a major company post-merger; the challenge faced by Thomas Cook Group following its merger with MyTravel in 2007. However, as acting group CFO Ludger Heuberg explains to Steve Coomber, while it has been no holiday, the signs are that the hard work has paid off.

The Thomas Cook Group is a complex business, involving aircraft, a physical high street presence, a financial services offering, and numerous brands around the world. The merger with MyTravel not only offered great synergies, but brought a change in attitude to Thomas Cook's debt position, and a new strategic approach to working capital management.

"As a privately held company owned by Lufthansa and Karstadt in Germany, we were in the comfortable position of having assets under management and, while we had credit lines, they were not drawn, so there were no debts from loans on our balance sheet at financial year ends," says Heuberg, who heads up a team of 50 in the finance function headquarters, based in London. "As a result, working capital management was not as important then. Now, as a FTSE 100 company, our shareholders want us to have the right amount of leverage."

When the company brought its strategy to the market in November 2007, it was definitely underleveraged. Although the levels of leverage acceptable then are no longer appropriate in today's business climate, a certain amount of leverage is important to Thomas Cook shareholders to enable the company to deliver the right profit levels, notes Heuberg. "Now, much more than before, we have to focus on a very sound, sensible working capital management strategy," he says.

The two most important items of working capital for Thomas Cook are the deposits and payments from customers for holidays and flights, and the payments to suppliers, says Heuberg. Working capital arrangements at Thomas Cook benefit from the prepayment policy that is commonplace in the tour operator industry. Customers pay at least 20% or more of the cost of their holiday within days, certainly weeks, of a booking. Most suppliers get paid far later. Consequently, the company usually has negative working capital.

"This puts us in a position where we can use that working capital far better than companies in many other industries are able to," says Heuberg.

However, booking patterns vary depending on the economic circumstances.

"In times of uncertainty, such as the current recession, customers book much later," says Heuberg. "Prepayments are with us later, and for a shorter period of time. Usually the strongest booking month is January for the upcoming summer, this year it was March and April, so the prepayments were with us for three to four months, rather than six."

Ready cash

Recently, cash from prepayments has been used to service the ongoing short-term needs of the business, plus a share buy-back programme worth almost €375m, and other investments. Thus a change in prepayments, from six to three months, has significant implications for Thomas Cook's business.

These changing customer behaviours led to an even greater focus on working capital management. There was a more candid approach to working capital targets, with a weekly focus on the numbers and how they compared to targets.

"In the past the main target for the business has been the profit target," says Heuberg. "But we have implemented a system where working capital, the absolute numbers, most importantly deposits and payments from customers, and payments and deposits for suppliers, and further breakdowns of those figure, are targets as well. Furthermore, they will be tied with the bonus targets. So there is much stricter reporting, and a more sound approach to target setting, not just a forecast that constantly changes."

Nor is working capital management and its related targets solely the province of the finance function any longer.

"It was not just about reminding the finance directors and controlling teams, it was more about getting the CEOs of the various business segments and their teams involved," says Heuberg. "There used to be a feeling that, while profit, expenses and turnover are of interest to both finance and the rest of the business, balance sheet items are just for the finance function. That position had to change; it was essential in order to get to the bottom of working capital management and other cashflow oriented items."

First, says Heuberg, it was a question of sharpening up the tools in the finance function itself, improving the capabilities for forecasting and analysing working capital movements, in order to supply those tools to the rest of the business, so they are really able to see the impact of what they are doing.

This exercise started in early 2008, and accelerated during the crisis. Now, says Heuberg, the business is in a position where it is as capable in regard of cashflows and working capital, as it has been for some time in terms of expenses and profits.

There was also a focus on maximising the collection of money, through a stricter prepayment policy, for example. While, at the same time on the supplier side, supplier payment terms have been extended, along with a reassessment of common industry practices such as deposit payments to suppliers, where, for example, guarantees and deposits with hoteliers were in place, and even prepayments to airlines. This practice stopped, not just because of working capital reasons, but also to protect against the situation should a supplier become bankrupt.

Inevitably, in the light of the MyTravel merger, as well as the shifting focus in terms of working capital management, there has been some restructuring and repositioning of the finance function.

"We have brought treasury and financial controlling closer together, for example," says Heuberg. "They were separate functions; treasury was taking care of banks, credit lines, and so on, while reporting was the province of financial controlling. Now the two functions are working together far better. We have enhanced each function's understanding of what the other does."

Well met

Despite considerable challenges the merger has gone particularly well.

"Of the many integration projects following mergers and acquisitions I have seen, this was the best. The deal was signed in February, closed in June and the major integration pieces were done by the end of October," says Heuberg.

The main drivers for such a smooth transition were clarity and transparency, ensuring that everyone knew, virtually from day one, what was about to happen. There was also clarity over where the headquarters would be located, given the overlap of the UK business of Thomas Cook and MyTravel; as well as the selected processes and IT tools.

"This was all done at the very beginning, so for finance it was more a case of retaining the right people, for example, than making people redundant," says Heuberg. "The main integration was done in 2007, with some overhanging corporate culture issues cleared up during the course of 2008, so that two and a quarter years later no one could say this is a Thomas Cook person and this is a MyTravel person."

The Group finance function HQ is based in Peterborough and London, UK, with some limited in-house shared services covering aspects of the business such as hotel settlement, and certain elements in the UK business offshored to India, and run by Accenture, including parts of accounting and payroll, for example.

The offshoring strategy works well, says Heuberg, but an important reason for this is that it was initially outsourced onshore in the UK, and then offshored.

"Given the issues involved I'm sure that doing it as a one-step process would never have worked," says Heuberg. And, to highlight the complexities involved in securing a smooth integration following the MyTravel merger, MyTravel had also offshored operations in India, but with a different company and in a different city, which then needed integrating into the Thomas Cook, Accenture operation.

Even potential issues over maintaining banking relationships following the merger did not materialise, as previous disruptions to MyTravel's business meant its relationships with lending banks were not that strong, with Thomas Cook bringing in the main banking relationships. These relationships are of course essential to the continuing success of the business. Thomas Cook was fortunate enough to arrange borrowing facilities 2 months before the failure of Lehman Brothers investment bank, maturing in May 2011. Unsurprisingly, there are regular discussions with banking partners about what happens after this date.

"Apart from some aircraft lease arrangements our main funding is with banks - we have 21 banks funding our organisation - the real debt is not bonds or private placement but from lending banks so the relationship with these banks is extremely important. Notably there is more focus in discussions at the moment, by the banking relationship teams, on both the numbers and our senior managers."

Despite customer behaviour in the downturn leading to increasingly shorter booking times, the tour operator's business model is proving fairly resilient, says Heuberg.

"Customers tend to protect their main summer holidays, cutting back on other items instead. So while bookings are down marginally, because of our flexible business model based on an asset light approach, with low guarantees, deposits or pre-bookings with our suppliers, we can mitigate a fall in bookings, and even increase profits in these troubled times."

Consequently, says Heuberg, the firm's strong cash position could be maintained. Returning to the task of ensuring an effective working capital management strategy, however, particularly in times of transition, whether economic transition from boom to downturn, or while integrating acquisitions, Heuberg offers some essential principles.

"One important tenet is never to offset or compensate a shortfall in working capital with profit. So the cash conversion of what we are achieving in profit is crucial; making sure what we can achieve as EBIT will convert into cash as well," says Heuberg. "The second thing I would mention is that you need to get working capital and cashflows as key targets, into bonus schemes. It makes people very aware of the importance of cashflow and working capital management."