The Madness of King Boris

Second in a series that examines what happened to Thomas Cook.

De'Nile is a Travel Destination in Egypt.

We have the Tory Government’s word for it: Thomas Cook's collapse had absolutely nothing to do with Brexit. Since this was asserted by a politician, Health Secretary Matt Hancock (Tory Minister and ardent Brexit supporter), I guess we must take it at face value.

Yeah – Right! (Insert your own Raspberry Here)

Secretary Hancock went on to state the obvious: Most of Cook’s collapse can be laid at the feet of Cook’s "long term problems as a business," it’s prehistoric business model, profligate management, and Cook’s failure to recognize that its market had changed.[1]

All of which is true and accurate – but it doesn’t take Brexit completely off the blame wagon.

Brexit Affected Cook’s Expense and Revenue Streams.

In the wake of the collective insanity that gave Brexit life, the British Pound suffered a roughly 20% drop in exchange value vs. the US dollar. As one wag observed; “The Pound now weighs about 12.8 ounces.”

The crashing pound would be of little concern if Cook was strictly a UK operator. However, Cook wasn’t. Cook flights serviced 82 international destinations. It’s German extension (Condor Air) services about 90 international destinations. Exchange rates – particularly the $USD to ₺ exchange rate – matter to Cook.

The air-services, hospitality, and touring industry is “denominated in dollars.”[2] Almost anything you require in order to operate a travel business costs dollars. No other currency plays a major role. International companies that use any other functional currency (e.g. British multi-nationals that use the Pound) execute their transactions in $USD – and are at the mercy of currency exchange rates.

When the functional currency loses 20% of its value vs. the $USD, then one unit of the currency buys only 80% as much “stuff” as it bought before the change. Viewed from a different angle – it requires 1.25 times as much of the functional currency to buy the same amount of “stuff” that used to cost 1 unit of functional currency. Obviously, this hurts both your income statement and the balance sheet. (BTW: We don't have an accurate notion about how much of Cook's foreign exchange exposure was hedged.)

Higher Prices - Less Demand

But there is more! (Isn’t there always?) It also costs Cook’s customers more to travel (to most places). If the destination country’s currency movement mirrors the $USD – lunch and dinner in the destination country get 25% more expensive. Where’s the fun in going to a place where you can’t afford to eat? If we believe the economists – higher prices lead to lower demand.[3] Fewer people travel, and Cook becomes even more vulnerable. Brexit squeezed demand and made what Thomas Cook sells – convenience and heritage - less relevant selling points.

A chaotic Brexit process raised uncertainties about its implementation. Those uncertainties, in turn, depressed travel demand for UK travelers. Many of them decided that delayed gratification beat the heck out of being stranded in Somalia. They stayed home in droves. Once again (through the magic of demand elasticity), Cook’s revenues suffered.

So, Brexit played both direct and indirect roles in Cook’s demise – even if Brexit’s fiscal impact is difficult to quantify.

[1] We cover these aspects of Cook’s collapse in other installments of this series. Hancock is right – management and market issues are the primary causes of Cook’s collapse – but that doesn’t mean that Brexit contributed nothing to the process. Thomas Cook itself warned that uncertainty around Brexit was hitting bookings industry-wide four months ago (March-April 2019).

[2] Richard Branson has made this observation on several occasions.

[3] The impact of a price increase on demand is straightforward – Higher price → Lower demand. The effect on revenue depends on “elasticity” of demand – how much does demand change relative to the price change. If demand changes proportionately more than the proportionate increase in price – revenues contract as price increases. This “demand elasticity” is a common feature of discretionary consumer product markets, including travel services.

#BusinessFinance #ThomasCook #BreakevenAnalysis #RiskAnalysis #ForeignExchangeRisk

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