Copyright © 2009 Pearson Prentice Hall. All rights reserved. Honeywell & Pakistan International Airways With all of the business, financial, and political complexities of doing business with a company like Pakistan International Airways, can Honeywell make an adequate return on the business which will compensate it for the risks?

Copyright © 2009 Pearson Prentice Hall. All rights reserved The Space and Avionics Control (SAC) Group of Honeywell, the U.S.-based multinational, was attempting to decide how to handle a proposed contract with Pakistan International Airways (PIA) The contract, a $23.7 million deal, was for the upgrading of the cockpit avionics on Boeing 747s operated by PIA. Honeywell had never actually performed retrofits on 747s before, but did have extensive experience with many other aircraft This contract represented an opportunity for Honeywell to establish a new area of competency – Boeing 747s – and grow its business PIA was under heavy pressure by the U.S. Federal Aviation Administration to upgrade their aircraft avionics and engine noise if they wished to be able to land at U.S. airports PIA, however, had requested that Honeywell accept payment in Pakistani rupee, a very thinly traded currency Accepting payment in Pakistani rupee would be against Honeywell’s corporate policies PIA appeared to be intransigent on the point, and as a result, if Honeywell refused to accept rupee payment the deal would most likely be off. Unfortunately, Honeywell’s SAC Group had already “booked” the deal into its “stretch sales goals” for the year and dearly needed the contract to happen. Honeywell and Pakistan International Airways

Copyright © 2009 Pearson Prentice Hall. All rights reserved SAC’s Growing Problems With Receivables Pakistan International Airways (PIA) was clearly a problem when it came to actually collecting the funds on products and services delivered.

Copyright © 2009 Pearson Prentice Hall. All rights reserved Pakistani rupees per US dollar Exchange Rate Source: © 1998 by Prof. Werner Antweiler, University of British Columbia, Vancouver BC, Canada The Pakistani rupee had been through two significant devaluations in recent years. The Pakistan government now appeared to be following an incremental devaluation strategy.

Copyright © 2009 Pearson Prentice Hall. All rights reserved Estimate what cash flows in which currencies the proposal would probably yield. What is the expected U.S. dollar value which would, in the end, be received? 2.Do you think the services that Makran is offering are worth the costs? 3.What would you do if you were heading the Honeywell SAC group negotiating the deal? Honeywell and PIA: Case Questions

Copyright © 2009 Pearson Prentice Hall. All rights reserved Estimate what cash flows in which currencies the proposal would probably yield. What is the expected U.S. dollar value which would, in the end, be received? The spreadsheet analysis on the following page is helpful in understanding the complexity of the proposed transaction. Original Agreement. The original proposal which Honeywell had thought it had negotiated was for all payments to be made in U.S. dollars. The original contract price of $23,700,000, would be paid in two installments, 20% on contract signing ($4,740,000), and the remaining balance would be invoiced at the end of one year upon completion of the cockpit retrofits ($18,960,000). It is a bit unclear as to whether the original contract under negotiation had included any type of up-front payment; it was evidently smaller than the 20% now on the negotiating table. The second payment invoice would be due in 180 days. All payments would be in U.S. dollars, and Honeywell’s Pakistani agent, Makran, would broker the transaction for the standard 5% fee. Honeywell and PIA: Case Questions

Copyright © 2009 Pearson Prentice Hall. All rights reserved Honeywell and Pakistan International Airways

Copyright © 2009 Pearson Prentice Hall. All rights reserved Honeywell and Pakistan International Airways

Copyright © 2009 Pearson Prentice Hall. All rights reserved (continued) Pakistani Rupee Invoicing. The Pakistan Airways counterproposal, for all invoicing and payments to be made in Pakistani rupee, constituted serious issues and risks for Honeywell. First, it was against corporate policy to receive payment in any other currency than U.S. dollars (not unusual in the global airline industry). This specific transaction was already considered a troubled one internally within Honeywell, as it did not meet corporate goals on return on sales and had been continually postponed. Unfortunately, the division within Honeywell had already included it in their prospective sales goals for the period, so the pressures were numerous. Secondly, the rupee appeared to be a currency subject to near-term devaluation. It had experienced a relatively recent devaluation of 7.86% which by traditional exchange rate standards was a small – and possibly incomplete – devaluation. Most devaluations were 15% to 25% in recent history, and the rumors of further devaluation were strong. The black market rate of Rp50.00/$ represented a devaluation from the current rate of Rp /$ of about 23.5%. Honeywell and PIA: Case Questions

Copyright © 2009 Pearson Prentice Hall. All rights reserved (continued) If Honeywell were to accept payment in rupee, it would be incurring substantial currency risk. If the payments were to occur on schedule, 20% advance payment upon contract signing and the 80% balance settled 180 days following invoice for completed work in 360 days ( = 540 days from the present, contract signing), and no currency devaluation were to take place, the present value of the sale was estimated at $18,662,397. If, however, the rupee suffered a 20% devaluation after the advance payment but before balance settlement, the sale has a present value of only $16,262,997. This will sure not meet corporate margin on sales goals! If Honeywell were to use Makran to both facilitate the transaction (mandatory) and provide currency conversion services, the exchange rate risk would be eliminated for a 5% fee, and the 80% balance would be settled in days (390 days total), rather than 540 days. Honeywell and PIA: Case Questions

Copyright © 2009 Pearson Prentice Hall. All rights reserved Do you think the services that Makran is offering are worth the costs? Yes. If Honeywell were to use Makran for currency services, it would eliminate the currency exposure and accelerate the remaining payment. This would provide a present value of $18,283,032, only $379,365 less than originally envisioned. This is far superior to incurring the currency risk, and waiting possibly 540 days or longer to receive rupees which would be worth who knows what in U.S. dollars at that time. The Makran solution also aids in reducing the days sales outstanding of the division, another divisional goal. This does not assume, however, that the sale is a good one from Honeywell’s perspective. It would still be up to Honeywell to decide whether the sale is sufficiently profitable and important from a corporate perspective. Honeywell and PIA: Case Questions

Copyright © 2009 Pearson Prentice Hall. All rights reserved What would you do if you were heading the Honeywell SAC group negotiating the deal? The spreadsheet analysis is helpful in understanding a variety of the negotiating alternatives. If the 20% advance payment is indeed a pivotal point, this could be reduced against either price or timing alternatives. A number of options could be explored here, including reducing the 20% to 10% in exchange for accelerated payment of the balance (guaranteed?). If Honeywell wishes to pursue the Makran currency management alternative, it may wish to tradeoff when Makran itself receives payment against the currency charge. (A reduction of the currency charge on both payments from 5% to 4% results in a present value of total payments of $18,498,127.) Postscript. Honeywell never completed the agreement as PIA continued to throw obstacles in the way of the contract signing, evidently not wishing to pursue the cockpit retrofit in the end. Honeywell and PIA: Case Questions