BF: Did Silicon Valley differ in terms of derivative hedging strategies?
Vilandre: One thing that was common to Intel and DEC was that we had very active hedging programs. At DEC, it was personally run by the CFO. One of my assignments when I was corporate group controller was to come up with a control reporting mechanism for hedging so that we could monitor how well were doing. One of the reasons for this was that hedging can create an awful lot of profit on the P&L, but it can also create losses pretty quickly as well. So, the first question is really, What is it that you hedge?
Most of what we were hedging was currency-related at DEC and at Intel as well. Think of currency from a high-tech point of view as a basket of products that are spread around the world. You don't necessary hedge everything. Sometimes, if you have a position in a currency that is strengthening versus the dollar (e.g., the yen), by not hedging you actually make a lot of money.
One of the characteristics of the high-tech industry is that you have long backlogs from when you take the order not only to when you ship it, but also then to the moment when you collect. It is sort of this exposure period that you are hedging.
I think that for the most part when you talk about derivatives you are talking about contractually based hedging, but there are other types of hedging, depending on where you park your currency and how you move your currency around. This became something of an art form for the treasury department. The connection, from a high-tech perspective, is that high tech tends to look at the different portfolio of products — think of microprocessors, memory, and watches if you were talking Intel. At DEC, we had, I think, 23 different product lines, and the 24th product line was the so-called corporate product line, where the hedging results would show. This was true at Intel as well, which had its books set up very similar to DEC's. Quite often at DEC, line 24 would be the most profitable of the bunch, and it would do quite well for the corporate earnings per share.
So when I think of hedging, I think of a portfolio of different activities, and as a controller guy, I viewed hedging as just another product line. Other product lines could be emerging new product lines with minimal revenue but lots of spending. But companies would manage themselves by using the product line manager technique, creating within a company groups of internal businesses. You'd want to make it worthwhile for that internal business leader and his team to stay within the company and not leave to go elsewhere, and here again is where stock options played a role. IBM certainly had trouble with this, because at one point in time they had negligible stock options, and sure enough, most of the PC business never stayed with IBM — a lot of people left.
I don't think that derivatives became a dominating issue in tech, but the interesting thing about derivatives to me is that traditionally there are two types of financial guys in the industry. It isn't as if one is better or worse, but there are the operational and controller types of CFOs. A great example of an operational one is Paul Otellini, the current CEO of Intel, who is from a financial background, although Intel likes to downplay that. But he was the product line controller for the microprocessor product line that was broken out from the memory business. The other type is the treasurer type. Now, at Intel, for the longest time treasury and controllership was very close and we all worked together very well, and we were always on the same page. I was at Intel 7 years, and for the first 3 or 4 years, the official treasurer of the company was Gordon Moore (one of Intel's founders). But what I think we have seen happen is that over time treasury has become more of a separate function. And I'm not speaking of Intel, but in general.
BF: I suspect that you don't view the separation of treasury as being healthy for a finance team?
Vilandre: Well, when a company gets into trouble, you can often guess the nature of the trouble by looking at the DNA of the CFO. Is he a treasury guy? Or is he a controller guy? Enron's CFO, for example, really had no operational experience to speak of. His whole background was almost pure treasury, and the people who have this pure treasury background are almost like pure MBAs. They are similar to hedge fund guys in that they often don't have any operations background. These treasurers are often pure financial mechanics. While the controller types are very P&L-focused, the treasurers tend to be more balance sheetâ€“focused, or if we want to be cynical, off-balance sheetâ€“oriented. We have seen this evolution happen in my time, and I have been at it for 35 years.
The other hedging challenge related to high tech was the fact that it was a long-lead-time business for currency and for product throughput. During my Intel days, the name of the game was managing that throughput. You would have a customer backlog, and there was an exposure when currency was moving up and down a lot in the '80s and '90s. This was a factor for the operational side of derivatives as opposed to pure derivatives. ###