Aspen Technology,Inc.:Currency Hedging Review

History and Overview

• Specialized in the development of simulation software for customer in process manufacturing industries

• Advanced System for Process Engineering (ASPEN) project conducted at the Massachusetts Intitutes of Technology (MIT) in Cambridge Massachusetts, from 1976 to 1981

• Founded in 1981 by Dr. Larry Evans, a professor of chemical engineering at MIT

• Larry Evans"leadership in the development and application of integrated systems for modeling, simulation and optimization of

industrial chemical process

History and Overview

• In 1982 its first year of operations, AspenTech lost USD565,000 on sales of USD182,000

• Over next 13 years AspenTech’s sales grew rapidly as it became a major payer in the process simulation segment of the software industry.

• 1995 company earned net income $5.4 million on sales $57.5 million. AspenTech estimated that it commanded 50% of the simulation market for chemical sector.

• 1995, it employed 417 people of which 265 ware based in the US and the remainder in office in 5 countries.

History and Overview

• AspenTech went public in USDD31 million IPO which included a USD 18 Million primary offering and USD 13 Million secondary offering :– to finance further R&D– to acquire externally developed technologies– to allow early investors to monetize their holdings in the company,

• Feb1995, Aspentech conducted a $23 million public offering, which included a USD 1 million primary offering and USD 22 million secondary offering.

• 1995, AspenTech was the only one of the firms that specialized in simulation programs for chemical petroleum, and petrochemicals industries that was publicly traded.

Products (versi makalah)• Aspen Plus

Aspen Plus is the most popular producta steady state modeling system built around the core technology This product accounted 48% of sales in 1995

• Speed UP It was AspenTech’s dynamic process modeling product commercialized in 1986 by Prosys Tecknology that AspenTech purchased in 1991

• MaxIt is a less powerful version of Aspen Plus

• Advent A software to optimize the tradeoff between capital expenditures for energy saving heat exchangers and the energy saving realized

Product Portfolio (versi makalah)

• Properties PLUSIt is a database of chemicals properties underlying its other products, popular with customers ~ developed in-house modeling software

• Other modules

– offers to the customers ~ license separately – use with its other products to model subsystems used in highly

specialized chemicals processing application.

Product Portfolio (versi web)• Process Engineering

– Process simulation Chemicals (10 products : AspenPlus)– Process simulation Oil&Gas (8 products : AspenHYSYS)– Process simulation Refining (11 products : Aspenadsim+)– Process simulation Batch/Pharma (8 products :Aspenproperties)– Model Deployment (3 products : AspenModelrunner)– Equipment modeling (8 products :AspenAcol+)– Basic Engineering (2 products :AspenKbase)– Economic Evaluation (3 products : Aspn Icarus Project Manager)

• Advance Process Control (14 products : Aspen Apollo, Aspen IQ)

• Planning & Scheduling (10 products : Aspen Advisor, Aspen MBO)

• Supply & Distribution (3 products : Aspen Retail)

• Production Management & Execution (16 products : Aspen 0server)

Sales & Marketing

• 1995, licensed to more than 450 companies ~ chemical industry and 350 univerities

• The selling cycle for process modelling software was long (6-12 months)

• AspenTech charged a premium over competitors products, raise licensing fees three times (1998-1995)~10%

• Customer loyalty – Over 90% renewed their software– 1994 : 34% revenue from software renewal; 34% from expansion from existing

customer

Sales & Marketing

• United States : – Directs sales force– Earned combination of salary & commission

• Sales subsidiaries : UK, Japan, HongKong, Brussels– Serve local & regional markets via directs sales forces

• Licensed software for a non-cancelable term ~ 3 or 5 years

• Charge : – annual fee x license term (year)– Interest rate 9.5% - 11% currently 12%

• Customer were more likely to buy software priced in local currency

Risk Exposure

1. Foreign Exchange Risk– sell software in local currencies – installment from three-to-five years creates foreign exchange exposure– exchange rate fluctuations– 52% revenue generated from foreign company with following revenues figures:

• Europe 31%• Asia 12%• Other countries 9%• In United State 48%.

Risk exposure are might be applicable : – Transaction Exposure (High)

most the costumer operated outside of US– Translation Exposure (Low)

convert foreign currency financial statements into a single currency (USD).

Risk Exposure

2. Interest Rate Risk (low)– AspenTech debt using US dollar currency fix interest rate and

mid term (3years)

– place a seasonal line-of-credit facility with a New England

Bank

Risk Exposure

3. Credit Risk – Credit risk (default risk) in high exposure level

• growing rapidly • customer choose to defer payment of their license over the life of the

contract• Ex: AspenTech was liable for $ 4,6 million of this amount under limited

recourse agreement – 2 sources probability trigger this risk:

• Unwilling (Low)most of the customers are a loyal customer

• Unable (High)depend on the type of business of customer

4. Liquidity Risk• many of its customers chose to defer payment of their licenses over the life

of the contract• the company usually experienced an operating cash shortfall• Ex: the firm booked revenue of USD57.5 million, yet receive cash payments

directly from customers of only $38.5 million (66.96%).

Management Risk Perform by AspenTech

• Foreign Exchange Riskeliminated all sales transaction exposure arising from foreign currency denominated license contract inline with its risk management policy by doing hedging :– Sale non USD installment receivable for USD– forward currency agreement

• Credit Risk– AspenTech has not managed the risk of the uncollectible installment– The contract with GE and Sanwa in selling the account receivable has limited recourse agreement

• Liquidity Risk– To manage its liquidity risk in order to cover their day to day operation, AspenTech sell its receivable to GE and Sanwa and other financial institution. –AspenTech also has debt to Massachusetts Capital Resources

– placed a seasonal line of credit facility with New England bank.

Recommendation

• AspenTech’s should reexamine the firm risk management policies and practices in light of the changes :

– over the past year AspenTech’s international sales had remained a substantial portion of its revenues

– the firm international expenses had increase a slightly faster rate than its international revenue

– AspenTech had gone from private company into a publicly traded company

• AspenTech’s should review and determine an acceptable level of risk. It involves determining reasonable level of risk in-line with appropriate opportunity to gain

Recommendation

• Net Foreign Exchange Exposure (Operational Hedging)

AspenTech's Net Foreign Exchange Exposure ('000) by Currency, 1995 Cash Inflows Cash Outflows

Current Sales Prior Sales Expenses Net Exposure

UK Pound 1,724 981 3,129 (424)

German DM 1,015 577 722 870 Belgian Franc - - 158,223 (158,223) Japanese Yen 308,984 175,781 414,793 69,972

AspenTech's Value at Risk, 1995 (95% confidence level)

Expenses in local

currency Monthly Std.

Deviation Exchange

Rate* VaR

UK Pound 3,129 2.90% 1.5873 $238

German DM 722 2.80% 0.6711 22 Belgian Franc 158,223 2.70% 0.0326 230 Japanese Yen 414,793 3.00% 0.0106 218

Total $707

*Average exchange rate (U.S. dollar per unit of foreign currency) over fiscal year 1995

AspenTech should hedge only the net exposure• Net foreign exchange exposure in German and Japan• Forward contract for Belgian’s operating expense

Recommendation

• Liquidity & Credit Risk

– AspenTech should look other possibility to deal with other financial institution to increase their bargaining position to GE and SanwaWith higher bargaining position, AspenTech can get lower cost and better position in managing their credit risk

– Maximize in selling long term receivable first

Recommendation

• Others Hedging Instrument :– Plain-Vanilla Options

• give the buyer of the option the right but not the obligation to buy (call) or sell (put) a specific amount of currency at a predetermined strike price (exchange rate

• High cost– Average-Rate Options

• Spot rate are calculated as an average over a period• Transaction possible during the expiry period at several predetermined

dates• Strike rate can be fixed or floating

– Knock-in/knock-out Options • Does not provide full protection• The key is in determining the barrier rate• Low cost

– Cross-currency transactions

– Foreign currency money-market borrowing

Recommendation

• Others Hedging Instrument :– Cross-currency transactions

• transaction basically does not provide ability to hedge or secure any risk

• provide probability of arbitrage if there is a difference between cross rate and indirect rate.

– Foreign currency money-market borrowing • Borrowing in the money market, rather difficult to use since the

company need to determine level of debt that matched with its cash inflow from other matched currency