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Burning cash

This was the worst CapEx committee meeting I’d ever seen.

There were 8 other people in the room. The outgoing CFO, four people from the finance team, the COO, and two VPs from the operations team.

In the two-hour meeting, 13 project managers were invited in one by one to present their projects. Every project had been approved at a total cost of over $10m. $10m the business did not have.

The discussions had been dominated by the outgoing CFO, CAO, and controller. They were only interested in discussing whether the projects should be classified as fixed assets, and what the right depreciation rate to use was.

There had been almost zero discussion on the projects themselves. And whether they represented a good investment decision or not.

I chose not to intervene. I was there as an observer only, in handover mode. The outgoing CFO would be gone by the end of the week. And I’d be the new CFO. So next month, I’d be chairing this meeting.

I pulled the COO aside after the meeting:

“Is that how those meetings always go?”

“Yeah, pretty much.”

“How often does a project get killed in that meeting?”

“Almost never, we only bring good projects forward, and the finance team agrees on the depreciation rate and signs the approval.”

“That’s going to change. Finance is going to have to crawl all over every project.”

“That’s fine, you guys just tell us what depreciation rate to use.”

“No, you are missing the point. I don’t give a sh*t about the accounting. It’s like arguing over the thermostat setting while the house is burning down. I’m only interested in the fire. I care about the cash outflow. Should we spend the money at all?”

“Isn’t that what the business case is for?”

“Yes, but the business cases aren’t good enough. Of those 13 projects, I would maybe have approved 2 on the strength of the case presented. 11 I would have sent back. And next month, unless you get stronger rationales together, I will send them back.”

“That is unnecessary and going to cause chaos. Our CapEx projects have always delivered.”

“I don’t see how that can be true. EBITDA margins have fallen for the last three years, yet you’ve had nearly $300m of CapEx. Where is the payback?”

Silence. Well … not quite silence. He murmured something about inflation, and operational challenges.

“Look… the harsh reality is, the business does not have this money to spend. We are running out of cash. We are going to have to be much more selective about what CapEx we spend. We can work together on it, but I need your head in the right place.”

“Sounds like things are going to change a bit round here.”

That was an understatement.

CapEx is Not About Accounting

This is the start of a new 5-week series on capital expenditure.

I must have signed off on over $1bn of CapEx across my finance career. Most of it has delivered a respectable return. Some has delivered extraordinary returns. And some has been a total train wreck.

The most common mistake I see from CFOs with CapEx is that they misread their role in the process. They focus on the accounting issues. And it’s easy to do, CapEx does ask interesting accounting questions (if that’s your thing):

• Capital vs expense debates

• Depreciation rates

• Residual values

• Asset impairment

• Maintenance vs improvements

• Lease accounting

These things are important, and because they are complex, can be distracting.

But … they aren’t the main game.

The main game with CapEx is to make sure your business makes the right investments. It’s about placing the great bets.

Defining CapEx

Capital Expenditure (CapEx) is the money a business spends to buy or upgrade assets that have a long-term benefit. Long term benefit defined as more than one accounting period.

Rolling the CapEx dice

By definition, CapEx is a gamble. You write a big check now, in expectation of a future return. Those returns often seem secure when written down in a business plan. But in practice, life is more complicated than that.

There is so much that can go wrong:

1. Cost overruns:

   • Underestimated initial costs

   • Scope creep

   • Inflation and price variances

   • Poor vendor management

2. Delays in project completion (which delay payback):

   • Construction delays

   • Supply chain disruptions

   • Poor project management

   • Regulatory compliance delays

3. Revenue shortfalls

   • Overestimated demand

   • Competitive pressure

   • Product launch delays

   • Economic downturns

4. Operational inefficiencies

   • Underperformance of new equipment

   • Integration issues

   • Higher operating costs

   • Learning curve issues

   • Disruption costs

5. Broader Disruptions

   • Poor project management

   • Cultural issues

   • Technological obsolescence

   • Regulatory and compliance matters

   • Shifts in strategy

And that’s off the top of my head. It’s a 4D risk map.

When you sign off on a CapEx project as CFO you are taking a view on all of these variables. Even if not explicitly.

CapEx J Curves

All CapEx - by definition - follows a J curve shape.

And at the point you sign a project off the only thing that is certain is that you’ll hit the bottom of the J. So much after that is in the lap of the gods. Subject to a huge number of variables over a long period of time.

To the upside, your result might be a bit better than your business case. You execute the project on time, on spec and on budget. And you underestimated the benefit case by a little. Bonus.

That does happen from time to time.

But to the downside… it could be horrendous. You either fail to execute the project, or there was a fundamental flaw in the proposal that you don’t discover until it’s too late.

In this scenario the J never curves.

CapEx disasters

Some high profile examples …

In 2009, the UK government announced a project to connect London to other major cities across the UK with high-speed rail (called HS2). The 335-mile network was expected to cost up to £36bn and be built by 2026.

Fifteen years later the estimated cost is now £80bn, and the project scope has been reduced to only 120 miles of railroad between London and just one other city.

The latest estimate is that it will be built in 2033.

The project has been plagued by archeological discoveries, protests, and legal issues. They even had to spend £100m to protect a rare species of bat. Meanwhile, lawyers, accountancy firms, and PR consultants have been on hand to help with these issues at eye-watering charge rates.

You’d expect this incompetence in government.

But companies are just as prone to mistakes like this…

When Intel announced the 10nm chip they planned for $5-6b of CapEx and R&D with a launch in 2015. In the end, they spent over $10b with a five-year launch delay. Meanwhile, TSMC and Samsung ate their lunch.

And we all remember the Peloton capital spending spree of 2020-2022.

I say this all without judgment. I’ve had my share of CapEx disasters too.

The truth is CapEx execution is hard. It’s full of risk.

Why CapEx?

If CapEx is so hard … then why bother at all?

You can’t shrink your way to greatness. Real transformation happens in leaps, not just small gains. CapEx is one of the most powerful levers for step-change growth - unlocking capacity, resetting the cost base, or launching new products.

As CFOs, our job is to find the best risk-reward tradeoffs and put controls in place to protect the downside. To manage the profile of the ‘J’.

This series will help you do that, more consciously.

Business Case & Sensitivities

Most company CapEx approval forms look the same. They’ll have a one pager that summarizes the project down to a few metrics (IRR, NPV, Payback, CROI).

Then there will be a sensitivity analysis, i.e. what if the discount rate is 1% higher, or sales are 10% lower?

This approach to sensitivity is flawed.

The sensitivity calculations are rarely tailored to the specific risks attached to a project. Instead, they are just some generic corporate mandate that no-one pays attention to.

And remember, there is rarely one rat in the kitchen.

So when things go wrong, they tend to go wrong in plural.

If a project takes 25% longer than planned, over-spend is inevitable. And more time means more exposure to material cost inflation (a key risk in CapEx). And you will have to wait longer for the returns to start…

It only takes one or two things to create a cascade that destroys the nice J curve of cashflows you were expecting. See the billion-dollar examples above.

So traditional sensitivity analysis doesn’t make a lot of sense.

The solution?

We need a way of looking at CapEx that appreciates the true range of outcomes. And assesses the probability of those outcomes.

Think of the ‘J’ like a heat map, with a probability weighted range of outcomes.

We’ll talk more about this throughout the series.

Bias in CapEx

CapEx projects cut across multiple departments. And often across every department.

That means every project comes with a hundred opinions. And each of those opinions carries bias. And that makes it hard to get a true sense of the cashflows and risks of a project.

You will have the project manager. The person who’s chiefly responsible for delivering the project. They will think it’s a great idea. Obviously. They might think it’s a great idea because it’s a great idea.

Or they might think it’s a great idea, because they are so far into it, that they are wondering what they would do if it doesn’t go ahead. They’ll never say it out loud, but this kind of bias is very real. I see it all the time.

Then you’ll have others in the business who don’t like the project. Maybe they are the operations lead, worried about disruption. Or the finance guy who has to find budget for it. Or just someone who has their own pet project and wants their moment in the sun.

Biases everywhere.

CapEx gives birth to new empires. Which means it’s rife for f*ckery.

And then there is the sunk cost fallacy. Managers or even whole organizations that are trapped in a cycle of throwing good money after bad. Often they are too close to the forest to even know that is what they are doing.

The CFO has to cut the noise and work out how to find the truth. In a world where there are multiple truths.

CapEx & stock prices

Investors often don’t know how to reflect CapEx in their valuations.

There are too many uncertainties (as we said above). Especially when compared to alternatives: paying dividends, paying down debt, and buying back stock. Even with M&A … at least investors have some sense of the cashflows they are buying.

The extraordinary run-up in Nvidia stock during 2024 was built on demand for their GPUs.

Who was buying those GPUs? Big tech. Building data centers and compute capability for the coming AI wave. So for Meta, Alphabet, Microsoft, Amazon, etc., this is CapEx.

This is serving up to be one of the biggest mass capital deployment campaigns in history. Across the Mag 7 alone it looks like more than half a trillion will be spent in CapEx in 2025.

And investors don’t really know what to think. How do they value it? What does the payback profile look like? And when? Can they all be winners?

The only thing they know for sure is that A LOT of money will be spent.

Google caught the brunt of this last month after releasing their latest quarterly earnings, guiding investors to an additional $20bn of CapEx this year to accelerate the build of data centers. Upon that news, they saw ~$150m of value wiped off their market cap with the stock falling by 7% in pre-market trading.

It didn’t help that investors were still digesting the AI news from China. Deepseek claimed to have produced their latest AI model at a cost in the millions, not billions. This news alone immediately changed how Wall Street thought about the AI-led capex spend in US big tech.

Series outline

So we are going to get into all these issues (and more) during this month long Playbooks series of CFO Secrets. Focusing on how to make sure CFOs place their CapEx bets on the right J curves.

Here is the running order:

1. Week 1 - Series Introduction (Today)

   • CFO role in CapEx

   • Where CapEx goes wrong

   • Examples

   • CapEx and the market

   • Series running order

2. Week 2 - The Capex Envelope (Next Week)

   • Strategy & Financial Policy

   • Long Range Planning & CapEx

   • Defining the CapEx Envelope

   • Maintenance vs Growth CapEx

   • Alternatives to CapEx

3. Week 3 - Selecting Projects (March 15th)

   • Strategic Fit vs Financial Return

   • Financial Analysis of CapEx

   • Allocating the envelope

   • Role of CapEx Committee

4. Week 4 - Approving Projects (March 22nd)

   • Pre-filters for Capex Approval

   • CapEx Evaluation

   • Sensitivities

   • Not all sign-offs are equal

   • Wedding Vows Moment

5. Week 5 - Project Execution (March 29th)

   • Delivering the promises

   • In project monitoring

   • Post investment review

   • Reporting

   • How to manage an overspend

Net-net

We will not talk about the accounting concerns with CapEx in this series. They are mostly mechanical and uninteresting (even though they are important).

Instead, our eyes will be on cashflows associated with CapEx. How much do you need to spend, and what will you get back? And when!?

Many of the principles in this series will apply to other J curve investments; beyond CapEx. i.e. R&D investments, marketing investments, and product launches. Anything that has the dynamic of ‘cash out now, for an undeterminable level of future cash in.’

Next week we will start by defining how much capital to allocate to CapEx or as I call it ‘The CapEx Envelope.’

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