Prof.

Rushen Chahal

Shareholder Value

SHAREHOLDER VALUE: A JOURNEY OF LEARNING

Focusing on Shareholder Value

Transforming Beliefs

Transforming Behaviour

Transforming Management Performance

 The ultimate test of management is value creation  Top quality CEOs deliver consistently superior shareholder returns  New fangled measures like EBITDA and EVA are not enough. There are no magic methodologies  Each management team needs to set out on a journey of learning together which will transform their beliefs, their behaviour and their performance

TRANSFORMING BELIEFS

Old Beliefs

New Beliefs

 We must achieve multiple objectives  We must balance the demands of multiple stakeholders  Global growth  Best in industry

 Our single purpose and governing objective is to maximise shareholder value  Maximising shareholder value maximises value for all the stakeholders: there is no conflict  Selective market leadership  If world class means anything, it means world class in value creation

RESTATING THE GOVERNING OBJECTIVE

 The governing objective of the company should be to maximise shareholder value, not growth

 Maximising good growth and eliminating bad growth is essential to achieving the governing objective

 Maximising strategic and organisational effectiveness is essential to achieving the governing objective

FOCUS ON MAXIMISING VALUE NOT GROWTH

Common Issues  Competing goals  Strategies which focus on growth not value  Management processes which focus on growth not value  Management remuneration, rewards and recognition which reflect a focus on growth not value  Lack of good information  Reluctance to lose a customer or product  Management beliefs

GOOD GROWTH AND BAD GROWTH

GOOD GROWTH When ROE exceeds COE, a business will  create value by growing  forgo value by not growing BAD GROWTH When ROE is less than COE, a business will  create value by eliminating underperforming investments  destroy value by growing Maximising value is about maximising good growth

ATTITUDE TO RISK

Replace the concepts of balance and diversity with the concepts of focus and competitive advantage

 It used to be thought that diversifying your risk reduces your risk. Not if it ends up in weak market positions and low, or negative, cash flow  The real risk is that you enter markets in which you dont have competitive advantage  Chasing market share frequently ends in tears. Profitability and competitive advantage result in high growth and share - not the other way round  Companies with high multiples have chosen focus over diversity  Outsource diversification to shareholders

MANAGING THE PORTFOLIO

Move from focusing on achieving balance to focusing on achieving competitive advantage

 Dispose of companies (and parts of companies) which cannot earn a return above the cost of equity  Reallocate equity away from the businesses which cannot create enough value (where you cannot be distinctive enough)  Acquire companies which broaden and strengthen competitive advantage

THE STANDARDS FOR STRATEGY DEVELOPMENT

Move from approving plans, to demanding new learning through debating issues and alternatives

The Top Ten Issues

 Demanding focus and follow-through  Cascading down the business  Demanding learning and innovation  Setting the right standard for strategy choices (the value of the next business alternative  Transparency  Significant thought and debate at all levels

3 - 5 Alternatives

New Behaviour

GENERATING ALTERNATIVE STRATEGIES

Alternative strategies represent different choices for one or more of five dimensions of any (Value Centres) strategy

1.

Business proposition: How the business will achieve a profitable strategic position (in terms of market economics and competitive position) Participation strategy: What product market segments to target for continued participation, entry or exit Offering strategy: Operating strategy: Pricing strategy: Whether and how to differentiate (customer perspective) Whether and how to differentiate (operating perspective) How to price for improved market economics or competitive position (or both)

2. 3. 4. 5.

ORGANISATION STRUCTURE
Move from managing the value of the Group as one business, to managing the value of the Group through multiple value centres
Multiple Product Specialist Value Centres Value Centres for Products and Customer Relationships

Single Organisation Business Structure

Market-Based Segmentation

 Change organisation structure to ensure clarity of accountability for value e.g, accountability for market segments  Change organisation structure to ensure new learning about new sources of competitive advantage  Delegate accountability for value as close as possible to the customer and competition  Avoid excessive centralisation

DIAGNOSIS
In which products and markets are we creating value?
Value creation A B C

Observations

 Most companies do not have the information needed to measure the value of their individual businesses

 Value tends to be concentrated

G H

 Cross-subsidisation is common

ECONOMIC PROFIT

 Economic Profit tells us how much value is being created  Economic Profit is the profit attributable to shareholders less a notional charge for the equity invested in the business  It is the only measure that brings together both the growth in equity and the return on that equity  Because Economic Profit measures the value being created, it allows us to evaluate alternative strategies that might create more value  Senior management incentive awards based on Economic Profit

A FINANCIAL DISCIPLINE
 Economic Profit measures are an integral part of the strategy development process  The strategy development process creates the conditions and enforces the financial standards for developing the highest-value strategies on a continuous basis in every business unit  The strategy development process, using Economic Profit measures, instils a financial discipline into the company: To avoid investing resources in areas of poor growth prospects or poor returns To encourage a continuous review of existing and alternative strategies that deliver demanding performance targets

SUSTAINABLE GROWTH IN ECONOMIC PROFIT

 Insist upon alternative, higher value, business strategies  Each value centre needs as a strategy showing how they will obtain a competitive advantage and the effect on economic profit  In any given year, some value centres may be growing rapidly while others are stable or declining  For the group as a whole, the reallocation of resources by value centre, by product, by customers, by channel increases economic profit substantially when process fully implemented

THE STRATEGIC QUESTION

What collection of divestments, acquisitions and reallocations of capital is necessary to change our return on equity, market value, access to capital and ability to sustain good growth?

APPROACH TO M&A

Move from an acquisitions strategy, to acquisition as the manifestation of strategy Strategic Fit  Dont let acquisitions determine your strategy  A ready meeting of minds on what business is about  A model to improve both parties competitive position  Focusing on how the model will work  Agreeing a price where both benefit  Demonstrating success without a heavy hand  Re-establishing the Governing Objective

Pre-Conditions for Success

Pre-Merger Discussions

Post-Merger Integration

VALUE CREATING EXTERNAL GROWTH

Creating value via external growth requires a combination of three critical elements:

Good Strategic Fit

Good Acquisition Economics

Highest odds of creating value Beware:

Pro-active and Rapid Integration

- Traditional measures of industry/market attractiveness - Revenue side synergies - Acquisition proposals with little or no integration plan

GUIDELINES FOR ACQUISITIONS

1. Look actively, systematically. 2. Look for synergies at several levels. Dont overestimate their value. 3. Analyse in depth financing, synergies, market, hidden values. 4. Look for pitfalls. Insist on open books. 5. Large synergies require a lot of work afterwards this means resources. 6. Dont get carried away with the price before the closing. 7. Middle management and analysts are often too eager to acquire. 8. Have patience in approaching target can take years. 9. Very profitable purchases are seldom found; be ready to respond quickly when the opportunity occurs.

WERE DOING IT FOR STRATEGIC REASONS: UNQUANTIFIED VALUE TOMORROW

A mix of motives

 Offensive: market share, penetrate new markets, strengthen product capabilities

 Defensive: eat or be eaten

 Increase market cap

strategic reasons often equals destroys value

POST MERGER MANAGEMENT

 The key to success  The deal is won or lost after the deal is done  A compelling, ambitious vision shared by the shareholders and management alike  Meticulous preparation for integrating organisational structures, processes and cultures  Speedy execution

CONCLUSIONS
 Mergers and acquisitions can transform a business, but they can also be a risky, uncertain means of achieving shareholder value Poor due diligence Hidden merger costs Massive leadership challenge Unpredictable events Does it fit with our current strategy? Is it a manifestation of it? Is it capable of integration with our existing business? Will it enhance our competitive advantage? Do the economics stand up to the test? Most acquisitions are killed by the premium required, which cannot be recaptured.

 Some lessons

A merger or acquisition only creates an opportunity. It is execution that creates value.

THE RIGHT BEHAVIOUR

Managing to maximise profitable growth of the business

Constant pursuit of higher value alternatives  Organisational alternatives  Structure  Processes  Information  Capabilities  Strategic alternatives  Participation  Offering  Operating  Pricing  Portfolio  Affiliation benefits

Superior discipline for eliminating unprofitable use of resources  Unprofitable products  Unprofitable customers  Unprofitable markets  Unprofitable activities  R&D  Manufacturing  Distribution  Central services

THE ROLE OF THE CENTRE

 Create a Superior Growth Organisation  Establish the right objectives at all levels  Establish the boundaries that maximise clarity and accountability  Establish value based management processes  Establish value based information systems  Develop management capabilities for creating value  Lead by example  Constantly pursue higher value portfolio strategies  Constantly pursue ways to exploit affiliation benefits  Constantly prune unprofitable activities at the Centre  Enforce the Governing Objective  Intervene with business units to stimulate higher value alternatives  Intervene with business units to eliminate unprofitable use of resources  Intervene with business units to ensure there are consequences for non-conforming behaviour

MANAGING FOR VALUE: THE JOURNEY OF LEARNING

Focusing on Shareholder Value Transforming Management Performance

Transforming Beliefs

Transforming Behaviour

 Over the 17 years ended December 2000, Lloyds Bank shareholders saw the value of their investment, with dividends reinvested, increase over 65 times, doubling and redoubling total shareholder return every 35 months  There were no a priori prescriptions and no magic methodologies  It involved a journey of learning together

USING SHAREHOLDER VALUE TO RAISE MANAGEMENT PERFORMANCE

If I started the journey today I would:  Create a map for the journey  Conduct more formal training  Give it a label  Go faster  Accept disagreement as the necessary step to agreement  Use consultants to accelerate learning; dont use them to change your beliefs  Define world class in terms of world class value creation What wouldnt I change:  Dont try to proceed ahead of changes in fundamental beliefs

CONCLUSION
 Managing for value is different  Managing for value must be tailored to each companys needs and style  Managing for value works BUT  Generating consistently superior shareholder returns is the most challenging task a company can set for itself  It is a tough discipline to accept  People will wriggle like mad to escape the discipline  It requires extraordinary commitment and belief to stick to it over the long haul