25,99 €
Mehr erfahren.
- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Future-proof your business today for stronger performance tomorrow The Stress Test Every Business Needs: A Capital Agenda for Confidently Facing Digital Disruption, Difficult Investors, Recessions and Geopolitical Threats provides a comprehensive approach to creating value and flexibility in an increasingly volatile business environment that presents both great risks and opportunities every day. The authors extend the banking "stress test" concept to a company's Capital Agenda -- how executives manage capital, execute transactions and apply corporate finance tools to strategic and operational decisions. Having a static Capital Agenda, however appropriate for your current market position, is not enough in today's uncertain world. Long-term success comes from building resilience into each element and in the way those elements interact. The book uses a broader definition of business stress that includes traditional macroeconomic and geopolitical risks, as well as technological disruption, hostile takeovers and activist shareholders. Companies that make poor strategic decisions or underperform operationally will likely find themselves facing great stress. And that stress is symmetric; threats come from downside risks and from missed opportunities. The chapters address the how and why of essential issues such as: * Formulating corporate strategy in a digital world * Pre-empting activist shareholders * Restoring distressed companies to operational and financial health * Ensuring effective collaboration among strategy, finance and operations * Getting the most out of your advisors * Proactively managing intrinsic value * Rigorously allocating capital across the enterprise * Acquiring and divesting for optimum value * Syncing financing decisions with business strategy and capital market conditions * Incorporating tax planning throughout the Capital Agenda * Liberating excess cash with leading working capital management practices * Aligning strategic goals and metrics to reach your company's full potential Companies that develop strategy and set operational priorities with a balanced Capital Agenda are best positioned to control their own destiny. The Stress Test Every Business Needs provides a roadmap to future-proof your business today for stronger performance tomorrow.
Sie lesen das E-Book in den Legimi-Apps auf:
Seitenzahl: 333
Veröffentlichungsjahr: 2018
Ähnliche
The Stress TestEvery BusinessNeeds
A Capital Agenda for Confidently FacingDigital Disruption, Difficult Investors,Recessions and Geopolitical Threats
Jeffrey R. Greene
with
Steve Krouskos
Julie Hood
Harsha Basnayake
William Casey
Cover design: Art Director Santiago Eli Lastra, Hogarth Worldwide
Copyright © 2018 by EYGM Limited. All rights reserved.
EYG no. 010118-18GblED None
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data
Names: Greene, Jeffrey R., author. | Krouskos, Steve, author. | Hood,
Julie, author.| Basnayake, Harsha, author. | Casey, William, author.
Title: The stress test every business needs : a capital agenda for
confidently facing digital disruption, difficult investors, recessions and
geopolitical threats / Jeffrey R. Greene, Steve Krouskos, Julie Hood, Harsha Basnayake, William Casey.
Description: First Edition. | Hoboken : Wiley, 2018. | Includes index. |
Identifiers: LCCN 2018020487 (print) | LCCN 2018033008 (ebook) | ISBN
9781119417965 (Adobe PDF) | ISBN 9781119418139 (ePub) | ISBN 9781119417941
(hardback)
Subjects: LCSH: Management. | Strategic planning. | Leadership. | BISAC:
BUSINESS & ECONOMICS / Management. | BUSINESS & ECONOMICS / General. |
BUSINESS & ECONOMICS / Leadership.
Classification: LCC HD31 (ebook) | LCC HD31 .G746 2018 (print) | DDC
658.4/0352–dc23
LC record available at https://lccn.loc.gov/2018020487
Acknowledgments
This book represents many decades of creative work by thousands of our EY Transaction Advisory Services colleagues around the world. We are particularly grateful to all the contributors who invested the time, energy, and insight to craft their chapters.
The opportunities and challenges our clients provide us every day are essential to our thinking. Regular discussions with members of EY's Corporate Development Leadership Networks in the United States, Europe, and Asia-Pacific region have inspired many of the themes we share in the following pages.
The project team deserves special thanks, beginning with Jonathan Rozek, who brought invaluable writing and editorial guidance. In addition to being the author of his own chapters, Daniel Burkly played the roles of muse and devil's advocate throughout. Linda Cunningham's project management helped get the manuscript over the finish line. Gaeron McClure led EY's rigorous internal review process, and the book is materially better because of him. Scott Chapski, Mateusz Kowalik, Abin Tijo, and Aparna Mitra supplied their much-needed copyediting, legal, and graphic knowledge. The global Brand, Marketing, and Communications team of Antony Jones, Nicola Gates, and Brielle Roldan sustained this effort from inception.
Intellectual challenges from John Celentano and Anne Board elevated our thinking. Dawn Quinn was present at the creation; it's unlikely we would have begun the book without her enthusiasm. We very much appreciate Richard Narramore, Senior Editor for Business Publications at John Wiley & Sons, for his substantial advice and patience throughout the writing process.
Finally, and most importantly, we thank our families–Teri Greene, Kamela Krouskos, the Hoods, Shanil and Shamin Lee Basnayake, and Amy Casey–for encouraging us, supporting our work, and helping us grow.
Jeffrey R. Greene, New York CitySteve Krouskos, LondonJulie Hood, LondonHarsha Basnayake, SingaporeWilliam Casey, New York City
CONTENTS
Acknowledgments
Chapter 1 How resilient is your Capital Agenda?
by Jeffrey R. Greene
Framing decisions within the Capital Agenda
The Capital Agenda’s building blocks
Who can benefit from this book?
Universal lessons from Allergan and Valeant
Stress test your Capital Agenda
Making the most of your Capital Agenda
Performance improvement opportunities
Navigating the book
Notes
Chapter 2 Do you know the intrinsic value of your company and how to manage it?
by Daniel Burkly
Closing the gap between intrinsic and market value
Common valuation applications
Getting more value out of valuation
Inconsistent applications of valuation
Eight ways to minimize misuse and maximize effectiveness
Cultivating a valuation mindset
Notes
Chapter 3 Are you allocating capital across the enterprise to reduce C-suite stress?
by Jeffrey R. Greene
Eight leading practices for allocating capital
Evaluating individual investment opportunities: Quantify, debate, judge
“Capital allocation is a contact sport”
Notes
Chapter 4 Are your portfolio reviews timely, objective, and thorough?
by Jeffrey R. Greene and Jeff Wray
Diagnosing the health of your portfolio management process
Preparation drives value
An acquisition perspective
Approach ownership flexibly
Implement world-class portfolio management
Can “virtual” carve-outs show the way to cost reduction?
Confront barriers to success
Putting theory into practice
Notes
Chapter 5 Do your acquisitions consistently pay off for shareholders?
by Brian Salsberg
An age-old M&A question
Stress testing your M&A activities
Lessons learned
Notes
Chapter 6 Are you planning and executing divestments for maximum value?
by Paul Hammes and Subin Baral
Divesting is critical to your capital strategy
What defines a successful divestment?
Divestment guiding principles
Leading sources of value erosion
Can you increase business value before divesting?
What does it take to close the deal and maximize value?
Divesting for value
Note
Chapter 7 Do your financing choices support flexibility and efficiency?
by K.C. Brechnitz
Use capital structure to facilitate business goals
Assess your business through the capital lens
Assess strategic financing alternatives
Chapter 8 How well does working capital management contribute to cash flow and earnings?
by Sven Braun and Steve Payne
Why working capital matters
Stress test your working capital proficiency
Are you using outdated metrics?
The psychology is harder than the math
Next steps in the optimization journey
Chapter 9 Is tax a full partner in building resilience and driving value?
by Bridget Walsh and Erica Lawee
Key tax issues affecting business today
Tax in the Capital Agenda
Turning tax uncertainty into opportunity across the Capital Agenda
Notes
Chapter 10 Are strategy, finance, and operations integrated for optimal value creation?
by Sharath Sharma and Daniel Burkly
Day 1
Strategy, finance, and operations integration
Complex change will be a constant
SFO integration creating value through M&A
How urgent is your need for SFO integration?
Stress testing your SFO integration
It’s a journey, not a destination
Notes
Chapter 11 How can you get the most out of your advisors?
by Giri Varadarajan and Aayush Tulsyan
Setting the context
First principles
When it is appropriate—and not appropriate—to use an advisor
Hiring process
Advisors as competitors and as peers
How to start the relationship with an advisor
Fourteen other leading practices (and what not to do) when hiring and managing advisors
Beyond advisors to journey partners
Note
Chapter 12 Can your strategy thrive in a digital world?
by Tony Qui and Glenn Engler
Extending the reach of digital
Who’s the digital disruptor?
Focus on seven dimensions of digital
Feeling overwhelmed? Join the club. But there is a way forward
This is for certain
Note
Chapter 13 How can you pre-empt activist shareholders?
by Shyam Gidumal
How activism has changed
Four areas of focus for activists
The best protection against activism
What to do when the activist’s letter arrives
Formulating your response
We thought about that, too
Activism is here to stay
Notes
Chapter 14 How should you restore a distressed company to health?
by Andrew Wollaston and Donald Featherstone
Turnaround versus restructuring
Recognizing corporate distress and the human dimension
Marshaling the recovery
Remaining in control
Early detection is the best prevention
Chapter 15 Will your strategic goals ensure your company reaches its full potential?
by Bill Achtmeyer and John Trustman
A good strategy starts with setting the right targets
Defining market context
Setting margin targets using the Performance Gap
Setting growth targets with the Opportunity Gap
Aligning with investors via the Perception Gap
Full potential value synthesis
Notes
Glossary
Contributor Biographies
About EY
Index
End User License Agreement
List of Illustrations
Chapter 1
Figure 1.1 Capital Agenda’s building blocks
Figure 1.2 Possible answers to “What went wrong?”
Chapter 3
Figure 3.1 Uniform hurdle rate problems
Figure 3.2 Putting the quantify-debate-judge approach into action
Chapter 5
Figure 5.1 Categories of deal types
Figure 5.2 Elements of a strong integration
Chapter 6
Figure 6.1 Transaction structuring considerations
Figure 6.2 Buyer focus areas and criteria
Figure 6.3 Divestment work plan
Figure 6.4 Financial statement requirements
Chapter 7
Figure 7.1 The capital lens framework
Figure 7.2 Instruments for different ranges of flexibility and cost of capital
Chapter 10
Figure 10.1 Evolution of required SFO integration
Figure 10.2 Drivers of change
Chapter 11
Figure 11.1 When is it appropriate—and not appropriate—to use an advisor?
Chapter 12
Figure 12.1 Reframe the question
Chapter 13
Figure 13.1 Evolution of activism
Chapter 14
Figure 14.1 Turnaround activities
Figure 14.2 EBITDA bridge
Figure 14.3 Value break summary
Chapter 15
Figure 15.1 Global beauty Market Map.
Figure 15.2 Global beauty Normative Band.
Figure 15.3 Global beauty Opportunity Strength Matrix.
Figure 15.4 Market Value Drivers analysis
Figure 15.5 Full potential value synthesis
Guide
Cover
Table of Contents
Chapter 1
Pages
v
vi
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
101
102
103
104
105
106
107
108
109
110
111
113
114
115
116
117
118
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
148
149
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
169
170
171
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
188
189
190
191
192
193
194
195
196
197
199
200
201
202
203
204
205
206
207
208
209
210
211
212
213
214
215
216
217
218
219
220
221
222
223
224
225
226
227
228
229
230
231
232
233
234
235
237
238
239
240
241
242
243
244
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262
263
264
1How resilient is your Capital Agenda?
Jeffrey R. Greene
Framing decisions within the Capital Agenda
The Capital Agenda is a comprehensive approach companies should use to manage capital, execute transactions, and apply practical corporate finance tools to strategic and operational decisions. This book synthesizes what we’ve learned over literally thousands of engagements helping clients as they navigated out of crises to confront technological disruption, unrelenting investor scrutiny, slow gross domestic product (GDP) growth, and geopolitical volatility.1 EY’s Capital Agenda framework has been such a valuable tool that we’ve built Transaction Advisory Services around it, using it to set priorities for recruiting and talent management, innovation, and thought leadership.
Having a static Capital Agenda, however appropriate for your current environment, is not enough in today’s uncertain world. Long-term success comes from building resilience into each element of the Capital Agenda and in the way those elements interact. Banking regulators have mandated well-defined parameters for stress tests of our most important global financial institutions. We believe every nonfinancial company should adopt an analogous approach to “future-proofing” its Capital Agenda.
We use a broader, more strategic definition of stress that encompasses not only traditional macroeconomic, sovereign-risk, and commodity- related shocks—such as interest rates, recessions, oil prices, and expropriation—but also forces such as technological disruption, hostile takeovers, and activist shareholders. In this expanded view, companies that make poor strategic decisions or underperform operationally—even in a benign economic and geopolitical climate—can still find themselves facing great stresses. We believe that stress is symmetric; the threat can come from downside risks as well as from missed opportunities.
The Capital Agenda’s building blocks
While every company’s Capital Agenda is specific to its strategy, operating model, and business environment, Figure 1.1 provides examples of common activities. Each quadrant represents one of the four key processes that make up the Capital Agenda framework:
Raising
. Accessing the capital markets to properly fund growth and day-to-day operations.
Investing
. Deploying capital to new opportunities, both organic and inorganic.
Optimizing
. Reviewing the business portfolio for capability gaps as well as divestment candidates.
Preserving
. Managing risk and adapting to changes in the business environment.
Figure 1.1Capital Agenda’s building blocks
As we’ll see, many essential activities affect more than one quadrant. For example, valuation, capital allocation, and tax planning are relevant to the entire Capital Agenda.
Who can benefit from this book?
We created this book to help boards and management teams make better, more informed decisions around their Capital Agenda in an increasingly uncertain business environment that presents both great risks and opportunities every day. How much better? Our friend, Professor Richard Ruback at Harvard Business School, tells students he hopes they’ll get 5% better from engaging in his class. It doesn’t seem like much, but if you’re a professional golfer, 5% better means 14 strokes over four rounds—normally the difference between winning and not making the top 25. In a major tournament, that’s likely a difference of more than US$1 million in prize money. As a chief executive officer (CEO) or chief financial officer (CFO), if your stock price is 5% higher each year than it otherwise would have been and that difference accumulates over time, your market value would be more than a quarter larger after five years, and almost two-thirds larger after 10 years—likely enough to ward off a hostile acquirer or activist shareholder. So maybe 5% better at managing your Capital Agenda from reading a book is pretty good.
In these pages we distill more than 400 years of the contributors’ collective experience into practical guidance for executives trying to master both the Capital Agenda and the ability to future-proof their companies. We measure business success in two ways:
Shareholder value creation
. How well are you rewarding shareholders, and what’s expected over the next two to three years?
Resilience
. Are you adaptable enough to absorb unexpected threats
and
to seize unanticipated opportunities? This applies to evolving long-term trends—like demographics and consumer tastes—and to the rapid pace of short-term changes.
Consistently creating value and maintaining resilience are complicated by the demands of optimizing all the individual elements of the Capital Agenda, as well as managing them holistically. Your ability to control your own corporate destiny faces ever-greater challenges created by:
Accelerating uncertainty from technology-driven disruption and industry convergence.
Less bounded macroeconomic and policy uncertainties.
Growing political divergence with emerging nationalism and subnationalism.
The formidable power of traditional investment managers and activist hedge funds.
Implementing the Capital Agenda well requires an integrated, strategic focus from C-suite leaders who can see and work across the enterprise. But fluency with the Capital Agenda is necessary for everyone from the board of directors to middle managers. Boards need to exercise their governance responsibilities by asking the right questions that are informed by the Capital Agenda, such as:
Do our large share repurchases signal to investors that we’ve exhausted our opportunities to grow organically?
Is this acquisition candidate a good strategic fit, and do we have the ability to earn an adequate return on our purchase price?
Are we the best owner of each business in our portfolio?
Leaders in key functions—manufacturing, supply chain, sales and marketing, research and development (R&D)—should understand how their day-to-day activities align with, and support, the Capital Agenda to create value and build resilience. Likewise, practitioners within companies working on strategy, corporate finance, mergers and acquisitions (M&A), tax planning, and operations have essential roles to play in helping make their company’s Capital Agenda complete, internally consistent, and resilient. Our thinking should also resonate with advisors looking for new perspectives to address their clients’ challenges at the intersection of global capital markets and competitive strategy. Academia represents another important audience: teachers and students who want to explore how financial theory works in practice.
Universal lessons from Allergan and Valeant
The 21st of April 2014 started out like any other beautiful day in Southern California. Despite a Monday packed with meetings, Allergan Inc.’s longtime CEO, David Pyott, took a break around noon to stop by the employee cafeteria and grab lunch.
It was the quiet before the storm.
Within hours, Pyott and his senior team learned of two US Securities and Exchange Commission (SEC) filings that put Allergan in the crosshairs of both an activist shareholder, Pershing Square Capital Management LP, and a hostile acquirer, Valeant Pharmaceuticals International, Inc. The next day Valeant went public with a US$47 billion offer for the Irvine, California–based pharmaceutical company.2
Pyott, who had been Allergan’s CEO for 16 years, is candid about the takeover attempt. “It felt a little bit like December 1941,” he says, and it’s not difficult to understand his surprise. Allergan’s 2013 revenues had grown nearly 12%, while total shareholder return jumped more than 90%. Few would have labeled Allergan an “underperformer.” Its flagship product was growing at double-digit rates, and the company had recently divested a lagging business to free up resources.
It’s also not difficult to see how an arbitrageur could develop a rationale for why the company was an enticing target. The year before, Allergan allocated 17% of its total revenue to R&D and 38% to selling, general, and administrative (SG&A) expenses. Both were on the high side for a specialty pharmaceutical company. Given its US headquarters, Allergan also had an effective tax rate 8.5 percentage points higher than the overall average for specialty pharmaceutical and generics players. Moreover, with roughly US$1.6 billion in cash on its balance sheet and little debt, Allergan had a stockpile of financial firepower waiting to be deployed.
These facts created an attractive opportunity for Valeant, a strategic buyer with a lean operating model and a focus on growing through serial acquisition. In his 22 April presentation to investors, Valeant’s CEO outlined the “financially compelling” results he believed would come from a merger, including US$2.7 billion in annual cost savings.
But with a market capitalization roughly equivalent to Allergan’s and a balance sheet that was already heavily leveraged, Valeant needed help with its bid. Enter Pershing Square, with US$13 billion under management. The hedge fund’s sum-of-the-parts valuation analysis showed that its likely return was worth the associated risks of an activist campaign. In other words, as a result of Allergan’s relatively high tax rate and operating expense levels, there was a big-enough gap between its market value and its perceived intrinsic value to attract a credible strategic buyer—and a powerful activist shareholder.
A seven-month battle of dueling investor presentations, acrimonious press releases, and litigation ended in a white-knight bid by Actavis PLC valued at more than US$70 billion, roughly twice Allergan’s market capitalization before Valeant weighed in. That Valeant ultimately didn’t succeed in its bid mattered less to Allergan’s stakeholders than the fact that together with Pershing Square it had succeeded in putting the company into play.
Throughout the book we’ll consider examples from many industries, but for now there is more for all companies to learn from in seeing how the story played out. Like many corporate tales, Allergan’s journey had a happy ending for shareholders, but a bittersweet one for its CEO and management team. They might be forgiven their schadenfreude over what happened to Valeant barely a year later.
Valeant’s rise and epic fall
Valeant’s stock soared from less than US$20 per share in 2010 to more than US$340 by August 2015, based on a widely celebrated business model of acquiring specialty pharmaceutical companies and individual drugs, then raising prices, cutting R&D spending, and rationalizing SG&A costs. In order to fuel this roll-up machine, acquisitions got larger and more expensive as pharma equities roughly doubled in price. Valeant’s debt levels rose to fund these transactions.
In mid-2015, public opinion began to turn decisively against drug companies that were thought to be aggressively raising prices. One analyst published a report saying Valeant had raised prices on more than 50 drugs by an average of 66%—well above the industry average.3 A congressional subpoena soon followed.
The company also faced investor concerns over some accounting practices and a lack of transparency in dealing with certain third parties. In March 2016, management announced it might be in danger of violating loan covenants. That month the stock fell under US$30 and Valeant joined the “90% club,” reminiscent of once high-flying stocks in the dot-com bubble’s aftermath. The CEO resigned after seven years at the helm. There were no happy endings for anyone in this story.
To learn from these examples, let’s start by examining the resilience of each company’s Capital Agenda, because things went quite well for years and then hit a wall owing to unanticipated outside forces. While Allergan’s performance looked strong relative to the company’s peer group, its absolute performance created an opening for Valeant’s critique, as some outsiders saw a path to even better results. David Pyott acknowledges that investors might have viewed its high SG&A-to-revenue ratio as a weakness, but counters that Allergan had “cogent arguments” for its decisions. “We had to create not only sales forces but market competencies,” he said.
Two trends converged to create real stress for the company:
Investor sentiment shifted in favor of cost reductions to increase margins versus investing in sales and marketing to create longer-term growth.
Activist hedge funds attracted more resources and gained credibility with institutional investors.
As the activist campaign wore on, priorities within Allergan did turn from enabling longer-term growth to demonstrating nearer-term earnings. Allergan cut 13% of its workforce and optimized capital allocation. These steps were motivated by conversations with investors, who told Allergan and its board that if the company couldn’t get to US$10 earnings per share (EPS), Valeant’s offer was too enticing.
Stress test your Capital Agenda
How might management have inoculated itself against these pressures? The well-documented process of scenario planning goes back decades, but we find that very few companies have come close to fully implementing its fundamental practices. One way to get started is to perform a “premortem”4 for important decisions. As with many powerful ideas, this one is simple and straightforward to apply to new strategic, operational, and capital decisions, as well as to initiatives already underway. Instead of asking what could go wrong, the team begins by assuming the effort failed in dramatic fashion. Then everyone writes down individually all the possible reasons he or she can think of for the failure, before each is considered in turn for ways to better future-proof the project. Even Nobel laureate Daniel Kahneman, widely regarded as one of the godfathers of modern-day behavioral economics, has complimented the power of the premortem approach.
Here are a few plausible action items that could have come out of an Allergan premortem on its Capital Agenda:
Strengthen our dialogue with investors to make sure they understand and buy into how our sales and marketing programs will drive future growth.
Demonstrate the productivity of our long-term R&D investments with compelling analysis.
Take a fresh look at all costs, and eliminate any unnecessary expenses.
Some of these may seem to use too much hindsight, but they amount to basic tenets about “thinking like an activist” and staying in touch with major shareholders—concepts that all boards and management teams should adopt, and which we discuss in detail in Chapter 13. In 2017, shortly after the US$130 billion DowDuPont merger closed, no less than four activists were criticizing the planned separation of the combined group into three publicly traded entities. DowDuPont responded by surveying its top 25 shareholders before making meaningful changes to its separation plans.5
Had Valeant management done a premortem around its business model, it might have given itself some to-dos as well:
Be transparent to investors about the role that product price increases will play in our ability to extract value from acquisitions.
Reduce our dependence on debt, in order to build more flexibility into our capital structure in case cash flow falls below our base-case expectations.
Hindsight again? Not really. Though there was additional complexity in the Valeant story, a common trait of roll-up strategies is that they eventually run out of fuel. Often competition bids up the price of desirable acquisition candidates, or the value of the strategic premise erodes—both of which happened here.
Turning to the components of Allergan’s and Valeant’s Capital Agendas and their internal alignment, we can see strengths and weaknesses:
Allergan’s conservative leverage provided a financial cushion but also suboptimized capital costs, and created the opportunity for a hostile acquirer to tap into its unused debt capacity.
David Pyott also admits the company should have looked harder at M&A opportunities: “In hindsight, we should have used the balance sheet more aggressively. We were trying to be disciplined,” he says. Indeed, had Allergan used some of its balance sheet to acquire a competitor—a move it attempted once the hostile bid became public—it might have moved out of Valeant’s reach.
In many ways, Valeant’s capital structure and M&A challenges were the opposite of Allergan’s. As debt levels rose for each successive acquisition, capturing the cash flow synergies of increasingly expensive targets became essential to reducing leverage. The cycle ended when substantial drug price increases became untenable.
Premortem stress testing generates valuable insights
Figure 1.2 shows some additional possibilities for answers to the question “What went wrong?” in a Capital Agenda premortem exercise. Of course, many are discovered after the fact—during the post mortem. You can use these examples to stress test your Capital Agenda as you build and refine it.
What went wrong?
What caused it?
We overpaid for the acquisition.
Our CEO fell in love with it.
Our due diligence did not properly vet the optimistic projections.
We failed to capture the planned synergies for the acquisition.
Integration planning wasn’t considered during due diligence.
We didn’t allocate enough resources to the functional work streams.
We waited too long to divest an underperforming business.
We thought we could fix it.
The group leader was incentivized on revenue and EPS contributions, not on shareholder value.
We had to retreat from an important market.
A new competitor from another sector provided our best customers with a dramatically better value proposition.
We had to give the activist shareholder a board seat.
We couldn’t refute the activist’s detailed critiques of our business units’ returns on invested capital (ROICs).
We couldn’t articulate why our strategy was better for shareholders.
Our stock was downgraded.
We have too much cash unnecessarily tied up in working capital.
We lost money on the joint venture.
The business unit sponsor rotated into a job in another part of the company.
Figure 1.2Possible answers to “What went wrong?”
During an introductory meeting on improving transaction processes, an executive said to us, “We have a great process in place to capture lessons learned from our strategic investments. The problem is that they’re always the same lessons!” Employing the premortem approach will increase your chances of designing and implementing your Capital Agenda properly in the first place.
Making the most of your Capital Agenda
Keeping in mind the following guiding principles will help provide order and prioritization as you hone all the moving parts of your company’s unique Capital Agenda.
Principle 1: Enterprise-wide capital allocation
. Investing experts from Warren Buffett to large money managers to hedge fund icons agree that capital allocation is one of the most important functions of your executive team. All types of investment decisions–capital expenditures, R&D, acquisitions, dividends, and share repurchases—must be evaluated using consistent criteria. This applies equally to new uses of capital and to decisions on how to manage your existing business portfolio that represents capital already invested. See Chapters 3 and 4.
Principle 2: Comprehensive transaction strategy and processes
. There are well-defined, repeatable practices that raise the odds of success for M&A, divestments, and other inorganic investments. Chief among them is having a clear, actionable view on how you will create strategic and financial value. Another is to build organizational readiness at a tactical level to acquire and divest when opportunities arise unexpectedly. See Chapters 5 and 6.
Principle 3: Adaptive financing and payout policies
. Overall capital structure and financing choices for individual investments go a long way to determining your company’s resilience. See Chapter 7. Dividends and share repurchases must balance shareholder preferences, operating needs, and risk. For private firms, the decisions concerning if and when to go public can have existential consequences.
Principle 4: Finance in sync with, and enabling, strategy and operations
. Your strategy and your operating model are translated into shareholder value through the Capital Agenda. As uncertainty rises, success requires closer collaboration among the policymaking and implementation teams in finance, operations, and strategy. See Chapter 10. Proper stress testing across the Capital Agenda will help management more clearly understand and better communicate the explicit trade-offs between flexibility and efficiency.
Three essential traits of a sound Capital Agenda
The right Capital Agenda for your business has three important characteristics:
Complete
. In addition to having all the requisite elements, each needs to work properly on its own. For example, a well-functioning portfolio management process helps ensure that every business unit is regularly reviewed using a consistent set of strategic and financial criteria. We cover this in more detail in Chapter 4.
Aligned
. All these elements need to complement each other and align with your strategy and operations. It’s no surprise that technology companies whose strategies emphasize heavy innovation tend to be predominantly equity financed in order to cushion the cash flow fluctuations that come with the ups and downs of R&D and commercial execution. Alignment among individual elements also helps executives make trade-offs, such as balancing share repurchases, capital expenditures, and M&A investments.
Resilient
. This is where stress testing is particularly important. A complete Capital Agenda with good alignment also has to help your company thrive by absorbing downsides and, equally important, by taking advantage of new opportunities that crop up. Building divestiture readiness—via execution capabilities, a robust watch list, and virtual carve-out analyses—provides the flexibility to respond quickly both to unexpected cash shortages and to overheated market conditions for in-demand assets.
Performance improvement opportunities
Throughout the book we highlight valuable by-products that come from great execution around your Capital Agenda. These performance improvement opportunities often show up in financial results and operating processes. Though not a comprehensive list, we summarize a few here so you can be on the lookout for them:
During acquisition integration, learn from the target to transform your own processes (Chapter 5).
As part of regular portfolio reviews, simulate a
virtual
carve-out of each business. Analyzing the stand-alone costs may shed light on ways shared services can be rationalized (Chapter 4).
Optimizing working capital management to liberate cash often leads to reduced costs (Chapter 8).
Performing an activist shareholder vulnerability assessment highlights where information systems need to improve (Chapter 13).
Analyzing your company’s intrinsic value provides the basis for a more compelling dialogue with investors (Chapter 2).
Navigating the book
The remaining chapters first delve into the essential principles and practices for building a resilient Capital Agenda that drives shareholder value (Chapters 2–9). Then we turn to organizational capabilities like getting strategy, finance, and operations to collaborate, and extracting value from outside advisors (Chapters 10 and 11). Next we illustrate holistic applications—real-life examples, if you will—in digitalization, activism, and restructuring (Chapters 12–14). We conclude by outlining a strategic framework to support the Capital Agenda (Chapter 15).
With more than 20 contributors to the book (see Contributor Biographies), each chapter naturally has its own voice, so we hope you’ll enjoy the variety as you gain actionable insights to help shape and execute your company’s Capital Agenda. If you’d like to explore any of the topics we discuss in more depth, we have a companion website ey.com/capitalagenda that regularly refreshes our current thinking.
Notes
1.
Throughout the book the terms
we
,
our
, and
us
refer to the authors and contributors collectively, who in turn represent EY.
2.
Jeffrey Greene and Ellen Licking, “Capital Allocation in the Age of Shareholder Activism,”
In Vivo: The Business and Medicine Report
33, no. 5 (May 2015).
3.
“What Caused Valeant’s Epic 90% Plunge?,” Reuters, 20 March 2016.
4.
Gary Klein, “Performing a Project Premortem,”
Harvard Business Review
, September 2007.
5.
David Benoit, “How to Carve Up DowDuPont? Four Activists Sharpen Their Knives,”
The Wall Street Journal
, 30 July 2017; “DowDuPont Alters Post-Merger Breakup Plans in Response to Investor Pressure,” Reuters, 12 September 2017.
2Do you know the intrinsic value of your company and how to manage it?
Daniel Burkly
“How are we going to double the value of our business in the next five years?” a business unit leader of a large industrial equipment manufacturer asked her CFO.
The pair had just received this mandate from the CEO, who had watched the company’s stock price flounder, and had commissioned a study to determine how to achieve top-decile results for total shareholder return (TSR). The study laid out specific value-creation targets for each part of the company; for this business unit, it was doubling its value in five years. The question was: “How?”
The company had been in extreme cost-cutting mode for several years. Along with doubling the business unit’s value, the CEO was asking for more of the same: slash R&D budgets, reduce the sales force, and drive back-office efficiencies.
The business unit leader had two concerns with the push for more cost cutting: first, she had to do significantly more than reduce expenses to double the business unit’s value; and second, the cost cutting was becoming unsustainable. The challenge was how to make a convincing case to her CEO. In addition, she also needed to lay out the strategic vision for her own management team.
After putting their heads together for a few weeks, the business unit leader and CFO decided they would need a comprehensive valuation analysis to help chart the path ahead.
The analysis included the following:
An objective, as-is valuation of the business unit.
A future-state vision of the business unit five years forward that would represent a doubling in value.
A portfolio of specific initiatives to close the gap:
Organic:
Grow sales of existing products in existing markets.
Expand into new markets with existing products.
Develop and launch new products.
Optimize the cost structure of the existing business.
Inorganic:
Make a transformational acquisition.
Complete a series of bolt-on acquisitions the business unit had been strategically focusing on for years.
Enter into joint ventures and partnerships to access needed capabilities.
Divest low-growth and noncore assets the business unit had held on to for far too long.
This valuation analysis helped answer some key questions:
How much additional value is there in sustainable cost cutting?
What is the value of each initiative, given its expected cash flows and risk profile?
How much value could be generated organically versus through M&A?
How much capital investment is required to reach the value- creation objective?
Which project-specific financing structures and third-party investments could enhance value?
What are the implications for the capital structure of the company overall?
