Posts Tagged ‘managers’

Ralph was convinced that one of the main reasons EG had gotten into trouble was a lack of focus on value creation in developing corporate-level and business-unit plans. Likewise, evaluations of the performance of the businesses had only a vague focus on value. Ralph firmly believed that it was the responsibility of all senior managers to focus on value creation. Ralph would ensure that company plans included a thorough analysis of the value of each of the businesses under alternative scenarios. He would also make sure that EG used the restructuring hexagon approach on an annual basis to identify any restructuring opportunities within EG’s portfolio.
This new focus on value would also require some changes in the way EG thought about its corporate strategy. For the next year or so, EG had to focus on restructuring. In the longer term, Ralph would need to develop a plan for sustaining EG’s advantage in the market for corporate control. To do this, he would need to better understand the company’s skills and assets and in which businesses they would be most valuable. Most important, he would have to ensure that the value of these skills could be identified in terms of higher margins, growth rates, and the like before building action plans around them. Too often, Ralph was convinced, EG had done a perfunctory analysis of its capabilities and entered businesses without a clear idea of how and why EG would be a better owner and able to create value for its shareholders. As a first step, later in the year Ralph would establish a task force to compile an inventory and do an analysis of EG’s skills and assets compared with its competition, as well as ideas for new businesses EG might enter.
At the business level, EG’s new focus on value would require some changes too. The restructuring review had pointed out a number of specific strategic and operating actions that the various business managers would need to take. Beyond this, management in the business units would need to think differently about their operations. They would need to focus on what was driving the value of their businesses—whether it was volume growth, margins, or capital utilization. Everyone was accustomed to focusing on growth in earnings, but what would matter in the future would be growth in value and economic returns on investment. Sometimes this would mean foregoing growth in the business that would have been accepted in years gone by. At other times, managers would have to get more comfortable with the idea of reporting lower earnings when investment in research and development or advertising with a longer term payoff made economic sense. Ralph knew that these changes would be difficult for his management group, because it had not been encouraged to think this way in the past. To help bring about change, he decided to share with the management group the results of the corporate restructuring analysis and to develop a series of training seminars for senior division management about shareholder value.

Ralph also urged his CFO to look hard at EG’s financial structure and come up with an aggressive plan to take advantage of the tax advantages of debt financing. EG had had a policy of maintaining an AA rating from Standard & Poor’s and liked to think of itself as a strong investment-grade company. Ralph knew that many companies had taken on much higher debt levels and performed well. The performance of many had been spectacular, as managers thought harder about how to generate additional cash flow and looked more critically at investment requirements and so-called fixed expenses.
EG had sizable and stable free cash flows that could support much higher debt. The Consumerco business, which generated the bulk of the cash, was recession resistant. Ralph also knew that he did not need much reserve financial capacity given the relative maturity of EG’s core business and its limited need for capital. He also believed that EG would be able to get access to funding for a major expansion or acquisition, if it made economic sense. Otherwise, it was probably a poor investment in the first place.
By the CFO’s calculations, EG could indeed carry a lot more debt than it did, depending on the interest coverage Ralph wished to maintain. As the financial performance of the EG businesses improved, EG would be able to carry an even higher debt load comfortably. Ralph figured that at a minimum, EG could raise $500 million in new debt in the next six months and use the proceeds to repurchase shares or pay a special dividend. This debt would provide a more tax-efficient capital structure for EG, which would be worth about $200 million in present value to EG’s shareholders, assuming a combined federal and state marginal tax rate of about 40 percent.