Fin.

690
Dr. Mo Vaziri
By: Mary Sterba

Chapter 2 Summary
The Value Manager

Becoming a Value Manager:

- Requires a focus on long-run cash flow returns
- Value-oriented view of corporate activities- investments in new productive
capacity that earn a return above their opportunity cost of capital or not.
- Characterized by an ability to take an outsiders view point and act on
opportunities that create incremental value.
- Need to develop and institutionalize a managing value philosophy throughout the
organization.

The process of becoming value-oriented has two aspects:

1) Restructuring to unleash the value trapped within the company.
2) Developing a value-oriented approach to leading and managing their companies
after restructuring. Including the establishment of priorities based on value creation;
gearing planning, performance measurement and incentive compensation systems
toward shareholder value; and communicating with investors in terms of value creation.

If the two steps above are done well the management will not need to address major
restructuring in the future but rather focus on smaller steps to reach higher levels of
performance.

EG Corporation Case:
 EG Corporation is underperforming similar organizations and recent acquisitions
further deteriorated/eroded their value.
 Ralph Demsky, felt that great opportunities existed for EG to boost their value.
 Ralph set out to evaluate the status of the organization “as is” and causes for low
shareholder value. He investigated the value among six dimensions:
1. Current Market Value – evaluated the organization to similar companies
2. Value as is - assessed the value of each component of the EG portfolio on
the basis of projected future cash flows. Established discounted cash flow
benchmarks to comparison purposes. Results were disturbing so they set
out to see what the results would be if the performance estimates in the
current business plans were hit. Again, the results would be too low.
3. Value with internal improvements – Reviewed what each business might
be worth under more aggressive plans and strategies. Also reviewed what
would happen if each business improved its performance. Results showed
that it was reasonable to assume that some of EG’s businesses could be
made to perform at higher levels. The team determined that the potential
internal value of EG’s businesses was at least $3.6 billion, 50% above its
current market value.
 4. Value with internal improvements and disposals – Reviewed the
businesses under four scenarios: sale to a strategic buyer; a floatation or
spin-off; leveraged buyout by managers or a third party; and liquidation.
5. Value with growth, internal improvements and disposals – long-term
growth was known to be imperative. They were willing to wait until after
the restructuring before acting on long-term growth.
6. Total potential value – took a look at ways to take advantage of the tax
advantages of debt financing. It was determined that the company could
take on more debt which would provide a more tax-efficient capital
structure and create about $200 million in present value to EG’s
shareholders.

Ralph determined that shareholder value should be derived from cash flow returns. EG
had been taking the cash flow created by Consumerco and re-investing it in businesses
that were not generating adequate returns to shareholders.

EG Corporations Restructuring Actions (Exhibit 2.13 pg. 34)

Area Action
Consumerco Cut cost of sales
Reorganize sales force
Increase advertising and R & D
Build marketing skills
Foodco Sell (too much capital being used and no value created-
property worth more than business as a whole)
Woodco Keep and consolidate; sell if in two years management
cannot reach next level of performance
Propco Sell (destroyed value)
Finco Liquidate (destroyed value)
Newsco Sell (needless distraction)
Corporate Cut by 50%; decentralize remainder
New growth To be determined
opportunities
Financing Increase leverage to maintain BBB rating and capture tax
benefit. (borrow $500 million)

It is estimated that this restructure would create the following values:

Equity value= $4,120 million which is +123%
Equity value with new growth opportunities = $4,920 million which is +166%

Ralph’s six steps to build EG’s ability to manage value:

1. Focus planning and business performance revenues around value creation
2. Develop value-oriented targets and performance measurements
3. Restructure EG’s compensation system to foster an emphasis on creating
shareholder value.
4. Evaluate strategic investment decisions explicitly in terms of impact on value.
5. Begin communication with investors and analysts about the value of EG’s
plans
 6. Reshape the role of EG’s CFO- blend corporate strategy and finance
responsibilities together

Long term, Ralph needed to develop a plan for sustaining EG’s advantage in the market
for corporate control. In order to do this Ralph needed to understand the company’s
skills and assets and in which businesses they would be most valuable. The value of
these skills needed to be identified in terms of higher margins, growth rates so that
action plans could be built around them.

Management of the business units needed to focus on what was driving the value of
their businesses- i.e.: volume growth, margins, or capital utilization. They needed to
focus on growth in value and economic returns on investments.

The measurement turned to Economic Profit (EP) which is the spread between the
return on capital and its opportunity cost times the quantity invested in capital:
EP = Invested capital x (ROIC – Opportunity cost of capital)

This measure discounts the value of future economic profit (plus the current amount of
invested capital) which would equal the discounted cash flow value (DCF). Therefore,
by maximizing EP, EG could maximize DCF.

Assessing the value of strategic investments:

1. Capital spending was tied closely to strategic and operating plans to ensure that its
evaluation was realistic and fact based.
2. Hurdle rates would vary by division to reflect the relevant opportunity cost of capital
3. Acquisition proposals would be handled by a relevant operations manager and CFO
who would perform a thorough valuation analysis based on cash flow returns for the
transaction.

Managing value consists of three broad steps in this case:

1. Taking stock in the value-creation situation within the company and identifying
restructuring opportunities.
2. Acting on those opportunities and
3. Instilling a value-creation philosophy in the company.