Chapter 8

Growth companies marketing focus

Corporate Financial Strategy

Growth companies: contents

 Learning objectives
 Financial strategy for a growth business
 Growth companies require a marketing focus
 Growth equity carries different risks to start-up equity
 Capital asset pricing model
 Dividend growth model
 Project risk and return
 Foregone low-risk opportunities
 Rights issue
 Bonus issue

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Learning objectives

1. Explain how the life cycle model relates to a company in the growth
stages of its life.
2. Critique the financial strategy adopted by a growth company, making a
decision as to which aspects of the life cycle model are relevant to its
circumstances, and why.
3. Appreciate some of the assumptions behind the Capital Asset Pricing
Model, and their flaws.
4. Calculate the theoretical impact of rights issues, bonus issues and
share splits, and understand their likely effect on corporate value.

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 
 Growth Company
 What Is a Growth Company?
 A growth company is any company whose business generates
significant positive cash flows or earnings, which increase at significantly
faster rates than the overall economy. A growth company tends to have
very profitable reinvestment opportunities for its own retained earnings.
Thus, it typically pays little to no dividends to stockholders opting instead
to put most or all of its profits back into its expanding business.
 Understanding Growth Company
 Growth companies have characterized the technology industries. The
quintessential example of a growth company is Google, which
has grown revenues, cash flows, and earnings substantially since.

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 its initial public offering (IPO). Growth companies such as Google are
expected to increase their profits markedly in the future; thus, the market
bids up their share prices to high valuations. This contrasts with mature
companies, such as utility companies, which tend to report stable
earnings with little to no growth.
 Growth companies create value by continuing to expand above-average
earnings, free cash flow, and spending on research and development.
Growth investors are less worried about the dividend growth, high price-
to-earnings ratios, and high price-to-book ratios that growth companies
face because the focus is on sales growth and maintaining industry
leadership. Overall, growth stocks pay lower dividends than value
stocks because profits are reinvested in the business to drive earnings
growth.
 Bull Markets Are Ideal Conditions for Growth Companies

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 What is market focus?
 A market-focused company is one that has imbedded in all of its
managers powerful planning processes and tools to continuously focus
and re-focus critical cash flow and human resources on a changing
portfolio of market opportunities that create long term cash flow. To
some, this may seem self-evident. However, I offer two sobering
thoughts: Firstly, the examples above show that many global companies
formerly thought unbeatable are losing their market focus. Secondly,
many of these same companies have literally hundreds of MBA’s from
the best business schools the world in management positions. Clearly,
at the critical conceptual and operational levels, many managers are
having difficulty understanding, creating and managing market focus.
Further, many of these managers have problems creating and managing
the critical conditions necessary in their company for achieving and
sustaining market focus. It clearly presents a very difficult task.

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What is a market-focused product winner?
The overriding objective of a market-focused company is to make sure
that every product in the portfolio at every level of the company is a
current or potential winner. At any moment, this is unlikely to happen in
any company’s entire product portfolio. However, the great market-
focused companies are constantly driving toward it. More importantly,
managers in market-focused companies are very tough on products and
portfolios that
Business risk is the exposure a company or organization has to
factor(s) that will lower its profits or lead it to fail. Anything that threatens
a company's ability to meet its target or achieve its financial goals is
called business risk

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Financial strategy for a growth business

Business risk High

Financial risk Low

Source of funding Growth equity investors

Dividend policy Nominal payout ratio

Future growth prospects High

Price/earnings multiple High

Current profitability (eps) Low

Share price Growing but volatile

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Growth companies require a marketing focus

0
Time

Focus on building market share in order to be a major

player by the time it starts to mature

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Growth equity carries different risks to start-up equity

Required
return
Start-up
equity,
provided
by venture
capital
Growth
equity,
often
provided
by IPO

Perceived risk

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Capital asset pricing model

𝐾𝑒 = 𝑅𝑓 + 𝛽( 𝑅𝑚 − 𝑅𝑓 )
 

′
 
𝐾𝑒 𝑖𝑠 𝑠h𝑎𝑟𝑒h𝑜𝑙𝑑𝑒𝑟 𝑠 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛
 
𝑅𝑓 𝑖𝑠 𝑟𝑖𝑠𝑘 − 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒
𝛽 𝑖𝑠 𝑠𝑒𝑛𝑠𝑖𝑡𝑖𝑣𝑖𝑡𝑦 𝑜𝑓 𝑠h𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 𝑡𝑜𝑚𝑎𝑟𝑘𝑒𝑡 𝑚𝑜𝑣𝑒𝑚𝑒𝑛𝑡𝑠
 

 
( 𝑅𝑚 − 𝑅𝑓 ) 𝑖𝑠 𝑚𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚

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Project risk and return

Project A should be
accepted, as it
Project
expected generates more return
return than its cost of capital.
B
Project B should be
A rejected, as it
generates less return
than its cost of capital

Company Project risk

overall risk
factor

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Foregone low-risk opportunities

Minimum return

Foregone
low-risk
opportunities

Company Project risk

overall risk
factor

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Rights issue

 In a rights issue, existing shareholder have the right to subscribe for new
shares in proportion to their existing holding
 For example, a 1 for 4 issue at 45p means that for every 4 shares held,
the shareholder has the right to buy one extra share at 45p
 If the shareholder chooses not to take up the rights, they are sold by the
company in the market, and the shareholder receives the net proceeds
 The theoretical post-rights price can be calculated. The actual post-
rights price will differ from this due to investors’ views on the information
released at the time of the issue

Theoretical post-rights price

Market capitalisation before the rights issue
+ Proceeds of rights issue
÷ Total number of shares in issue post-rights

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Rights issue

 What is Rights Issue of Shares?

 A rights issue of shares is basically a way through which a listed
company in a stock exchange raises additional fund. It may seem similar
to the Follow-on Public Offer (FPO), but there is a catch here. Here
the new shares being issued are not offered to the public, instead, it is
offered to the existing shareholders of the company. The shareholders
have the right to subscribe the shares in proportion to their existing
holdings, in a pre-defined time period.
 For example, 1:2 rights issues signify that the existing shareholders of
the company can purchase one extra share for every two shares already
held in the Demat account. Here, a very important point to be noted that
the new shares are issued at a discounted price than the current or
prevailing rate in the market.
 

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Why Does a Company Go for Rights Issue of Shares?
 Companies opt for the rights issue of shares to raise funds for expansion,
launching new products, improving debt to equity ratio, paying off debt or
for taking over another company. It is perhaps one of the best ways to
raise capital without incurring additional debt because instead of
borrowing money from the banks and pay high-interest rates, it is quite a
feasible option to raise funds from the existing shareholders.
Advantages of the Rights Issue of Shares
 The shares are offered to the shareholders at the discounted price to
encourage them to purchase the rights issue.
 The company saves a significant amount of money, such as underwriting
fees, advertisement cost and so on.
 The control of the company remains in the hands of the existing
shareholders. This is because the shares are only issued to those
shareholders who on the date of rights issue are the holders of the
shares.
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 There is an equitable distribution of the shares and the same proportion
of the voting rights.
Disadvantages of the Rights Issue of Shares
 The company may not be able to raise more funds and fail to achieve
their target. This may happen if the existing shareholders of the
company are not too keen to invest more.
 The value of each share may get diluted if there are an increased
number of shares issued.
 If a well-established company is going for the rights issue of the shares,
then it goes on to create a negative market sentiment. It is assumed that
the company is struggling to run its business operations smoothly.
Types of Rights Issue of Shares
 There are two main types of rights issue of shares, which are as follows:

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 Renounceable Rights Issue: Here, an existing shareholder of the
company has the right to transfer his/her right to subscribe rights issue of
shares to anyone who may not be even shareholder of the company.
 Non-Renounceable Rights Issue: The existing shareholders do not have
the right to transfer his/her right to subscribe rights issue of shares to
anyone. Here, the shareholder only has two options available, either to
skip or purchase the shares.
 Procedure for Rights Issue of Shares
There is a proper process that is followed by the company for the rights
issue of shares, which is mentioned below:
A board meeting is called for the purpose of the rights issue of shares.
After the approval of the board of directors of the company, an offer letter for
the rights issue of shares, which also includes the right for renunciation
option, is sent to the existing shareholders of the company. It must be noted
that the letter must reach the shareholders around three days before the
date of the rights issue.
 

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 The company must receive the letters of rejection or acceptance from
the shareholders.
 A board meeting is called again to approve the allotment of the shares to
the shareholders who have shown keen interest to subscribe to the
rights issue of shares.
 A share certificate is issued to the shareholders

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Bonus issue

 In a bonus issue, retained profits are capitalised to give new shares to

the shareholders, in proportion to their existing holdings
 The par value of the shares remains the same
 No new cash is received by the company
 The theoretical price after the bonus issue can be calculated. The actual
price will differ from this due to investors’ views on the information
released at the time of the issue

Theoretical price after the bonus issue

Market capitalisation before the issue
÷ Total number of shares in issue after the bonus issue

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What is Bonus issue

 A bonus issue, also known as a scrip issue or a capitalization issue, is

an offer of free additional shares to existing shareholders. A company
may decide to distribute further shares as an alternative to increasing
the dividend payout. For example, a company may give one bonus
share for every five shares held.
 Introduction
 A bonus issue is an offer given to the existing shareholders of the
company to subscribe for additional shares. Instead of increasing the
dividend payout, the companies offer to distribute additional shares to
the shareholders. For example, the company may decide to give out one
bonus share for every ten shares held.
 Understanding Bonus Issue
 Such an offer is given when the company is short of cash, and the
shareholders expect regular income. Bonus issue does not involve cash
flow in the company. It does not increase the net assets of the company
but only the share capital.
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