Companies' that create value ,win. those that cannot ,lose. But once captured value has to be sustained .
Which value ? Book value Liquidation value Market value Replacement value A company creates value for shareholders when the shareholder return exceeds the required return to equity (Ke). In other words, a company creates value when it outperforms expectations. Created shareholder value is quantified as follows: Created shareholder value = Equity market value x (Shareholder return - Ke) Created shareholder value can also be calculated as follows: Created shareholder value = Shareholder value added - (Equity market value x Ke). What Drives Shareholder Value? Many corporate executives still focus on quarterly earnings figures as a key driver of stock market values. Although no-one can discount the importance of quarterly earnings numbers or the impact on the stock market of earnings surprises, they are not the fundamental driver. Stock market values are driven by real corporate performance, as compared to market benchmarks. The key relationship is whether the money entrusted to corporate management earns a higher return than the owners can get elsewhere. Focusing on this key relationship differentiates the value manager from other managerial styles. Implementing a value managerial system can be accomplished by two main metrics: a sales, operating margin, turnover metric and a more traditional return on investment, reinvestment rate metric. Both metrics are simply ways of expressing the underlying determinants of market value. The most critical decision facing a firm is whether to adopt a value based managerial system rather than a particular set of decision tools.
Discussion of finance topics involves both normative and positive statements, and it is important to be aware of their distinction. Normativestatements refer to what ought to be and are usually derived from an assumption about how the world behaves. This is most evident in standard economics topics, where assumptions about human and corporate behaviour are made to derive supply and demand curves, which are then used to explain how prices are determined. Financial theory is an application of these standard economic models to explain how prices in the capital market are determined. As such, financial economists use essentially the same tools as their colleagues in other areas of economics to predict how, for example, equity prices ought to be determined, and how as a result corporate management ought to behave. In contrast, positive statements refer to what is, was or will be, it is commonly referred to as an appeal to the facts.1 The above distinction between positive and normative statements is imp
Value creation: accretion in value
value moves in mysterious ways. Some strategies work, some of the times. Others, don't all the time the ability to cut through the cross Sections of industry and company profitability and see the pattern that functions as invisible forces that add and destroy value is invaluable. The capacity to decipher profit patterns is the ultimate strategy machine .
Why should Infosys go for NASDAQ listing when stock prices in domestic markets were piercing through the roof ?
why should Reliance & MTNL, Wipro etc list their shares at NYSE . Why should united phosphorous prepare two sets of corporate accounts- one for domestic markets as per AS-ICAI other as per GAAP- of USA.
Morgan Stanley mutual fund bought back 300cr. Worth of its unit capital to reduce the corpus from 1000 cr. To 700 cr. What for?
Obviously all these gestures are for shareholder vale creation.
Similarly Ballarpur hived off majority of the unrelated business activities-glass, chemicals etc. and ACC sold off its ferrites (unrelated) business and took over eternit-everest ( related business). Why shareholder value? Shareholder Value or. Market capitalization but for certain aberrations is offen a reflection of the equity markets expectations of the future performance of a company. For corporate to grow- they must attract capital therefore they must focus on shareholder value. Tremendous growth and importance of Shareholder Value concept globally because: 1- increasing amount of private capital in developed countries have reached their limits of taxation and borrowing powers using pension & social security funds. Growth of private mutual funds institutional investors expansion of equity markets & increasing proportion of equities held by institutions. . Investor wants the funds to maximize their performance; in turn the funds demand value from the companies they invest in 2. Globalization of markets: Financial deregulation has created global market for financial assets. Corporate now compete globally not only for products, customer and employees but for capital too. Attracting capital depends on being the best in class with a thrust on shareholder value 3. Information: Complex calculations and access to information through computers and internet has assisted investors to evaluate corporate in terms of the value creation. Indian scenario Since independence in 47- Govt. the major stockholder in business Economic policy followed import substitution and protected regime. Extensive public ownership of productive capital with complex cans boles regulations. Restriction on foreign ownership of capital. Financial inst itutions and govt. the provider of capital Outcome: public operates consumed resources without providing adequate returns. Pvt. Corporate-key driver of growth The procurement of licenses. Banking sector-directed lending to demand priority crease NPAs 1991 winds of liberalization: Economic reforms accompanied with financial sector reforms. Pvt. Players allowed in banking mutual funds industry FIIs were allowed to invest in Indian equity. Corporate allowed to raise GDRs ADRs Greater freedom to financial intermediates to raise resources. Competition led to greater accountability to fund providers dismantling of capital issue controls. FII and GDR investment had a relatively higher growth institutional investors have expressed concern regarding the shareholder value and lack of transparency and quality of information of Indian companies. Shareholder value: key future drivers: greater stiv orientatition of domestic MFs. The earlier rate of passive non-interfering creditors/ minority shareholders would have to change to aggressive shareholder value oriented institutional investors. Growth in importance of pvt. Investors Quantum of FII & GDR in vests shall be guided by presence of Sh. V. Oriented globally competitive corporate.
privatization:
Greater exposure to equity mkt. why is would feed to a change in mgt. style-oriented towards shareholder value creation. The Indian corporate: A greater sensitivity to the interests of share holders would feed to appreciation by equity markets and an enhanced monetary flow into equity markets. Creating value for the shareholder is not an overnight thing it is a long term objective our goal is to keep enhancing this value-over a changing mix of changing business cycle Sustain ably enhancing value for shareholders will come from a sound competitive strategy, improving profits, a fair dislnbution policy and corporate transparency that rein forces investor condolence Economic value added [EVA] 1 Average debt - 500cr 2. Average equity - 1500cr 3. Average capital employed (1+2) absolute amt.)3. 4. Cost of debt post tax % 5. Cost of equity % 6. Weighted average cost of capital WACC (%) 6% 7. COCE= 3x6- 200x6% 8. Profit after tax (PAT) 9. Add. Interest offer taxes 10. Net operating profit offer taxes (NOPAT)- 11. EVA= NOPAT-COCE (10-7) 12 EVA % capital employed= EVA/average capital employed = (11/3) 1997-98 1998-99 1. AVERAGE DEBT. 49.6 CR. 65.6 CR. 2. AVERAGE EQUITY 35.2 CR. 49.7 CR. 3. AV. CAPITAL EMPLOYED 84.8 CR. 115.0 CR. 4. COST OF DEBT POST TAX( % ) 8.82% 9.75% 5. COST OF EQUITY % 22.5% 22.5% 6. WACC 14.5% 15.26% 7. COCE 12.3 CR. 17.5 CR. 8. PAT 12.7 CR. 22.1 CR. 9. ADD INTEREST OFFER TAXES. 4.13 CR. 6.06 CR. 10. NET OPERATING PROFIT OFFER TAX 16.7 CR. 28.2 CR. 11. COCE (AS PER 7) 12.3 CR 17.5 CR. 12. EVA AS % OF COCE 4.6/12.3 CR. 10.7 CR/17.5 CR. (12/3) 5.44% 9.28% Economic value added: EVA EVA is the profit realized offer deducting the cost of all capital employed (Debt equity) EVA is the amount by which the companys pre interest but offer tax net operating income (or NOPAT) exceeds the charge for capital. Coco colas CEO Robert goizueta remarked you only get richer of you invest money at a higher return than the cost of that money to you. Every body knows that but many seem to forget it EXP: NILKAMAL registered an Eva of 10.68 corers in 1998-99. This indicates that the co. was able to meet the expectations of its shareholders. Traditional approaches to measuring Shareholder value creation have used parameters such as earnings capitalization, market capitalization and PV estimates of cash flows. Extensive equity research has now established that it is not earnings per se but value which is important. A new measure called economic being applied to understand and evaluate financial performance. EVA= net operating profits after taxes (NOPAT) (minus) EVA NOPAT-COCE) Cost of capital employed Where NOPST: = profits after depreciation and taxes but before interest costs. It represents the total pool of profits available on an unguarded basis to provide a return to lenders shareholders. COCE: is weighted average cost of capital WACC+average capital employed. Cost of debt is taken as effective rate of invest applicable to a rates co. (HLL-AAA-14% pre tax) Cost of equity: is the return expected by investors to compensate them for variability in returns caused by fluctuating earnings and share price. Cost equity (HLL) = risk free return equivalent to yield on long term Govt. bonds (12.5%) RM. Market risk premium (9%) x beta equivalent fore co. (.8) =12.5 %+( 9%x.8) HLL its Ke. = 19.7% Ke Eva is a residual income offer charging the co. for the cost of capital provided by fondues shareholders it represents the value added to the shareholder by generating op profit. KO capital employees. EVA-developed by stern Stewart co. VSA from definition stand point EVA refers to the systems of corporate management that defines profitability in farms of the returns on capital above the cost of servicing the capital employed. EVA, however is not just a measure of operating performance, it is also a highly sophisticated tool of financial management which encompasses the entire financial management which encompasses the entire financial management function from capital budgeting acquisition pricing to tragic planning and shareholder communications When will EVA increase: 1. efficiency? Eva will increase if: 2. profitable operating profits can be made to grow without employing more capital i.e. greater efficiency additional capital is invested in projects that return more than the cost of obtaining funds (new capital) i.e. profitable growth-(takeover) capital is curtailed in activities that dont cover the cost of capital i.e. Liquidate unproductive i.e. Liquidate unproductive capital (hive-off) Or Theodora me thud of evaluating performance: 1. prt-interest profit/total turnover NPBT/sales
% PBIDT to year ROCE 2.return on capital employed % 3.return on net worth (RONW)% Growth in PBIDT. % New techniques: 1.EVA.-stern Stewart co. U&A. 2.Market capitalization to sales-Adrian slyworkly. Latest techniques of creating Shareholder value .1. Buy back of shares: Reduction in capital Enhanced EPS Communization of massage of value. Exp: Indian rayon buy back through book building selan exploration buying back at Rs.20/- Easel packing to buy back at 300/- [Scrip shooting at 500/- fabulous dividend instead] ESOP: employees stock option scheme to create shareholder value. Creeping acquisition: Exp: 1. reliance going for creeping acquisition 2. TISCO/TELCO-Tata's stake enhanced. ACC-Rs 100/-share to Rs 10/- . 10 share for one WIPRO-splitting the stock price % Rs. 21/- ZEE-splitting Rs. 10 stock % Rs.1/- Splits have become convenient because of dematerialization Offer of shares. Exp: orchid chemicals offering shares to Asia pacific funds (36.11%) at 164/- Promoters equity diluted The scrip price jumps from Rs 170 % Rs. 270/- in 6 sessions. Corporate restructuring: Ballarpur hiving off unrelated activities. Wealth creators & destroyers Whether shareholder value management is a fad? That vill eventually pass? No its a global phenomenon that is especially relevant in the Indian context. Good corporate governance:- is about ensuring that managers run the business in the long term interests of shareowners and in doing so , ensure that all other stockholders are also taken care of (customer employees , suppliers etc.) Although many companies may manage to comply with regulatory requirements for good corporate governance, their shareowners continue to get a raw deal Managers of mature businesses that generate large cash flows but have limited opportunities for value creating investment projects tend to destroy shareholder wealth by investing too much capital. Back into their existing business and/or making ill conceived and over-priced acquisition forays into unrelated areas. Improving corporate governance and shareholder wealth creation performance is especially relevant in the Indian context for the following reasons: 1. The shareowner wealth creation track record for Indian companies is poor compared with companies in other countries. 2. proportion of population that owns shares is increasing. 3. family-controlled cos are increasing by moving to delegate managerial responsibility to professional rather than family members-driving the need for more formal corporate governance mechanisms 4. Improvements to the takeover code and other regulatory policies are slowly but surely making it eases for Share owns to boot for efficient management the level pf M&A activity is increasing. 5. Global mobility of funds across the world means that opportunity cost of shareowners funds is increasingly real. If Indian corporate dont perform. FIIs will look elsewhere. On an average Indian companies create only 50 paisa of market value added ( MVA) for every rupee of capital invested, whereas pan-Asian, European and U S cos are at lease twice as productive , in other worlds, their MVA/ capital ratios are greater than one. However, Indian companies that create wealth, on an average, earn higher MVA/ capital than their comparable peer set in other economics- WIPRO, INFY, HLL, Reliance, and ITC. Indian wealth creators utilize only 35% of total capital invested in our public capital market. It is alarming to note that the Indian companies which destroy about 26 paisa, For every rupee invested in our market. In contrast, U S economy invests 87% of its capital in wealth creators, in pan- Asian mkts. 65% is invested in wealth creators. The problem with the Indian capital market lies in improper allocation of capital and is a cause of great concern in India. 10 yrs later, J uly 2002, orchid is set to chart a new history of global innovation and integration. Orchid now has a joint venture for drug discovery in the U S A, the worlds largest mkt. for new drug innovations. Orchid is now establishing a joint venture for manufacturing cephalosrin & in china , the worlds largest mkt (non-regulated) for pharmaceuticals. These are but two of the initiatives that exemplify a radical business transformation and structural metamorphosis that under way of orchid to fuel growth. Orchid is well poised to become a composite pharma. Corp. Covering bulk actives, formulations and research through a judicious combination of ORGANIC and INORGANIC growth initiatives. Orchid would be truly multi national in character in the years to come with manufacturing operations in India and china, marketing offices and subsidiaries in the U S, Brazil and Russia and Research infrastructure in India, U S and Europe, China is emerging not only as a worlds largest mkt place but also a very competitive manufacturing base. A manufacturing base in china would be an appropriate move for orchid in the emerging scenario of global integration. Orchid has jointed hands with china pharma. Corp. to promote NCPC orchid pharma co. Ltd, a 50:50 J .V for manufacture and marketing of cephalosporin bulk actives and formulations in china. Pending completion of the non- sterile bulk pardon. Facility orchid will supply the product for first 2 yrs for conversion to the find product. The joint venture could well pave the way for diversification into other the repeaters later. China has emerged as one of the most competitive production bases and the single largest market for pharma cuticles apart from some of the developed markets. Achieving higher value addition optimal capacity utilization and continuous productivity impairments in operations. Orchids corporate strategies, particularly the product market and technology project strategies recognize the concepts of EVA. Orchid has transited from the entry mode in the quickest span of time possible and positioned it self in the growth mode, which is a specific strategic position considering the technology and investment intensive mature of the global pharma. Industry. Through this orchid has been able to optimize the EVA even while assuring long term competitiveness of the business through required investments in technology. Moreover. In specific product segments orchid has been able to position its self in the harvest mode reaping high EVA through prudent operations managements. Orchid would continue to adopt relevant strategic approaches which support long term business development and assuse sustainable value enhancement for shareholders. 1. Av. Shareholders net worth-155.9 cr. 2. Av. Debt-352.7 cr. 3. Av. Capital employed-508.6 cr. 4. Cost of debt (post tax)-9.35% 5. Cost of quity-20.20% 6. WACC-12.71% 7. Cost of capital employed-508.6 crx12.71/100-64.47 cr. Net operating profit offer taxes: Pat - 35.57 cr. Add int. adjusted for taxes. 32.98 cr. No PAT 68.55 cr. EVA- 68.55cr-64.47cr=4.04cr. EVA as % of capital employed-08% MVA is the excess of the market value of the company over the value of investors capital (economic book value). It is an obsolete measure of value, calculated as the total value of the company. It quantifies the premium the market is willing to pay for the value created by the company. MVA=current value of debt+equity-economic book value Economic book value=share capital +free resemes+debt March 31st 1999 Economic book value: Total debt - 312.69 cr. Equity - 17.34 cr. Free resumes 152.47 cr. + Total share holders net worth- 169.81 cr. Total economic book value- =482.51 cr. Market capitalization of equity: No of out standing shares- 1.73 cr. Share prices. High - 189.90 Low - 84.05 Average 116.55 Market capitalization of equity-(1.73cr.x116x55)=202.17cr. Market value of debt - 312.69 cr. Market value of debt+equity - 514.86cr. MVA- market value- economic book value. 514.86 cr. - 482.51 cr. =32.35 cr. Excess wealth accretion to shareholders over Economic book value- 6.7 % S.V.C. emerging as most crucial criteria in investment selection of a company. Fund managers non relegate other parameters like Industry outlook Investment philosophy of corporate Market capitulation Traded volume. Etc. Now its only shareholder value A co. generates shareholder value only if it generates returns in excess of its Cost of capital Higher growth Higher returns Appropriate risk. Till corporate gear up and show concern for shareholder, raising funds in the stock market will not be easy . Many IT cos have shown voracious hunger for growth and expansion in their effort for building market share. This has produced significantly higher returns for investors composed to many other corporate. Many of the latter through their choice of investments demonstrated inefficient use of capital, speaking volumes about lack of concern for creating shareholder value Gone are the boom days of 90s when shareholders were taken for granted. Tables have turned Managements now realize the need to change tactics to enhance shareholder value.
Turn over
Profit margin Tax rate Working capital Fixed assets Cost Of capital Competitive Advantage. Shareholder Return. Increase of shareholder value Free cash flow valuation. Seven mantras to enhance shareholder value. Increasing importance to share price to 1- Generate wealth to ensure modification of funds. 2- Deface tool to stall takeovers. Study by price water house coopers Shareholding pattern getting more institutionalized making investors more demanding. PWCs study: parameters taken by most senior analysts and fund managers professional investors cover 80% of the assets of Indian mutual funds and 65 % of FIIs Traditional P/E ratios based on historical information no longer on investment tool. Insts investors in their invst. Appraisal look at anticipated future value, based on expected cash flow (FCF) Study conducted in vs. revealed a high correlation Between change in the free cash flow and share price performance. (PWC) Other mkts. In the world experience the some phenomenon. PWC says the shift in investment focus from EPS to free cash flow(FCF) indicates that markets are thinking long term though that is not to say they dont still act short term at times in cash of institutional investors with longer time horizon , the use of free cash flow is more regular in capturing growth risk and return expectations - Ashwin puri PWC stress on free cash flow valuation feeds to the mastering of seven value drivers The golden principle followed is a company generates shareholder value only if it generates returns in excess of cost of capital. Study on U K. Hong Kong- Australia ranks operating profit margin as the highest driver. Delivering value To shareholder The management of BPL is committed to strong thinning shareholder value over the long run. It recognizes that the drivers of the enhanced shareholder value are strategy like a sound competitive strategy, implored profits, a fair distribution policy and corporate transparency that reinforces investor confidence.
The value creation drivers of BPLs business Operating profit margin Tax rate Fixed capital investment management Working capital management Sales growth KPMG &BS made first ever ranking of Indian companies by value creation. Shareholder value is bound to appear in most of the annual reports in good / well established corporate (h level, Nilkamal, BPL ,Ranbaxy, L&T etc.) No longer can managements gloat over its gigantic expansion plans, unless it is sure it can meet stringent return on capital norm. A dramatic shift in the way the co's are measured & evaluated. Metric predecessors: Return on sales (ROS) was good when markets were not very competitive and firms could concentrate on asset and market share buildup. Whenever a firm needed to increase value, it could simply take a margin like. Once markets become competitive the freedom to increase margins is reduced. Since every body has sufficient assets (capacities), the priority has to shift from building assets to utilizing the existing assets most effectively a shift to ROI. ROI: the way to improve ROI is to improve w . Cap. Mgt, turn assets faster, better liquid cash mgt. Speeds up collections delay payable dont leave cash lying around. Efficient treasury management and cash management leads to better ROI: The use ROI has offen led to co's to adopt value destroying approach to growth and put the measure (ROI) under question. ROI is unsuitable for semiconductor / software inds-where the rate of change of product performance and cost of manufacturing are non-linear. The 1980s saw the rise of ROE, ROCE & RONA which used earnings as a measure of invested capital. Managers realized that the more the depreciation of assets the lower was capital employed and higher RONA. They found that they could apparently improve earnings efficiency without increasing assets. Managers immediately switched to milking the existing asset base and refrained from reinvesting for the future. Enter EVA. With EVA, the capitals providers are making corporate understand that growth is a privilege and not a right. They are making the marketing finance people evolve a strategy that is sustainable as well as viable. The moment a firm starts developing its strategy with inputs from marketing finance and production it adopts a cross functional approach. So, unprofitable and value destroying activities can be hunted down and mitigated. Share holder value measure ments are now routinely used by a wide cross section of brokers fund managers and company executives. However, much of this effort at measuring share holders value is seldom disseminated across a wide cross-section of industry. There fore no one is sure to how Indian firms have fared on value creation. Surry of KPMGRBS in 1998 computed economic profit (EP) And market value added (MVA) To lest 1000 corporate. EP: after tax operating profits. A snapshot MVA: A longer term picture. Contemporary indicators used by analysts to estimate shareholder value. 1. Total shareholder return: Since dividends and expansion in market capitulations are the too principal ways in which shareholder value can be enriched, TSR takes into A/C the sum of these 2 factors. The increase in market capitalization is added to the dividend paid during the financial Y.R the sum is then expressed as a % of mkt. cap. Of co. at the beginning of the year under renew. Rs.cr. Year 1996-97 97-98 98-99 Closing capital value 20.14 18.08 70.78 (17.30) Less of value (cap.) 25.45 18.64 13.30 Add dividend 1.89 2.06 3.43 Incremental gain. 3.42 1.50 56.98 Inc. gain/beg. Value(%) 13.44 8.04 330.70 Look at yields, rather than get into the distribution battle zones: top brands Pantene, Ariel, whisper , Camay& Vicks to be advertised heavily on its own. Smaller brands 10 % of volume shifted to Marico. NIIT appointed stern steward to provide training to its 400 managers. Task: introducing the concept to managers helping then grasp the nuances of implementing EVA. 1. Measuring performance at 125 EVA points. Managers generating EVA reports. 2. Use the concept while making investment decision buying was sacrificed by outsourcing the main frame time with utilization being low. 3. introduce EVA into planning goal setting and budgeting 4. Link it to compensation. EVA brochures, EVA news letters Eva web pages. EVA in practice 2 One manager was using both a desk top a well as a note book now he has only a notebook. NIIT is banking on eventual linkage of compensation to EVA So for you were rewarded for your effort, now You will be rewarded for results The very notion of having a large component of ones salary being variable is something new in Indian context. COCE. 1996. 1997 1998. 1. AV. Debt. 156 160 16.5 2. AV. Equity 815 1127 1487 3. AV. Cap. Employed (1+2) 971 1287 1652 4. Cost of debt post tax (%) 7.88 8.82 9.10 5. Cost of equity 19.7 19.7 19.7 6. WACC % 17.8 18.34 18.64 7. COCE (3x6) 173 cr. 236 cr. 308 cr. 8. PAT 413 580 837 9. add. Interest offer tax. 32 21 19. 10. NO PAT (8+9) 445 601 856 11.COCE (7) 173 236 308 EVA_(10-11) 272 365 548 EVA % of capital Employed (12/3) 28. 01% 28.39% 33.22%. EVAis being widely used as a tool to measure value added to the organization during the facial year. It takes into account the cost of capital that the company incurs to generate it suppose and add value to its shareholders. EVA. Is an indicator of the operating efficiency of the company and its ability to add (value to its shareholders) to the bottom- line by reducing financing charges. 1999 1997 Operating profit before int & tax 934 476 net profit. 518 335 Shareholders funds 3838 2753 Debt 1109 625 Total capital employed. 4948 3359 Cost of debt 11.57% 21.10% Ke. 18.44% 18.44% WACC 15.94% 15.22% Absolute cost of capital 788 511 EVA- (OPBIT-ACC) 145 -34