Business

Value creation and investor management

What does “value creation” mean? How can companies prevent value improvement plans from culminating in value destruction? The answers lie in Value-Based Management, a framework designed to manage internal corporate processes in order to maximize the value created.

Why are value improvement plans often failing to impact the market value of the company? Is it an undervaluation problem? How can managers change the market assessment? The answers lie in Active Shareholder Management, a framework designed to identify target investors through segmentation and develop a strategy that, in line with value creation plans, allows a company to optimize its market value and for the shareholder.

A comprehensive vision of value creation is presented below, from an internal point of view, Value-Based Management, and from an external point of view, Active Shareholder Management.

What does “value creation” mean?

It is common for management to announce plans to create shareholder value. It’s also common for your financial statements going forward to reveal that, if anything, the value has been destroyed. What went wrong?

It is critical that managers realize that “value creation” is a clearly defined and tangible measure, based on personal interpretations or evaluations. There are mathematical formulas that objectively and rigorously verify whether value has actually been created, based on the financial statements. These formulas are based on the EVA (TM) or Economic Benefit concept, which is defined as the difference between the return on invested capital and its cost.

If the return on capital employed is greater than its cost, the company is creating value. Otherwise, you are destroying the value.

Once “value creation” is defined, how can it be maximized?

In our consulting experience, companies with low value creation tendencies are often plagued by poor management processes. VBM (Value-Based Management) is an approach that aims to maximize value creation by leveraging and effectively aligning strategic actions, resource allocation, performance evaluation, and management rewards.

VBM has been successfully implemented by a large number of very diverse companies around the world. Some demonstrate the focus in their external communications: for example, see the section of the BASF website dedicated to creating value.

Companies may differ in terms of size and business focus, but if they have successfully implemented VBM, they share two elements: an organic approach and a well-designed roadmap.

Implementing VBM means redesigning and aligning all internal processes. Once the value creation indicator is well defined, all processes, from the strategic plan to the management incentives, must be renewed.

Logically, VBM should start with the construction of a strategic plan designed to maximize the value creation indicator. The next stage is disciplined execution, which is monitored by a system of Key Performance Indicators. Finally, the management incentive plan should be configured to focus on creating value.

VBM implementation

The standard VBM framework can be modified based on customer needs and priorities. You can also change the time and characteristics of the deployment.

The key point for a successful VBM program is organic implementation, even if the sequence of projects and actions differs from company to company. VBM implementation requires discipline to follow a precise plan of action. The administration must have a roadmap that clearly defines all the actions to be taken in some key dimensions (value indicators, processes, systems and incentives) and establishes clear milestones.

A medium to long-term range of vision is necessary to drive implementation effectively. That’s why CEOs with “short-term reach” tend not to start such programs.

VBM is a comprehensive program that requires a strong leader, usually the CEO, to drive its implementation. Introducing the approach is an opportunity for a significant cultural change and upgrade in the company. Within the roadmap, management must also plan times for collective discussions, sharing and aligning the entire management team, in addition to communication and training sessions throughout the organization.

VBM is not just something to make the business run better. It is the key methodology to maximize the economic benefit and, consequently, the value of the shares of the company. In fact, the market value of the company is directly related to the present value of the future performance of the company, measured as economic profit.

Simply deciding to adopt VBM is not enough. It is common for VBM adopters not to translate improvement plans into higher market value. The mismatch stems from two root causes: unrealistic assumptions about planned future performance and, second, lack of recognition from the financial community for the fair value of the company.

This article investigates the second problem.

Active investor management

Some managers accuse the market of not being rational enough. However, we believe that the problem is not a crooked dance floor. The main source of mismatch between the market value and the expected improvements in Economic Profit lies in the inability of the administration to adequately communicate the value of the company to the outside world.

Active Shareholder Management (ASM) is an innovative methodology to improve the market value of the company by managing key financial investors. The main objective of ASM is to develop a strategy that, given internal plans and results, maximizes value for shareholders.

The ASM approach is based on Investor Segmentation, a tool for identifying and understanding top investors and managing them accordingly. Investor Segmentation takes advantage of the breadth of increasingly available information channels to provide CEOs and CFOs with the necessary elements to target new investors and define an active and effective financial communication strategy.

Investor segmentation is based on a coordinated analytical effort. It can be carried out through various data collection methods and market intelligence sources. Specific interviews are conducted with investors to describe management styles and behaviors. Documentary research allows the investigation of different investor strategies and groups them in a homogeneous way.

Special attention should be paid to investors who own significant assets in similar companies, identifying the most relevant shareholders, including those who currently do not hold positions and could be at risk of being further explored.

With key investor identification in hand, managers are equipped to visualize the actions necessary to improve shareholder value. In fact, based on the ASM approach, managers can “test” their potential stocks by simulating investors’ reactions with the help of mathematical models and thus can predict the impact on the value of stocks.

The future behavior of investors is a relevant input for the commercial, financial and communication strategy.

Consider the dividend strategy. Some investors do not “appreciate” dividends, many for tax reasons. Others do like, for example, shareholders in low-tax brackets who need cash from dividend payments or tax-exempt institutions that need periodic cash. Many investors are simply used to receiving dividends from a certain company and would not welcome any reduction.

There are also investors who prefer companies that pay no dividends and instead funnel money into ambitious “growth stocks” strategies. Other investors prefer more stable behaviors, typically “stock value” companies, where dividends are usually quite high and constant.

These preferences are often public knowledge and can greatly influence fund managers’ actual portfolio strategy. Knowing this information can help managers better understand which investors would be attracted to their strategies.

Share buybacks and splitting, common tools for increasing the market value of the company, should also be planned with key investors in mind, taking into account their needs and foreseeable reactions. Share buybacks can provide a strong signal of management’s confidence in future performance. Following buyback announcements, financial analysts frequently revise their forecast earnings estimates upward. An empirical study showed an abnormal average return on stocks of 3.42%.

Managers must develop ad hoc approaches for each identified investor segment. For example, investors who rely on analysis based on “strategic” issues would prefer information on industry trends, competitive strengths, and new “growth stories.” Meanwhile, “finance-oriented” investors prefer data related to cash flow, operating profitability, and returns on working capital. Communication actions, such as preferred channels and meeting frequency, need to be adapted accordingly.

ASM implementation

The ASM management methodology has yet to catch up with VBM popularity, primarily because investor management is typically restricted to the Investor Relations team, but should be an organization-wide process.

Many companies, including large corporations, manage investors with a highly qualitative approach, based on personal relationships. Analytics is used little and infrequently, which is a surprising difference compared to standard sales and marketing activities and tools, essentially helping a business sell a product / service to someone (a customer, not a customer). investor).

To build momentum for ASM implementation, a clear benefit case must be built. In addition to the benefits already described, another key benefit of ASM is the opportunity for senior managers to invest their valuable and expensive time with greater precision. In-depth knowledge of target investors enhances focus: Management can only attend the “right” events and meet only the “right” investors.

In conclusion, value creation can and should be measured analytically. It is an objective quantity, not a qualitative interpretation. Best Practices apply Value-Based Management as a tool to manage internal processes in order to increase the value created for shareholders.

When improvements are not reflected in market value, management must work on communication strategies. Active Shareholder Management can be leveraged to influence market perception by getting the right messages to the right investors so they can hear you loud and clear.

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