Whatever the strengths and weaknesses of the various systems available to help companies build and measure shareholder value, none will get very far without real commitment to the endeavor from the top. That means senior management. The CEO and CFO must both be talking the talk – and making sure they are heard throughout the company; they must also follow through with internal implementation systems that show they mean business. And managing for value has to be about the long term, since it goes to the heart of the way capital is allocated for future investment.
Fine words. But words reminiscent of these have been used in connection with most of the management fads of the last quarter century. So how do successful value creators turn them into quantifiable action? To find out, Investor Relations talked to key people at three European companies espousing value-based management.
The first is Lloyds TSB, one of the UK’s big four clearing banks. Plain Lloyds Bank until 1995 when it merged with the Trustee Savings Bank, the company is now easily the most profitable of the UK’s banks and its chairman Sir Brian Pitman is one of the City’s value-creating heroes. He, group finance director Kent Atkinson and others have been rigorous in their application of value-based management processes and principles at the bank.
A more seat-of-the-pants approach has been taken by our second profiled company, Bank of Ireland in Dublin. It has only just started to adopt formal measurement systems after a decade of producing outstanding returns to shareholders without them.
The third profile, of SGL Carbon, looks at a very different animal: a company that’s just five-years old; operates in an obscure sector; and is domiciled – for now, at least – in a country that doesn’t even have a term for shareholder value. Yet the pursuit of shareholder value has been its guiding light. Pitman’s Progress
‘Brian Pitman first talked about shareholder value in 1983, when he’d just become CEO,’ recalls Kent Atkinson, group finance director at Lloyds TSB. ‘Nobody else was using the term in the UK then and we assumed some American guru had got hold of him.’
In those days Pitman was talking about creating shareholder value. Today, it’s a question of maximizing shareholder value. Atkinson sums up the difference. ‘You create value if you make a penny more than the cost of equity. If you’re making two or three pennies more, then you’re talking about maximizing shareholder value.’
And if shareholder value is to be more than a general term used by senior management in the hope of persuading investors of their good intentions, a company needs to be disciplined in its approach to its creation, measurement and maximization. The regime at Lloyds is undoubtedly rigorous, and it informs the group’s whole approach to strategy, business development, performance-related pay and more.
The discipline begins with putting an absolute limit on the capital available for investment. ‘This creates what Sir Brian Pitman likes to call healthy tension – otherwise known as a dogfight,’ notes Atkinson. ‘Even if every business unit creates value, they create different amounts of value. So there’s a league table. And nobody wants to be at the bottom of that table.’ Not least because money available for investment gets taken away from the division at the bottom of the league and given to the top.
This has resulted, among other things, in Lloyds TSB shying away from corporate banking or stockbroking. ‘You maximize value in retail businesses – mortgages, insurance, pensions and so on,’ believes Atkinson. ‘And if you look at Lloyds TSB, you’ll see that we have become more and more retail over the years.’
But how can Pitman, Atkinson et al be so confident that Lloyds TSB really is maximizing shareholder value? What are the measures?
Back in the early 1980s Lloyds’ board asked itself that question and discovered that FT-SE and S&P 500 companies were typically doubling their value every six or seven years as they still are today. The best companies double shareholder value every four to five years; and truly exceptional companies double it every three years.
Lloyds TSB, for the past 15 years, has doubled shareholder value every three years. But, according to Atkinson, ‘Although we’ve been at this for 15 years, we’re still learning every day.’ He readily acknowledges the company that served as a role model: ‘We got it from Coke,’ he says. And he notes that it’s no coincidence companies like Coke, Kellogs, and GE, which typically feature in Most Admired Companies lists, are those that manage for value.
Lloyds TSB uses warranted equity value, a variant of EVA, for measuring value, and all its business decisions are judged in the light of the economic profit they will produce. ‘This is the only measure that brings in growth in equity and return on equity,’ avers Atkinson. It represents the profit attributable to shareholders, less a charge for the equity invested in the business.
Atkinson stresses that the preoccupation with shareholder value permeates the company – not surprisingly, given that three-quarters of its staff are also shareholders. The impact certainly reaches down to the level of the business units. ‘They report economic profit figures. They are rewarded according to economic profit figures. And if they want to spend capital, they have to calculate the impact on the warranted equity value and the economic profit.’
Although Lloyds has been driven by the goal of maximizing shareholder value for a decade and a half, it was only in February of this year that it rolled out the economic profit concept to the financial community. And the following month it became the first UK company to publish economic profit figures in its annual report & accounts, a report that, incidentally, is peppered with references to shareholder value.
Simple Recipe
For Paul D’Alton, finance director at the Bank of Ireland, there are two distinct ingredients to shareholder value: ‘One is the mindset; the other is the more formal techniques used for measuring value.’
Only in recent times has Bank of Ireland been using the latter, with assistance from Price Waterhouse’s shareholder value consultants. ‘You have to walk the talk,’ says D’Alton, but he has no doubt that mindset is more important than technical process. Indeed, he believes that having the technical wherewithal without the right culture is pretty worthless. ‘And we’ve had the mindset for years,’ he says. ‘It’s been in our mission statement for a long time. We’re now trying to reinforce that by introducing formal shareholder value measurement.’
Bank of Ireland’s impressive record of total returns to shareholders over the last ten years certainly bears witness to its shareholder value mindset. ‘Our return on equity has been into the 20s for a number of years,’ D’Alton points out, while acknowledging that external factors have worked in its favor. These include the impressive performance of the Irish economy in recent years, earning it the Celtic tiger moniker.
Another benign factor for Bank of Ireland has been the establishment of the financial services center in Dublin. The key benefit here is the low 10 percent tax rate for financial services activities undertaken for export under the umbrella of the center. In the Bank’s case, these mostly take the form of forex business, structured financings and syndicated loans.
But external factors are only part of the equation. The bank has a strong market share in its key areas of deposit taking, lending and mortgage business. ‘So we’ve had good volumes, fueled by the growth of the economy,’ notes D’Alton. In shareholder value terms, of course, the amount of business is one thing, its worth quite another. A steadily declining cost:income ratio illustrates the bank’s achievement here. That ratio has come down from 65 percent in 1992 to 59 percent last year.
In terms of deals, the bank has recently been involved in two major corporate transactions. The first was the merger of New Hampshire Bank, a wholly-owned subsidiary, and Citizens Bank. Bank of Ireland ended up with 23 percent of the enlarged bank.
The second was the Bank’s acquisition of Bristol & West Building Society. ‘That was a good acquisition for us,’ notes D’Alton. ‘It was earnings-accretive almost from day one.’ Bristol & West’s business is focused fairly and squarely on mortgage lending, savings and investments – activities which may sound to some like the less glamorous areas of banking but, as D’Alton says, ‘It’s a business that enjoys a relatively low level of risk and one that we know well.’ It’s also a particularly good business in the bank’s home territory. ‘Ireland traditionally has very high home ownership levels,’ explains D’Alton. ‘And whatever other financial demands are facing Irish home-owners, they virtually always meet their mortgage payments.’
But that’s not to say Bank of Ireland has stayed out of institutional business. On the contrary, it has expanded its international asset management activities over the last half dozen years, mainly managing global portfolios on behalf of US institutions. D’Alton says the bank now manages some $10 bn from the US – up from almost nothing six years ago.’
Put all that together and Bank of Ireland has earned a record of value creation to be proud of. But how far is shareholder value growth consciously pursued by senior management? How far is it just a question of running the business as well as possible with value creation resulting as a natural and welcome by-product? ‘We’re certainly conscious of it at the strategic planning level; and it certainly influences our approach to acquisitions,’ answers D’Alton. ‘Before we looked at Bristol & West, for example, we formally considered whether a buy-back would have delivered more value. But we decided buying Bristol & West would serve shareholders better.’
Nevertheless, this record has been achieved without recourse to the measuring and monitoring techniques proffered by consultants. Indeed, the bank’s senior executive stock option scheme is tied to EPS, a measure scorned by most shareholder value enthusiasts. But all that is likely to change pretty soon, as the company seeks to reinforce and monitor its cultural preoccupation with shareholder value through implementation of a systematic methodology.
Lean On Me
Across the channel in Wiesbaden, Germany, Robert Koehler, chairman of SGL Carbon, has been running his company in accordance with shareholder value precepts ever since it was spun out of Hoechst AG. For Koehler, the methodology is essential. ‘It’s just a crutch but it’s a necessary crutch. It’s a crutch to change the thinking.’
Koehler, whose company manufactures carbon and graphite, is an undoubted maverick, particularly in the German context. A passionate proponent of managing for value, he has learnt that implementing this approach requires persistence and patience – not to mention communication skills of the highest order. ‘And internal communication is a damn site more difficult than external communication,’ he insists.
Koehler, now 48, worked for Hoechst after training as an economist, ending up at HQ in Germany in corporate planning at the end of the 1980s. There, he was instrumental in moves begun in 1991-2 to restructure the group’s half dozen carbon and graphite businesses into a single global company.
In 1992, SGL Carbon made a loss of DM110 mn on a turnover of DM1 bn. By April 1995, it was ready to raise capital and to sell minority shareholder interests. Now all Koehler’s communication skills were needed. SGL Carbon was an unknown business operating in an obscure sector and based in a country not renowned for its concern for shareholder interests.
Circumstances didn’t make the job any easier: as the international IR and bookbuilding processes got under way (SGL was the first German company to use bookbuilding), the DAX index of leading German shares tumbled from 2,100 to 1,800. Nevertheless, the SGL stock was sold, albeit at DM55, the lower end of the anticipated range. That first sale was followed by offerings of two further tranches of Hoechst’s holding. The latter, in June 1996, saw SGL listing ADRs on the NYSE only the second German company (after Daimler-Benz) to do so. By now the shares were priced at DM150 – nearly three times the IPO price.
Two and a half years since the original IPO, SGL’s share price has quintupled to around DM250; market cap has grown roughly two-and-a-half times to DM2.5 bn; and the company has become about the 40th highest valued in Germany.
From the start, Koehler’s intention was to manage for shareholder value. The nature of SGL’s business meant it was never going to appeal to retail investors. ‘We knew from the beginning that we had to face the demands of institutions, in terms of our shareholder value approach, in terms of investor relations and communications, and in terms of management commitment,’ explains Koehler.
In the years since then Koehler has learnt more and more about managing for value, he says. Initially the company had outside help with introducing the methodology, from firms like Arthur D Little and KPMG. But the toughest obstacles facing SGL have been cultural ones. ‘Shareholder value is gaining momentum in Germany but to a large extent it is still lip service. Germans are among the last to understand it. They still don’t understand it,’ he says, noting that there is a debate currently going on about how the term should be translated. ‘It’s interesting: German has no word for shareholder value; English doesn’t have a word for Schadenfreude.’
This is just one of Koehler’s complaints about Germany. He has little respect for his fellow citizens’ approach to business. He is dismissive of their lack of ambition and entrepreneurial zeal, their lack of competitive instincts and the difficulty, as a result of all that, of incentivizing staff.
Rocking the Boat
SGL has rocked the German corporate boat in various ways, among them by becoming the first company in Germany to offer US imports like share ownership and stock option schemes to its management and staff. More flexible management compensation, linked to the shareholder value corporate strategy, are important tools for fostering a change in attitude. ‘The philosophy behind this is to facilitate a change from the employed manager syndrome to the owner-manager syndrome. That’s a very difficult task in Germany,’ Koehler avers.
But then, SGL’s management and staff are not particularly German – either literally or metaphorically speaking. All in all, some two-thirds of the total staff of the company worldwide, and two out of the company’s four-strong executive committee, are non-Germans. Koehler knows he must recruit to management positions people who, if they are German, have sloughed off the old corporate culture with its civil service approach to management so that they can help build an entrepreneurial spirit and, in turn, pass the shareholder value message on down through the company.
So does stockholder value now pervade the company? ‘I wouldn’t claim that,’ responds Koehler with disarming honesty. ‘It’s a very long-haul process. I’d say we’re perhaps half way through.’
But this brings him back to the value he places on internal communication. ‘You’re only as good as the next link in the chain,’ he maintains. ‘Value-based management is a set of mind, a management philosophy. Once you have the system in place you look at every strategy, every business plan, every acquisition, from the point of view: Does it create value? Or does it destroy value?’
For Koehler, managers are there, above all, to communicate the philosophy. ‘And in my view, what cannot be communicated cannot be implemented.’
Lloyds TSB
Total Return to Shareholders 35%
Share Price Increase 30%
Cost:Income Ratio 56%
Increase in Shareholders’ Funds 21%
Increase in Economic Profit 69%
Increase in EPS 47%
Increase in Market Cap 37%
Source: Lloyds TSB – all figures for 1996
Bank of Ireland
Total Return to Shareholders 55%
Share Price Increase 51%
Cost:Income Ratio 59%
Return on Stockholders’ Funds 21.7%
Increase in Profit 8.8%
Increase in EPS 0.77%
Increase in Market Cap 53%
Source: Bank of Ireland – all figures for 1996-97
SGL Carbon
- Total Return to Shareholders 76%
- Share Price Increase 75%
- Cost:Income Ratio 5%
- Increase in Profit 25%
- Increase in EPS 18%
- Increase in Market Cap 65%
Source: SGL Carbon – all figures for 1996
