大众 cash

Strategic Management
3 Shareholder Value
Prof. Dr. Bernd Venohr

Berlin, April 2007
© 2007 Prof. Dr. Bernd Venohr

Agenda
Introduction to Strategy
1 Course Overview and Strategy Concept
2 Economics of Strategy
3 Shareholder Value
Business Strategy
4 External Environment
5 Internal Environment
6 Competitive Positioning
Corporate Strategy
7 Diversification
8 Mergers & Acquisitions
9 Global Strategy
Strategy Process
10 Organizational Structure and Control
11 Strategic Leadership
© 2007 Prof. Dr. Bernd Venohr 2
Agenda
3 Shareholder Value
- Group Reports on Assignment Session 2
- Shareholder Value Concept
- Summary
- New Assignment and Outlook next Session

Where are we today?
Course Overview Economics of
1 Strategy Concept 2 Strategy
3 Shareholder Value
Business Strategy Corporate Strategy

External Internal
4 Environment 5 Environment 7 Diversification
Competitive Mergers & Global

6 Positioning 8 Acquisitions 9 Strategy
Strategy Process
Organizational
10 Structure and
Control
Strategic
11 Leadership
Agenda
3 Shareholder Value
- Summary

Shareholder Value Concept
 Shareholder value is defined as the part of of a companies

capital that is equity as opposed to long-term debt: number of
outstanding shares times current shareprice
 Primary goal for a company is to enrich its shareholders

(owners) by paying dividends and/or causing the stock price to
increase
 More specifically: shareholder money should be used to earn

a higher return then they could earn themselves by investing
their money in alternative assets (measured by cost of capital)
Source: Wikepedia, Shareholder value
Shareholder Value:
The concept was „invented“ by Alfred Rappaport
Alfred Rappaport is the Leonard Spacek Professor

Emeritus at Northwestern University’s J.L. Kellogg
Graduate School of Management
His book, “Creating Shareholder Value: The New

Standard for Business Performance”, was published
in 1986
Key insight: competitive advantage and creating share-

holder value both stem from a common economic framework

Rappaport Shareholder Value Analysis framework
Total Shareholder
Shareholder
CORPORATE Return
Value Added
OBJECTIVE - Dividends
(SVA)
- Capital gains
VALUATION Cash flow

Discount
COMPONENTS from Debt
rate
operations
KEY - Working
- Sales growth
VALUE capital
Value growth - Operating Cost of
DRIVERS investments
duration profit margin capital
- Fixed capital
- Income tax rate
investments
KEY
MANAGEMENT
DECISIONS Operating Investment Financing
Source: Alfred Rappaport; Creating Shareholder Value, The Free Press 1998
Need for link between stock market (shareholder value) and
strategy (competitive advantage)
 The shareholder approach: firm exists to maximize the wealth of its owners.
– to replace assets, firm must earn return on capital > cost of capital
– to avoid acquisition, firm must achieve stock-market value > break-up value
 Shareholder Value: Capital market perspective

– prime goal of management to maximize shareholder value
– Need „bridge“ between operations, strategy / competitive advantage and capital
market
 Key questions to link shareholder value and strategy
– which financial metrics bridge demands of products and capital markets?
– what methods can be used to determine if a company has an competitive
advantage that leads to shareholder value creation?
– how are share prices set in the capital market? Which metrics (profit growth; sales
growth etc.) drive stock prices and ultimately shareholder value?
Source: Accenture, Value Creation III

Spread between return on invested capital
(ROIC – WACC) as key metric for shareholder
value creation and competitive advantage
 ROIC – WACC spread key measure of shareholder value creation and compe-
titive advantage
 By definition, a business with a competitive advantage earns returns on
capital in excess of cost of capital
 Positive „spreads“ are reflected in stock price valuation
– businesses earning above-cost-of-capital returns trade at a firm value to invested
capital ratio higher than one
– the higher the ROIC-WACC spread (holding growth constant), the higher the firm
value / invested capital multiple
– in addition to the size of the spread the duration is important (sustainable
competitive advantage)
 ROIC-WACC spreads have to be used with caution as „proxy“ for future
performance
– reflect mainly past performance (invested capital)
– stock markets are primarily forward-looking
– positive Net Present Value as theoretically right metric
Source: Michael Mauboussin/Bob Hiler; Why Strategy Matters
Shareholder Value and Stakeholder Value
 Stakeholders in a corporation are individuals and constituencies

(groups) contributing, either voluntarily or involuntarily to its wealth-creating
activities and who are therefore potential beneficiaries and / or risk bearers
of its operations
 „Enlighted“ stakeholder view: capacity of a business to generate

sustainable wealth over time determined by relationships within resource
base. The firm is a coalition of interest groups - it seeks to balance their
different objectives. Economic profit enables firms to satisfy stakeholders
 German model (“Geamtunternehmensinteresse”) versus US model of

corporation (shareholder primacy)
Source: Michael Porter; Sybille Sachs, Der strategische Managementansatz “Stakeholder View”;
Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (5th edition, Blackwell, 2004)
Financial Indicators
Shareholder Value is created by improving the

spread, the difference between a company’s
ROIC and Cost of Capital, and through growth
Value creation roadmap: shareholder perspective and management perspective
Operating Value is created
Return on Margin when spread, the
Invested difference
Capital (ROIC) between ROIC
Capital
Efficiency and WACC, is
increased
Spread –
Weighted
Average Cost
of Capital
(WACC)
Value Total Return

to Share-
Creation
holders (TRS) Value is also
Organic
Growth created when
positive spread
Historical
is “magnified”
Growth through growth
through M&A in cash flow
Growth
Future
The spread of economic return over economic
cost of capital drives shareholder value-creation:
US industries 2004
2.0X Luxury goods
R2 = 78%
Pharma
1.9X
Telecom equipment
1.8X Medical
technology
Business
1.6X Media serv ices
Consumer
products
Market Value / 1.4X Semiconductors Bev erages Robell
Book Value*
1.2X
Market ex-financials
1.0X Leisure
Capital goods
0.8X Tele-
com
Transportation Aerospace
0.6X Paper
0.4X Steel Utilities
0.2X
0.0X
0.0X 0.2X 0.4X 0.6X 0.8X 1.0X 1.2X 1.4X 1.6X 1.8X 2.0X
ROIC / WACC
Source: Goldman Sachs Global Equity Research, September 11, 2003 , page 15 *EV / GCI **CROCI / WACC

The spread of economic return over economic
cost of capital drives shareholder value-creation:
US stock market 1992 - 2004
1.6X
R2 = 71%
2000
1.4X 1999
2002
1.2X 2001
1997
Market Value / 1.0X 2002
Book Value*
1996 2003E
0.8X 1995
2004E
0.6X 1991 1994

1992 1993
0.4X
0.2X
0.0X
0.0X 0.2X 0.4X 0.6X 0.8X 1.0X 1.2X 1.4X 1.6X

ROIC / WACC
Source: Goldman Sachs Global Equity Research, September 11, 2003 , page 19 *EV / GCI **CROCI / WACC
TRS – Basic: Simple example to calculate average annual
total shareholder return
Stock Price: $50 $60 $55 $70

Dividends: $1 $1 $1
12/98 12/99 12/00 12/01
^(1/n) ^(1/3)
Ending Stock Price + Accumulated Dividends $70+$3
-1 = -1 = 13.4%
Beginning Stock Price $50

Example Volkswagen: Average annual total shareholder
return 2002-2005 (€)
Stock Price: 52,50 34,74 44,15 33,35 44,61

Dividends: 1,30 1,30 1,05 1,05
12/01 12/02 12/03 12/04 12/05
^(1/n) ^(1/4)
Ending Stock Price + Accumulated Dividends 44,61+4,70
-1 = -1 = -1,55%
Beginning Stock Price 52,50

Over the long-term, TRS is driven by economic spread
and growth
Value creation roadmap
Operating
Return on Margin
Invested
Capital (ROIC) Capital
Efficiency
Spread –
Weighted
Average Cost
of Capital
(WACC)
Total Return
Value
to Share-
Creation
holders (TRS)
Organic
Growth
Growth
Growth
through M&A

Spread – Return on Invested Capital (ROIC)
Operating
Return on Margin
Invested
Efficiency
Spread –
Weighted
Average Cost
of Capital
(WACC)
Total Return
Value
to Share-
Creation
holders (TRS)
Organic
Growth
Growth
Growth
through M&A

Return on Invested Capital (ROIC) captures the return
on the investment provided by the company’s investors
(debt and equity investors)
Return on Invested Capital (ROIC)
Net operating profit

less adjusted taxes
NOPLAT
ROIC =
Invested Capital
Capital provided by
debt and equity
investors

Ratio Analysis
NOPLAT is calculated to estimate the profit derived

from company operations available to debt and equity
holders
Calculation NOPLAT (Net Operating Profit Less Adjusted Taxes)
Total revenues
- Cost of goods sold
- Selling, general and administration expenses
- Depreciation expense
- Other operating expenses
Reported EBIT
- Taxes on EBIT
NOPLAT

Invested capital can be calculated two ways - where
the capital is invested (working capital + fixed assets)
and where the capital is from (essentially equity + interest
bearing debt)
Invested Capital
Balance Sheet
Assets Liabilities
Current Assets Current non-interest bearing liabilities
1 3
Fixed Assets Debt and Equity
2 4
Invested Capital ≈ 1 - 3 + 2 = 4
Working Capital
Example Volkswagen Calculation of NOPLAT 2005
2005 in € million
Total revenues 95.268

- Cost of goods sold - 82.391
- Distribution and administration expenses - 11.288
- Other operating income and expenses + 1.203
Operating Profit 2.792
+ Amortization of Goodwill 0
EBIT 2.792
- Operating Taxes (38,3%) - 1.069
NOPLAT 1.723

Example Volkswagen NOPLAT 2001-2005
NOPAT
3.000
2.500
2.000
1.500
1.000
500
0
2001 2002 2003 2004 2005
NOPAT 2.720 2.938 1.076 1.730 1.723

Example Volkswagen Calculation of Invested Capital
by reorganizing the balance sheet into sources and
uses of capital
Where
Invested? Where From?
Assets Total current assets 57.846
(€ Million) 75.235
Total non-current assets
Total assets 133.081
Liabilities Current financial liabilities 30.992 30.992

and Equity
Other current liabilities 22.317 -22.317
(€ Million)
Total current liabilities 53.309
Non-current financial liabilities 31.014 31.014

Other non-current liabilities 23.489 -23.489
Deferred tax liabilities 1.622 1.622
Total shareholders’ equity 23.647 23.647
Total liabilities and equity 133.081 87.275 87.275

Example Volkswagen IC 2001-2005
Invested Capital
100.000
80.000
60.000
40.000
20.000
0
2001 2002 2003 2004 2005
Invested Capital 69.426 73.183 82.186 87.291 87.275

Volkswagen Calculation the ROIC 2005
NOPAT 1.723 Million €

ROIC: = = 1,97 %
Invested Capital 87.275 Million €

Volkswagen ROIC 2001-2005
ROIC
5,00%
4,00%
3,00%
2,00%
1,00%
0,00%
2001 2002 2003 2004 2005
ROIC 3,92% 4,01% 1,31% 1,98% 1,97%

Spread – ROIC tree
Operating
Return on Margin
Invested
Efficiency
Spread –
Weighted
Average Cost
of Capital
(WACC)
Total Return
Value
to Share-
Creation
holders (TRS)
Organic
Growth
Growth
Growth
through M&A

ROIC can be disaggregated into smaller components
that provide more insight into the performance
Disaggregating ROIC
Starting with… NOPLAT EBITA

ROIC = = X (1 – cash tax rate)
Invested capital Invested capital
Substituting EBITA EBITA Revenue

= X
with… Invested capital Revenue Invested capital
We get… EBITA Revenue

ROIC = X X (1 – cash tax rate)
Revenue Invested capital
Operating Capital
Margin Utilization
ROIC can be further broken down into a tree format
to gain insight concerning a companies value drivers
describing how a company creates shareholder value
ROIC tree ILLUSTRATIVE
Operating COGS/ Revenues

Margin 52.79%
EBITA/
Revenues SG&A/ Revenues
15.0% 28.8%
Depreciation/
Revenues
3.5%
Pretax ROIC X
32.9%
Working Capital/
Revenues
14.0%
ROIC X
23.2% Revenues/ Net PP&E/
1- Invested Capital Revenues
2.18 38.5%
Cash tax rate
on EBITA
29.0% Capital Other Assets/
Revenues
Utilization -6.7%

ROIC tree example: Merck (US Pharma Company)
Small includes Sanofi, Elan, and Novo and Merck

KGAA. Large includes all others except Bayer and
Source: Accenture, Value Creation III Merck KGAA.

Each industry is unique and has its own set of value drivers
Pharmaceuticals Industry Value Drivers
Research
Marketing
Business and Deve- Mergers and
Pipeline and Sales
Mix lopment Acquisitions
Capabilities
Capabilities
 Ethical  Product  Investment  Sales Force  Strategic

Concentration Patent Level Productivity Combinations
Expiration
 Therapeutic  Productivity  Time to  Divestitures
Areas  Pipeline Market
Strength  Success
 Market Position
Rates  Alliances
 Blockbuster
Reliance
 Geographic
Focus

Value Drivers: The value creation process depends
on the translation of strategies and corresponding actions
into value drivers that influence shareholder value
 Financial value drivers are the financial parameters driving ROIC and
WACC:
– operating profit margin
– investments (working capital; fixed capital)
– cost of capital
– others (growth rate of revenues, tax rates)
 Strategic value drivers link the fundamental strategic determinants of

market attractiveness and competitive position to the financial value drivers
: e.g. operating margins are driven be revenue and costs; revenues are
driven by customer mix etc.
 Key is linking financial and strategic value drivers to the operational level
and specific decisions of front-line managers
Source: Alfred Rappaport, Creating Shareholder Value, page 50 – 77, Timothy Koller, What is value-based management?
Spread – Weighted Average Cost of Capital
Operating
Return on Margin
Invested
Efficiency
Spread –
Weighted
Average Cost
of Capital
(WACC)
Total Return
Value
to Share-
Creation
holders (TRS)
Organic
Growth
Growth
Growth
through M&A

The Weighted Average Cost of Capital (WACC) is the
opportunity cost for investing in an asset. It is the
sum of the cost of debt and the cost of equity, each
weighted by their share of the overall value of the asset
Weighted Average Cost of Capital (WACC)
WACC
+ Weighted
Weighted
cost of
cost of debt
equity
Kd* D E
X Ke X
(1-t) D+E D+E
Market value Market value
of debt of equity
After tax cost
Market value Cost of equity Market value
of debt of debt and of debt and
equity equity
Cost Weighting Cost Weighting

Example Volkswagen: Calculation of WACC 2005
Parameter Value Source
Cost of Debt (rD) 3,7 % Annual report, p. 57

38,3 %
Debt
Tax Rate (tc) Annual report, notes No. 7, Income tax expense
Total Debt (D) 109.434 Balance sheet
Cost of debt
Risk Free Rate (RF) 3,3 % Annual report, yield on 10-year bond
Ordinary Share Price € 44,61 Annual report, p. 27
Ordinary Shares 322 mm Annual report, p. 27
Equity Preferred Share Price € 32,50 Annual report, p. 27
Preferred Shares 105 mm Annual report, p. 27
Beta (ß) 1,0 Annual report, p. 57
DAX Market Risk Premium 6% Annual report, p. 57

Example Volkswagen : Calculation of the WACC 2005
Cost of Equity WACC

Equity
E = ordinary shares WACC = rD (1 – tc) D rLE EL
* * + *
rLE = rf + * price (D + EL) (D + EL)
MRP * ß + preferred shares
* price
= 3,3% + = 0,37*(1–0,383) * 109.434 + 0,093 * 17.781
= 322mm * € 44,61
6% * 1 109.434+17.781 109.434+ 17.781
+ 105mm * € 32,50
= 9,3% = €17.781 million = 3,26%

Volkswagen WACC 2001-2005
WACC
6,00%
4,00%
2,00%
0,00%
2001 2002 2003 2004 2005
WACC 4,77% 4,53% 3,80% 3,61% 3,26%

The Spread 2005: ROIC - WACC
ROIC
Spread –
WACC
1,97 %
-1,29 % –
3,26 %

Volkswagen: Negative Spread 2001-2005
RIOC - WACC
0,00%
-0,50%
-1,00%
-1,50%
-2,00%
-2,50%
2001 2002 2003 2004 2005
RIOC - WACC -0,85% -0,52% -2,49% -1,63% -1,29%

Volkswagen Average annual total shareholder
return 2002 - 2005 (€)
Stock Price: 52,50 34,74 44,15 33,35 44,61

Dividends: 1,30 1,30 1,05 1,05
12/01 12/02 12/03 12/04 12/05
^(1/n) ^(1/4)
Ending Stock Price + Accumulated Dividends 44,61+4,70
-1 = -1 = -1,55%
Beginning Stock Price 52,50

As a consequence there was a wide gap between market
value of Volkswagen and value of equity in 2005
23.647
17.781
?
Market value VW Equity stated in
shares 2005 Balance Sheet
2005

Volkswagen : Recent developments share price
12/2005 : € 44,61
vs.
12/2006: € 90,70

Value creation introduction
Operating
Return on Margin
Invested
Efficiency
Spread –
Weighted
Average Cost
of Capital
(WACC)
Total Return
Value
to Share-
Creation
holders (TRS)
Organic
Growth
Growth
Growth
through M&A

Revenue growth and shareholder value creation:
“good growth” versus “bad growth”
 Revenue growth in addition to size and lengths of spread as key value driver
– Determines the amount of capital that can be invested at such a spread
– Key is to invest into areas with high incremental ROIC surpassing cost of capital
 “Good growth”
– Growth only creates value when a company generates returns on investment that
exceed cost of capital
– Growth acts as “magnifier”: the more “good growth” investments a company can
create, the more value it will create
 “Bad growth”
– Money is invested in strategies that produce negative “spreads”
– The more investments a company makes in “bad growth”, the more shareholder
value it destroys. Economically unprofitable growth may increase sales and
earnings, but it will always destroy shareholder value
Source: James McTagggart, Peter W. Kontes, Michael C. Mankins, The Value Imperative, pp. 75 - 78
Agenda
3 Shareholder Value
- Summary

Agenda
3 Shareholder Value
- Summary

New Assignment and Outlook next Session
 Read slides on session 4 on ILIAS
 Visit company web pages and prepare as team a brief description
– what kind of internal shareholder value creation measure is your company using?
– is your company creating shareholder value? Calculate the market capitalisation

change of your company in the last three years (price per share*number of
shares outstanding today versus three years ago)
 Topics of next session:
– Brief 2 page presentation on each company; bring presentation on USB stick
– Lecture: External environment

Appendix: Shareholder Value

Other typical „shareholder value“ problems
 Economic profit ambiguous goal (total profit vs. rate of profit; over what
time period?)
 Adjusted accounting profit as proxy for economic profit (accounting adjust-

ments to economic profit obscure true economic performance and can lead
to manipulations by management and bad choices
 Short-term movements of shareholder value (stock price of shares) driven

by a lot of factors unrelated to real economic value creation by the firm
 Too simplistic performance objecties based an stock price improvements

may lead to wrong incentives for managers

The definition of economic return
The definition of economic return valuation or CROGI
EV ( Enterprise value) =
Market capitalisation (number of shares
outstanding * price per share)
EV CROCI
= GCI ( Gross cash invested) =
Gross tangible and intangible assets
GCI WACC
(before depreciation or write offs) +
investments in working capital
CROCI (Cash return on cash invested)

The total The spread of =
Post tax, pre interest cash flow as a
capitalisation of economic percentage of average GCI
the cash = return over
WACC ( Weighted average cost of
invested in the economic cost capital) =
business of capital Economic cost of equity (dividend yield
+ long term share price growth) + cost
of debt, adjusted for capital structure
Source: Based on :Goldman Sachs Global Equity Research, September 11, 2003 , page 19
The cost of equity is normally calculated using the Capital Asset
Pricing Model (CAPM) which postulates that investors set their
opportunity cost of capital equal to the returns on risk-free securities,
plus a premium for the systematic risk of the individual stock
Capital Asset Pricing Model – Cost of Equity
Ke = rf + (rm – rf) * ß
Opportunity The risk-free The historic The factor

cost of rate of return market risk by which a
capital for available to premium given stock’s
investors in all investors required to returns differ
this asset compensate from the
investors for returns of
the the market
additional portfolio
risks
associated
Source: Accenture, Value Creation III with equity
© 2007 Prof. Dr. Bernd Venohr
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Strategic Management

Prof. Dr. Bernd Venohr

© 2007 Prof. Dr. Bernd Venohr

- Group Reports on Assignment Session 2

- Shareholder Value Concept

- New Assignment and Outlook next Session

© 2007 Prof. Dr. Bernd Venohr 3

Business Strategy Corporate Strategy

Competitive Mergers & Global

- Group Reports on Assignment Session 2

- Shareholder Value Concept

- New Assignment and Outlook next Session

© 2007 Prof. Dr. Bernd Venohr 5

 Shareholder value is defined as the part of of a companies

 Primary goal for a company is to enrich its shareholders

 More specifically: shareholder money should be used to earn

Alfred Rappaport is the Leonard Spacek Professor

His book, “Creating Shareholder Value: The New

Key insight: competitive advantage and creating share-

© 2007 Prof. Dr. Bernd Venohr 7

VALUATION Cash flow

 Shareholder Value: Capital market perspective

Source: Accenture, Value Creation III

 Stakeholders in a corporation are individuals and constituencies

 „Enlighted“ stakeholder view: capacity of a business to generate

 German model (“Geamtunternehmensinteresse”) versus US model of

Shareholder Value is created by improving the

Value Total Return

0.4X Steel Utilities

© 2007 Prof. Dr. Bernd Venohr 13

0.6X 1991 1994

0.0X 0.2X 0.4X 0.6X 0.8X 1.0X 1.2X 1.4X 1.6X

Stock Price: $50 $60 $55 $70

12/98 12/99 12/00 12/01

Source: Accenture, Value Creation III

Stock Price: 52,50 34,74 44,15 33,35 44,61

12/01 12/02 12/03 12/04 12/05

© 2007 Prof. Dr. Bernd Venohr 16

Source: Accenture, Value Creation III

Source: Accenture, Value Creation III

Net operating profit

Source: Accenture, Value Creation III

NOPLAT is calculated to estimate the profit derived

© 2007 Prof. Dr. Bernd Venohr 20

Fixed Assets Debt and Equity

Total revenues 95.268

© 2007 Prof. Dr. Bernd Venohr 22

NOPAT 2.720 2.938 1.076 1.730 1.723

© 2007 Prof. Dr. Bernd Venohr 23

Total assets 133.081

Liabilities Current financial liabilities 30.992 30.992

Total current liabilities 53.309

Non-current financial liabilities 31.014 31.014

Total liabilities and equity 133.081 87.275 87.275

© 2007 Prof. Dr. Bernd Venohr 24

Invested Capital 69.426 73.183 82.186 87.291 87.275

© 2007 Prof. Dr. Bernd Venohr 25

NOPAT 1.723 Million €

© 2007 Prof. Dr. Bernd Venohr 26

© 2007 Prof. Dr. Bernd Venohr 27

Source: Accenture, Value Creation III

Starting with… NOPLAT EBITA

Substituting EBITA EBITA Revenue