Using Total Shareholder Return as a Lens

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As Seen in CFO Studio Magazine Q4 2016 Issue

DUN & BRADSTREET HAS MADE IMPORTANT REVISIONS TO ITS BUSINESS STRATEGY, BASED ON HOW IT VIEWS SHAREHOLDERS

-BY JULIE BARKER-

Every company, be it private or public, should focus on two primary goals: Being a great company and being a great investment or a great stock, says Jeffrey Kotzen, Senior Partner & Managing Director, The Boston Consulting Group (BCG). But there are very few companies that do both of those well, he continues. “To do both is hard,” but by focusing on the metric Total Shareholder Return, and actually using TSR as a lens for considering business strategy and decision-making, organizations are more likely to be successful in both the “great company” sphere and in delivering returns that satisfy investors’ expectations.

Most companies decide on their business strategy and then set two other strategies, financial and investor, sequentially. The business strategy is usually based on the growth and margin they want to achieve, the geographies they are in or would like to be in, and the businesses they want in their portfolios. They filter all of that through a risk-management screen. The result is then translated into numbers: In light of our strategy, we would see X amount of revenue growth, our margins would do Y, and our bottom line would grow by Z. Those numbers are the financial strategy, and they in turn become a series of investor messages — the corporation’s investor strategy.

Kotzen advises developing the same three pieces of strategy, but in parallel, “not locking in on a business strategy until a financial strategy and the investor strategy are understood.” Otherwise, the risk is that the business strategy “will not be supported by their current investors. And we’ve all seen a big increase in investor activism.”

D&B Changes Strategy

Just before the precipitous downturn of 2008, Dun & Bradstreet began implementing a TSR lens for value creation. D&B, founded in 1841 the firm was once Abraham Lincoln’s employer, is a trusted company, successful in its field, which is collecting and selling business data. But its direction for many years had been to cut costs in order to drive earnings. Though it had very strong cash flow, the company wasn’t using the cash as effectively as it could. D&B’s CFO Richard Veldran has moved the company forward, using TSR as a lens to evaluate strategy and make decisions on the use of cash.

Veldran first encountered TSR when he worked for Procter & Gamble in the 1990s. “BCG came in [to consult], and Procter & Gamble began to use TSR as the lens for managing growth,” evaluating every brand in terms of its value creation potential, and cutting brands that were not driving appropriate return, he told a group of CFOs recently at the 2nd Annual CFO Innovation Conference at MetLife Stadium in New Jersey, where he shared the podium with Kotzen. At P&G, the stock and price-to-earnings multiple rebounded. “The stock turnaround was almost night and day,” said Veldran.

In around 2006, Veldran, who was then Dun & Bradstreet’s Treasurer and Investor Relations Officer, brought Kotzen to D&B to help implement the TSR emphasis there. “We had been focused on cutting costs to drive earnings,” Veldran said. “But we began to see a compression in the price-to-earnings ratio. It wasn’t quite where it needed to be.” As a result of hiring BCG, D&B adjusted its business strategy toward more growth, and at the same time launched its first dividend.

“We hadn’t looked to the many investors who want the stability of a dividend, who want that cash return,” Veldran said. Developing the company’s thinking regarding who its optimal investors should be contributed to the decision to pay a dividend, and in turn stabilized the company when about a year later, in 2008, the market collapsed. While D&B’s growth stopped in the recession, along with almost all companies’, Veldran says, “Our investor base was pretty stable, and our stock weathered the storm better than most companies’. I’d attribute this to three factors:

•Our resilient, time-tested business model

•We had attracted the right set of investors to our story and had set appropriate investor expectations; and

•We had a demonstrated track record of making smart, disciplined use of cash — a critical factor in times of economic uncertainty.”

The Drivers of TSR

Total Shareholder Return is defined as the change in share price plus dividends, or to put it another way, the wealth that corporations return to shareholders. There are three components of TSR, with various “management levers” that can be applied, says Kotzen:

• Profit growth: how is the top line growing and what’s happening to your margin

• P/E multiple change

•Cash flow contribution: working capital, other capital expenditures, dividends, share repurchases, debt, and cash

The second of these, P/E multiple change, offers a lot of opportunity for control by management by “reshaping their financial strategy, reshaping their business portfolio, driving much stronger margin, perhaps at the expense of growth,” among other choices, says Kotzen. He notes that in conversation with clients, there’s sometimes an obsession with growth, “trying to get 6 percent growth whereas in actuality what their shareholders need is 4.5 percent or 5 percent organic growth.” Other management levers for P/E multiple change include performance consistency, meeting expectations, confidence in management, portfolio changes, and targeting optimal investors. Kotzen says that private companies, too, can implement the TSR discipline. “We develop a TSR model for them. We use regression analysis, look at a peer group of publicly traded companies, develop a synthetic P/E or EBITDA multiple, and we create a synthetic share price.”

At D&B in 2013, in a period of historically low interest rates, Veldran said he felt the time was right to buy back some shares. “We bought back $1 billion worth of shares at an average price of around $83,” he said at the conference. “But we wouldn’t have done that unless the key elements of TSR were in play: if we weren’t on a strategy that was geared towards driving growth, if we weren’t able to expand margin, and if we weren’t able to drive strong, free cash flow as a result of those. So everything is situational. You have to look at the TSR equation on an ongoing basis and adjust at the right time.”

Today, the business strategy at D&B, launched a couple of years ago, is geared toward driving sustainable mid-single-digit growth with ongoing margin expansion, and “making sure that we use our cash extremely effectively,” says Veldran. “It’s a very disciplined approach,” he says, but “it’s just the way we live and breathe as a company: a healthy balance of great innovation to drive growth, but leveraging your core so that you can expand your margin, and then making sure that once you generate cash as a result of that, you’re using that cash very wisely.”

The relationship between Rich Veldran and Jeff Kotzen, forged in the financial offices of large global companies, is longstanding. Both men respect what the TSR lens can suggest about the way forward. Neither of them, however, fears making a contraindicated decision, as long as it rests on facts and data. They have even joined forces to go against large investors clamoring for a leveraged recap or an ASR. In that case, the intent was to bring to D&B a different type of investor, one who looks for longer-term, growth-oriented stocks.

The decision paid off. As Kotzen puts it, those investors became D&B’s partners on its journey.

 

 

Grounded

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As Seen in CFO Studio Magazine Q4 2016 Issue Cover Story

A DOCUMENT FROM 73 YEARS AGO GUIDES THE DECISIONS OF JOHNSON & JOHNSON CFO DOMINIC CARUSO

-BY JULIE BARKER-

-PHOTOGRAPHY BY MATT FURMAN-

 

“OUR CREDO.”

So begins a four-paragraph statement penned by General Robert Wood Johnson II in 1943. “We believe our first responsibility is to the doctors, nurses, and patients, to mothers and fathers and all others who use our products and services,” it starts.

Paragraph three expounds: “We are responsible for the communities in which we live and work and to the world community as well. …We must maintain in good order the property we are privileged to use, protecting the environment and natural resources.”

These principles of corporate responsibility are chiseled into twin slabs of marble eight feet high and five feet wide at the entrance to Johnson & Johnson’s headquarters in New Brunswick, NJ. The same words appear at the entrance of all the J&J facilities around the world, and no matter how routine it becomes to see the words, everyone pays attention to them.

Dominic Caruso, J&J’s Executive Vice President and Chief Financial Officer, who joined the company in 1999, has long since internalized the Credo’s meaning. If a business leader calls him and says, “I need to speak with you about Our Credo,” it’s clear there will be little debate; the General’s words themselves will point to the right solution.

He got such a phone call in 2007, just months after J&J’s $1.4 billion acquisition of Conor Medsystems and its unique cardiovascular stent. At the time, J&J had 45 percent of the $6 billion worldwide market for coronary stents, according to a May 2007 article by MD+D (Medical Device and Diagnostic Industry). The unique stent was being offered in some foreign markets but had not yet received FDA approval. New tests, however, gave J&J reason for concern: A competitive stent was a safer choice for patients. “We withdrew that product from the market,” Caruso says.

Caruso, who was CFO of the medical devices business segment at the time, says walking away from the product’s potential was “gut-wrenching,” but it was a decision made “easy” by the Credo, which creates a structure for thinking about the implications of every action. J&J’s cardiovascular business leader at the time “knew this would be financially painful,” says Caruso. “But he explained the situation, and what he heard from me was, ‘Okay, I get it.’”

Throughout its 130-year history, J&J has earned a reputation as a top-performing company. Along with Microsoft, it is one of the only two U.S. corporations with a AAA S&P credit rating (beating even the U.S. government). On Fortune’s list of the World’s Most Admired Companies, J&J is the top-ranking pharmaceutical company, and in June J&J topped the list of Barron’s 100 most respected companies.

But hitting numerical benchmarks, Caruso insists, is far from the company’s primary motivator. When asked how useful and valuable it is for the company to have a moral compass like the Credo, Caruso doesn’t hesitate with his answer. “What Our Credo does for us,” he says, “is to require us to always stop and think, reflect, not to be simply reactionary to current developments, but to be grounded in our decision-making.”

Although the Credo cannot insulate the company from the realities that face leading global companies today — including litigation and regulatory challenges — it is an ethical platform and decision framework that the General, son of one of the founding brothers, felt would be needed when he took the company public.

Embedding Principles

“Our Credo has lots of constituencies: doctors, nurses, patients, employees, and our shareholders. Our shareholders are listed last, but it’s really just another of our responsibilities,” says Caruso, age 58. As CFO, he sees part of his job as helping the company grow through proper allocation of cash. Under his leadership, the company has articulated its disciplined capital allocation strategy. This begins by paying dividends to shareholders. Subsequently, he considers M&A opportunities, using about 30 percent of J&J’s free cash flow for value-creating acquisitions, and finally, share repurchases.

Another component of his role is to maintain an ethical organization by developing leaders in the finance area who live and breathe the company’s values as he does. J&J’s Finance Leadership Development Program (FLDP) is well recognized as a “leader feeder,” providing exceptional training in a two-year rotational program that gives young hires the chance to work in multiple areas of the business in three eight-month assignments.

The program has particular appeal to millennials, Caruso says, because it provides prompt, regular feedback, and with quick rotations, they are “not stuck in one place for a long period of time.” He says that J&J successfully recruits top graduates who might otherwise go to Wall Street or Silicon Valley by dint of its Credo and social responsibility activities. “[Millennials] appreciate when the organization they work for has a mission aligned with their values.”

Although he was well beyond entry level when he joined J&J, Caruso himself benefited from the company’s focus on talent development. After graduating from Drexel University in 1980 with a B.S. in Finance, he went into public accounting at Peat Marwick Mitchell, now known as KPMG. In 1985, he joined Centocor, a startup now called Janssen Biotech. He became CFO of Centocor in 1992, then added the role of general manager of that company’s diagnostic division. In 1999, Centocor was acquired by J&J. That’s when his own J&J development story began; two years later he became VP of Finance of its Ortho-McNeil Pharmaceutical subsidiary; and in another two years he was tapped for a bigger job.

“In the summer of 2003, I went to the office of our then CFO, Robert Darretta,” he remembers. “We were meeting to discuss succession planning as part of our normal talent-planning cycle.” It was a sunny June day, and the office was at the top of the World Headquarters Tower, with views over the Raritan River and the Rutgers University campus. Darretta started the meeting by reminding Caruso that “as part of our Finance leadership development priority, we are always looking for that key question we have about a leader’s ability to be successful.”

Darretta wanted to know if Caruso’s success would be transferable outside of pharma, where he had spent most of his career. According to Caruso, Darretta said: “We’d like you to take a role in our medical devices business. It will teach us more about you and teach you more about yourself.”

Caruso’s first thought was, “Why would I want to do that?” And even though it was a beautiful, clear day, he remembers imagining the storm he would be entering in a new, unknown environment.

As it turned out, taking that job was one of the best moves of his career. “I expanded my network and exposure across the company and was able to demonstrate my value beyond the pharmaceutical sector. Being new to the role allowed me to ask probing questions that my business partners may not have been asked in a long time.” He didn’t mind challenging the way things had always been done.

Leaving behind a niche he knew well and immersing himself in a far different one gave him an opportunity to say, “Wait a minute: What am I really good at?”

“We all have unanswered questions,” says Caruso. “You just have fewer and fewer of them as you go up the ladder.”

Caruso proved that he was good at leading, not just good at what he did in a particular sector. He was named CFO of J&J in 2007. At that time, the stock price was around $50; today it’s climbed to an all-time high above $122.

Long-Term Value

Caruso seems formal but comfortable during an interview and in between other pressing obligations. He is gracious with his time and articulate. We were in a small conference room down the hall from the office where he had met with Darretta 13 years earlier, talking long-term versus short-term value. A few weeks prior, Larry Fink, the CEO of BlackRock (which is one of J&J’s top-five shareholders), sent a letter to chief executives of the S&P 500 urging them to lay out for shareholders their value-creation plans each year. When asked his reaction to that letter, Caruso says, “First of all, I was glad that he called upon CEOs to take a longer-term view of their responsibilities to shareholders and to not be overly influenced by short-term thinking.”

Caruso notes that many of the shareholders he meets with are “long-term, loyal J&J shareholders,” though he does meet some who wish J&J would do more share buybacks. “That’s more of a trader mentality than an investor. The majority of our shareholders have more of an owner mentality,” he says.

“I think [Fink] was appropriately critical of companies that just react to short-term shareholder demands, and he was giving at least his endorsement to say, ‘Look, there are other shareholders who have your back.’ And that’s good to know.”

Caruso remarks that CFOs in the pharmaceutical industry tend to be more long-term thinkers compared to those in other sectors, because they are used to an environment where development times are drawn out. “You’re more patient, you’re making long-term investments, you’re continuously funding research and development to find cures.”

Later, he says one of the most exciting parts of his job is watching innovations become reality. For example, the finance team was involved in structuring a transaction with Genmab, a Danish biotech company, whereby J&J and Genmab would co-develop a drug for multiple myeloma. Subsequently, in 2013, the therapy received Fast Track designation from the FDA. Finance has been in the mix at each juncture in the product’s development, he says, and now the drug “is benefiting patients.”

Caruso has a deep personal interest in health-related causes. He is on the Board of Trustees of the Children’s Hospital of Philadelphia. His partner through 40 years of marriage, Debbie, also has a strong interest in the health and welfare of children. They have three grown children and nine grandchildren. Because one of his grandchildren has cystic fibrosis, Caruso became involved with the Cystic Fibrosis Foundation – Delaware Valley Chapter. He serves on the Board, and helps raise money to find a cure.

Besides being a family man, Caruso is a guitarist (rock, jazz, classical) and a golfer. He says he would enjoy having a superpower that enabled him to be in two places at one time. “If I could come to work and do what I love doing here, but also spend time at home simultaneously, that would be fantastic.”

The J&J organization has 50 other CFOs around the world reporting to him. They meet annually to discuss who is going to succeed whom, choosing from around 5,000 finance professionals in the J&J organizational structure. “I can’t possibly be involved in developing each of the 5,000 people,” says Caruso, “but I can be involved in the top 120 to 150 people: knowing who they are, seeing how they’re doing, making sure they’re answering those critical questions.”

Thinking about succession and giving the top picks the right opportunities “takes some time, but it’s really important because if I don’t get that right, when I leave, I haven’t really done a service to the organization,” he says.

Caruso doesn’t say so directly, but developing a successor who understands and will adhere to the principled business practices he has followed is how the CFO can best create long-term value.

 

Featured in the Q4 Issue of CFO Studio Magazine: CFO Dominic Caruso of Johnson & Johnson And Why D&B’s CFO Focuses on Total Shareholder Return

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FOR IMMEDIATE RELEASE

Lorenz Capalad

Lorenz.Capalad@CFOstudio.com

(732) 868-0000 x118

September 8, 2016

 

Featured in the Q4 Issue of CFO Studio Magazine:

CFO Dominic Caruso of Johnson & Johnson

And Why D&B’s CFO Focuses on Total Shareholder Return

 

SOMERSET, NJ – Ethical judgments, satisfying shareholders, making acquisitions, managing growth: All these topics are voiced in articles that profile CFOs and their decision-making, appearing in the latest issue of CFO Studio magazine. The issue will be released Sept. 15.

The cover story on Dominic Caruso, executive vice president and chief financial officer of Johnson & Johnson, describes his decisions on matters of ethics, guided by J&J’s 73-year-old Credo. When he receives a call from the head of one of J&J’s business units asking him to weigh in on an ethical matter, Caruso says that the Credo’s words, though written in a far different era, nevertheless signal the right solution.

The Q4 2016 issue of CFO Studio magazine also highlights a close working partnership between Richard Veldran, chief financial officer of Dun & Bradstreet, and Jeffrey Kotzen, senior partner and managing director, The Boston Consulting Group. A collaboration between the two men helped bring about D&B’s embrace of the concept of Total Shareholder Return (TSR). In the article, Veldran and Kotzen weigh in on why D&B uses a TSR lens for value creation.

Three other feature articles profile CFOs from New Jersey and Pennsylvania companies describing their roles, decisions, and thoughts on leadership. Profiled are:

  • Joe Ritzel, CFO of Day & Zimmerman, a Philadelphia-based, century-old, family-owned company that provides construction & engineering, staffing, and defense solutions for leading corporations and governments around the world. Readers will learn why Ritzel believes that “It’s the right time to invest.”
  • Anthony Conte, CFO of Newtown, PA–based EPAM Systems, Inc., who describes the excitement and difficulties of presiding over the finances of a company in hyper-growth mode. EPAM, a global product development and platform engineering services firm, has completed eight acquisitions in the past three years. Meanwhile organic growth has been over 20 percent per year. “What this requires,” Conte says in the article, “is a high degree of flexibility and innovation to continue to create a financial organization that supports the business.”
  • T&M Associates of Middletown, NJ, is in the architecture/engineering/consulting market. Its CFO, Michael Dentici, describes the firm’s team-based approach, where a four-person executive team serves as the operating committee. “The validity of this kind of sharing has been vetted in studies, including one by the IBM Center for Applied Insights and the IBM Institute for Business Value… Collaboration in the C-suite is linked to higher enterprise performance,” Dentici is quoted as saying.

 

About CFO Studio

 

CFO Studio and CFO Studio magazine deploy the best of new and traditional media to promote finance executives as business and strategy thought-leaders. The magazine, published quarterly by CFO Studio and underwritten by great promotional partners, features business profiles and strategic advice for CFOs in the New York, New Jersey, and major metropolitan areas including Philadelphia and Chicago. Andrew Zezas is the host of CFO Studio and the Publisher of CFO Studio magazine. The company’s third annual CFO Innovation Conference & Awards will be held in spring 2017. Nominations are now open at www.CFOstudio.com

Visit www.CFOstudio.com to watch interviews with New Jersey area CFOs, and to register for Executive Dinner events in New Jersey, Manhattan, Philadelphia, Chicago, and San Francisco, and for the CFO Breakfast Learning Series. All events are available to CFOs at no cost. To read articles that have appeared in CFO Studio magazine, or for subscriptions and advertising opportunities, visit www.CFOstudio.com

 

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