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.

 

 

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