A case study in value destruction: Eastman Kodak ...adamodar/podcasts/cfspr17/session3.pdf · A case study in value destruction: Eastman Kodak & Sterling Drugs Kodak enters bidding

Acasestudyinvaluedestruction:EastmanKodak&SterlingDrugs

Kodakentersbiddingwar¨ Inlate1987,EastmanKodak

enteredintoabiddingwarwithHoffmanLaRocheforSterlingDrugs,apharmaceuticalcompany.

¨ ThebiddingwarstartedwithSterlingDrugstradingatabout$40/share.

¨ At$72/share,Hoffmandroppedoutofthebiddingwar,butKodakkeptbidding.

¨ At$89.50/share,Kodakwonandclaimedpotentialsynergiesexplainedthepremium.

Kodakwins!!!!

!

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EarningsandRevenuesatSterlingDrugs

AswathDamodaran

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Sterling Drug under Eastman Kodak: Where is the synergy?

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

1988 1989 1990 1991 1992

Revenue Operating Earnings

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KodakSaysDrugUnitIsNotforSale…but…

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¨ AnarticleintheNYTimesinAugustof1993suggestedthatKodakwaseagertosheditsdrugunit.¤ Inresponse,EastmanKodakofficialssaytheyhavenoplanstosellKodak’sSterlingWinthrop

drugunit.¤ LouisMattis,ChairmanofSterlingWinthrop,dismissedtherumorsas“massivespeculation,

whichfliesinthefaceofthestatedintentofKodakthatitiscommittedtobeinthehealthbusiness.”

¨ Afewmonthslater…Takingastrideoutofthedrugbusiness,EastmanKodaksaidthattheSanofiGroup,aFrenchpharmaceuticalcompany,agreedtobuytheprescriptiondrugbusinessofSterlingWinthropfor$1.68billion.¤ SharesofEastmanKodakrose75centsyesterday,closingat$47.50ontheNewYorkStock

Exchange.¤ SamuelD.Isalyananalyst,saidtheannouncementwas“verygoodforSanofiandverygood

forKodak.”¤ “Whenthedivestituresarecomplete,Kodakwillbeentirelyfocusedonimaging,” saidGeorge

M.C.Fisher,thecompany'schiefexecutive.¤ TherestoftheSterlingWinthropwassoldtoSmithklinefor$2.9billion.

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Theconnectiontocorporategovernance:HPbuysAutonomy…andexplainsthepremium

AswathDamodaran

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Ayearlater…HPadmitsamistake…andexplainsit…

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ApplicationTest:Whoowns/runsyourfirm?

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¨ Lookat:BloombergprintoutHDSforyourfirm¨ Whoarethetopstockholdersinyourfirm?¨ Whatarethepotentialconflictsofintereststhatyousee

emergingfromthisstockholdingstructure?

Control of the firm

Outside stockholders- Size of holding- Active or Passive?- Short or Long term?

Inside stockholders% of stock heldVoting and non-voting sharesControl structure

Managers- Length of tenure- Links to insiders

Government

Employees Lenders

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Case1:SplinteringofStockholdersDisney’stopstockholdersin2003

Aswath Damodaran

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Case2:VotingversusNon-votingShares&GoldenShares:Vale

Vale Equity

Common (voting) shares3,172 million

Preferred (non-voting)1,933 million

Golden (veto) shares owned

by Brazilian govt

Valespar(54%(Non/Brazilian(

(ADR&Bovespa)(29%(

Brazilian(Ins=tu=onal(6%(

Brazilian(retail(5%( Brazilian(

Govt.(6%(

Valespar(1%(

Non.Brazilian((ADR&Bovespa)(

59%(

Brazilian(Ins<tu<onal(18%(

Brazilian(retail(18%(

Brazilian(Govt.(4%(

Litel&Participaço 49.00%Eletron&S.A. 0.03%Bradespar&S.A. 21.21%Mitsui&&&Co. 18.24%BNDESPAR 11.51%

Valespar(ownership

Vale has eleven members on its board of directors, ten of whom were nominated by Valepar and the board was chaired by Don Conrado, the CEO of Valepar.

Aswath Damodaran

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Case3:CrossandPyramidHoldingsTataMotor’stopstockholdersin2013

Aswath Damodaran

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Case4:LegalrightsandCorporateStructures:Baidu¨ TheBoard:Thecompanyhassixdirectors,oneofwhomisRobinLi,

whoisthefounder/CEOofBaidu.Mr.LialsoownsamajoritystakeofClassBshares,whichhavetentimesthevotingrightsofClassAshares,grantinghimeffectivecontrolofthecompany.

¨ Thestructure:BaiduisaChinesecompany,butitisincorporatedintheCaymanIslands,itsprimarystocklistingisontheNASDAQandthelistedcompanyisstructuredasashellcompany,togetaroundChinesegovernmentrestrictionsofforeigninvestorsholdingsharesinChinesecorporations.

¨ Thelegalsystem:Baidu’soperatingcounterpartinChinaisstructuredasaVariableInterestEntity(VIE),anditisunclearhowmuchlegalpowertheshareholdersintheshellcompanyhavetoenforcechangesattheVIE.

Aswath Damodaran

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Thingschange..Disney’stopstockholdersin2009

AswathDamodaran

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II.Stockholders'objectivesvs.Bondholders'objectives

AswathDamodaran

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¨ Intheory:thereisnoconflictofinterestsbetweenstockholdersandbondholders.

¨ Inpractice:Stockholderandbondholdershavedifferentobjectives.Bondholdersareconcernedmostaboutsafetyandensuringthattheygetpaidtheirclaims.Stockholdersaremorelikelytothinkaboutupsidepotential

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Examplesoftheconflict..

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¨ Adividend/buybacksurge:Whenfirmspaycashoutasdividends,lenderstothefirmarehurtandstockholdersmaybehelped.Thisisbecausethefirmbecomesriskierwithoutthecash.

¨ Riskshifting:Whenafirmtakesriskierprojectsthanthoseagreedtoattheoutset,lendersarehurt.Lendersbaseinterestratesontheirperceptionsofhowriskyafirm’sinvestmentsare.Ifstockholdersthentakeonriskierinvestments,lenderswillbehurt.

¨ Borrowingmoreonthesameassets:Iflendersdonotprotectthemselves,afirmcanborrowmoremoneyandmakeallexistinglendersworseoff.

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AnExtremeExample:UnprotectedLenders?

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III.FirmsandFinancialMarkets

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¨ Intheory:Financialmarketsareefficient.Managersconveyinformationhonestlyandandinatimelymannertofinancialmarkets,andfinancialmarketsmakereasonedjudgmentsoftheeffectsofthisinformationon'truevalue'.Asaconsequence-¤ Acompanythatinvestsingoodlongtermprojectswillberewarded.

¤ Shorttermaccountinggimmickswillnotleadtoincreasesinmarketvalue.

¤ Stockpriceperformanceisagoodmeasureofcompanyperformance.

¨ Inpractice:Therearesomeholesinthe'EfficientMarkets'assumption.

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Managerscontrolthereleaseofinformationtothegeneralpublic

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¨ Informationmanagement(timingandspin):Information(especiallynegative)issometimessuppressedordelayedbymanagersseekingabettertimetoreleaseit.Whentheinformationisreleased,firmsfindwaysto“spin”or“frame”ittoputthemselvesinthebestpossiblelight.

¨ Outrightfraud:Insomecases,firmsreleaseintentionallymisleadinginformationabouttheircurrentconditionsandfutureprospectstofinancialmarkets.

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Evidencethatmanagersdelaybadnews?

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DO MANAGERS DELAY BAD NEWS?: EPS and DPS Changes- byWeekday

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

Monday Tuesday Wednesday Thursday F r i d a y

% Chg(EPS) % Chg(DPS)

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Somecritiquesofmarketefficiency..

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¨ Investorirrationality:Thebaseargumentisthatinvestorsareirrationalandpricesoftenmovefornoreasonatall.Asaconsequence,pricesaremuchmorevolatilethanjustifiedbytheunderlyingfundamentals.Earningsanddividendsaremuchlessvolatilethanstockprices.

¨ Manifestationsofirrationality¨ Reactiontonews:Somebelievethatinvestorsoverreactto

news,bothgoodandbad.Othersbelievethatinvestorssometimesunderreacttobignewsstories.

¨ Aninsiderconspiracy: Financialmarketsaremanipulatedbyinsiders;Pricesdonothaveanyrelationshiptovalue.

¨ Shorttermism:Investorsareshort-sighted,anddonotconsiderthelong-termimplicationsofactionstakenbythefirm

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Aremarketsshortsightedandtoofocusedonthenearterm?Whatdoyouthink?

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¨ Focusingonmarketpriceswillleadcompaniestowardsshorttermdecisionsattheexpenseoflongtermvalue.a. Iagreewiththestatementb. Idonotagreewiththisstatement

¨ Allowingmanagerstomakedecisionswithouthavingtoworryabouttheeffectonmarketpriceswillleadtobetterlongtermdecisions.a. Iagreewiththisstatementb. Idonotagreewiththisstatement

¨ Neithermanagersnormarketsaretrustworthy.Regulations/lawsshouldbewrittenthatforcefirmstomakelongtermdecisions.a. Iagreewiththisstatementb. Idonotagreewiththisstatement

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Aremarketsshortterm?Someevidencethattheyarenot..

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¨ Valueofyoungfirms:Therearehundredsofstart-upandsmallfirms,withnoearningsexpectedinthenearfuture,thatraisemoneyonfinancialmarkets.Whywouldamyopicmarketthatcaresonlyaboutshorttermearningsattachhighpricestothesefirms?

¨ Currentearningsvs Futuregrowth:Iftheevidencesuggestsanything,itisthatmarketsdonotvaluecurrentearningsandcashflowsenoughandvaluefutureearningsandcashflowstoomuch.Afterall,studiessuggestthatlowPEstocksareunderpricedrelativetohighPEstocks

¨ Marketreactiontoinvestments:Themarketresponsetoresearchanddevelopmentandinvestmentexpendituresisgenerallypositive.

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Ifmarketsaresoshortterm,whydotheyreacttobiginvestments(thatpotentiallylowershorttermearnings)sopositively?

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Butwhataboutmarketcrises?

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¨ Marketsaretheproblem:Manycriticsofmarketspointtomarketbubblesandcrisesasevidencethatmarketsdonotwork.Forinstance,themarketturmoilbetweenSeptemberandDecember2008ispointedtoasbackingforthestatementthatfreemarketsarethesourceoftheproblemandnotthesolution.

¨ Thecounter:Therearetwocounterargumentsthatcanbeoffered:¤ Theeventsofthelastquarterof2008illustratethatwearemore

dependentonfunctioning,liquidmarkets,withrisktakinginvestors,thaneverbeforeinhistory.Aswesaw,nogovernmentorotherentity(bank,Buffett)isbigenoughtostepinandsavetheday.

¤ Thefirmsthatcausedthemarketcollapse(banks,investmentbanks)wereamongthemostregulatedbusinessesinthemarketplace.Ifanything,theirfailurescanbetracedtotheirattemptstotakeadvantageofregulatoryloopholes(badlydesignedinsuranceprograms…capitalmeasurementsthatmissriskyassets,especiallyderivatives)

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IV.FirmsandSociety

AswathDamodaran

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¨ Intheory:Allcostsandbenefitsassociatedwithafirm’sdecisionscanbetracedbacktothefirm.

¨ Inpractice:Financialdecisionscancreatesocialcostsandbenefits.¤ Asocialcostorbenefitisacostorbenefitthataccruestosocietyasawholeandnottothefirmmakingthedecision.n Environmentalcosts(pollution,healthcosts,etc..)n QualityofLife'costs(traffic,housing,safety,etc.)

¤ Examplesofsocialbenefitsinclude:n creatingemploymentinareaswithhighunemploymentn supportingdevelopmentininnercitiesn creatingaccesstogoodsinareaswheresuchaccessdoesnotexist

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SocialCostsandBenefitsaredifficulttoquantifybecause..

AswathDamodaran

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¨ Cannotknowtheunknown:Theymightnotbeknownatthetimeofthedecision.Inotherwords,afirmmaythinkthatitisdeliveringaproductthatenhancessociety,atthetimeitdeliverstheproductbutdiscoverafterwardsthatthereareverylargecosts.(Asbestoswasawonderfulproduct,whenitwasdevised,lightandeasytoworkwith…Itisonlyafterdecadesthatthehealthconsequencescametolight)

¨ Eyesofthebeholder:Theyare‘person-specific’,sincedifferentdecisionmakerscanlookatthesamesocialcostandweightthemverydifferently.

¨ Decisionparalysis:Theycanbeparalyzingifcarriedtoextremes.

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Atestofyoursocialconsciousness:Putyourmoneywhereyoumouthis…

AswathDamodaran

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¨ AssumethatyouworkforDisneyandthatyouhaveanopportunitytoopenastoreinaninner-cityneighborhood.Thestoreisexpectedtoloseaboutamilliondollarsayear,butitwillcreatemuch-neededemploymentinthearea,andmayhelprevitalizeit.

¨ Wouldyouopenthestore?¤ Yes¤ No

¨ Ifyes,wouldyoutellyourstockholdersandletthemvoteontheissue?¤ Yes¤ No

¨ Ifno,howwouldyourespondtoastockholderqueryonwhyyouwerenotlivinguptoyoursocialresponsibilities?