Shareholders Value Creation

Shareholder value creationShareholder value creationValue is every thing.Value is every thing.Companies' that create value ,win. Companies' that create value ,win. those that cannot ,lose.those that cannot ,lose. But once captured But once captured value has to be sustained .value has to be sustained . Which valueWhich value ? ? Book value Book value Liquidation value Liquidation value Market value Market value Replacement value Replacement value

A company creates value for shareholders when A company creates value for shareholders when the shareholder return exceeds the required return the shareholder return exceeds the required return to equity (Ke). In other words, a company creates to equity (Ke). In other words, a company creates value when it outperforms expectations. Created value when it outperforms expectations. Created shareholder value is quantified as follows: Created shareholder value is quantified as follows: Created shareholder value = Equity market value x shareholder value = Equity market value x (Shareholder return - Ke) Created shareholder (Shareholder return - Ke) Created shareholder value can also be calculated as follows: Created value can also be calculated as follows: Created shareholder value = Shareholder value added - shareholder value = Shareholder value added - (Equity market value x Ke). (Equity market value x Ke).

What Drives Shareholder Value? Many corporate executives still focus on quarterly earnings figures as a

key driver of stock market values. Although no-one can discount the importance of

quarterly earnings numbers or the impact on the stock market of earnings

surprises, they are not the fundamental driver. Stock market values are driven by real

corporate performance, as compared to market benchmarks. The key relationship is whether

the money entrusted to corporate management earns a higher return than the

owners can get elsewhere.

Focusing on this key relationship differentiates the value manager from

other managerial styles. Implementing a “value managerial” system can be

accomplished by two main metrics: a sales, operating margin, turnover metric and a

more traditional return on investment, reinvestment rate metric. Both metrics are

simply ways of expressing the underlying determinants of market value. The most

critical decision facing a firm is whether to adopt a value based managerial system

rather than a particular set of decision tools.

Discussion of finance topics involves both normative and positive statements, and it is

important to be aware of their distinction. ”Normative“statements refer to what

“ought” to be and are usually derived from an assumption about how the world

behaves. This is most evident in standard economics topics, where assumptions about

human and corporate behaviour are made to derive supply and demand curves, which

are then used to explain how prices are determined. Financial theory is an application

of these standard economic models to explain how prices in the capital market are

determined. As such, financial economists use essentially the same tools as their

colleagues in other areas of economics to predict how, for example, equity prices

“ought” to be determined, and how as a result corporate management “ought” to

behave. In contrast, “positive” statements refer to “what is, was or will be,” it is

commonly referred to as an appeal to the facts.1 The above distinction between positive and normative statements is imp

Value creation:Value creation: accretion in value accretion in value

“ “ value moves in mysterious ways. Some value moves in mysterious ways. Some strategies work, some of the times. strategies work, some of the times.

Others, don't all the time” Others, don't all the time” the ability to cut through the cross Sections of the ability to cut through the cross Sections of

industry – and company profitability and see the industry – and company profitability and see the pattern that functions as invisible forces that add pattern that functions as invisible forces that add and destroy value is invaluable. and destroy value is invaluable.

The capacity to decipher profit patterns is the The capacity to decipher profit patterns is the ultimate strategy machine .ultimate strategy machine .

Why should Infosys go for NASDAQ listing Why should Infosys go for NASDAQ listing when stock prices in domestic markets were when stock prices in domestic markets were piercing through the roof ?piercing through the roof ?

why should Reliance & MTNL, Wipro etc list why should Reliance & MTNL, Wipro etc list their shares at NYSE .their shares at NYSE .Why should united phosphorous prepare two Why should united phosphorous prepare two sets of corporate accounts-sets of corporate accounts-one for domestic markets as per AS-ICAI one for domestic markets as per AS-ICAI other as per GAAP- of USA. other as per GAAP- of USA.

Morgan Stanley mutual fund bought back Morgan Stanley mutual fund bought back 300cr. Worth of its unit capital to reduce the 300cr. Worth of its unit capital to reduce the corpus from 1000 cr. To 700 cr. What for?corpus from 1000 cr. To 700 cr. What for?

Obviously all these gestures are for Obviously all these gestures are for shareholder vale creation.shareholder vale creation.

Similarly Ballarpur hived off majority of the Similarly Ballarpur hived off majority of the unrelated business activities-glass, chemicals unrelated business activities-glass, chemicals etc.etc.and ACC sold off its ferrites (unrelated) and ACC sold off its ferrites (unrelated) business and took over eternit-everest business and took over eternit-everest ( related business).( related business).

Why shareholder value?Why shareholder value?Shareholder Value or. Market capitalization but for Shareholder Value or. Market capitalization but for certain aberrations is offen a reflection of the equity certain aberrations is offen a reflection of the equity markets’ expectations of the future performance of a markets’ expectations of the future performance of a company.company.For corporate to grow-For corporate to grow- they must attract capital they must attract capital therefore they must focus on shareholder value.therefore they must focus on shareholder value.Tremendous growth and importance of Shareholder Tremendous growth and importance of Shareholder Value concept globally –Value concept globally – because: because: 1- increasing amount of private capital in developed 1- increasing amount of private capital in developed countries have reached their limits of taxation and countries have reached their limits of taxation and borrowing powers using pension & social security borrowing powers using pension & social security funds.funds. Growth of private mutual funds institutional investors Growth of private mutual funds institutional investorsexpansion of equity markets & increasing proportion expansion of equity markets & increasing proportion of equities held by institutions. .of equities held by institutions. .

Investor wants the funds to maximize their Investor wants the funds to maximize their performance; in turn the funds demand value from performance; in turn the funds demand value from

the companies they invest in the companies they invest in 2. 2. Globalization of markets:Globalization of markets:

Financial deregulation has created global market Financial deregulation has created global market for financial assets. Corporate now compete globally for financial assets. Corporate now compete globally not only for products, customer and employees but not only for products, customer and employees but for capital too. Attracting capital depends on being for capital too. Attracting capital depends on being the best in class with a thrust on shareholder value the best in class with a thrust on shareholder value

3. Information:3. Information:Complex calculations and access to information Complex calculations and access to information

through computers and internet has assisted through computers and internet has assisted investors to evaluate corporate in terms of the value investors to evaluate corporate in terms of the value

creation.creation.

Indian scenarioIndian scenarioSince independence in 47- Govt. the major stockholder in Since independence in 47- Govt. the major stockholder in business Economic policy followed import substitution and business Economic policy followed import substitution and protected regime. Extensive public ownership of protected regime. Extensive public ownership of productive capital with complex cans boles regulations.productive capital with complex cans boles regulations.Restriction on foreign ownership of capital. Financial inst Restriction on foreign ownership of capital. Financial inst itutions and govt. the provider of capitalitutions and govt. the provider of capital Outcome: public operates consumed resources without Outcome: public operates consumed resources without providing adequate returns.providing adequate returns.Pvt. Corporate-key driver of growth The procurement of Pvt. Corporate-key driver of growth The procurement of licenses. Banking sector-directed lending to demand licenses. Banking sector-directed lending to demand priority crease –NPA’s –priority crease –NPA’s –

1991 winds of liberalization:1991 winds of liberalization:Economic reforms accompanied with financial sector Economic reforms accompanied with financial sector reforms. reforms. Pvt. Players allowed in banking mutual funds industry FII’s Pvt. Players allowed in banking mutual funds industry FII’s were allowed to invest in Indian equity. were allowed to invest in Indian equity.

Corporate allowed to raise GDR’s Corporate allowed to raise GDR’s ADR’s ADR’s Greater freedom to financial Greater freedom to financial intermediates to raise resources. intermediates to raise resources.

Competition led to greater Competition led to greater accountability to fund providers accountability to fund providers dismantling of capital issue dismantling of capital issue controls.controls.

FII and GDR investment had a relatively higher FII and GDR investment had a relatively higher growth institutional investors have expressed growth institutional investors have expressed

concern regarding the shareholder value and lack of concern regarding the shareholder value and lack of transparency and quality of information of Indian transparency and quality of information of Indian

companies.companies.Shareholder value: key future drivers:Shareholder value: key future drivers:

greater stiv orientatition of domestic MF’s. The greater stiv orientatition of domestic MF’s. The earlier rate of passive non-interfering creditors/ earlier rate of passive non-interfering creditors/ minority shareholders would have to change to minority shareholders would have to change to

aggressive shareholder value oriented institutional aggressive shareholder value oriented institutional investors. Growth in importance of pvt. Investorsinvestors. Growth in importance of pvt. Investors

Quantum of FII & GDR in vests shall be guided Quantum of FII & GDR in vests shall be guided by presence of Sh. V. Oriented globally by presence of Sh. V. Oriented globally competitive corporate. competitive corporate.

privatization: privatization:

Greater exposure to equity mkt. why is would Greater exposure to equity mkt. why is would feed to a change in mgt. style-oriented towards feed to a change in mgt. style-oriented towards shareholder value creation.shareholder value creation.The Indian corporate:The Indian corporate:A greater sensitivity to the interests of share A greater sensitivity to the interests of share holders would feed to appreciation by equity holders would feed to appreciation by equity markets and an enhanced monetary flow into markets and an enhanced monetary flow into equity markets.equity markets.

Creating value for the shareholder is not Creating value for the shareholder is not an overnight thing it is a long term an overnight thing it is a long term

objective “our goal is to keep enhancing objective “our goal is to keep enhancing this value-over a changing mix of this value-over a changing mix of

changing business cycle”changing business cycle”“Sustain ably enhancing value for “Sustain ably enhancing value for

shareholders will come from a sound shareholders will come from a sound competitive strategy, improving profits, competitive strategy, improving profits, a fair dislnbution policy and corporate a fair dislnbution policy and corporate transparency that rein forces investor transparency that rein forces investor

condolence”condolence”Economic value added [EVA]Economic value added [EVA]

1 Average debt - 500cr1 Average debt - 500cr 2. Average equity - 1500cr2. Average equity - 1500cr 3. Average capital employed (1+2) absolute amt.)3.3. Average capital employed (1+2) absolute amt.)3. 4. Cost of debt post tax %4. Cost of debt post tax % 5. Cost of equity %5. Cost of equity % 6. Weighted average cost of capital WACC (%) 6%6. Weighted average cost of capital WACC (%) 6% 7. COCE= 3x6- 200x6%7. COCE= 3x6- 200x6% 8. Profit after tax (PAT)8. Profit after tax (PAT) 9. Add. Interest offer taxes9. Add. Interest offer taxes 10. Net operating profit offer taxes (NOPAT)-10. Net operating profit offer taxes (NOPAT)- 11. EVA= NOPAT-COCE (10-7)11. EVA= NOPAT-COCE (10-7) 12 EVA % capital employed= EVA/average capital 12 EVA % capital employed= EVA/average capital

employedemployed = (11/3)= (11/3)

1997-981997-98 1998-991998-99

1. AVERAGE DEBT.1. AVERAGE DEBT. 49.6 CR.49.6 CR. 65.6 CR.65.6 CR.

2. AVERAGE EQUITY2. AVERAGE EQUITY 35.2 CR.35.2 CR. 49.7 CR.49.7 CR.

3. AV. CAPITAL EMPLOYED3. AV. CAPITAL EMPLOYED 84.8 CR.84.8 CR. 115.0 CR.115.0 CR.

4. COST OF DEBT POST TAX( % )4. COST OF DEBT POST TAX( % ) 8.82%8.82% 9.75%9.75%

5. COST OF EQUITY %5. COST OF EQUITY % 22.5%22.5% 22.5%22.5%

6. WACC6. WACC 14.5%14.5% 15.26%15.26%

7. COCE7. COCE 12.3 CR.12.3 CR. 17.5 CR.17.5 CR.

8. PAT8. PAT 12.7 CR.12.7 CR. 22.1 CR.22.1 CR.

9. ADD INTEREST OFFER TAXES.9. ADD INTEREST OFFER TAXES. 4.13 CR.4.13 CR. 6.06 CR.6.06 CR.

10. NET OPERATING PROFIT OFFER TAX10. NET OPERATING PROFIT OFFER TAX 16.7 CR.16.7 CR. 28.2 CR.28.2 CR.

11. COCE (AS PER 7)11. COCE (AS PER 7) 12.3 CR12.3 CR 17.5 CR.17.5 CR.

12. EVA AS % OF COCE12. EVA AS % OF COCE 4.6/12.3 CR.4.6/12.3 CR. 10.7 CR/17.5 10.7 CR/17.5 CR.CR.

(12/3)(12/3) 5.44%5.44% 9.28%9.28%

Economic value added: EVAEconomic value added: EVAEVA is the profit realized offer deducting the EVA is the profit realized offer deducting the

cost of all capital employed (Debt equity) EVA is cost of all capital employed (Debt equity) EVA is the amount by which the company’s pre interest the amount by which the company’s pre interest but offer tax net operating income (or NOPAT) but offer tax net operating income (or NOPAT)

exceeds the charge for capital.exceeds the charge for capital.Coco cola’s CEO Robert goizueta remarked Coco cola’s CEO Robert goizueta remarked

–“you only get richer of you invest money at a –“you only get richer of you invest money at a higher return than the cost of that money to you. higher return than the cost of that money to you. Every body knows that” but many seem to forget Every body knows that” but many seem to forget

it”it”EXP: NILKAMAL registered an Eva of 10.68 EXP: NILKAMAL registered an Eva of 10.68

corers in 1998-99.corers in 1998-99.This indicates that the co. was able to meet the This indicates that the co. was able to meet the

expectations of its shareholders.expectations of its shareholders.

Traditional approaches to measuringTraditional approaches to measuringShareholder value creation’ have used parameters Shareholder value creation’ have used parameters

such as earnings capitalization, market such as earnings capitalization, market capitalization and PV estimates of cash flows. capitalization and PV estimates of cash flows.

Extensive equity research has now established Extensive equity research has now established that it is not earnings per se but value which is that it is not earnings per se but value which is

important. A new measure called economic being important. A new measure called economic being applied to understand and evaluate financial applied to understand and evaluate financial

performance. EVA= net operating profits after performance. EVA= net operating profits after taxes (NOPAT) (minus) EVA NOPAT-COCE) Cost taxes (NOPAT) (minus) EVA NOPAT-COCE) Cost

of capital employedof capital employedWhere NOPST: = profits after depreciation and Where NOPST: = profits after depreciation and

taxes but before interest costs. It represents the taxes but before interest costs. It represents the total pool of profits available on an unguarded total pool of profits available on an unguarded

basis to provide a return to lenders shareholders.basis to provide a return to lenders shareholders.

COCE: is weighted average cost of capital COCE: is weighted average cost of capital WACC+average capital employed. Cost of debt is WACC+average capital employed. Cost of debt is

taken as effective rate of invest applicable to a rates taken as effective rate of invest applicable to a rates co. (HLL-AAA-14% pre tax) Cost of equity: is the co. (HLL-AAA-14% pre tax) Cost of equity: is the

return expected by investors to compensate them for return expected by investors to compensate them for variability in returns caused by fluctuating earnings variability in returns caused by fluctuating earnings

and share price.and share price.Cost equity (HLL) = risk free return equivalent to yield Cost equity (HLL) = risk free return equivalent to yield

on long term Govt. bonds (12.5%) RM. Market risk on long term Govt. bonds (12.5%) RM. Market risk premium (9%) x beta equivalent fore co. (.8) =12.5 %+( premium (9%) x beta equivalent fore co. (.8) =12.5 %+(

9%x.8)9%x.8)HLL its Ke. = 19.7% KeHLL its Ke. = 19.7% Ke

Eva is a residual income offer charging the co. for the Eva is a residual income offer charging the co. for the cost of capital provided by fondues shareholders it cost of capital provided by fondues shareholders it represents the value added to the shareholder by represents the value added to the shareholder by

generating op profit. KO capitalgenerating op profit. KO capital employees.employees.

EVA-developed by stern Stewart co. VSA EVA-developed by stern Stewart co. VSA from definition stand point EVA refers to the from definition stand point EVA refers to the

systems of corporate management that systems of corporate management that defines profitability in farms of the returns on defines profitability in farms of the returns on capital above the cost of servicing the capital capital above the cost of servicing the capital

employed.employed.EVA, however is not just a measure of EVA, however is not just a measure of

operating performance, it is also a highly operating performance, it is also a highly sophisticated tool of financial management sophisticated tool of financial management

which encompasses the entire financial which encompasses the entire financial management which encompasses the entire management which encompasses the entire financial management function from capital financial management function from capital

budgeting acquisition pricing to tragic budgeting acquisition pricing to tragic planning and shareholder communications”planning and shareholder communications”

When will EVA increase: 1. efficiency? When will EVA increase: 1. efficiency? Eva will increase if: 2. profitable Eva will increase if: 2. profitable operating profits can be made to grow without operating profits can be made to grow without employing more capital i.e. greater efficiency employing more capital i.e. greater efficiency additional capital is invested in projects that additional capital is invested in projects that return more than the cost of obtaining funds return more than the cost of obtaining funds (new capital) i.e. profitable growth-(takeover)(new capital) i.e. profitable growth-(takeover)

capital is curtailed in activities that don’t cover capital is curtailed in activities that don’t cover the cost of capital i.e.the cost of capital i.e.

Liquidate unproductive i.e. Liquidate unproductive i.e. Liquidate unproductive capital (hive-off) Liquidate unproductive capital (hive-off)

Or Theodora me thud of evaluating Or Theodora me thud of evaluating performance:performance:

1. prêt-interest profit/total turnover NPBT/sales1. prêt-interest profit/total turnover NPBT/sales

%%

PBIDT toPBIDT to

yearyear

ROCEROCE

2.return on capital employed % 2.return on capital employed % 3.return on net worth (RONW)%3.return on net worth (RONW)%Growth in PBIDT. %Growth in PBIDT. % New techniques: New techniques: 1.EVA.-stern Stewart co. U&A.1.EVA.-stern Stewart co. U&A.2.Market capitalization to sales-Adrian slyworkly.2.Market capitalization to sales-Adrian slyworkly.Latest techniques of creatingLatest techniques of creatingShareholder value .1.Shareholder value .1.Buy back of shares:Buy back of shares:Reduction in capitalReduction in capitalEnhanced EPSEnhanced EPSCommunization of massage of value.Communization of massage of value.Exp: Indian rayon buy back through book building selan exploration Exp: Indian rayon buy back through book building selan exploration buying back at Rs.20/-buying back at Rs.20/-Easel packing to buy back at 300/-Easel packing to buy back at 300/-[Scrip shooting at 500/- fabulous dividend instead] [Scrip shooting at 500/- fabulous dividend instead] ESOP: employee’s stock option scheme to create shareholder value.ESOP: employee’s stock option scheme to create shareholder value.Creeping acquisition: Creeping acquisition: Exp: 1. reliance going for creeping acquisitionExp: 1. reliance going for creeping acquisition 2. TISCO/TELCO-Tata's stake enhanced. 2. TISCO/TELCO-Tata's stake enhanced.

ACC-Rs 100/-share to Rs 10/- . 10 share for oneACC-Rs 100/-share to Rs 10/- . 10 share for one WIPRO-splitting the stock price % Rs. 21/-WIPRO-splitting the stock price % Rs. 21/- ZEE-splitting Rs. 10 stock % Rs.1/- ZEE-splitting Rs. 10 stock % Rs.1/- Splits have become convenient because of Splits have become convenient because of

dematerialization “dematerialization “ Offer of shares.Offer of shares. Exp: orchid chemicals offering shares to Asia pacific funds Exp: orchid chemicals offering shares to Asia pacific funds

(36.11%) at 164/-(36.11%) at 164/- Promoter’s equity dilutedPromoter’s equity diluted The scrip price jumps from Rs 170 % Rs. 270/- in 6 The scrip price jumps from Rs 170 % Rs. 270/- in 6

sessions. sessions. Corporate restructuring:Corporate restructuring: Ballarpur hiving off unrelated activities.Ballarpur hiving off unrelated activities. Wealth creators & destroyersWealth creators & destroyers Whether shareholder value management is a fad?Whether shareholder value management is a fad?

That vill eventually pass?That vill eventually pass?No – it’s a global phenomenon that is especially No – it’s a global phenomenon that is especially

relevant in the Indian context.relevant in the Indian context.Good corporate governance:- is about ensuring that Good corporate governance:- is about ensuring that

managers run the business in the long term interests of managers run the business in the long term interests of shareowners and in doing so , ensure that all other shareowners and in doing so , ensure that all other

stockholders are also taken care of (customer stockholders are also taken care of (customer employees , suppliers etc.)employees , suppliers etc.)

Although many companies may manage to comply with Although many companies may manage to comply with regulatory requirements for good corporate regulatory requirements for good corporate

governance, their shareowners continue to get a raw governance, their shareowners continue to get a raw dealdeal

Managers of mature businesses that generate large Managers of mature businesses that generate large cash flows but have limited opportunities for value cash flows but have limited opportunities for value

creating investment projects tend to destroy creating investment projects tend to destroy shareholder wealth by investing too much capital.shareholder wealth by investing too much capital.

Back into their existing business and/or making ill Back into their existing business and/or making ill conceived and over-priced acquisition forays into conceived and over-priced acquisition forays into

unrelated areas.unrelated areas. Improving corporate governance and shareholder Improving corporate governance and shareholder

wealth creation performance is especially relevant in wealth creation performance is especially relevant in the Indian context for the following reasons:the Indian context for the following reasons:

1. The shareowner wealth creation track record for 1. The shareowner wealth creation track record for Indian companies is poor compared with companies in Indian companies is poor compared with companies in

other countries. other countries. 2. proportion of population that owns shares is 2. proportion of population that owns shares is

increasing.increasing.3. family-controlled co’s are increasing by moving to 3. family-controlled co’s are increasing by moving to

delegate managerial responsibility to professional delegate managerial responsibility to professional rather than family members-driving the need for more rather than family members-driving the need for more

formal corporate governance mechanismsformal corporate governance mechanisms

4. Improvements to the takeover code and other 4. Improvements to the takeover code and other regulatory policies are slowly but surely making it regulatory policies are slowly but surely making it

eases for Share owns to boot for efficient eases for Share owns to boot for efficient management the level pf M&A activity is management the level pf M&A activity is

increasing.increasing.5. Global mobility of funds across the world means 5. Global mobility of funds across the world means

that opportunity cost of shareowners funds is that opportunity cost of shareowners funds is increasingly real. If Indian corporate don’t perform. increasingly real. If Indian corporate don’t perform.

FII’s will look elsewhere.FII’s will look elsewhere.On an average Indian companies create only 50 On an average Indian companies create only 50 paisa of market value added ( MVA) for every paisa of market value added ( MVA) for every rupee of capital invested, whereas pan-Asian, rupee of capital invested, whereas pan-Asian, European and U S co’s are at lease twice as European and U S co’s are at lease twice as

productive , in other worlds, their MVA/ capital productive , in other worlds, their MVA/ capital ratios are greater than one.ratios are greater than one.

However, Indian companies that create wealth, However, Indian companies that create wealth, on an average, earn higher MVA/ capital than on an average, earn higher MVA/ capital than

their comparable peer set in other economics- their comparable peer set in other economics- WIPRO, INFY, HLL, Reliance, and ITC.WIPRO, INFY, HLL, Reliance, and ITC.

Indian wealth creators utilize only 35% of total Indian wealth creators utilize only 35% of total capital invested in our public capital market.capital invested in our public capital market.

It is alarming to note that the Indian companies It is alarming to note that the Indian companies which destroy about 26 paisa,which destroy about 26 paisa,

For every rupee invested in our market. In For every rupee invested in our market. In contrast, U S economy invests 87% of its capital contrast, U S economy invests 87% of its capital

in wealth creators, in pan- Asian mkts. 65% is in wealth creators, in pan- Asian mkts. 65% is invested in wealth creators.invested in wealth creators.

The problem with the Indian capital market lies in The problem with the Indian capital market lies in improper allocation of capital and is a cause of improper allocation of capital and is a cause of

great concern in India.great concern in India.

10 yrs later, July 2002, orchid is set to chart a new 10 yrs later, July 2002, orchid is set to chart a new history of global innovation and integration.history of global innovation and integration.

Orchid now has a joint venture for drug discovery in Orchid now has a joint venture for drug discovery in the U S A, the world’s largest mkt. for new drug the U S A, the world’s largest mkt. for new drug innovations. innovations.

Orchid is now establishing a joint venture for Orchid is now establishing a joint venture for manufacturing cephalosrin & in china , the world’s manufacturing cephalosrin & in china , the world’s largest mkt (non-regulated) for pharmaceuticals.largest mkt (non-regulated) for pharmaceuticals.

These are but two of the initiatives that exemplify a These are but two of the initiatives that exemplify a radical business transformation and structural radical business transformation and structural metamorphosis that under way of orchid to fuel metamorphosis that under way of orchid to fuel growth.growth.

Orchid is well poised to become a composite pharma. Orchid is well poised to become a composite pharma. Corp. Covering bulk actives, formulations and Corp. Covering bulk actives, formulations and research through a judicious combination of ORGANIC research through a judicious combination of ORGANIC and INORGANIC growth initiatives.and INORGANIC growth initiatives.

Orchid would be truly multi national in character in the Orchid would be truly multi national in character in the years to come with manufacturing operations in India years to come with manufacturing operations in India

and china, marketing offices and subsidiaries in the U S, and china, marketing offices and subsidiaries in the U S, Brazil and Russia and Research infrastructure in India, U Brazil and Russia and Research infrastructure in India, U

S and Europe, China is emerging not only as a world’s S and Europe, China is emerging not only as a world’s largest mkt place but also a very competitive largest mkt place but also a very competitive

manufacturing base. A manufacturing base in china manufacturing base. A manufacturing base in china would be an appropriate move for orchid in the would be an appropriate move for orchid in the

emerging scenario of global integration.emerging scenario of global integration.Orchid has jointed hands with china pharma. Corp. to Orchid has jointed hands with china pharma. Corp. to promote NCPC orchid pharma co. Ltd, a 50:50 J.V for promote NCPC orchid pharma co. Ltd, a 50:50 J.V for

manufacture and marketing of cephalosporin bulk manufacture and marketing of cephalosporin bulk actives and formulations in china.actives and formulations in china.

Pending completion of the non- sterile bulk pardon. Pending completion of the non- sterile bulk pardon. Facility orchid will supply the product for first 2 yrs for Facility orchid will supply the product for first 2 yrs for

conversion to the find product.conversion to the find product.

The joint venture could well pave the way for diversification into The joint venture could well pave the way for diversification into other the repeaters later. China has emerged as one of the most other the repeaters later. China has emerged as one of the most competitive production bases and the single largest market for competitive production bases and the single largest market for

pharma cuticles apart from some of the developed markets.pharma cuticles apart from some of the developed markets.Achieving higher value addition optimal capacity utilization and Achieving higher value addition optimal capacity utilization and

continuous productivity impairments in operations.continuous productivity impairments in operations.Orchid’s corporate strategies, particularly the product market Orchid’s corporate strategies, particularly the product market

and technology project strategies recognize the concepts of EVA.and technology project strategies recognize the concepts of EVA.Orchid has transited from the entry mode in the quickest span of Orchid has transited from the entry mode in the quickest span of time possible and positioned it self in the growth mode, which is time possible and positioned it self in the growth mode, which is

a specific strategic position considering the technology and a specific strategic position considering the technology and investment intensive mature of the global pharma. Industry.investment intensive mature of the global pharma. Industry.Through this orchid has been able to optimize the EVA even Through this orchid has been able to optimize the EVA even while assuring long term competitiveness of the business while assuring long term competitiveness of the business through required investments in technology. Moreover. In through required investments in technology. Moreover. In

specific product segments orchid has been able to position its specific product segments orchid has been able to position its self in the harvest mode reaping high EVA through prudent self in the harvest mode reaping high EVA through prudent

operations managements.operations managements.

Orchid would continue to Orchid would continue to adopt relevant strategic adopt relevant strategic

approaches which support approaches which support long term business long term business

development and assuse development and assuse sustainable value sustainable value enhancement for enhancement for

shareholders.shareholders.

1. Av. Shareholder’s net worth-155.9 cr.1. Av. Shareholder’s net worth-155.9 cr. 2. Av. Debt-352.7 cr.2. Av. Debt-352.7 cr. 3. Av. Capital employed-508.6 cr.3. Av. Capital employed-508.6 cr. 4. Cost of debt (post tax)-9.35%4. Cost of debt (post tax)-9.35% 5. Cost of quity-20.20%5. Cost of quity-20.20% 6. WACC-12.71%6. WACC-12.71% 7. Cost of capital employed-508.6 crx12.71/100-64.47 cr.7. Cost of capital employed-508.6 crx12.71/100-64.47 cr. Net operating profit offer taxes:Net operating profit offer taxes: Pat - 35.57 cr.Pat - 35.57 cr. Add int. adjusted for taxes. 32.98 cr.Add int. adjusted for taxes. 32.98 cr. No PAT 68.55 cr.No PAT 68.55 cr. EVA- 68.55cr-64.47cr=4.04cr.EVA- 68.55cr-64.47cr=4.04cr. EVA as % of capital employed-08%EVA as % of capital employed-08%

MVA is the excess of the market value of the company over the value of investor’s capital (economic MVA is the excess of the market value of the company over the value of investor’s capital (economic book value). It is an obsolete measure of value, calculated as the total value of the company. It book value). It is an obsolete measure of value, calculated as the total value of the company. It quantifies the premium the market is willing to pay for the value created by the company.quantifies the premium the market is willing to pay for the value created by the company.

MVA= current value of debt+ equity-economic book value MVA= current value of debt+ equity-economic book value Economic book value= share capital +free resemes+debtEconomic book value= share capital +free resemes+debt March 31st ‘1999March 31st ‘1999 Economic book value:Economic book value: Total debt - 312.69 cr.Total debt - 312.69 cr. Equity - 17.34 cr.Equity - 17.34 cr. Free resumes – 152.47 cr. +Free resumes – 152.47 cr. + Total share holder’s net worth- 169.81 cr.Total share holder’s net worth- 169.81 cr. Total economic book value- = 482.51 cr.Total economic book value- = 482.51 cr. Market capitalization of equity:Market capitalization of equity: No of out standing shares- 1.73 cr.No of out standing shares- 1.73 cr. Share prices.Share prices. High - 189.90High - 189.90 Low - 84.05Low - 84.05 Average – 116.55Average – 116.55 Market capitalization of equity-(1.73cr.x116x55)= 202.17cr.Market capitalization of equity-(1.73cr.x116x55)= 202.17cr. Market value of debt - 312.69 cr.Market value of debt - 312.69 cr. Market value of debt+ equity - 514.86cr.Market value of debt+ equity - 514.86cr. MVA- market value- economic book value.MVA- market value- economic book value. 514.86 cr. - 482.51 cr.514.86 cr. - 482.51 cr. = 32.35 cr.= 32.35 cr. Excess wealth accretion to shareholders overExcess wealth accretion to shareholders over Economic book value- 6.7 %Economic book value- 6.7 %

S.V.C. emerging as most crucial criteria in investment selection of S.V.C. emerging as most crucial criteria in investment selection of a company.a company.

Fund managers non relegate other parameters likeFund managers non relegate other parameters like Industry outlookIndustry outlook Investment philosophy of corporate Investment philosophy of corporate Market capitulationMarket capitulation Traded volume. Etc. Traded volume. Etc. Now its only shareholder valueNow its only shareholder value A co. generates shareholder value only if it generates returns in A co. generates shareholder value only if it generates returns in

excess of its excess of its Cost of capitalCost of capital Higher growthHigher growth Higher returnsHigher returns Appropriate risk.Appropriate risk.

““Till corporate gear up and show concern for Till corporate gear up and show concern for shareholder, raising funds in the stock market will not shareholder, raising funds in the stock market will not be easy . Many IT co’s have shown voracious hunger be easy . Many IT co’s have shown voracious hunger for growth and expansion in their effort for building for growth and expansion in their effort for building market share. This has produced significantly higher market share. This has produced significantly higher returns for investors composed to many other returns for investors composed to many other corporate. Many of the latter through their choice of corporate. Many of the latter through their choice of investments demonstrated inefficient use of capital, investments demonstrated inefficient use of capital, speaking volumes about lack of concern for creating speaking volumes about lack of concern for creating shareholder value’shareholder value’

Gone are the boom days of 90’s when shareholders Gone are the boom days of 90’s when shareholders were taken for granted.were taken for granted.

Tables have turned Tables have turned Management’s now realize the need to change tactics to Management’s now realize the need to change tactics to

enhance shareholder value.enhance shareholder value.

TurnTurnoverover Profit Profit

marginmarginTaxTax raterate

WorkingWorkingcapitalcapital

FixedFixedassetsassets

Cost Cost Of Of

capitalcapitalCompetitiveCompetitiveAdvantage.Advantage.

ShareholderShareholderReturn.Return.

Increase of shareholder valueIncrease of shareholder value

Free cash flow valuation.Free cash flow valuation.

Seven mantras to enhance Seven mantras to enhance shareholder value.shareholder value.

Increasing importance Increasing importance to share price to to share price to

1- Generate wealth to 1- Generate wealth to ensure modification of ensure modification of

funds.funds.2- Deface tool to stall 2- Deface tool to stall

takeovers.takeovers.

Study by price water house coopersStudy by price water house coopers Shareholding pattern getting more institutionalized Shareholding pattern getting more institutionalized

making investors more demanding.making investors more demanding. PWC’s study: parameters taken by most senior PWC’s study: parameters taken by most senior

analysts and fund managers professional investors analysts and fund managers professional investors cover 80% of the assets of Indian mutual funds and 65 cover 80% of the assets of Indian mutual funds and 65 % of FII’s% of FII’s

Traditional P/E ratios based on historical information Traditional P/E ratios based on historical information no longer on investment tool. no longer on investment tool.

Inst’s investors in their invst. Appraisal look at Inst’s investors in their invst. Appraisal look at anticipated future value, based on expected cash flow anticipated future value, based on expected cash flow (FCF)(FCF)

Study conducted in vs. revealed a high correlation Study conducted in vs. revealed a high correlation Between – change in the free cash flow and share price Between – change in the free cash flow and share price

performance. (PWC)performance. (PWC) Other mkts. In the world experience the some Other mkts. In the world experience the some

phenomenon.phenomenon.

PWC saysPWC says ‘ ‘ the shift in investment focus from EPS to free the shift in investment focus from EPS to free

cash flow(FCF) indicates that markets are thinking cash flow(FCF) indicates that markets are thinking long term though that is not to say they don’t still act long term though that is not to say they don’t still act short term at times”short term at times”

‘‘in cash of institutional investors with longer time in cash of institutional investors with longer time horizon , the use of free cash flow is more regular in horizon , the use of free cash flow is more regular in capturing growth risk and return expectations ‘- capturing growth risk and return expectations ‘- Ashwin puri PWC stress on free cash flow valuation Ashwin puri PWC stress on free cash flow valuation feeds to the mastering of seven value driversfeeds to the mastering of seven value drivers

The golden principle followed is a company generates The golden principle followed is a company generates shareholder value only if it generates returns in excess shareholder value only if it generates returns in excess of cost of capital.of cost of capital.

Study on U K. Hong Kong- Australia ranks operating Study on U K. Hong Kong- Australia ranks operating profit margin as the highest driver.profit margin as the highest driver.

Delivering valueDelivering value To shareholderTo shareholder ‘‘The management of BPL is committed to The management of BPL is committed to

strong thinning shareholder value over strong thinning shareholder value over the long run. It recognizes that the the long run. It recognizes that the drivers of the enhanced shareholder drivers of the enhanced shareholder value are strategy like a sound value are strategy like a sound competitive strategy, implored profits, a competitive strategy, implored profits, a fair distribution policy and corporate fair distribution policy and corporate transparency that reinforces investor transparency that reinforces investor confidence.confidence.

The value creation drivers of BPL’s businessThe value creation drivers of BPL’s business

Operating profit marginOperating profit margin

Tax rateTax rate

Fixed capital investmentFixed capital investmentmanagementmanagement

Working capitalWorking capitalmanagementmanagement

Sales growthSales growth

KPMG &BS – made first ever ranking of Indian KPMG &BS – made first ever ranking of Indian companies by value creation.companies by value creation.

Shareholder value is bound to appear in most of the Shareholder value is bound to appear in most of the annual reports in good / well established corporate annual reports in good / well established corporate (h level, Nilkamal, BPL ,Ranbaxy, L&T etc.)(h level, Nilkamal, BPL ,Ranbaxy, L&T etc.)

No longer can managements gloat over its gigantic No longer can managements gloat over its gigantic expansion plans, unless it is sure it can meet expansion plans, unless it is sure it can meet stringent return on capital norm. stringent return on capital norm.

A dramatic shift in the way the co's are measured & A dramatic shift in the way the co's are measured & evaluated. evaluated.

Metric predecessors: Metric predecessors: Return on sales (ROS) was good when markets were Return on sales (ROS) was good when markets were

not very competitive and firms could concentrate on not very competitive and firms could concentrate on asset and market share buildup. Whenever a firm asset and market share buildup. Whenever a firm needed to increase value, it could simply take a needed to increase value, it could simply take a margin like.margin like.

Once markets become competitive the freedom to increase Once markets become competitive the freedom to increase margins is reduced.margins is reduced.

Since every body has sufficient assets (capacities), the Since every body has sufficient assets (capacities), the priority has to shift from building assets to utilizing the priority has to shift from building assets to utilizing the existing assets most effectively a shift to ROI. existing assets most effectively a shift to ROI.

ROI: the way to improve ROI is to improve w . Cap. Mgt, turn ROI: the way to improve ROI is to improve w . Cap. Mgt, turn assets faster, better liquid cash mgt.assets faster, better liquid cash mgt.

Speeds up collections delay payable don’t leave cash lying Speeds up collections delay payable don’t leave cash lying around.around.

Efficient treasury management and cash management leads Efficient treasury management and cash management leads to better ROI:to better ROI:

The use ROI has offen led to co's to adopt value – The use ROI has offen led to co's to adopt value – destroying approach to growth and put the measure (ROI) destroying approach to growth and put the measure (ROI) under question.under question.

ROI is unsuitable for semiconductor / software inds-where ROI is unsuitable for semiconductor / software inds-where the rate of change of product performance and cost of the rate of change of product performance and cost of manufacturing are non-linear.manufacturing are non-linear.

The 1980’s saw the rise of ROE, ROCE & RONA which The 1980’s saw the rise of ROE, ROCE & RONA which used earnings as a measure of invested capital.used earnings as a measure of invested capital.

Managers realized that the more the depreciation of Managers realized that the more the depreciation of assets the lower was capital employed and higher RONA.assets the lower was capital employed and higher RONA.

They found that they could apparently improve earnings They found that they could apparently improve earnings efficiency without increasing assets.efficiency without increasing assets.

Managers immediately switched to milking the existing Managers immediately switched to milking the existing asset base and refrained from reinvesting for the future.asset base and refrained from reinvesting for the future.

Enter EVA.Enter EVA. With EVA, the capitals providers are making corporate With EVA, the capitals providers are making corporate

understand that growth is a privilege and not a right.understand that growth is a privilege and not a right. They are making the marketing finance people evolve a They are making the marketing finance people evolve a

strategy that is sustainable as well as viable.strategy that is sustainable as well as viable.

The moment a firm starts developing its strategy with inputs The moment a firm starts developing its strategy with inputs from marketing finance and production it adopts a cross from marketing finance and production it adopts a cross functional approach.functional approach.

So, unprofitable and value destroying activities can be hunted So, unprofitable and value destroying activities can be hunted down and mitigated.down and mitigated.

Share holder value measure ments are now routinely used by a Share holder value measure ments are now routinely used by a wide cross section of brokers fund managers and company wide cross section of brokers fund managers and company executives.executives.

However, much of this effort at measuring share holders value However, much of this effort at measuring share holders value is seldom disseminated across a wide cross-section of is seldom disseminated across a wide cross-section of industry.industry.

There fore no one is sure to how Indian firms have fared on There fore no one is sure to how Indian firms have fared on value creation.value creation.

Surry of KPMGRBS in 1998 computed economic profit (EP) Surry of KPMGRBS in 1998 computed economic profit (EP) And market value added (MVA)And market value added (MVA) To lest 1000 corporate.To lest 1000 corporate. EP: after tax operating profits. A snapshot EP: after tax operating profits. A snapshot MVA: A longer term picture.MVA: A longer term picture.

Contemporary indicators used by analysts to estimate Contemporary indicators used by analysts to estimate shareholder value.shareholder value.

1. Total shareholder return:1. Total shareholder return: Since dividends and expansion in market capitulations Since dividends and expansion in market capitulations

are the too principal ways in which shareholder value can are the too principal ways in which shareholder value can be enriched, TSR takes into A/C the sum of these 2 be enriched, TSR takes into A/C the sum of these 2 factors. factors.

The increase in market capitalization is added to the The increase in market capitalization is added to the dividend paid during the financial Y.R the sum is then dividend paid during the financial Y.R the sum is then expressed as a % of mkt. cap. Of co. at the beginning of expressed as a % of mkt. cap. Of co. at the beginning of the year under renew.the year under renew.

Rs.cr.Rs.cr.

YearYear 1996-971996-97 97-9897-98 98-9998-99

Closing capital valueClosing capital value 20.1420.14 18.0818.08 70.7870.78

(17.30)(17.30)

Less of value (cap.)Less of value (cap.) 25.4525.45 18.6418.64 13.3013.30

Add dividendAdd dividend 1.891.89 2.062.06 3.433.43

Incremental gain.Incremental gain. 3.423.42 1.501.50 56.9856.98

Inc. gain/beg. Inc. gain/beg. Value(%)Value(%)

13.4413.44 8.048.04 330.70330.70

Look at yields, rather than get Look at yields, rather than get into the distribution battle zones: into the distribution battle zones: top brands Pantene, Ariel, top brands Pantene, Ariel, whisper , Camay& Vicks to be whisper , Camay& Vicks to be advertised heavily on its own. advertised heavily on its own. Smaller brands 10 % of volume Smaller brands 10 % of volume shifted to Marico.shifted to Marico.

NIIT appointed stern steward to NIIT appointed stern steward to provide training to its 400 provide training to its 400 managers.managers.

Task: introducing the concept to Task: introducing the concept to managers helping then grasp the managers helping then grasp the nuances of implementing EVA.nuances of implementing EVA.

1. Measuring performance at 125 EVA points. 1. Measuring performance at 125 EVA points. Managers generating EVA reports.Managers generating EVA reports.

2. Use the concept while making investment 2. Use the concept while making investment decision buying was sacrificed by outsourcing decision buying was sacrificed by outsourcing the main frame time with utilization being low.the main frame time with utilization being low.

3. introduce EVA into planning goal setting and 3. introduce EVA into planning goal setting and budgetingbudgeting

4. Link it to compensation.4. Link it to compensation.

EVA brochures, EVA news letters Eva web pages.EVA brochures, EVA news letters Eva web pages. EVA in practice 2EVA in practice 2 One manager was using both a desk top a well as a One manager was using both a desk top a well as a

note book now he has only a notebook.note book now he has only a notebook. NIIT is banking on eventual linkage of compensation NIIT is banking on eventual linkage of compensation

to EVAto EVA ““So for you were rewarded for your effort, nowSo for you were rewarded for your effort, now You will be rewarded for results”You will be rewarded for results” The very notion of having a large component of The very notion of having a large component of

one’s salary being variable is something new in one’s salary being variable is something new in Indian context.Indian context.

COCE.COCE. 1996.1996. 19971997 1998.1998.

1. AV. Debt.1. AV. Debt. 156156 160160 16.516.5

2. AV. Equity2. AV. Equity 815815 11271127 14871487

3. AV. Cap. Employed 3. AV. Cap. Employed (1+2)(1+2)

971971 12871287 16521652

4. Cost of debt post tax 4. Cost of debt post tax (%)(%)

7.887.88 8.828.82 9.109.10

5. Cost of equity5. Cost of equity 19.719.7 19.719.7 19.719.7

6. WACC %6. WACC % 17.817.8 18.3418.34 18.6418.64

7. COCE (3x6)7. COCE (3x6) 173 cr.173 cr. 236 cr.236 cr. 308 cr.308 cr.

8. PAT8. PAT 413413 580580 837837

9. add. Interest offer tax.9. add. Interest offer tax. 3232 2121 19.19.

10. NO PAT (8+9)10. NO PAT (8+9) 445445 601601 856856

11.COCE (7)11.COCE (7) 173173 236236 308308

EVA_(10-11)EVA_(10-11) 272272 365365 548548

EVA % of capital EVA % of capital Employed (12/3) 28. 01% 28.39% 33.22%.Employed (12/3) 28. 01% 28.39% 33.22%.

EVAis being widely used as a tool to EVAis being widely used as a tool to measure value added to the organization measure value added to the organization during the facial year. It takes into account during the facial year. It takes into account the cost of capital that the company incurs to the cost of capital that the company incurs to generate it suppose and add value to its generate it suppose and add value to its shareholders.shareholders.

EVA. Is an indicator of the operating EVA. Is an indicator of the operating efficiency of the company and its ability to efficiency of the company and its ability to add (value to its shareholders) to the bottom-add (value to its shareholders) to the bottom-line by reducing financing charges.line by reducing financing charges.

19991999 19971997

Operating profit before int & taxOperating profit before int & tax 934934 476476

net profit.net profit. 518518 335335

Shareholders fundsShareholders funds 38383838 27532753

DebtDebt 11091109 625625

Total capital employed.Total capital employed. 49484948 33593359

Cost of debtCost of debt 11.57%11.57% 21.10%21.10%

Ke. Ke. 18.44%18.44% 18.44%18.44%

WACC WACC 15.94%15.94% 15.22%15.22%

Absolute cost of capitalAbsolute cost of capital 788788 511511

EVA- (OPBIT-ACC)EVA- (OPBIT-ACC) 145145 -34-34