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Propco 125 140 (15)
Finco 25 55 (30)
Corporate overhead (425) 0 (425)
Total 2,150 1,615 535
Debt (300) (300) -
Equity value 1,850 1,315 535
Stock market value 2,400
Value gap (SS0)
Percent of stock market value -23%
standards. He especially did not like the idea that they would need to do all the hard work implied by the plans just to stand still from their shareholders' perspective. The market took for granted that EG would either improve its performance on its own, or someone would take it over soon and make the needed improvement. Ralph was beginning to think that EG would need to come up with some big ideas to create the impact on the value of his shareholders' investment that he was seeking during his tenure as CEO.
Ralph also was interested to note the change in value of the individual businesses projected by the plans. For example, Consumerco's plan performance would increase its value by about 20 percent, which would have a large impact on EG, given Consumerco's large size. Foodco's value, on the other hand, would actually
Exhibit 2.8 EG Corporation—Value of Business Plans
Historical extrapolation ($ million) Business plans ($ million) Difference (percent)
Consumerco 1,750 2,115 +21
Foodco 300 275 -a
Woodco 200 600 +200
Newsco 175 200 +14
Propco 125 150 +20
Finco 25 35 +40
Corporate overhead (425) (425) 0
Total 2,150 2,950 +37
Debt (300) (300)
Equity value 1,850 2,650 +43
Stock market value 2,400 2,400
Value gap (550) 250
Percent of stock market value -23% +10%
decline despite the fact that its plan involved substantial growth in the number of outlets and overall sales and earnings. To Ralph this could mean only one thing—the returns on investment in the business were too low. Foodco management was more focused on growth than returns. In contrast, the Woodco consolidation looked set to improve the value of the furniture businesses dramatically, while the newspaper, finance, and property businesses would improve somewhat, too.
At this stage, Ralph drew some conclusions. Consumerco would have to do even better, given its large impact on the company. Foodco would need to revamp its strategy to make sure it built value, not simply bulk. Woodco's consolidation was far more important than he had thought and would need to succeed to maintain EG's value. Finally, EG would need to run hard just to maintain shareholder value, and any missteps could spark a collapse in the share price.
EG’s Potential Value with Internal Improvements
After looking at EG's value ''as is," Ralph's team tried to assess how much each business might be worth under more aggressive plans and strategies. The team first identified key value drivers for each business. The managers estimated the impact on the value of each business of increasing sales growth by 1 percent, raising margins by a point, and reducing capital intensity, while holding other factors in constant proportion. The results, shown in Exhibit 2.9, indicated that the key factors varied by business. Foodco was most sensitive to reductions in capital intensity and increased margins. At current margins and capital intensity, however, Foodco's value would actually decrease if it grew faster. Its growth would be unprofitable with Foodco earning a rate of return on invested capital less than its cost of capital. Woodco was most sensitive to improvements in operating margin, which he hoped would come about as a result of the consolidation of the companies. Consumerco was most sensitive to sales growth. Because of Consumerco's high margin and outstanding capital utilization, each dollar of sales generated large profits and cash flows.
The team next assessed the prospects for each business to improve its performance. One approach it used was simply to compare each EG business with similar companies to gauge relative operating performance. The team also broke down each
Exhibit 2.9 EG Corporation—Impact of Changes in Key Operating Measures
of EG's businesses into a business system that allowed it to compare—step by step—relative costs, productivity, and investment for EG versus the competition, based on observations and analyses provided by operating managers in each of the divisions. These analyses, coupled with the financial comparisons, showed that it was reasonable to assume that some of EG's businesses could indeed be made to perform at much higher levels.
Consumerco, despite its already high operating margin, seemed to have room to increase revenue significantly while simultaneously earning ever-higher margins:
• The team discovered that Consumerco had been holding down research and development (R&D) and advertising spending to generate cash for EG's diversification efforts and to buffer the impact of EG's poor performance in other parts of its portfolio. Ralph's team believed that increased spending in the short term would lead to higher sales volumes of existing products, as well as the introduction of additional high-margin products to the marketplace.