Wayne Wilson on Companies in Transition

Where have all the growth companies gone?

A few years ago, a growth company [1] from a public investor perspective [2] was any company whose revenues and earnings per share were growing at rates greater than 20% per year.

Earnings growth drives valuation and revenue growth is the essential precursor for earnings growth. And owners of privately held companies aspired to the same growth rates, especially if they wanted to go public company or sell out to a public company.

Where is the growth bar today?

In a recent conversation with bankers from a major Wall Street firm, I asked that very question. Their answer: “anything in double digits.”

How times have changed. But some things have not changed - above average revenue and earnings growth rates are still the keys to above average valuations.

Management’s three financial priorities remain the same:

1. Keep costs under control
2. Manage cash carefully
3. Plan for growth

Now is the time to set in motion those plans and strategies which will drive growth and profitability when the economy emerges from recession.

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[1] “Any firm whose business generates significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy. A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Thus, it typically pays little to no dividends to stockholders, opting instead to plow most or all of its profits back into its expanding business.”  Investopedia at http://bit.ly/QIVRc

[2] Excludes companies that have not yet reached operating profitability.

Measuring your ROI on acquisitions

Many CEOs rely on acquisitions of other companies or product lines as an important component of their overall growth strategy. However, they seldom look back through rigorous post-acquisition financial analyses to measure their return on investment (ROI), especially how the deals performed versus expectations at the time of the deal.

I prefer two relatively simple measures: annual cash-on-cash (COC) return on capital invested and cash payback or how long will it take for the buyer to recover its investment on a cash basis. Other methods such as discounted cash flow, while more theoretically pure, suffer from complexity of calculation and estimation bias when trying to determine appropriate discount rates. If not done properly, the analysis is worse than worthless.

A proper analysis should be performed on an annual basis covering all significant acquisitions made by the company (or the current management team). EBITDA (earnings before interest, taxes, depreciation, and amortization), adjusted for significant changes in the level of capital expenditures and working capital, is often a reasonable proxy for cash. Some would argue that free cash flow is a better proxy. Pick a method and use it consistently.

The real question and value is less in the numbers than whether the management team holds itself accountable for results through an open and honest “lessons learned” analysis.

One company recently completed its annual exercise indicating somewhat mixed cumulative returns for several transactions over several years with COC returns barely exceeding the company’s weighted average cost of capital. On the qualitative side, one acquisition was truly transformational and displayed excellent returns.

It’s better to do deals with your eyes wide open than your eyes wide shut.

The recession grinds on

At ground level the recession grinds on, despite recent optimistic comments by various government and other public figures, A recent survey of corporate chief financial officers [1] highlights the gap between hope on the one hand and reality on the other.

Fifty-four percent of U.S. CFOs surveyed were more optimistic this quarter than they were last. But on average, the “CFOs say the recession will last another 10 months,” and they are continuing to maintain tight control over spending.

This is a classic pattern: management actions tend to lag changes in the environment. At the beginning of a recession, managers hope for a quick rebound. They begin to seriously reduce spending only when it becomes clear that the revenue decline is not a brief aberration. On the rebound, managers must be absolutely convinced that revenues are turning up before they ease up on spending controls.

The key strategy is watchful waiting. Those business owners who have the courage to begin investing again before the pack does will have an advantage over their competitors.

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[1] CFOs Hoping for the Best, Planning for the Worst, www.CFO.com, June 3, 2009

Catching the Social Media Wave

The May issue of our periodic email newsletter to clients and friends has been posted to our website at Companies in Transition – May 2009. The lead article in this issue is about catching the social media wave and includes the following articles:

• Catching the Social Media Wave - Facebook and twitter are all the rage now, but can they really be effective business tools?

• Has your company reached a strategic inflection point? – The key business fundamentals may be changing but the management challenges remain the same.
  

• Yogi Berra was right when he said... – What can companies in transition learn from Yogi?

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Invest During Hard Times

-         Craig Barrett, former Intel CEO

Owner/CEOs often find it difficult to invest during difficult economic times. And yet, it is the investments made now which will drive revenue growth when the current economic recession ends. The challenge is to reduce spending while preserving or increasing investment. What’s the difference?

Investments support or drive increases in revenues and profitability. Spending is the cash disbursed for everything else which does not meet the investment definition. Like politicians, spending sponsors will argue vociferously that their particular program / budget / personnel are necessary investments and are absolutely essential for the health and even the survival of the enterprise. It is simply not true.

Finding funds for investment requires reducing large amounts of spending. Most managers are tempted to start with the free coffee in the employees’ lounge and the travel budget. There is often not enough money here to make a difference. Instead, challenge programs, markets, product lines, customer concentrations, and significant research and development programs.

Can the particular program or activity make a difference in the trajectory of the business and if successful will it be big enough to matter? The chief decision maker must be brutal in choosing among all of the good ideas. Only the very best should be funded; everything else must be jettisoned. The future of your business depends on it.

Pricing Pitfalls

It takes a strong manager to consider raising prices in a period of declining consumer demand and falling profitability. And yet pricing is one of the most important tools available for improving margins, strengthening customer relationships, and trimming the business’ overall profile.

There are right ways and wrong ways to manage pricing. Per Sjofors, [1] a pricing consultant, recently offered his list of the Top 10 Pricing Mistakes Most Companies Make. [2] Here is an abbreviated version:

1. Basing prices on costs, not customers’ perception of value
2. Basing prices on the marketplace (whatever that is)
3. Trying to achieve the same margin across multiple product lines
4. Failing to segment customers
5. Holding prices for too long at the same level (too high or too low)
6. Compensating sales reps on revenue rather than profitability
7. Changing prices without considering competitor reactions
8. Failing to actively manage pricing practices
9. Failing to establish internal procedures to optimize prices
10. Spending too much time serving the least profitable customers

Improve your business’ prospects for prosperity by taking charge of the product or service pricing process.

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[1] Managing partner at Atenga Inc., a Newport Beach California, strategic pricing consulting company

[2] Financial Executive, May 2009, p 30.

Are you focusing on what’s strategic?

Owner/CEOs frequently struggle with resource allocations, especially among tactical operating initiatives and potential game changing strategic moves. And strategic investing can be especially difficult in the current economic environment.

A proper prioritization might look like the following:

1. First, ensure current tactical performance and organizational sustainability,
2. Then, determine what’s strategic for longer-term success, and
3. Finally, hire key talent to support new strategic investments

Apple is a great example. It’s iPhone and iPod products are riding high, and now the company appears to be hiring to bring key parts of its chip design process in house as a way of protecting its proprietary strategies while differentiating its capabilities from competitors.

Another company is stretching out the introduction of a new generation of products to better match current market demand while shielding some of its newer technologies from pre-mature competitive challenges.

Working out what’s strategic and then committing sufficient resources is critical for every company’s long-term sustainability.

What's your agenda?

Do your professional advisers understand your agenda? Have they even asked you about it?

As the new general manager of a two hundred million dollar company, I had a clear agenda – ensure the company’s economic survival and position it for sustainable future growth. Every decision I made was focused on those two strategic objectives.

Consultants and other professional advisers who could help me advance my agenda were welcome partners in the struggle. Those merely attempting to sell me something were vendors to be squeezed for the best possible deal if not simply shown the door.

To be effective, an adviser must be able to:

• Put themselves in your shoes, to appreciate the pressures and concerns you face
• Draw out your most pressing issues through thoughtful and creative questions
• Help you shape your agenda through supportive, but intellectually honest discourse
• Deliver bold, forceful advice consistent with your mutual understanding of the challenges you face

Effective, empathic advisers are few and far between. Keep looking until you find one, and then don’t turn loose.

The power of militant simplicity

Igor Shindel introduced me to the concept of militant simplicity. Some years ago, I hired Igor to lead the development of a next generation B2B e-commerce web site for PC Connection. The challenge was to build a fast, robust web site on time and under budget.

Militant simplicity became the mantra. Keep the site fast, clean, simple (what would now be called the Google model) by providing the 20% of desired functionality that would drive business value and ignoring the rest. Everyone seeks simplicity until the requests start coming in. Can we do this? What about that? Soon the team is mired down by the 80% of stuff that will never matter.

That’s where the militant part comes in. Once the project strategy, core objectives and critical functionality had been thoroughly defined and vetted by both business and technical teams, the team became militant in resisting scope creep. They made a list of all the ideas coming in and promised people the new ideas would be considered for the next release (maybe). Having their idea on the list seemed to keep people happy even if you never worked on it. Strange …

The free dating web site, Plenty of Fish, is a great example of a business built on militant simplicity. Founder and owner Markus Frind is currently taking millions of dollars to the bank while retaining 100% ownership. His secrets?

• A “dead-simple,” web site that practically runs itself on eight servers while serving up 1.6 billion web pages per month
• A free service attracting millions of users and supported by ads (often from competitors)
• Avoiding any improvements to the site that do not support fast, efficient matching
• Fixing problems quickly and simply instead of throwing resources at them

How much more effective and efficient could your business be if you adopted militant simplicity as a guiding principle?

Get some smart people to challenge you!

Business owner/CEOs can get so wrapped up in our own plans and worldviews that we miss our full potential, or worse we can be heading for a ditch without realizing it! Physicists call it a closed feedback loop. In lay terms, if we only talk to ourselves, we will only hear our own voices.

One of the essential roles of a board of directors or board of advisors is to challenge and vet the ideas and plans proposed by management. The end result should be that good plans are strengthened and poor plans are discarded or significantly re-worked.

My best investor relations meetings were the ones with the toughest analysts who asked the most difficult questions. They were experts at ferreting out the weak spots in our story, in effect telling us the areas we needed to work on going forward.

Customers and clients are often the best sources of real world feedback. Don’t fight them; embrace them. Your future may depend on it.