Hi-Fi: Pumping up the Valuation Volume « Customs Street Advisors

Jan
8
2010

Hi-Fi: Pumping up the Valuation Volume

Author:	Obi T. Onyeaso
Categories:	Investor relations
Tags:	analyst coverage, analysts, business strategy, Corporate Finance, corporate governance, Equity carve-out, Financial communications, Investor relations, Mofe Boyo, NEXT, Nigerian investor relations, Nigerian Stock Exchange, Oando, Oando Marketing Limited, online IR, Shareholder value, spin-off, Wale Tinubu

In announcements on strategic actions, companies often present the singular act as sufficient cause for a boost in shareholder value. This week in Street Talking on NEXT, I argue that that is not enough. To enjoy a higher valuation, companies need to improve the information environment to give investors a clearer view on the business. Simply focusing on other companies that have enjoyed higher trading multiples consequent to such transactions misses the subsequent actions they took in ensuring that the markets had a better understanding of their value creating actions.

This week marks the second anniversary since Apple, the maker of iconic products, announced its entry into the mobile handset space with the iPhone. On the same day Steve Jobs, its CEO, demoed the phone at the January 2007 MacWorld Conference, the company changed its name from Apple Computer to simply Apple, Inc. The Cupertino, California-based company’s decision to excise ‘computer’ from its name was intended to reflect its transition from solely designing and making personal computing products with cult status to a broader portfolio of consumer electronics goods and services, including on-line distribution of music, home entertainment systems, digital audio players, cellphones, software and of course, computers with wider appeal outside its core geek demographic.

By removing the suffix ‘computer’ from its moniker, the company signaled that its competition universe had extended beyond Dell, HP, Lenovo and Microsoft to Blackberry, LG, Nokia, Sony, Samsung and Bang&Olufsen. Of greater significance, Apple sent a strong message to the market that it expected to enjoy the higher valuations of the adjacent sectors it had diffused into. In fact, the valuation expectations signal was a concomitant of the change in Apple’s business model. The name change was only incidental. By the end of the year, Apple had a higher market capitalization than Cisco, Intel, HP and IBM.

In the new dispensation of shareholder value preeminence, the bid for higher valuations and raised market capitalizations is the Holy Grail of every responsible board. Whether it involves a change in the business model, as in the Apple case, equity carve-out, spin-off, merger, acquisition or sale, it is not unusual for contemporary boards to commission strategic reviews of their business in their bid for capital markets competitiveness.

At Apple, the company introduced the products first, and then expected the upward valuation revision to follow. However, in most other cases, companies announce a change in strategic direction and explicitly declare that the purpose is for an increase in valuation. Sometimes, such decisions are endogenously determined like the decision of EnCana, the largest energy company by market capitalization in Canada, to split itself into two companies, with one focused on natural gas, and the other, focused on refining, mature oil projects and oil sands; while in other cases, they are exogenously provoked by external agitators like hedge funds and activist investors as in the cases of Trian Partners at Cadbury-Schweppes and The Children’s Investment Fund at ABN Amro.

Throughout the objective is to unlock value and increase visibility on earnings potential, operational efficiencies along the value chain and alignment of agent-owner interests. By exposing divisions or subsidiaries to external, as opposed to internal capital markets, the risk perceptions of the company drops and consequently, investors demand a smaller discount.

In July 2009, Oando, the integrated energy company, announced plans to list Oando Marketing Limited, its petroleum marketing subsidiary on the Nigerian Stock Exchange. Speaking at the company’s 32^nd annual general meeting, Wale Tinubu, Oando’s CEO, stated that ‘while OML is Nigeria’s largest petroleum products retail firm, its value has not been properly appreciated because it has been part of the Oando Group. . . However, after its listing, its performance will be separated for all stakeholders to see.’ Oando plans to offload up to 49% of its shareholding in its marketing subsidiary, which regularly contributes as much as 30% of the group’s profits. Historically, pure play companies have commanded higher valuations than diversified ones.

Tempting as it is to assume that the simple act of an equity carve-out is sufficient to deliver a premium to owners of OML’s stock and the residual Oando Group, the truth is that it cannot. A slice-up transaction will not by itself improve a firm’s valuation. The keys to the kingdom are held by a higher visibility on earnings potential, enhanced operational efficiencies along the value chain and closer alignment of agent-owner interests’.

In other words, listing Oando Marketing as a separate entity on the Nigerian Stock Exchange without management resolution to improve access, engagement and transparency according to the standards listed above will not bring home the bacon. After all, a stock exchange quotation of the subsidiary by itself cannot cause a boost in profitability.

The benefits of a higher valuation can only come from reduced perception of risk which is the result of an improved information environment. When it is all said and done, and the transaction advisors and PR consultants walked away with their hefty fees, investors will judge the Oando Marketing Limited not by the act of the split but by what it does post-partum.

The original article mat be read here on the NEXT website.

2 Comments (Leave a Reply)

Obi Tabansi Onyeaso (January 30, 2010)

Thanks for the observation Stefan,

Yes, it is true that senior executives at public companies would sooner cry foul when they feel that their shares are undervalued and not when they know they are overvalued. It is a bit of a paradox of sorts that the same improved clarity on the financial surplus creating potential of a firm can cut both ways: to lower the valuation or to raise it.

Ultimately, even for investors in those companies command 'undeserved' trading multiples on the market, an improved information environment is far better than one of poor visibility because it allows them to judge each company on the merits of its own business, rather than unsubstantiated or generalized assumptions of its sector, peers, region or capitalization.
Obi Tabansi Onyeaso (January 31, 2010)

You hit the nail on the head Stefan,

Companies should aim for a fair valuation and not the dubious aspiration of 'share price maximization'.

Any so-called IR professional who claims to be able to maximize a company's share price is a snake oil salesman, and the company that engages his services should know better.

Seriously, the point you raise underlines the need for true IR professionals to redouble efforts at raising awareness about the realizable goals of of an investment community engagement program.

Until we as IR practitioners do that, the confusion between reputable IR and market hucksters will continue to persist in the mind of many company executives who make unreasonable demands about 'maximizing the share price.'

Thank you.

Customs Street Advisors is a full service investor relations firm based in Lagos, Nigeria.

Hi-Fi: Pumping up the Valuation Volume

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