p27 projects and sv

Projects and Shareholder Value in Financial Services

PMI NIC, 5 Nov 09

Mauro Tortone, Chartered MCSI

Summary• Publicly traded firms are expected to create shareholder

value, allocating their scarce resources to the most promising operations – and projects

• Ten areas critical to the selection and management of projects aimed at maximising shareholder value were identified using the literature available

• Several weaknesses that financial firms should address to maximise SV thru projects were highlighted in an industry survey, based on the ten critical areas

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Projects and Shareholder Value• Projects

– are a way in which firms take advantage of opportunities and deal with threats

– are, nowadays, a continuous effort, alongside operational processes– represent, arguably, the larger portion of the future earnings of a firm

• Shareholder Value– Business value + marketable securities or investments – market value

of debt and obligations* Business value is the value generated by the cash flows in which all

providers of funds have a claim

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*Mills et al

The Questions• How aligned are projects to maximising Shareholder Value

(SV) in Financial Services? What are the areas in which improvements could be made by financial firms?

• Theory – in the Financial Services sector, the key to maximising SV is achieving the right mix of projects, coupled with effective allocation of resources between operations and projects

• Objectives:– To analyse how financial firms select and manage their project

portfolios, in relation to SV– To identify the improvement areas (disconnects between projects and

creating SV)– To offer recommendations on how to address the improvement areas

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Literature• Reviewed 1000+ literature sources

• The review suggests that, though there is extensive research on company valuation and single projects appraisals, there is limited research that attempts to relate projects and SV

• The literature available quite clearly indicates that projects have a significant impact on SV

• The financial services industry is no exception

• Ten areas and fifty indicators: questionnaire questions

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Questionnaire

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Group High scores indicate1. Shareholder Value (SV) drivers a firm manage to maximise the SV / is aware of its main SV drivers (revenue growth, profit margin, cost of

capital, etc) and the impact projects have on them

2. Investment (project) appraisal – financial considerations

a firm uses a broad spectrum of good financial valuation tools to select projects, depending on the type of projects

3. Investment (project) appraisal - non-financial considerations

projects have good business cases, supported by technical and marketing studies / use of the Balanced Scorecard (or a similar) for portfolio selection / good resourcing consideration, including ‘change capacity’* and ‘critical chain’ at portfolio level

4. Risk good risk impact and probability assessment / management at portfolio level

5. Project portfolio / prioritisation the contribution to shareholder value is the main criterion for project prioritisation and inclusion of a project in the active portfolio

6. Project structures and systems formal project structures and systems, including good reporting which provide comparative information on projects, allowing informed decisions before changes to project portfolio and capital budget are made

7. Stakeholders / complexity / integration

there is a good level of project work integration among units, lines and functions / complexity is proactively managed

8. Innovation / IT innovation is championed by the business. IT is well managed and leveraged to support business innovation, rather than just administer technology stability and maintenance

9. Productivity / performance the project portfolio yield is measured using a diverse set of measures – including value measures – and actively managed

10. Continual basis / uncertainty / flexibility

changing dominant investors' expectations influence the project portfolio, which is regularly reviewed / a rolling budget is used

Survey• Well over 600 people were contacted in more than 300 of

firms. Overall response rate: 9%. 59 questionnaires were returned complete (in line with expectations)

• Most of the respondents worked for large European financial firms which operate globally – they were from all the main organisational functions

• Note a small number of organisations contacted were non-financial firms (8%) from Fortune’s Most Admired Companies list, used as a benchmark for the financials

• Projects in Financial Services don’t appear to be selected and managed in a way that maximises SV

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Respondents

0

5

10

15

20

25

30

35

40

45

Large Cap Basket (financial) Mid & Small Cap Basket(financial)

Most Admired Basket (non-financial)

IT(blank)Sales / TradingResearch / AdvisoryOtherOperations (Middle / Back Office)Operational RiskHRGeneral ManagementFinance / Accounting

1.2 - Role (All) 1.3 - Corporate position (All) 2.2 - Sector (All) 2.3 - Head Office (All) 2.4 - Geographical market (All) 2.5 - Size (All)

Count of Respondent ID

Basket

1.1 - Function

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Respondents (cont.)

0

5

10

15

20

25

30

35

40

45



(blank)Senior managementProject managementProfessionalOtherLine managementBoard member

1.1 - Function (All) 1.3 - Corporate position (All) 2.2 - Sector (All) 2.3 - Head Office (All) 2.4 - Geographical market (All) 2.5 - Size (All)


Basket

1.2 - Role

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Respondents (cont.)

0

5

10

15

20

25

30

35

40

45



Corporate/cross unitBusiness unitBusiness line

1.1 - Function (All) 1.2 - Role (All) 2.2 - Sector (All) 2.3 - Head Office (All) 2.4 - Geographical market (All) 2.5 - Size (All)


Basket

1.3 - Corporate position

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Respondents (cont.)

0

5

10

15

20

25

30

35

40

45



Universal bankingOtherInvestment bankingInsuranceCommercial banking

1.1 - Function (All) 1.2 - Role (All) 1.3 - Corporate position (All) 2.3 - Head Office (All) 2.4 - Geographical market (All) 2.5 - Size (All)


Basket

2.2 - Sector

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Respondents (cont.)

0

5

10

15

20

25

30

35

40

45



(blank)Western EuropeOtherNorth AmericaEastern EuropeCentral / South AmericaAustralasia

1.1 - Function (All) 1.2 - Role (All) 1.3 - Corporate position (All) 2.2 - Sector (All) 2.4 - Geographical market (All) 2.5 - Size (All)


Basket

2.3 - Head Office

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Respondents (cont.)

0

5

10

15

20

25

30

35

40

45



OtherGlobalEurope, Middle East & AfricaAsia PacificAmericas

1.1 - Function (All) 1.2 - Role (All) 1.3 - Corporate position (All) 2.2 - Sector (All) 2.3 - Head Office (All) 2.5 - Size (All)


Basket

2.4 - Geographical market

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Analysis by Area (overall scores)

0.52

0.27

0.57

0.00

0.10

0.20

0.30

0.40

0.50

0.60

Large Cap Basket(financial)

Mid & Small Cap Basket(financial)

Most Admired Basket(non-financial)

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Analysis by Area (cont.)

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-0.20

0.00

0.20

0.40

0.60

0.80

1.003.1 - Shareholder Value (SV) drivers

3.2 - Investment (project) appraisal - financial considerations

3.3 - Investment (project) appraisal - non-financial considerations

3.4 - Risk

3.5 - Project portfolio / prioritisation

3.6 - Project structures and systems

3.7 - Stakeholders / complexity / integration

3.8 - Innovation / IT

3.9 - Productivity / performance

3.10 - Continual basis / uncertainty / flexibility

Large Cap Basket (financial) Mid & Small Cap Basket (financial) Most Admired Basket (non-financial)

Recommendation 1 – investment appraisal (financials)

• The business case should either state the cost of capital assumptions specific to the project or use a risk-adjusted NPV model

• There should be a standard model across the organisation for NPV calculations, to ensure consistency and fair assessments of competing projects

• The NPV needs to be revised on a regular basis to take into account changes in the markets and confirm the business case is still viable

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Recommendation 2 - project portfolio/ prioritisation

• At strategic level, mgmt should– listen to the market to understand what it considers the drivers of

shareholder value creation for the firm (in the long run) – test the impact of different project portfolios with the help of models

simulating the SV generated in different scenarios

• At operational level, mgmt should– decide, on a regular basis, which projects should be in – and out of –

the portfolio, thru project portfolio reviews – form a Project Portfolio Committee, composed by functional heads and

a board member, that will attend the reviews– use best practice project portfolio management tools to review and

manage the portfolio

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SVA ModelYear 0 1 2 3 4 5 BeyondSales Growth Rate (SGR) 5% 5% 5% 5% 5% 0%EBITDA Margin 10% 10% 10% 10% 10% 10%Cash Tax Rate (CTR) 30% 30% 30% 30% 30% 30%IFCI 10% 10% 10% 10% 10% 0%WCI 10% 10% 10% 10% 10% 0%Cost of Capital 10% 10% 10% 10% 10% 10%

£m £m £m £m £m £m £mDepreciation 10 10 10 10 10 10RFCI 10 10 10 10 10 10

Sales Receipts 300.0 315.0 330.8 347.3 364.7 382.9 382.9

EBITDA 31.5 33.1 34.7 36.5 38.3 38.3less Cash Tax 9.5 9.9 10.4 10.9 11.5 11.5Operating Cash Flow 22.1 23.2 24.3 25.5 26.8 26.8less RFCI 10.0 10.0 10.0 10.0 10.0 10.0less IFCI 1.5 1.6 1.7 1.7 1.8 0.0less WCI 1.5 1.6 1.7 1.7 1.8 0.0Free Cash Flow 9.1 10.0 11.0 12.1 13.2 16.8Discount factor 0.909 0.826 0.751 0.683 0.621Present Value (Free Cash Flow) 8.2 8.3 8.3 8.2 8.2Cumulative Present Value (Cum FCF) 8 16 25 33 41Present Value of Residual Value 104

Business Value 145add Marketable Securities 0

Corporate Value 145less Market Value of Debt 20

Strategic Value 125Number of Shares (m) 100Strategic Value per Share 1.25Based on Mills' Model (Mills, 1999); figures are illustrative Legend:EBITDA = Earnings before Interest and Tax, Depreciation and AmortisationRFCI = Replacement Fixed Capital Investment [to enable intended sales growth]IFCI = Incremental Fixed Capital investment [to enable intended sales growth]WCI = Working Capital Investment [to enable intended sales growth]

COMPETITIVE ADVANTAGE PERIOD

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Project Portfolio Management

NPV Risk adjustment

Risk-adjusted

NPV

A B A*B Mgmt InvestorsProject E (Product E)

$250 0.7 $175 “good” “great” Fund

Project A (Product A)

$160 0.9 $144 “great” “great” Fund on track, no assumptions changes

Project C (Product C)

$180 0.7 $126 “good” “good” Fund on track, no assumptions changes

Project D (Product D)

$200 0.6 $120 “good” “good” Fund

Project F (Product F)

$200 0.6 $120 “good” “okay” Reject Good financials, but story not good enough compared to Project D. Both fit the strategy, but D better meets investor expectations

Project B (Product B)

$100 0.2 $20 “okay” “okay” Kill Major assumptions changes, due to changes in the market (sentiment)

Legend:PPC call = Project Portfolio Committee decision at last (quarterly) PPC meetingFigures are illustrative

Comments

INVESTMENT CUT-OFF (Financial / Human Resource Constrains)

Story(case – non financial

considerations / strategic alignment)

PPC Call

Investment name(ranked by Risk-adjusted NPV)

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Project Portfolio Management (additional)

• Alternative perspectives: payback (period); capital already invested & achievements (v plan), capital requirements to completion (v plan)

• Real options: high risk-high reward initiatives that may be ruled out by low risk-adjusted NPV

• Cost and risk projects: respectively impact E(Ct) and αt in the Walters formula:

Where:• NPV(firm) = the risk-adjusted discounted present value of a firm’s after-tax earnings • E(Rt) = the expected future revenues of the firm• E(Ct) = expected future operating costs, including charges to earnings for restructurings, loss

provisions and taxesThe net expected returns in the numerator are then discounted to the present using

• It = risk-free rate and • αt = a composite risk adjustment which captures the variance of expected net future returns

resulting from– credit risk, market risk, operational risk, and reputation risk, and– the correlations between such risks associated with the firm’s various activities

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n

tttItCtERtEfirmNPV

1 )1()()()(

Recommendation 3 – productivity/ performance

• Regular reviews of NPV assumptions, project progress

• Good financial and non-financial metrics

• DB of projects with current and historical project data:– Projects contribution, current & over time: new v old (ops)– Repeat project mistakes – avoid!

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The Great Recession

22Source: Interactive Data

Q&A

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Thank [email protected]

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