Canada: Business Valuation and Financial Loss

Written by Jeff Buckstein

Adversity need not be a barrier for corporate executives in successfully creating shareholder value when market conditions are less than ideal, and a standard blueprint is not required in meeting goals, according to a recently released report sponsored by the Chartered Professional Accountants of Canada and Canada's Venture Capital & Private Equity Association (CVCA).

"The best analogy I have is a farmer needing good soil to grow their crops. It doesn't necessarily matter what you're growing. Unless you have fertile soil it doesn't work. I think that was the revelation within this paper ... no one size fits all," said Howard Johnson, managing director of Veracap Corporate Finance Limited in Toronto.

"Shareholder value can be accomplished [with] different companies pursuing different strategies," added Johnson, author of the CPA Canada/CVCA sponsored Strategies for Creating Shareholder Value in a Low- Growth Environment.

The report emphasized the commonality of several themes in the corporate pursuit of shareholder value, including the strength of a management team that espouses open and frequent communication, an emphasis on establishing an organizational culture grounded by passionate employees, attentiveness to customer needs, maintaining a progressive approach to risk management, moderate use of debt in the corporate capital structure, and the ability to maintain a long-term perspective.

"A lot of companies will talk about open and frequent communication, but the question is 'how well do they do it?' " Johnson told The Bottom Line.

Strong communication is particularly important as companies expand their global presence. Those employees feel better informed and as such are better able to make decisions that are in line with corporate policies and objectives, he added.

When employees are passionate about their jobs and want to service external customers and help their peers with problems they may be experiencing on an internal basis, that can also positively impact shareholder value. When people like to work for a company, it creates an environment where customers also enjoy dealing with it.

"And if that happens it's just a natural wind at your back in terms of driving the business forward," said Johnson.

One of the hallmarks of that passion is the willingness and ability to seek, read, and react to customer feedback on a timely basis, especially as business progresses deeper into a digital world and consumer expectation for instant gratification increases, said Johnson.

The report also emphasized the need to take a progressive approach to risk management.

"An example there is allowing your employees some latitude to try new things, to develop products that maybe aren't going to be successful, but saying 'we're prepared to invest X dollars in this new venture, and if it works out it's going to be fantastic. But if it doesn't, let's use it as a learning experience.' So they set parameters in which losses or costs are acceptable and work within those parameters, as opposed to saying 'don't try anything new because if you try and you fail you're out of here,' " said Johnson.

The report also advocated for using debt in moderation within the corporate capital structure.

"The moderate use of financial leverage helps organizations to foster an entrepreneurial environment of managed risk-taking, given that there is less concern with breaching banking covenants in the event that certain initiatives do not turn out as planned, or take longer than expected to foster results," it said.

It's a tough sell, but patience should pay off

Implementing a long-term perspective for creating shareholder value is important, although the report acknowledges this can be more difficult for public companies than for private firms.

"I've experienced this first-hand in the public-company world, whereby decisions were sometimes made that were oriented toward the current quarter or current annual profit as opposed to what's best for the long-term perspective of the corporation," Johnson said.

"And so it is difficult for a lot of companies to say 'this quarter won't be as strong as expected. However, we're setting the foundation for future growth.' The headwinds are against having this long-term perspective if you're a public company. But if you can demonstrate over the long term that your strategies are well-founded, then I think you develop an expectation among the investors and analysts that if they're patient their patience will pay off," he added.

The report focused on the strategies of four Canadian companies that implemented some of these best practices to help them create shareholder value.

Constellation Software Inc. was cited for its ability to acquire smaller companies in complementary software industry areas without having to resort to excessive amounts of leverage. Constellation, it said, has experienced significant revenue growth, while maintaining strong profit margins.

Birch Hill Equity Partners, a private equity firm, was praised for the success it achieved as a result of its focus on capital discipline when acquiring companies. "Specifically, the private equity firm looks to acquire companies that do not require significant amounts of working capital or capital spending in order to generate a higher cash return on invested capital," the report said.

GoodLife Fitness Clubs was lauded for its emphasis on operational excellence, including instituting innovative programs that help it stay attuned to customer needs. "GoodLife's effort in achieving shareholder value through operational excellence has propelled the company to be the largest fitness company in Canada and the fourth largest in the world," it said. "The company has also relied on innovation, a culture of employee engagement, strategic acquisitions and capital discipline to create shareholder value."

Johnson noted how lack of integration is repeatedly cited as one of the key reasons for deal failure.

"If you're trying to meld two very disparate corporate cultures, they both may be good cultures independently. But if the cultures are not grounded in the same fundamental beliefs and values, then that clash will make an integration more difficult, and the likelihood of deal failure all of a sudden escalates exponentially," he said.

Cineplex Inc. was praised for focusing on identifying its core competencies and finding innovative ways to leverage those capabilities, including its theatre infrastructure and customer base.

"Because of the company's high fixed cost structure, the incremental revenue, particularly because of the company's media business ... leads to significantly higher profits without the need to deploy additional capital. This, in turn, leads to shareholder value creation," the report said.

It elaborated on how, for example, Cineplex has been able to leverage its fixed costs and generate incremental revenues on high-margin product offerings such as concession sales. It has also expanded its core theatre offerings to cover a variety of events, such as music concerts, sports entertainment programs, party rooms and gaming, among other uses.

Two years in the making

CPA Canada and Canada's Venture Capital & Private Equity Association (CVCA) first teamed up in 2012 to brainstorm about identifying major issues affecting corporate finance professionals, including their own members.

"Generally what came out of it was we know that in a slow growth environment, you can't just focus on organic growth. So, what is hidden behind the public persona of these organizations, and what do they do well?" said Carol Raven, principal of strategy, management accounting and finance for CPA Canada in Toronto.

The result was the recently released report sponsored by those organizations and written by Howard Johnson, the Toronto-based managing director of Veracap Corporate Finance Limited, entitled Strategies for Creating Shareholder Value in a Low- Growth Environment.

"I think when we first embarked on the project, we were hoping that there was going to be some big 'aha' moment that we could share with the members," said Raven. "But what it really came down to is having a strong management team in the organizational culture grounded by employees. It was really [about] just staying the course, and sticking to the areas of focus that these organizations have."

Mike Woollatt, the CVCA's Toronto-based chief executive officer, said the management team and structure is a vitally important component of the ability to create shareholder value in their companies.

"I see it around my members every day. The importance of what type of culture you set up in a company can really lead to a transformational change, and lead to significant shareholder growth. It's a side I find that's often under-recognized as [being] important. It comes down to [having] a strong management team, and a flexible entrepreneurial environment. You see that time and time again.

"So I was happy to see the report come forward," he said.

Source: The Bottom Line, December 2014