Combatting the Financial Crisis

For my final post, I want to look at the success stories (in a business sense) following the financial crisis, and look into how companies have combatted the recession and in doing so have increased shareholder wealth.  

The consumer shopping trend that optimised the recession in the UK, was the flocks of people swapping supermarket giants such as Tesco for the bargaining power of German-based retailers Aldi and Lidl (Wood, 2011). The trend has been dubbed the “Aldi effect” and has led Aldi to significant increases in profits where consumers changed to “recession mode” to cut their spending (Wood, 2011). So how did retailers like these combat the recession, and in doing so see profits surge? Better still, did they even need to change their strategies to attract new customers?

In a word, No! Retailers like Aldi have always adopted a ‘no frills’ approach whereby customers don’t need to spend masses of cash on their weekly shop. In a way, the recession was made for them. Their previous image of cheap and unappealing products, which was purely down to their discounted pricing, was seen post-recession as an ideal way to spend less. Four years later, in 2015, Aldi announced they would be expanding their store portfolio by introducing 70 new stores and recruiting over 5,000 employees in a further attempt to break into the big four (Tovey, 2015). Aldi has proved that the recession has not been so terrible for everyone and have come out shining in a time when it seems every major company is seeing reduced profits leading to increase shareholder wealth.

On a similar level, the same can be said of UK based organisation Sports Direct. A company who have seen profits surge by 40%, whilst other high street retailers were struggling profoundly (Neville, 2013). This, led to huge bonus payments for its staff and the image of an employee centric company. Oh, how far from the truth this really is! 

Sports Direct is controlled by Mike Ashley with his 64 percent share, a company he founded (BBC, 2013). The company has come under severe criticism for its business operations, and its staffing methods of employing the majority of staff on zero-hours contracts (O’Connor, 2015). Despite being a major success story of the recession, with its bargain based product lines, they have treat their employees horrendously. From a personal standpoint, I have friends who were previously employed at the company and they have discussed their dismay of their zero-hours contract and how they often go weeks without work. Unlike Aldi, who have seen profits in a justified manner, Sport Direct have been successful for its demanding approaches to cutting costs and mistreatment of staff. Mike Ashley is known for being a shrewd business strategies has found criticism and hatred in his ownership of Newcastle United FC for his tight (at times to tight) controlling methods. Of course, business is not a popularity contest, and in applying these methods has led to increased shareholder wealth, but you surely have to bear in mind the consequences your actions have on others.         

I have researched two retailers who have both combatted the recession, who similarly have employed bargained products to attract customers. Both have always been renowned for providing products that don’t stretch consumer budgets, and have stepped up their game where others have been slow to react. However, concentrating on Sports Direct, they have done so in a poor manner from an ethical viewpoint, but from a business front, brilliantly! 

Reference List

BBC (2013). Mike Ashley sells £100m stake in Sports Direct. Retrieved from: http://www.bbc.co.uk/news/business-21585456

Neville, S. (2013). 2,000 Sports Direct staff to receive £100,000 bonus after record profits. Retrieved from: http://www.theguardian.com/business/2013/jul/18/sports-direct-staff-bonus-profits

O’Connor, S. (2015). Sports Direct tussle offers test case for UK’s zero-hours workers. Retrieved from: http://www.ft.com/cms/s/0/af172ae6-ac90-11e4-9d32-00144feab7de.html#axzz3Zg2ksdQ1

Tovey, A. (2015). Aldi to open 70 more UK stores and recruit almost 5,000 staff. Retrieved from: http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/11389594/Aldi-to-open-70-more-UK-stores-and-recruit-almost-5000-staff.html

Wood, Z. (2011). Aldi-effect is back: spending squeeze lifts discounter into profit. Retrieved from: http://www.theguardian.com/business/2011/oct/04/aldi-effect-back-discounter-profit

Wood, Z. (2011). Cash-strapped Britons flock to discount stores Aldi and Lidl. Retrieved from: http://www.theguardian.com/business/2011/feb/01/retail-industry-discount-stores

Crowdfunding

In early 2015, a welsh-based biotech company claimed a UK record for crowdfunding in the life sciences segment (Ward, 2015). The company, Cell Therapy Limited, focuses on stem cell medicine and is co-founded by Nobel Prize winning Professor Sir Martin Evans. They have so far raised over £650,000 of a £250,000 target for 1.07% of equity (Crowdcube, 2015). This significant method of raising money, has in modern days allowed hopeful business persons to raise finance via a large amount of people investing small amounts, rather than relying on a few investors for large amounts of money (UK Crowdfunding, no date). Crowdfunding sits between three measures: financial management, tribal marketing, and entrepreneurial strategy. 

So why did Cell Therapy opt to go down the route of crowdfunding in search of investment rather than seeking a more traditional view of finding fewer investors to put up larger amounts? Let’s take a quick look at crowdfunding history.  

One of the earliest examples of crowdfunding was in the US, following their gift from French for their independence. Although the statue was a gift, the US still had to raise $250,000 for the plinth. Group tasked with raising the money fell well short, and had exhausted themselves of suitable options until a New York publisher, Joseph Pulitzer, launched a fundraising campaign in The New York World. The campaign was a huge success as after five months the money was raised with over 160,000 donators (BBC News, 2013).

Although crowdfunding seems an exciting method of raising capital, resulting in at times limited equity for investors there are some negatives regarding the concept. For example: if a company wants to raise £50,000, they have to do so within a certain time frame, and even if they raise £49,000 of the £50,000 needed, the money will return to investors. This is the case in the biggest crowdfunding website, Kickstarter, but not for Indiegogo which implies a keep it all system where all funds are kept regardless of target. So it is important to be realistic in your target amount. Also, if you opt to crowdfund a specific product or area without a patent, then someone could easily copy the idea (Finance Scotland, no date). In regards to Cell Therapy, a patent on stem cell medicine could be vital in ensuring their medical knowledge is not copied, however medical research commonly takes years to conduct so this would not be an issue for them.

Cell Therapy has reached a UK record, but why? Lots of companies achieve thousands of pounds from crowdfunding, and have failed to return dividends to investors. In my opinion, the fact that the company was medical based was a major factor. Rather than the common perception of creating a business to generate wealth, this company has its goal of saving lives, and is backed by a Nobel Prize winning Professor. If they were to decide to seek out wealthy business persons for investment, they could simply take a life-saving medical concept, and turn it into a money driven corporate company. However, the fact that the investors will receive a combined equity stake of just 1.07% makes me question their underlying morals. This could yet be a major medical development, which in time could be purchased for huge amounts of money to major pharmaceutical firms. Hopefully, this is not the case, and the company has its priorities of saving lives rather than self-wealth.          

 

Reference List

BBC News (2015). The Statue of Liberty and America’s crowdfunding pioneer. Retrieved from: http://www.bbc.co.uk/news/magazine-21932675

Crowdcube (2015). Cell Therapy. Retrieved from: https://www.crowdcube.com/investment/cell-therapy-17426

Finance Scotland (no date). Crowdfunding: pros and cons. Retrieved from: http://www.finance.scotland.gov.uk/types/equity/crowdfunding/pros-and-cons#

UK Crowdfunding (no date). What is crowdfunding? Retrieved from: http://www.ukcfa.org.uk/what-is-crowdfunding

Ward, A. (2015). Biotech company hits crowdfunding record for life sciences. Retrieved from: http://www.ft.com/cms/s/0/5d0c91d8-ae38-11e4-8d51-00144feab7de.html#axzz3Zg2ksdQ1

Dividend Policy Issues

In the summer of 2014, Tesco unexpectedly announced that they would be cutting their interim dividend by a huge 75 percent, and reducing their capital investments by 16 percent (Thesing, 2014). This news came just a week before their new CEO was due to start. Their new CEO, Dave Lewis, former veteran at Unilever will take charge with no real experience of working in the supermarket sector. The fact that they have appointed a marketing man, rather than an experienced chief displays the great deal of alarm shareholders have over the declining supermarket (Rankin, 2014). Their idea behind the reduced dividend is to give Lewis more firepower to turn around the chain.   

 

Of course, with Tesco losing their market share following the financial crisis you would easily assume that they would be reducing dividend payments with profit margins down. However the scale of the reduction in dividend payments is likely to further alarm shareholders, but they need to be aware that it will take time to reverse their underperformance of the past 3 years (Burgess, 2014).

 

So why did Tesco opt to reduce its dividends on such a great scale. Besides giving more firepower to new CEO (as mentioned above), does this lead to the acknowledgement that Tesco’s overall company valuation has declined significantly? Not if you acknowledge Modigliani and Miller’s (M & M) 1963 argument concerning their dividend irrelevance theory. M & M proposed that, in a perfect capital market with no taxation or related costs, the valuation of a company is not affected by the dividend payments. Their argument implies that when a company has no new investments to undertake, that the funds that would have went to investments should go to shareholders (Drake and Fabozzi, 2010: p143). In 2015, Tesco’s cash reserves fell by £648 million, showing an increased debt to equity ratio (Financial Times, 2015).

 

Tesco, have opted to ignore the above argument, and have used cash that would have went to shareholder’s dividends to turn the business around. This ignores the clientele effect where shareholders have a need for regular dividend payments, and should not be different to the dividend policies. This could lead to a negative clientele effect where shareholders opt to sell some of their shares to meet liabilities (Petty et al, 2011). This could come at a cost to Tesco’s shareholders as they may have to sell shares at a cheaper rate to cover their liabilities, as well as the process being time-consuming and implying transaction costs.   

 

Tesco have to consider whether this could be an ongoing trend for the near future, and if so consider the backlash they would receive as shareholders will be, in the short term, losing out on payments that they should have received. If their new CEO’s turnaround plans don’t pay off within the short to medium term then their shareholders could attack him (verbally) at the AGM, which was the case two years ago when they criticised then CEO Phillip Clarke for failing to stem losses (Neate, 2012).

 

In my opinion, I think that Tesco are making a wise decision, although it is to the dismay of their shareholders. As shareholders they should know how difficult the market has been and consider the supermarket price wars, as well as the rise of the bargain-based retailers such as Aldi and Lidl. With a new CEO with no experience working in the supermarket sector, you can understand shareholder worries but I think this could be just what Tesco needs. A fresh perspective on the company could bring ideas that were before not realised, and with the CEO’s successful past with Unilever they know that he has a good track record. I was surprised to see the 75 percent reduction in the interim dividend but this could well be a one off dilemma, and normal payments could preside in the flowing 6 months. All in all, Tesco has a difficult task of restoring the supermarkets past glory, and by investing in new ideas and with a new chief at the helm they could well do so if they adopt new strategies and consider consumer shopping habits in the future.    

 

 

Reference List

 

Burgess, K. (2014). Tesco’s shareholders must wait to feel the love. Retrieved from: http://www.ft.com/cms/s/0/23919e2c-10e9-11e4-b116-00144feabdc0.html#axzz3ZZJn8kia

Drake, P, P., Fabozzi, F, J. (2010). The Basics of Finance: An introduction to Financial Markets, Business Finance, and Portfolio Management. New Jersey: John Wiley & Sons Inc.

Financial Times (2015). Tesco PLC. Retrieved from: http://markets.ft.com/research/Markets/Tearsheets/Financials?s=TSCO:LSE

Neate, R. (2012). Tesco shareholders attack Phillip Clarke at AGM. Retrieved from: http://www.theguardian.com/business/2012/jun/29/tesco-shareholders-philip-clarke-agm

Petty, J, W., Titman, S., Keown, A, J., Martin, P., Martin, J, D., Burrow, M., Nguyen, H. (2011).  Financial Management: Principles and Applications, 6^th Edition. New South Wales: Pearson Higher Education.

Rankin, J. (2014). New Tesco CEO Dave Lewis – profile. Retrieved from: http://www.theguardian.com/business/2014/jul/21/new-tesco-ceo-dave-lewis-profile

Thesing, G. (2014). Tesco Slumps as Retailer Slashes Dividend 75% on forecast. Retrieved from: http://www.bloomberg.com/news/articles/2014-08-29/tesco-says-full-year-profit-will-fall-cuts-interim-dividend

 

 

Capital Structure Decisions

 

The modern day organisation, seems to be focused on one aspect; shareholder wealth and ensuring that they remain content. Unlike companies who, in the nineteenth century, wanted to contribute more as a business to society such as Ford (Henry and William Clay Ford), today’s major organisations have undoubtedly one main goal of creating wealth for shareholders. Of course this is the main goal of most companies, but at what lengths do they go to create shareholder value, and what risks are they willing to take to do so?

 

 In June 2014, Pfizer made public their failed takeover bid of UK based AstraZeneca, with price being the issue according to their CFO Frank D’Amelio. The takeover offer, valued at £55 per share, was rejected and led to Pfizer’s share price declining by 1 percent. The significant part of D’Amelio’s comments was that he said that the company would be willing to take on more debt for the right deal, and that he would, if necessary, lever up the balance sheet to get a deal done that would create shareholder value (Pettypiece, 2014). To do so they would have to reshuffle their capital structure to identify their optimal capital structure. The optimal capital structure only exists when a certain mixture of capital used by the firm leads to maximising the company value (Culp, 2002: p72).   

 

Effectively what the CFO was saying, was that they were willing to risk taking on more debt, and become more highly geared in order for them to create value for their shareholders. By increasing their debt capital, their equity capital would reduce. This would surely increase the risk, given they are willing to be more highly geared, or would it?

 

It is important to also consider the other motives towards the move, as they wanted to use their merger with AstraZeneca to move its tax base to the UK, a move commonly known as tax inversion (Kollewe, 2014).

 

Well if Pfizer were to increase their financial leverage, they risk exposing themselves to risks and financial distress costs, and increase debt means increased repayment costs (Petty et al, 2011). Pfizer currently have a debt to equity ratio (as of 2014) of around 0.50, as they have almost twice as much owner equity compared to their debt (Stock Analysis on Net, 2014). So they are not currently at major risk of increased debt, and could afford to take on more debt to boost their balance sheet.

 

Frank D’Amelio (CEO) had clear intentions of boosting shareholder wealth significantly through the attempted takeover, and signalled that they were in a strong financial position, despite decreasing profits, to take on more debt if it led to increased shareholder wealth. However following the failed takeover, their share price declined by 1 percent. This is not unusual, as even if the takeover was approved Pfizer, as the bigger of the two, would have inevitably seen a slight decrease in share price. However, if the deal was successful, then the future share price would surely increase as the company was expanding its portfolio with another major firm and would reap the benefits of M & A activity.

Of course, there are tax reasons to why they wanted to acquire AstraZeneca, but they have done so with the clear, stated, intention of increasing their shareholder wealth by stating that they would be willing to take on more debt to make a deal surface, with little risk to the company.     

 

 

 

 

 

Reference List

 

Culp, C, L. (2002). The ART of Risk Management: Alternative Risk Transfer, Capital Structure, and the Convergence of Insurance and Capital Markets. New York: John Wiley & Sons.

Kollewe, J. (2014). Pfizer unlikely to try AstraZeneca takeover again after tax clampdown. Retrieved from: http://www.theguardian.com/business/2014/nov/06/pfizer-unlikely-astrazeneca-takeover-tax-inversion-clampdown

 

Petty, J, W., Titman, S., Keown, A, J., Martin, P., Martin, J, D., Burrow, M., Nguyen, H. (2011).  Financial Management: Principles and Applications, 6^th Edition. New South Wales: Pearson Higher Education.

Pettypiece, S. (2014). Price the Reason Pfizer-AstraZeneca Deal Died, CFO Says. Retrieved from: http://www.bloomberg.com/news/articles/2014-06-11/pfizer-cfo-says-astrazeneca-deal-broke-down-over-price

 

Stock Analysis on Net (2014). Long-term Debt and Solvency Analysis. Retrieved from: https://www.stock-analysis-on.net/NYSE/Company/Pfizer-Inc/Ratios/Long-term-Debt-and-Solvency

 

Major Mergers - Implications for Shareholder Wealth Maximisation, Market Competitiveness, and Society

 

In the past week, it was reported that BT were set to finalise its acquisition of Britain’s largest mobile operator, EE, for the hefty fee of £12.5bn. The merger would lead to the combined group supplying home-phone lines, broadband, TV and mobile services (BBC News, 2015).

The expected merger would combine “the UK’s biggest telecoms and broadband network with the country’s most advanced 4G mobile system” (Monaghan, 2015).

With BT set to splash the cash to add to its current services, it is worth noting the effect this could have on their shareholder value maximisation. The deal may look good on paper, but major mergers of the past haven’t all been as successful as first thought. Also, from an external perspective, it is worth appreciating the knock on effect this will create within the market and its competitiveness.

 A primary aim of all profitable companies is to maximise shareholder wealth. Their wealth is measured by the company’s share price, and this price takes into account factors such as timing, magnitude and risk of cash flows generated over a period of time. The wealth created commonly indicates that the company has satisfied all stakeholders (Graham et al, 2009).

BT’s potential acquisition of EE is a clear statement of intent to dominate the UK telecoms market. On the day the two firms agreed the deal, BT’s share price rose by 4.8 per cent. This will give BT access to EE’s 31million customers (Ehrenburg, 2015). One of the clear indicators of shareholder wealth (as mentioned above) is share price, and with BT’s rocketing up due to the deal this can only be seen as a positive sign for shareholders. However, some shareholders may seek information on their motive for the move. Obviously they want to reinstate themselves within the mobile networking market, but is their primary aim to add this service to their current services to fend off competitors. The group have made plans to target customers with a bundle deal, providing all four of their services in one unique package, however Talk Talk and Virgin media already offer these packages (Bachelor, 2015). Some shareholders may be concerned that they are chasing the pack, in the sense that they are following other major competitors with an all in one deal. Although the bundle deal looks a promising venture, providing this will lead to the reduced cost of individual services which could concern shareholders.

Regarding competitiveness, Porter’s 5 forces model provides a good insight into what companies identify and threats and opportunities within markets. Porter’s 5 forces model, according to Hill and Jones (2007, p45), concerns 5 forces that shape competition in markets. They are: 1 – risk of entry by potential competitors, 2 – intensity of rivalry among established firms, 3 – bargaining power of buyers, 4 – bargaining power of suppliers, 5 – closeness of substitutes to products/service. With Talk Talk and Virgin already providing a bundle package they are not providing diversity and with those companies already establishing a popular bundle deal, BT could be seen as a substitute for their services, so this would be seen as a huge threat to their future plans. There is little chance of other companies following BT’s plans as the majority who provide services do so solely, not in a 4 service deal. Bargaining power of suppliers could affect BT, as they suppliers could see BT’s plans and opt to hike their prices to force BT to pay more for their supplies.

 

 

  Source: Hill and Jones (2007, p45)

With EE services to be combined with BT’s current amenities, the concept of competitiveness is becoming a smaller factor. With so few companies offering multi-product/service deals customers may be forced to opt for bundle deals, if BT decides to increase the cost of individual services costs to force customers into a package deal. The British public may not take too kindly to this approach, but in a sense it would be an intelligent decision for the company to make as their popularity could increase as the company would be providing a diverse service.       

It is worth noting the cost of the acquisition, and the effects this would have on their other ventures. With BT paying over £12 billion for the purchase of EE, some of their shareholders may feel concerned that they did not compete more with Sky for the English Premier League football rights. Sky forked out over £4 billion for the rights of 126 games, whilst BT paid £960m for 42 games (all in an annual basis). Although everyone concerned was shocked that Sky paid so much for the rights, some may think that BT did not do enough to challenge them (BBC Sport, 2015). It is worth noting the satisfaction of shareholders, as UK football rights is a huge deal worth mega money, they may be alarmed that BT are putting all their eggs in one basket.  

 

All in all, I believe that regulators should move to cancel the merger. BT are clearly attempting to dominate the market, which is not particularly good for customers as they will have limited choice of what services they can purchase due to larger companies dominance. I was surprised that BT did not fork out more on the premier league rights, as this would have increased the urge for the public to buy their TV services. In terms of shareholder wealth, although there are some concerns, as raised earlier, I believe their bundle deal will prove massively popular as customers could get 4 services at a reduced price. With EE currently providing their network services to 31million across the UK (almost half the population), the deal will surely put BT into the driving force within the industry.

 

 

Reference List

Bachelor, L. (2015) The Guardian. http://www.theguardian.com/money/2015/feb/05/how-bt-purchase-ee-affect-me

 

BBC News (2015). Retrieved from http://www.bbc.co.uk/news/business-31144009

 

BBC Sport (2015). Retrieved from http://www.bbc.co.uk/sport/0/football/31357409

 

Ehrenburg, D. (2015) City A.M. Retrieved from http://www.cityam.com/208765/bt-agrees-deal-buy-mobile-network-ee-125bn

 

Graham, J. Smart, S. Megginson, W. (2009). Corporate Finance: Linking Theory to What Companies Do. Third Edition. Ohio: Cengage Learning.

 

Hill, C., Jones, G. (2007) Strategic Management: An Integrated Approach. Eight Edition. Boston: Cengage Learning.   

 

Monaghan, A. (2015). The Guardian. Retrieved from http://www.theguardian.com/business/2015/feb/05/bt-to-buy-ee-4g-broadband