Activism Investment as the Key to Unlocking Value in Regional Firms

Activism investment as the key to unlocking value in regional firms | September 2015 1

Activism investment as the key to unlocking value in regional firms

Management Consulting September 2015

kpmg.com/eastafrica/mc

IntroductionAn activist investor is an individual or group that purchases a significant portion of a company’s shares and tries to obtain seats on the company’s board with the goal of effecting or enabling a major transformation in the company. A company can become a target for activist investors if it is mismanaged, has excessive costs, can be run more profitably or has another problem that the activist investor believes can be fixed to make the company more valuable.

Fuelled by performance pressures and a growing expectation of low, inadequate and increasingly questionable returns from traditional investment avenues, investors are increasingly seeking higher returns and diversification by allocating a growing portion of their investment funds to less liquid but more promising alternatives through venture capital firms, private equity and hedge funds.

The challenge in assessing the attractiveness of asset classes targeted by such activist investors lies in the inadequacy of financial statements to capture all elements affecting their value since business models can be disrupted, inventories can grow obsolete and receivables uncollectible; liabilities are sometimes unrecorded and property values over or understated.

Growth companies on the other hand have multiple opportunities to expand their business models into other rapid-growth markets. However, most of the companies under this category have not been able to realise their full potential owing to inadequate capital, inconsistent performance, lack of properly established structures and lack of a clearly defined growth strategy that would-be investors find essential in assessing a company’s overall investment attractiveness.

Apart from a company’s future prospects, other factors considered by these investors might include; return on assets, liquidity, leverage ratio, annual sales growth rate, dividend yields, price-to-book values and price-to-earnings ratios. These provide a tried and tested approach to identifying attractive companies in high growth industries with sustainable competitive advantages. However, unquoted companies that cannot observe the above financial ratios due to lack of adequate capital structures might not attract as many investors and thus continue to register sub-optimal returns.

The challenge lies in the inadequacy of financial statements to capture all elements affecting the value of a business...

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The challenge therefore lies in establishing a clear analysis and evaluation framework that enables investors minimise their investment risk whilst also enabling growth companies adopt leading operating practices that attract investment and unlock untapped shareholder value.

Accordingly, investors are adopting a more hands-on approach to investment to enable high potential businesses in their portfolios unlock value and realise higher returns. For instance in January 2013, the Nairobi Securities Exchange (NSE), Kenya championed for the formation of the Growth Enterprise Market Segment (GEMS), which enables growth companies to raise capital to drive their growth plans while benefiting from increased profile and liquidity within a regulatory environment designed to meet their needs. The GEMS segment of the NSE makes it affordable for SME’s to gain access to financial resources previously the reserve of larger companies, while giving investors the assurance of the safety of both principal and interest due to increased oversight on the operations of their portfolio companies.

However, the lack of a dynamic framework for comprehensively evaluating emerging business models has kept firms in high growth industries such as technology away from the GEMS of the Nairobi Securities Exchange. Almost three years later, only four (4) companies have subscribed to the GEMS. These account for a paltry 6% of the total listed companies on the bourse. Meanwhile, investors recognise the untapped value of unquoted growth companies globally. However, striking the delicate balance between constructively supporting a company unlock its hidden value whilst also maintaining a focus on the core function of effectively sourcing and allocating capital in addition to avoiding a costly asset-management operation, remains a challenge. What tools can these investors and businesses owners use to collaborate more effectively?

Part of the solution lies in the application of the various options available to both business owners and investors to create better channels of collaboration and communication to ensure consistent revenue growth. By analysing emerging trends in global and regional investment markets, it is possible to prescribe a set of interconnected levers of strategic and operational value.

What tools can management teams and investors use to collaborate more effectively?

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These levers of value as detailed below, form a prescription for business owners to apply strategic and operational best practice to enable them fine-tune performance, identify potential innovation, and cost saving avenues. This in turn, can increase their chances of attracting funding to scale operations and explore untapped markets. It is a prescription for seeking out undervalued companies with a value-creating program in place to enable the partial or full realisation of the underlying value. Additionally, it provides activist investors with a framework for developing value creation programs that also includes a monitoring and evaluation model spanning key business functions.

However, this is not a prescription for revolving-door capitalists, but for investors with a longer-term objective, prudent enough to identify untapped value yet patient enough to commit over the long term. Such investors are not driven by quick fixes, such as cost cutting or debt-funded share buybacks; tricks employed to create short-term value at the expense of long-term value, rather they seek sustainable, outsized returns.

These levers therefore allow for the careful and in-depth consideration of emerging business models and complements various financial analyses, including free cash flow. Free cash flow is the cash generated annually from the operations of a business after all capital expenditures are made and changes in working capital are considered. Investors have increasingly turned to this metric because reported earnings can be an accounting fiction, masking the cash generated by a business or implying positive cash generation when there is none. Following the cash— as the manager of a business must do—is one of the most reliable and revealing means of assessing a company.

Collectively, business model evaluation based on the four strategic levers of value and financial analysis provides a repeatable model for business owners to maximise the value of their firms and for activist investors to limit their risk exposure and maximise their return on investment on an investment-by-investment basis.

However, this is not a prescription for revolving-door capitalists...

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The strategic leversof value include; value chain and operational efficiency, automation, crowdfunding and data analytics.

Four strategic levers of valueBusinesses require a bespoke strategy to raise capital in order to strategically expand operations and improve efficiencies. Research and experience suggest four strategic levers that are driving success in growth companies. These levers provide a framework for companies to redefine value for customers innovating in their respective markets. Secondly, they serve as a guide to building powerful, cohesive business systems that will deliver more value than competitors will. Finally, they provide a roadmap for raising customers’ expectations beyond the competition’s reach.

Market leaders of the past decade have cemented their dominance by focusing on delivering value for their customers in line with three principles and perfecting them beyond the reach of their competitors. They include focusing on operational excellence, product and service innovation and customer intimacy. The levers discussed here are therefore a prescription for applying the above principles using four emerging strategic levers of value - value chain and operational efficiency, automation, crowdfunding and data analytics.

The levers are by no means comprehensive. For one, they do not touch on talent and people management, which is just as important in emerging markets as in developed ones; indeed, people are a company’s most valuable assets and these levers of value exist to help employees achieve excellence in their day-to-day operations. In a preferred way, attention is drawn to areas where transformational growth has been witnessed because of their successful implementation.

1. Value chain and operational efficiencyIn an ever volatile and disruptive business environment where companies face competition from traditional and non-traditional players, activist investors need a well-defined and agile framework for assessing an organisation’s value chain and operational efficiency.

Increasingly, management teams face three key challenges around value chains and operational management. These include cost containment, increasing operations visibility and risk management. Depending on how a management team approaches the coordination of these three factors, they can either have a positive or negative impact on a company’s bottom-line results.

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Investors must ensure that businesses have frameworks in place to address challenges around cost containment, increasing operations visibility and risk management.

Accordingly, the activist investor has to ensure that management teams are focusing on both short-term and long-term value chain cost containment strategies to complement enterprise growth and product/service innovation strategies and activities. With increasing globalisation, management teams are increasingly forced to adopt a granular view to operations coordination. This is because even minor missteps and miscalculations can have major consequences as their impacts spread rapidly throughout complex, costly and increasingly vulnerable value chain networks, thereby eroding margins and impacting negatively on shareholder value.

By consistently out-operating competitors, companies can achieve sustainable growth and establish a leading position in their industries. Operational efficiency allows for cost savings that can be passed on to customers by offering services and products at a discount compared to competitors. It is therefore the imperative of a company’s management and shareholders to agree on best value chain and operations methodologies to apply based on the company’s objectives. These should be complemented by a dynamic monitoring and evaluation schedule of the tools and processes that are in place to ensure growth and innovation goals are attained. This approach, accompanied by technology, can be used to inject efficiencies in high growth industries such as energy, media, healthcare, service industries, education and even agriculture.

In Kenya for instance, flower farms are adopting lean six sigma process-based improvements to benchmark and enhance their production and distribution processes against global best practices. This has led to the increase in the vase life of flowers exported to European markets due to better storage and faster delivery of flowers. There has also been a notable decrease in the number of required workers per farm with most farms registering an average of 40% decrease in the number of required farm labourers. Process-based mobility has also enabled farmers monitor the temperature in their greenhouses using mobile-enabled sensors, greatly enhancing the quality of grown flowers. These incremental gains have enhanced profitability of the farms while also enabling Kenya to solidify its position as one of the leading global producers of flower products.

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Choosing where to focusThe key to successfully improving value chains and operations performance is to focus on those areas that are not only under-performing but also, those that are aligned with the overall product and service innovation strategy. The challenge lies in having a cost-effective operation but not necessarily competing on cost. By instituting innovation and mapping constant value chain performance gap analysis programs, activist investors and management teams can use their findings to compare these key performance indicators with competitors and achieve this objective.

Secondly, by mapping out value chains on mobility applications accessible via hand-held devices such as tablets and mobile phones, management teams all over the world now have digital assistants that enables them to monitor production process and identify bottlenecks in real time.

Activist investors can therefore benefit greatly from enhanced visibility by coming up with an internal and industry monitoring standard in collaboration with management teams. Such frameworks allow for seamless scalability of process excellence across similar portfolio companies and greatly enhance the performance of an investor’s portfolio.

The monitoring and evaluation standard should have key performance indicators which addresses the current performance and future desired performance of elements such as product selection, forecasting and procurement, warehousing, inventory management and distribution based on quality, response time, costs and productivity.

Such a dynamic system provides an objective assessment of the performance of the business relative to industry and provides both the management teams and investors with the agility and transparency that they need in order focus on their core business of managing and allocating capital respectively, without leading to unnecessary conflicts of interest due to the overlap of functions.

Illustration 1Graphical representation of a key performance indicator of value chain efficiency


2. Automation of processes and functionsInvestors need to be on the lookout for high growth companies that are automating others or instituting automation internally. Automation of processes and systems leads to innovation and costs savings by improving efficiency and promoting connectivity, which in turns deepens the activist investor’s understanding of events and sharpens decision-making.

The proliferation of smarter end-points, scalable computing, mobility and visualization are reshaping the future of industrial and service automation. Around the world, forward-thinking investors are insisting on the adoption of leading-edge automation technologies and practices by their portfolio companies. This is because automation enables company to deliver superior customer value in line with operational excellence, customer intimacy, or product leadership.

By strategically formulating growth strategies around taking advantage of emerging opportunities in high growth industries, activist investors can evaluate a company’s automation index and potential, including the attendant cost-saving and scaling avenues and make appropriate investments that will catapult it to higher levels of profitability.

For instance, the falling price and rising reliability of sensor technologies means that practically any process can now be measured. The convergence of physical and digital infrastructure means production tools and solutions can communicate and collaborate directly, without human intervention. Entire systems including supply chains, transportation systems and electric power grids can be connected.

This trend explains the success of Amazon, the world’s largest retail chain. By automating its logistics process and the repetitive tasks in its marketing and sales processes, Amazon has established its dominance by providing superior customer service compared to its competitors. Amazon has demonstrated that automation efforts are most effective when a business deliberately links its automation strategy to specific measurable objectives. By automating nurturing functions through a series of emails, video, surveys or mailing customers a box of cookies from a fulfilment centre (distribution warehouses) Amazon aims to get the prospect to call, schedule an appointment or buy something. This strategy explains its success with the millions of customers who flock its website daily.

Investors need to be on the lookout for high growth companies that are automating others or instituting automation internally.

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Therefore, every insight derived from an automated and interconnected manufacturing operation can lead to action and more value, including increased visibility for investors removed from the day-to-day operations. In addition, sensors, RFID tags, meters, actuators, GPS and other devices and systems will increasingly generate information that was previously created by people.

Management teams do not have to rely on labour-based tracking and monitoring for objects like shipping containers, trucks, products and other parts. This reduces variability and uncertainty in value chains and presents an exciting opportunity for investors seeking long-term stability. By seeking out businesses in high growth industries with a high automation potential, activist investors can collaborate with management teams to automate the operations, catalyse product innovation and improve the customer experience and by so doing unlock sustainable value.


3. CrowdfundingCrowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people though an electronic platform e.g. the internet or mobile applications. Three types of actors anchor the crowdfunding business model: the project initiator who proposes the idea or project to be funded; individuals or groups who support the idea; and a moderating organization that brings the parties together to launch the idea. Crowdfunding can be either reward-based, equity-based or debt-based. The popularity of crowdfunding has grown at a phenomenal rate in the last few years and is now an industry that is worth in excess of $5 billion worldwide.

Crowdfunding is traditionally used to validate emerging business models that are considered too risky by traditional financiers such as banks and private equity firms. By allowing entrepreneurs to raise capital from a group of smaller investors in a secure and automated platform, crowdfunding democratizes fundraising and allows people outside the traditional investor groups and lenders to join in on the process. Increasingly, it is also being used to finance proven business models in high growth industries, albeit at a lower scale.

Equity crowdfunding platforms are also gaining traction as a gateway to viable investment opportunities. New equity crowdfunding platforms are providing a gateway to alternative investments that have historically been difficult to source and almost impossible to access. Until recently, investors needed to meet relatively large investment minimums and an existing relationship or personal connection to an investment manager in order to invest directly in high growth investments apart from start-ups.

Many well-established private companies and attractive funds can be launched on these crowdfunding platforms, which will greatly benefit both the end investor and the issuers seeking non-traditional sources of funding.

For instance, through the online investment platform RealtyShares, crowdfunding is disrupting the traditional private real estate funding model by providing accredited investors access to real estate investment opportunities in the United States of America. Investors can browse opportunities by asset type (i.e. single family home or apartment building) or geography and can pool their money with other investors to purchase shares in these opportunities for as little as $5,000 (Ksh.500,000). Investors also have access to an investor dashboard where they can monitor their investments, returns and tax documents.

Crowdfunding is traditionally used to validate emerging business models that are considered too risky by traditional financiers such as banks and private equity firms.

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MicroVentures, on the hand allows investors to contribute as low as $3,000 (Ksh.300,000) and invest alongside more established venture capital investors. To date, MicroVentures has raised over $20 million, spread among over 45 companies implementing new-age business models including Twitter, Facebook, and Yelp. Thus, through crowdfunding, RealtyShares and other crowdfunding platforms make investing in real estate and other high growth sectors transparent as investing in stocks of publicly traded companies.

Crowdfunding platforms like RealtyShares, Indiegogo, Kiva and KickStarter will not only provide a level of access and transparency that has never before been possible for high growth industries in emerging economies in Africa, but also greatly reduce the time and capital requirements needed to invest. However, a more activist approach, from both investors and the investment platform coordinators will be necessary to improve both fundraising and operational outcomes for businesses seeking investment.

In South Africa for instance, crowdfunding platform Thundafund not only provides a fundraising platform, but also works closely with entrepreneurs pre-and-post fundraising to enable them get the best out of their ventures. This is because in most cases, business owners with potentially disruptive business models lack the skills and resources to enable their ventures achieve sustainable profitability. Hence, an activist investor of modest means making a bet on a potentially disruptive business model through crowdfunding requires a more stringent due diligence framework.

In this connection, Thundafund’s projects acceptance rate currently stands at over 10% with only 160 of the 1400 projects submitted for consideration made accessible to investors after a collaborative screening process with the Thundafund team where the financial viability of the submitted ventures is tested.

Additionally, this activist approach enables management teams access a new breed of investors. For example, Thundafund has been able to raise funds from a new group of investors through targeting the unbanked and unconnected populous in rural areas in South Africa. Accordingly, it has reached its funding target for various projects by holding talks in local churches and libraries with prospective investors who account for over a third of its investor’s profile.

To date, MicroVentures has raised over $20 million, spread among over 45 companies implementing new-age business models including Twitter, Facebook, and Yelp.

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For the aspiring activist investor, the crowdfunding business model presents an exciting opportunity for scale. Applied judiciously, it is a lucrative platform to diversify capital through early stage investments in ventures with high growth prospects e.g. in consumer products. Together with the other levers of value, it can enable investors to pool resources and consequently realise outsized returns when the venture achieves a sufficient maturity level to warrant an exit either by acquisition by a larger company or listing in the capital markets.

In East Africa, crowdfunding is an emerging concept in need of a few success stories to be fully effective. The successful implementation of the crowdfunding concept will require the collaboration of platform sponsors/owners with business owners to create an analysis framework that allows for comprehensive due diligence on a business-by-business basis, in line with an industry’s peculiarities. This will promote the understanding of emerging business models in high growth industries and enhance the mass mobilisation of funds from non-traditional investors who are more risk averse.

Secondly, it will require targeted awareness creation through various channels, depending on the target group. Generation, education, wealth levels, ethnicity and any other relevant criteria can be used to segment these prospective investors. The marketing medium used to promote the investment opportunity has to be sensitive to the target group e.g. social media and other online platforms for the youth and middle class, and in-person discussions with investors organised around savings groups.

Finally, a very definitive performance management framework is required to ensure that the stakeholders’ definition of value is uniform and measurable. A balanced scorecard touching on the other three levers of value that are defining the success of market leaders globally is a good starting point. This will greatly enhance assessments based on capital performance and give a more comprehensive picture of an investment opportunity or portfolio company.

For the aspiring activist investor, the crowdfunding business model presents an exciting opportunity for scale.

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Illustration 2Business models adopted by major crowdfunding firms globally


4. Data analyticsData analytics can be an effective communication tool for management teams and prospective investors by allowing for increased collaboration as each group taps into the vast amounts of data available for analysis. For management teams in data-rich industries, the insights gleaned from the vast amounts of available data allows a more complete picture of customers’ preferences and demands. Through this deeper understanding, organizations of all types are finding new ways to engage with existing and potential customers.

In addition to customer-centric objectives, other functional objectives that management teams are addressing through the application of data analytics include operational optimization, risk management, financial management, employee collaboration and enabling new business models. According to research by MIT, companies that inject data analytics into their operations show productivity rates and profitability that are 5% to 6% higher than those of their peers are. This statistic presents an interesting opportunity for an activist investor encumbered with an underperforming portfolio company in a high growth, data-rich industry such as fast moving consumer goods (FMCGs), technology, telecommunications, media, healthcare, energy and finance.

In a report published by KPMG (See “Data and Analytics: A new driver of performance and valuation”, July 2015), twenty-four percent of the respondents said they changed one or more of their investment opinions based on a company’s data and analytics strategy, and 45% expect that to be the case in the next two years. The report indicates that data and analytics strategies are affecting organizations across industries. Hence, failing to have a data and analytics strategy, or executing one poorly, can negatively affect a company’s ability to compete -- and therefore its value.

In particular, investors view companies more favourably if they use data analytics to achieve any of three specific objectives—improving operating performance by controlling costs, shrinking inventory, and allocating resources optimally; developing new business models and information-based products and services; or limiting supply chain risk based on mining data from transactions with partners, suppliers, and vendors.

In order to increase operational efficiency and achieve significant and measurable business value, activist investors can encourage management teams to put into place an information foundation that is integrated, scalable, extensible, secure and supports the rapidly growing volume, variety and velocity of data.

In a report published by KPMG, twenty-four percent of the respondents said they changed one or more of their investment opinions based on a company’s data and analytics strategy, and 45% expect that to be the case in the next two years.

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Investors can promote for the integration of information systems in companies with disparate data storage structures. The silo effect, where information from different departments cannot be used by managers to drive key decisions effectively, has the effect of obscuring key value-adding avenues that exist across many businesses. Therefore, integrated information is a core component of any analytics effort. Moreover, an organisation’s data bank also has to be uniform, readily available and accessible to the people and systems that need it.

In this connection, activist investors can improve the overall performance of their portfolio companies by continuously reviewing operations to ensure that their management teams have the capability to build advanced analytics models for predicting and optimizing outcomes. They can achieve this by ensuring that a clear strategy on how to use the data and analytics to compete is in place and that the right technology architecture and capabilities are deployed. The cumulative gains realised because of a company’s insight-based operations are manifested through better decisions and more agile and profitable operations.

The democratisation and availability of information because of increased mobility can also empower activist investors to benchmark a company’s internal data against external data sources from its competition, suppliers, customers, and regulatory bodies.

For example, global retailer Wal-Mart has been able to realise a 10% to 15% online customer’s completion rate by deploying Polaris, its inbuilt search engine that relies on text analysis, machine learning and even synonym mining to produce relevant search results. Other companies are also using data analytics to inform their pricing strategies. Most businesses make reactive changes based on fluctuations in commodity prices, competitors’ price shifts, or pressure applied by their distribution partners. This approach inevitably leads to a chaotic pricing framework and underperformance across many businesses with wide product portfolios. By adopting integrated price management systems, such departments can realise increased sales by collaboratively setting prices to avoid cannibalisation within the portfolio.

In conclusion, management teams need three key elements of data analytics to enhance the value of their organisation: the technology, the ability to execute, and a culture that embraces data-driven decision-making. Any prudent activist investor should therefore look out for this winning formula before making any investment.

ConclusionThe four levers of value as discussed above provide long-term oriented activist investors with a framework for identifying and closing significant performance gaps in companies in emerging and high growth industries. By benchmarking on value chains and operational efficiency, activist investors can initiate constructive dialogue with management on a value creation agenda focused on improving and monitoring operational efficiency.Automation and data analytics on the other hand provide both management teams and investors with an efficient avenue for real time data collection and analysis, leading to the establishment of a positive momentum for the long-term improvement of corporate strategy and operations.

Finally, crowdfunding also presents good news for the emerging activist investor: a large capital base is no longer a prerequisite for unlocking value in businesses. Furthermore, the transparent performance assessment capabilities that crowdfunding platforms possess make it easier, now more than ever, for the activist investor to identify disciplined management teams with rational portfolios and strategies and invest in them appropriately.

About Bill Allela

Bill Allela is a Strategy and Operations consultant in KPMG Advisory’s Management Consulting practice in Nairobi, Kenya. Bill is a CFA candidate and has extensive experience in entrepreneurship and research having worked with Fin-tech start-ups and an industrial research organisation.

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Activism Investment as the Key to Unlocking Value in Regional Firms