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Hiroki Sampei Director of Research
Why is sustainability is an
issue now, why is value
creation critical?
6th November 2012
The Corporate Reporting Lab The 3rd Meeting of Planning Committee
To urge crisis of accessibility to
capital and actions to lead
lower cost of capital
Introduction
Reminder of Communication Gap(1)
Key takeaways and evidence of communication gap from
“Integrated Reporting Tokyo Forum 2012” and other relevant
recent meetings
Typical Communication Gap is found in the discussions on
1. Value creation
2. Stakeholders
3. Short-termism vs. Long term
A gap exists between companies and investors, and between
domestic parties and foreign parties
2
“Of course, companies want to raise more capital.”(Corporate Reporting Tokyo Forum
2012, 1st November 2012)
- Prof. Marvin King, Chairman, IIRC
“Value means financial value in the end.”(WICI Symposium 2012, 31st October 2012 )
- Paul Druckman, CEO, IIRC
“The 6 capitals – financial, manufactured, human, intellectual, natural and social capital. Social capital includes relation with community, network,
suppliers, and customer loyalty.” (WICI Symposium 2012, 31st October 2012 )
- Charles Tilley, CIMA & IIRC TTF Chair
“Don‟t mix up value with valuation, what we mean by value is sustainable earnings power or economic value.” (Corporate Reporting Tokyo Forum 2012, 1st November
2012 )
- Christianna Wood, the former Chairman, ICGN
3
Reminder of Communication Gap(2) Domestic vs. Foreign parties
(Appendix) The 6 Capitals – to drive business model and value
creation
4
Contents
5
1 Definition of “Value Creation”
2 Perception Gap on Stakeholders
3 Perception Gap on Short-termism vs.
Long term
4 Degree of distance b/w Companies
vs. Investors × Domestic vs. Foreign
5 Conclusions and Key Action Points
(proposal)
6
1. Definition of “Value Creation”
1)Ambiguity of “value” among parties in Japan
Corporate Value ?
Enterprise Value ? ・・・Market Value+Debt-Cash, or Present value of future cash flow
Shareholders Value ? ・・・Book Value, Market Value, or Present Value
• Ambiguous “Corporate Value” in Japanese cannot be translated into
English
• An interpretation of “value” varies according to the stakeholder
1. Definition of “Value Creation”
2) “Don‟t mix up value with valuation, what we mean by value is sustainable earnings power or economic value.”
earnings power : ROIC
economic value: > 1
ROIC: Return on Invested Capital
CoC: Cost of Capital
7
CoC
ROIC
C
R
8
1 Definition of “Value Creation”
2 Perception Gap on Stakeholders
3 Perception Gap on Short-termism vs.
Long term
4 Degree of distance b/w Companies
vs. Investors × Domestic vs. Foreign
5 Conclusions and Key Action Points
(proposal)
shareholders
investment banks
bond holders
creditors
banks
Academy
R&D org
ad agency industry
association
revenue office
authority
trade partners
suppliers
Employees/hiring customers
企業
9
2.Perception Gap on Stakeholders
1)Although the Social Capital defined by IIRC is one of the 6 Capitals, Social Capital is the majority of non-financial capital
in Japan
Social capital
Financial capital
(Human capital,
Intellectual capital)
(Intellectual capital)
Stakeholders on the Income Statements
Income Statements Stakeholders
Net Sales Customers
CoGS Trade Partners, Employees
SG&A Trade Partners, Employees
EBIT
Interest expense Banks, Creditors
Pre-Tax Profit
Tax Government, Local government
Net Income
Dividends Shareholders
Retained Earnings Shareholders<Recycling>
Stakeholders on Balance Sheet
Assets Liabilities & Equity Stakeholders
Cash All stakeholders
A/C Receivables A/C Payables Customers, Trade Partners
Inventories Customers, Trade Partners
PP&E and other investments Subsidiaries, Affiliates, others
Int Bearing Debt Banks, Creditors
Retirement Benefits Employees
Equity Shareholders
10
2.Perception Gap on Stakeholders
Japanese
companies say
that they are
“responsible to
public society”
…
The lower net
income is, the
less effective to
contribute to
whole economy
due to less
expansionary.
11
1 Definition of “Value Creation”
2 Perception Gap on Stakeholders
3 Perception Gap on Short-termism vs.
Long term
4 Degree of distance b/w Companies
vs. Investors × Domestic vs. Foreign
5 Conclusions and Key Action Points
(proposal)
1)Short-termism as a phenomenon and its driving factors
Short-termism as a phenomenon is no doubt true, but it is questionable to accuse
companies of their disclosure (corporate reporting) for misleading investors, or
investors of their impatience of lead time to deliver return.
Macro economic environments shouldn‟t be irrelevant to the outcome,
moreover, the responses to the economic environment change weren‟t
necessarily appropriate, and hence various side effects were derived from the
inappropriate responses.
As the developed economies become mature, a low growth and a low return
environment continues, investors have become more cautious about long term
prospects. In other words, earnings power becomes subdued and investment risk
arises. The first response to the investment environment change was to enhance
leverage. Leverage was used to enhance return. However, some savvy investors
attacked this low quality returns and hedge funds took advantage of leveraging
and short-selling to participate the opportunities. Highly leveraged short-selling
strategies should bear high risk and hence cause high turnover of transactions
12
3.Perception Gap on Short-termism vs. Long term
3.Perception Gap on Short-termism vs. Long term
(short term trading). Securities brokers prioritised dealing with these high turnover
hedge funds to maximise commissions, i.e. focusing on providing trading ideas to
drive high frequency trades. FYI, these trading decisions are often driven by
„direction‟ (e.g. positive news or negative news) rather than „valuation‟.
While companies sought for M&A opportunities to counter slower organic growth
(foreign companies in particular). Incentives such as stock option which were
originally designed for alignment of interests between corporate management
and shareholders were misused autotelic way and caused M&A boom to
maximise short term share price surge.
In contrast, Japanese companies dealt with arising uncertainty with strengthening
their balance sheet, i.e. reducing debt and piling up cash. As a result, their
earnings power (e.g. ROE, ROIC) failed to improve and hence they become
“value destructive” rather than “value creative” companies.
Japanese companies in general are known as low growth (indecisive, no action,
and slow execution), value destructive or value trap, and hence not suitable for
long term investment. In other words, they became short term trading vehicles
(commoditised equities: no economic values, but providing volatility for trading).
13
3.Perception Gap on Short-termism vs. Long term
Lower risk tolerance (or doubt for return) for equity investment would cause
disadvantage for capital intensive businesses and put them in inferior position to
have access to the capital to the high monetise-cycle business, such as SNS, and
the competitors in the emerging market. Sustainability would be at risk.
14
1) Short-termism as a phenomenon and its driving factors
3. Perception Gap on Short-termism vs. Long term
15
Long term value creation is
very critical for viability of
long term investment
3. Perception Gap on Short-termism vs. Long term
2)Investment opportunities and time horizon
16
Return opportunity
by time horizon
Decision factor
1) Day, week position, news flow, technical
2) 1-6 Months theme, sentiment, quants, monthly indicators,
quarterly earnings
3) 1 Year company fundamentals, theme
4) 1-5 Years corporate strategy & execution
5) 5 years or more corporate management: hands-on involvement
3. Perception Gap on Short-termism vs. Long term
(Pharmaceutical company, Japan) (Const. & Mining equip. company, Sweden)
Eisai Co, Ltd. (Japan - Pharmaceutical)
0
2
4
6
8
10
12
14
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CF
RO
I (%
)
Cash Flow Return on Invested Capital (%)
66% (9% p.a.) 553% (48% p.a.)
0
5
10
15
20
25
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CF
RO
I (%
)
Cash Flow Return on Invested Capital (%)
17
E.g.1)Investment opportunity in a good company
(Source:Bloomberg) (Source:Bloomberg)
(Source:Credit Suisse HOLT, Fidelity Worldwide Investment) (Source:Credit Suisse HOLT, Fidelity Worldwide Investment)
3. Perception Gap on Short-termism vs. Long term
Victor Company of Japan, Ltd.
-12
-10
-8
-6
-4
-2
0
2
4
6
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CF
RO
I (%
)
Cash Flow Return on Invested Capital (%) Infineon Technologies
-10
-5
0
5
10
15
1999 2000 2001 2002 2003 2004 2005 2006 2007
CF
RO
I (%
)
Cash Flow Return on Invested Capital (%)
(Audio/Video Products company, Japan) (Semiconductors company, Germany)
-89% (-53%p.a.)
-34% (-6%p.a.) +43%
+138% +148% +107%
-80% (-15%p.a.)
+52% +66% +264%
+42%
18
E.g. 2)Investment opportunity in a bad company
(Source:Credit Suisse HOLT, Fidelity Worldwide Investment) (Source:Credit Suisse HOLT, Fidelity Worldwide Investment)
(Source:Bloomberg) (Source:Bloomberg)
3. Perception Gap on Short-termism vs. Long term
(Pharmaceutical company, Japan)
Price Street EPS PER
FY1 FY2 FY1 FY2
27 Dec ‘00 4000 59 75 68 53
02 May ‘03 2050 144 164 14 13
Change -49% 146% 119% -79% -77%
Expectation was stretched
Short of expectation
caused share price fall
Eisai Co, Ltd. (Japan - Pharmaceutical)
0
2
4
6
8
10
12
14
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CF
RO
I (%
)
Cash Flow Return on Invested Capital (%)
66% (9% p.a.)
-49% (-25% p.a.)
15 Aug ‘05 4010
It took 4.6 years to exceed 27 Dec ‘00 price
19
E.g. 3)Good company = good investment?
(Source:Credit Suisse HOLT, Fidelity Worldwide Investment )
(Source:Bloomberg)
3. Perception Gap on Short-termism vs. Long term
Summary of examples1-3
A good business vs. a bad business … does this matter?
Yes, …Why does this matter?
– A good business: ROIC>CoC, and IC Growth
– A good business can be a bad company • Business fundamentals vs. the parent of the business
– Investing in a good company and investing in a bad company is essentially different
Where do the investment opportunities exist?
– A good company can be a terrible investment
– A bad company can be a great investment
– All depend on what is in the share price
20
Long term investment
stance doesn‟t necessarily
mean long term holding
period due to the share
price often fully or overly
discounts long term
prospects.
Day-Wk Month Quarter 1~2yrs 3yrs 5yrs 10yrs 40yrs 60yrs 100yrs
Traders ○ ○
Short term investors ○ ○
Typical institutional investors ○
Long term investors ○
Bond investors ○ ○
Monthly sales レ
Quarterly results レ
Full year results レ
Mid term plan レ
Restructuring レ
Long term projects レ レ
Lifetime employment レ
Retirement benefits レ
Sustainability レ
21
3)Time Horizon
3. Perception Gap on Short-termism vs. Long term
22
High time disc rate “impatient” group:time preference to the near term and discounting higher risk
Low time disc rate “patient” group: time preference to the long term and discounting lower risk
Pro
fits
Lo
sse
s
time
3.Perception Gap on Short-termism vs. Long term
4)Behavioural Finance approach(time discount factor)
Perception Gap
Disc rate
Disc rate
Loss bias
Loss bias
23
1 Definition of “Value Creation”
2 Perception Gap on Stakeholders
3 Perception Gap on Short-termism vs.
Long term
4 Degree of distance b/w Companies
vs. Investors × Domestic vs. Foreign
5 Conclusions and Key Action Points
(proposal)
(Authority, Self-regulatory body,
accountants, etc.)
24
Foreign
investors
Domestic
companies
Domestic
investors
(Authority, Self-regulatory body,
accountants, etc.)
Foreign
companies
4.Degree of distance between Companies vs. Investors × Domestic vs. Foreign parties
4. Companies vs. Investors × Domestic vs. Foreign
×: No, △: Yes, to some extent,
〇: Yes, ◎: Of course, yes!
Japan Foreign
Cos Investors Cos Investors
Is “Value” common language?
Earnings power: ROIC
Economic Value: >1
×
△
△
△
△
○
○
○
○
◎
◎
◎
Cognition of the 6 Capitals ◎ ○ △ △
Are there various “R‟s” specific to each
capital (6R), or is “R” Financial Return?
6R FR FR FR
What are the critical factors for
Sustainability, LT Value Creation?
Accessibility to 6 Capital Cost of Capital
△
×
△
×
○
◎
○
◎
25
CoC
ROIC
26
The recent comments from overseas investors
– Subdued economic performance or lack of leadership in politics are NOT the key reasons for the “Japan Passing”
– Low ROIC, low ROE is evidence of disregard for shareholders – this is the key reason for not interested in Japanese companies
– Low growth – indecisive, no action, or slow execution
– Value of company is often less than the sum of the value of businesses – because the company is NOT the best parent of the businesses
⇒ Hard to expect sustainable value creation(not suitable for long term investment)
⇒ Could be a trading vehicle(commoditised equities)
4. Companies vs. Investors × Domestic vs. Foreign
(appendix) A good business doesn’t necessarily mean a good
company
Is the company the best parent of the businesses?
– Maximizing value of the business portfolio in the long term
– The best provider of resources (supplies, professionals and financial)
to their businesses
Good steward of capital
– Allocation of capital
– Efficient capital structure
A good company creates value for shareholders:
ROIC > CoC, and IC growth
27
28
標準偏差
0
10
20
30
40
50
60
70
OP Margin (%)
ROE
ROIC
PBR
EV / IC
EV / EBITDA
Japan 492 companies
US 1397
Europe 604
Asia ex-J 1133
Japan US Europe Asia ex-Japan
Standard deviation of KPIs
(Source: Macquarie’s, Fidelity Worldwide Investment)
Relentless challenges to the competition (foreign companies) vs.
staying at the average and the average is losing competitiveness
(Japanese companies)
4. Companies vs. Investors × Domestic vs. Foreign
29
Although Japanese companies claim their emphasis on the relationship with
stakeholders and intangible values …
Can intangibles such as customer loyalty, employee loyalty, brand value
be visible?
– Has their high technical advantage translated into profit margins?
– Has their brand value translated into profitability?
– Has employee loyalty translated into per head productivity?
– Has customer loyalty translated into profit margins?
4. Companies vs. Investors × Domestic vs. Foreign
30
製品・サービスの価値
0102030405060708090
0 20 40 60 80 100
GP-R&D (% Sales)
SG
A-R
&D
(%
Sale
s)
Japan US Europe Asia ex-Japan
Operating
losses
High products value
Hig
h m
ark
eting c
osts
(Source: Macquarie’s, Fidelity Worldwide Investment)
Can intangibles such as customer loyalty, employee loyalty, brand
value be visible?
4. Companies vs. Investors × Domestic vs. Foreign
Value of products
31
1 Definition of “Value Creation”
2 Perception Gap on Stakeholders
3 Perception Gap on Short-termism vs.
Long term
4 Degree of distance b/w Companies
vs. Investors × Domestic vs. Foreign
5 Conclusions and Key Action Points
(proposal)
5.Conclusions and Key Action Points (proposal)
Lower Cost of Capital – critical for companies and investors to
speak common language and to be on the same page
To avoid being overwhelmed by global competition,
a) Win the support from capital providers and secure accessibility to capital,
b) Lower Cost of Capital,
c) Deliver superior return and strengthen competitive advantage
Why communication should act key role?
Because investors‟ perception drives risk premium which is a key component of the
cost of capital
How to enhance sustainability?
Connect ecosystem of the business with competitive return on capital
Hence, being able to a) sustain corporate motto, and b) maintain relationship with
stakeholders
32
5.Conclusions and Key Action Points (proposal)
Companies Investors
Points of Communication:
Accountability
with regard to relevance of 6Capitals to Return
> CoC is the desirable outcome. To
achieve this, understand and
resolve investors‟ concerns over
visibility for growth, return, and
risk management
Articulate sustainable value creation in
relevance to ecosystem of operating
activities and recycle of capital
(Note:6C・・・financial, manufactured, human,
intellectual, natural, and social capital)
Points of Evaluation:
Pay (premium) for growth,
Pay (premium) for return,
Pay (premium) for visibility,
Pay (premium) for management
Lead lower cost of capital, and
hence support company to
create long term value
33
C
R
6
C
R
6
34
Data(1)
Region
Mkt.
Value ($
mn)
FY2007 FY2008 FY2009 FY2010 FY2007 FY2008 FY2009 FY2010 FY2007 FY2008 FY2009 FY2010
Japan count 492 452 454 456 na 487 489 492 450 482 487 489 482
mean 6229 30.9 28.6 29.4 na 12.4 7.1 9.0 8.7 9.8 1.7 4.6 7.9
median 2664 26.7 24.6 24.4 na 8.5 5.2 6.1 6.5 8.7 3.3 4.9 7.0
std 10675 18.3 19.0 19.3 na 11.4 14.6 11.7 9.8 8.1 14.1 11.5 8.1
US count 1397 1239 1243 1245 na 1387 1392 1394 1354 1323 1341 1358 1349
mean 9447 38.5 37.1 37.0 na -72.7 -47.2 -146.8 16.6 8.1 1.1 11.5 18.9
median 3033 34.7 34.5 34.1 na 14.7 12.9 12.9 15.7 13.5 10.7 10.1 13.1
std 23193 21.9 32.6 22.9 na 2930.2 1707.0 5805.5 34.7 381.1 331.0 58.1 63.9
Europe count 604 521 529 523 na 592 597 598 577 577 586 588 569
mean 11131 43.1 42.4 41.9 na 16.9 -6.7 25.5 18.3 24.9 16.9 26.4 22.2
median 3490 41.6 40.8 40.6 na 14.2 11.8 11.3 13.9 17.3 12.4 10.9 14.6
std 22285 29.0 22.9 23.4 na 116.2 377.0 356.6 20.6 67.5 73.1 289.1 61.9
AxJ count 1133 1086 1091 1090 na 1125 1129 1131 986 1074 1115 1126 1030
mean 5784 28.6 28.1 29.7 na 59.7 7.7 14.4 20.0 17.0 14.6 11.7 18.6
median 2196 25.8 24.8 26.4 na 15.1 12.2 13.8 14.5 17.1 12.2 13.4 15.6
std 17083 51.7 42.7 21.7 na 1345.6 379.5 199.0 17.9 147.7 26.9 103.9 19.2
ROEGP Margin OP Margin (%)
FY2007 FY2008 FY2009 FY2010 FY2007 FY2008 FY2009 FY2010 FY2007 FY2008 FY2009 FY2010 FY2007 FY2008 FY2009 FY2010
487 489 492 450 481 486 490 491 482 488 491 492 486 471 479 415
9.9 5.4 6.7 7.5 1.7 1.2 1.5 1.4 1.7 1.4 1.5 1.4 7.5 10.6 11.1 8.0
8.3 4.3 4.7 5.8 1.3 1.0 1.2 1.1 1.2 0.9 1.0 1.0 5.5 7.7 7.3 6.4
8.0 10.1 8.3 7.4 1.6 1.3 1.3 1.2 2.0 1.8 1.6 1.6 10.8 14.6 31.3 9.8
1376 1393 1397 1355 1304 1304 1336 1365 1325 1340 1366 1397 1341 1317 1325 1313
17.9 12.4 13.6 15.0 4.7 2.6 3.9 3.9 3.7 2.8 2.9 3.3 25.6 21.4 17.6 12.0
9.1 8.5 7.4 10.3 2.6 1.7 2.1 2.3 2.0 1.3 1.6 1.8 10.4 10.6 10.7 8.7
50.3 87.8 42.8 23.0 14.5 4.8 18.4 12.9 8.6 10.2 4.8 5.0 201.7 70.0 41.2 25.1
598 602 603 579 575 577 588 595 582 589 597 604 590 567 571 556
18.2 8.0 9.2 11.5 3.8 2.1 3.0 4.7 3.4 1.7 2.1 2.3 14.8 15.6 13.7 9.9
8.6 7.1 6.6 8.7 2.7 1.5 1.9 2.1 1.6 1.0 1.3 1.4 9.1 9.5 9.8 8.3
112.4 17.0 15.4 11.6 6.3 2.7 5.8 35.9 20.1 2.8 2.4 2.7 35.4 35.2 18.1 8.6
1118 1130 1133 987 977 1012 1069 1131 982 1017 1072 1133 1112 1092 1106 917
12.6 9.6 8.7 14.4 6.6 2.3 4.1 4.9 3.4 1.8 3.1 4.0 54.4 36.2 26.4 18.1
8.9 6.8 7.2 8.9 4.2 1.7 3.2 3.5 2.9 1.2 2.2 2.5 21.3 21.4 17.0 13.2
20.6 16.0 36.6 40.8 23.6 2.3 3.6 5.2 28.7 3.7 3.5 4.6 338.6 61.6 30.8 23.4
EV / IC EV / EBITDAROIC PBR
(Source: Macquarie’s, Fidelity Worldwide Investment)
35
Data(2)
OP Margin
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
FY2007 FY2008 FY2009 FY2010
ROE
0
2
4
6
8
10
12
14
16
18
20
FY2007 FY2008 FY2009 FY2010
ROIC
0.0
2.0
4.0
6.0
8.0
10.0
12.0
FY2007 FY2008 FY2009 FY2010
PBR
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
FY2007 FY2008 FY2009 FY2010
Japan US Europe Asia ex-Japan
(Source: Macquarie’s, Fidelity Worldwide Investment)
36
Data(3)
EV/IC
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
FY2007 FY2008 FY2009 FY2010
EV/EBITDA
0.0
5.0
10.0
15.0
20.0
25.0
FY2007 FY2008 FY2009 FY2010
Japan US Europe Asia ex-Japan
(Source: Macquarie’s, Fidelity Worldwide Investment)
37
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