Corporate Strategy, Part Deux

Last night I spoke with Kurt Orlofski, President of G&W Labs, which is a small ($150mm in revenues last FY) pharmaceutical manufacturer of topically applied generics. I reached out to him because he holds an MBA in Finance, so I figured he'd be able to offer some advice from that perspective on how to approach my meeting / interview.

Aside from all of the wisdom he imparted about strategy development, one thing he did say is to have one idea that is a bit out in left field. Something to challenge the way things are normally done. (He did caution not to be too far in left field; otherwise, I'd come off as being a kook.)

I had already considered something like this, so that advice specifically confirmed that I need to flesh this out. I'm going to do some research myself, but I know there are some smart financial people here.

Here's the problem: our cash cow, the mainframe BU, generates huge sums of cash for us. But the YoY growth rate is 2-3%, which isn't bad for a mainframe company but abysmal for any company that isn't exclusively focused on the mainframe. Our distributed side of the business is in the 10-15% range, which is great compared to our peers. But the total YoY revenue growth is getting dragged down by the mainframe folks.

If the mainframe BU gets spun off as a wholly owned subsidiary, how does that impact the mother company from a financials perspective (i.e. according to GAAP)? Are there any other ways to negate the impact of the low YoY % growth?

Did you considered YOLO?
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Originally posted by: Cummins aka RomneyBot
I woke up at like 8 am, woke her up and she told me she needed to be honest. She said I fucked both your friends last night. I dont know why I did it. I punched a hole in the wall because I realized how stupid I was. Then I looked outside no sign of any rain. <--update Jun 1st, 2012.

Bump.

And I answered my own question through some research I did yesterday. Still, I'm interested in the broader question, i.e. is it possible to jettison a low performing (from a % YoY growth perspective) but high revenue generating BU from a company without it being a death blow to the stock price?

Go enjoy your vacation with your family. There are lines forming at the rides!

Heavily overcast. Threatening to rain. We're gonna attempt it anyway.

Plus Lauren takes forever to get ready. She started 15 minutes before I did and I still beat her in spite of the fact that I had to shave both my head and my face in addition to showering too. So while she finishes preening I come here.

Originally posted by: Questor
Here's the problem: our cash cow, the mainframe BU, generates huge sums of cash for us. But the YoY growth rate is 2-3%, which isn't bad for a mainframe company but abysmal for any company that isn't exclusively focused on the mainframe. Our distributed side of the business is in the 10-15% range, which is great compared to our peers. But the total YoY revenue growth is getting dragged down by the mainframe folks.

I have a few questions. What is the "Mainframe BU"?

Is it a mature product? If it has hit the mature phase of the life cycle, you aren't going to be betting obscene amounts of growth (unless you're an exception to the rule like Apple, Google, etc..).

Since I don't know what industry you're in, what is the difference between your distributed side of the business and the cash cow (?). What are you comparing the distributed side to?

Questy is just name dropping and patting himself on the back...

BU = Business Unit. We have more mainframe products in that BU than we do in the other 4 BUs combined.

Mainframes, generally speaking, do not get net-new deals done. Instead, 100% of the deals that aren't additional capacity on top of existing footprints (of our products) are us stealing from our competition.

In other words, it's not like lots of companies are buying mainframes that didn't have them before.

As a result of this, the YoY growth rate is horrible since it's tough to steal business from a competitor. In fact, it's nearly impossible because they will almost always drop their per MIPS rate to match ours just so they don't lose the business.

However, because all mainframe software (from us or others) is licensed by MIPS capacity (with some exceptions for software that can be run on ZIPs and ZAPs or IFLs for z/Linux), our software brings in huge sums of money for the company.

The problem is that Wall St. values stocks on things like YoY growth. Maintaining revenue only keeps the stock from tanking but doesn't provide any incentive for people to buy it up, unless they're looking for either stability in their portfolio or to receive a dividend.

Does this help provide context?

My pondering is about turning our stock from a value stock to a growth stock. See this article on the differences between the two. Doing so would require us to acquire some specific characteristics, like double digit overall growth. That's nearly impossible for us to do given that the mainframe BU's YoY growth % is so low. (From a revenue perspective the mainframe BU accounts for nearly half of our total revenue, according to the last 10-K, so a 2% growth rate for that BU has a huge negative impact on our overall growth rate.)
Post edited by Questor at 10/9/2013 10:14:29 PM

http://www.spinoffadvisors.com/articles/spinoffs101.htm
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I haven't posted in these forums in years but thought I'd put out a few thoughts for consideration. (Disclaimer: I know nothing about your company or IT)

Your original question: How does a wholly owned subsidiary impact the mother company from a financials perspective?

I don't think it would have any impact. If the parent company has 51% ownership, the financials will be consolidated. It is also likely that the subsidiary will be reported seperately on the financials because it comprises such a large % of revenue. I usually think of subsidiaries from a legal structure perspective and as a risk management tool. Is there a brand name that's valuable? Legal, tax, or financial reporting regulations? Need to limit legal liability?

Most likely, your company already has multiple entities set up based on geographic location. The financials stay the same if ownership remains the same. Sure, there can be different ways to present that information but those wharton educated analysts at goldman will figure it out.

Now if you want to unlock value by spinning off the BU as a separate company......I have a lot more questions
Post edited by atog2 at 10/10/2013 6:46:19 PM

Originally posted by: atog2
Now if you want to unlock value by spinning off the BU as a seperate company......I have a lot more questions

Ask them. The spinoff idea was a hairbrained one to hopefully unlock more value. That's the ultimate goal, or at least to have an idea of how it could be potentially accomplished.

If the company spun off the BU into an independent company, its financials would no longer be reported in you company’s FS. This could drastically change their financial position and ratios.

Three big questions came to mind:
1. Has anyone thought of this before and why has your
company not done this already?
2. What is the company’s current strategy?
3. Will senior leadership be receptive?

You’ve probably thought of some of these things already but this was my thought process.

The fact pattern I have is your company has a mature BU with low growth potential. My belief is that wall street looks at more than just statistical metrics like Revenue growth, EBITDA, or EPS when valuing a business.

Q1. Here are some possible reasons why your company or an activist investor hasn’t already done this:

You are right, the mature BU sounds like a cash cow. But what is your company doing with the money? A company can use it to create value by giving it back to the shareholders. Or, a company like Microsoft or P&G will use a cash cow as a source of financing for growth instead of going to the debt markets, selling assets, or issuing stock. What is the benefit? It is usually cheaper, can keep operations healthy, and keep financial ratios under control. When looking at the Cash Flow Statement of a healthy company, the driver of positive CF usually is the operations section and not financing or investing. If you want to get more technical, I am thinking about value in terms of WACC and DCF modeling. The lower WACC (internally financed) will result in a higher NPV.

Two other reasons could be earnings stability and business strategy diversification.

Q2. Strategic Importance

What is your company selling? Do they sell a widget, system, or solution? The goal of the mainframe business might not be big profits or growth. It could exist to drive customer relationships and upsell related products and services that are high margin or recurring sources of income. If your firm got rid of the product line, would customers leave because you don't offer those products? If customers leave, will you create a greater net value by redirecting your resources elsewhere?

Q3. Human capital strategy

Where do the senior leaders in the company come from? If they are external hires or have worked their way up through the growth BU then leadership might be receptive to your idea. However, if they have built their career within the mainframe business, then I would expect a little more resistance. I remember reading that the guy you are meeting with likes you. However, will someone else be comfortable putting your ideas in front of the CEO?


The spinoff site mentions two big reasons to do one:

Unrelated businesses may be separated so that the market can better appreciate the spin-off & separate a "poor" or underperforming business so that an untarnished "good" business can shine through to investors

I don’t think either of these apply to the mainframe BU.

You mentioned low growth but I didn’t see anything about profitability. As a cash cow, I am assuming it’s fairly profitable. Therefore reason #2 doesn’t apply. For reason #1, the site talks about spinning off a growth or unrelated business. I think mainframe is highly relevant to your company and it’s not a growth business. Therefore, my opinion is that there isn’t value creation to justify the spin off (aka why it hasn’t been done already). If anything, you should be considering a spinoff of a growth BU.

Something I would want to know is what exactly your “business strategy” group does. Are they purely M&A focused, do they closely influence BU strategy, are they just execution minions? Does the group’s composition include ex bankers, ex MBB consultants, BU people?

Although I neither have the answer nor have experience in your situation, I would consider the 90-day approach and pitch a smaller idea that could add immediate value within your first 90 days. Also, with your experience and network, you seem to have enough industry knowledge to throw out a possible acquisition target. I think both ideas are low risk but could also be “out there”. Then, when you get the job and establish credibility, you can start thinking bigger.

As for other ideas to drive growth, some things I commonly associate with business strategy are:
1. Strategic Planning - integrate process with other decision making
2. Growth Strategy - new customers, countries, products, and services & execution
3. Operating Model Design - Streamline business functions, org structure, governance, and metrics
4. Cost Reduction - Improve Margins

Sorry for the long post but I hope my opinion is helpful.

That post was incredibly helpful. Thank you very much. You've given me a lot to think about.

Before seeing this, I was thinking about possibly doing something very similar to what I was originally suggesting, but with a slightly different structure: rather than spin off the mainframe BU as a subsidiary of the remaining BUs, why not establish a holding company that has the mainframe BU as one subsidiary and the balance as another?

I'm not sure this would have any benefit yet but it's something to ponder. Here's the net benefit of this approach, at least off the top of my head: both subsidiaries have independent financials and the accompanying reporting. Obviously, the holding company has some form of a consolidating set of financials incorporating both of the subsidiaries.

But if the subsidiaries are not wholly owned, i.e. based on stock class structuring and voting power per share class, the holding company could still hold the majority of the voting power while each subsidiary executes an IPO to raise additional funding. This would provide cash for future growth, TBD in a newly developed corporate strategy for each subsidiary after this splitting occurs.

The net benefit is that each subsidiary could be considered / valued based on their respective merits. In other words, it is well known that any mainframe company is going to have low growth rates, so compared to their peers they may be performing well. But since they are independent of the other subsidiary, that other one can be compared against other ISVs that also do not have a mainframe component without being bogged down by the low growth rate of the former mainframe BU.

Again, I'm not sure what the full set of pros and cons are yet, but it is something to take under consideration in conjunction with some of the great questions you also asked.

If you are curious, here is the FY13 10-K. You will notice that in spite of the fact that we aren't required to report things separately, there are some financial metrics that we provide for the mainframe and distributed sides of the business. And, as I understand it, this more finely granular data has had an impact on our stock. But at the end of the day, shareholder value is tied to both of these together so the impact is limited since you can't have one half without the other.
Post edited by Questor at 10/11/2013 7:29:09 PM

questie, hit me up. i have a friend who has a patented topically applied product that has a lot of potential. perhaps you can do an intro with this Kurt Orlofski?
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The right is more virtuous than the left. They have twice as many virtues because they have double the standards.

Pixel, y u no do pick'em this year? < / 3
Post edited by Zoomacroom at 10/12/2013 10:22:06 PM

Meh. My meeting got bumped to Monday the 21st because he has a meeting with the CEO at HQ. If I didn't have a meeting myself in lower Manhattan (our HQ is 2h away) quickly after that I would have met him out there.

I can use the extra days to prep at least.
Post edited by Questor at 10/14/2013 9:43:35 AM

Originally posted by: Questor
But if the subsidiaries are not wholly owned, i.e. based on stock class structuring and voting power per share class, the holding company could still hold the majority of the voting power while each subsidiary executes an IPO to raise additional funding

I'm not sure if I've encountered something like this before. My thought is why would someone buy stock in a company in which a parent has control? And can you IPO a company and retain control?

The closest thing to this that I can think of is in the Oil & Gas industry with Master Limited Partnerships. Ex. Ticker symbols MPLX, MMP, and KMI. My understanding is that the Holding/Parent Company serves as the general partner while investors are limited partners. The company transfers assets like oil pipelines to the MLP, assets with stable, predictable, and long-term cash flows. Then, the MLP would pay quarterly distributions to investors. The big benefit is that the depreciation on these assets would flow through as a loss to the partners which offsets other income for tax purposes. I think the concept of a REIT might be similar but am not sure.

I'll try to take a look at the 10-k before the weekend. I am curious to learn about your company.
Post edited by atog2 at 10/14/2013 10:20:12 PM

Control is all about the voting capacity afforded the individual shareholders. There are several examples currently where CEOs have different class shares that have multiple votes per share of stock that they own. (Mark Zuckerberg is one.)

Even so, an IPO (or what would probably be a secondary offering) is just a sale of a large, but limited number of shares. The number of shares being offered helps dictate the initial price (along with the usual stuff like fundamentals, etc.).

My point is that being a subsidiary doesn't mean you have to be wholly owned. A subsidiary, by definition, is another company where you own 51% of the stock. But I would imagine that it should be amended to say that you have 51% of the voting power.

Berkshire Hathaway, unless my memory fails me, is probably the best known holding company that owns controlling stakes in (several) other public companies.

You'll enjoy the 10-K by the way. CA Technologies is a Fortune 100 company, and is the largest purely software vendor (i.e. not IBM or HP which also produce hardware) in the world. The 10-K is chock full of interesting information.
Post edited by Questor at 10/14/2013 10:55:13 PM

Originally posted by: Questor

You'll enjoy the 10-K by the way. CA Technologies is a Fortune 100 company, and is the largest purely software vendor (i.e. not IBM or HP which also produce hardware) in the world. The 10-K is chock full of interesting information.

There's only one 10-K I want to read anytime soon...the one for the company I work at

+1

Meeting was today.

It was an interview.

I didn't have to discuss any ideas with him, though I was fully prepared to if asked.

Next steps: he asked me to reach out to his interim head of strategy, which I've done already.

Originally posted by: Zoomacroom
Pixel, y u no do pick'em this year? < / 3

yeah man i wanted to but something happened on the way to football season. i met the most amazing woman and since things are complicated and time with her is limited, Sunday is always my day with her and so really, I have barely watched football this year at all. And it's not like she is not totally willing to spend half the day with me at a bar with the games on I want to watch, I just don't give a flying fuck about a sport when something far more important in life is going on. It's the best feeling I've had in some time. Football will be around when she and I can spend more time together. If it's this season or I have to wait until next, doesn't bother me.
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The right is more virtuous than the left. They have twice as many virtues because they have double the standards.

Originally posted by: Pixel

Originally posted by: Zoomacroom
Pixel, y u no do pick'em this year? < / 3

yeah man i wanted to but something happened on the way to football season. i met the most amazing woman and since things are complicated and time with her is limited, Sunday is always my day with her and so really, I have barely watched football this year at all. And it's not like she is not totally willing to spend half the day with me at a bar with the games on I want to watch, I just don't give a flying fuck about a sport when something far more important in life is going on. It's the best feeling I've had in some time. Football will be around when she and I can spend more time together. If it's this season or I have to wait until next, doesn't bother me.

dude... that is awesome!

kick ass puddn.

Originally posted by: Pixel

Originally posted by: Zoomacroom
Pixel, y u no do pick'em this year? < / 3

yeah man i wanted to but something happened on the way to football season. i met the most amazing woman and since things are complicated and time with her is limited, Sunday is always my day with her and so really, I have barely watched football this year at all. And it's not like she is not totally willing to spend half the day with me at a bar with the games on I want to watch, I just don't give a flying fuck about a sport when something far more important in life is going on. It's the best feeling I've had in some time. Football will be around when she and I can spend more time together. If it's this season or I have to wait until next, doesn't bother me.

Ya know, I would troll you a bit but this is one time you actually seem rather happy.

Just try not to let your emotions put you in an awkward position. People have a tendency to do silly things for love.

Bonus: Im sure monkey will send you some unused hairbrushes.

^ uh... he is an Emocrat.

Originally posted by: [-NM-] -SS-

Originally posted by: Pixel

Originally posted by: Zoomacroom
Pixel, y u no do pick'em this year? < / 3

yeah man i wanted to but something happened on the way to football season. i met the most amazing woman and since things are complicated and time with her is limited, Sunday is always my day with her and so really, I have barely watched football this year at all. And it's not like she is not totally willing to spend half the day with me at a bar with the games on I want to watch, I just don't give a flying fuck about a sport when something far more important in life is going on. It's the best feeling I've had in some time. Football will be around when she and I can spend more time together. If it's this season or I have to wait until next, doesn't bother me.

Ya know, I would troll you a bit but this is one time you actually seem rather happy.

Just try not to let your emotions put you in an awkward position. People have a tendency to do silly things for love.

Bonus: Im sure monkey will send you some unused hairbrushes.

i've followed the rules. i've protected myself until i couldn't deny her intentions. once you figure that out it's just time to let go. you only live once.

p.s. i'm not sure any hairbrush in monkey's possession is unused. they are all used and abused

Originally posted by: samUwell
^ uh... he is an Emocrat.

deep down you know that when we are truly human and truly feel alive it has everything to do with emotions you ole' raver boy you.
Post edited by Pixel at 10/21/2013 11:59:45 PM

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The right is more virtuous than the left. They have twice as many virtues because they have double the standards.

Don't tell me this is the same woman...

Originally posted by: Questor
Don't tell me this is the same woman...

meeting....how'd it go?

Oh crap. I thought I posted that in here.

It did end up being a job interview, albeit a preliminary one. In other words, he asked me the typical "tell me about yourself" question and then told me what his area of responsibility encompasses at least from a corporate strategy perspective.

He did acknowledge that the head of the group is vacant and a search is actively underway, but added that they are looking for someone with previous experience. This isn't a surprise, but if he hadn't said that I would have gone for the jugular. Heh.

Finally, he said that he wants me to contact the interim head of the group but cautioned that this person (Michael) is currently preparing for the upcoming board meeting so he may not be very responsive for the next 2 weeks.

I've already reached out to Michael and have connected to him on LinkedIn. My strategy will be to send Jacob an email mid-next week and offer endorsements from 4 people:

- Kurt Rao (Corporate CIO at Time Warner) and Pierre Bouchard (Chief Development Officer at JP Morgan Chase) on my ability to engage C level executives, understand high level strategic goals, and ensure that meetings with both of them have always ensured that significant progress is made toward achieving those objectives.

- Tom Schodorf (Global Head of Sales and Field Operations at Splunk) on my understanding of how business is affected (and effected, heh) by technology.

- Doug Laney (VP and head of Gartner's Data and Infonomics practice) on my analytical capabilities and how I have used them in the past to solve some rather large business problems when I ran day to day operations for the Professional Services group in our BU when I worked for him at BMC.

I also have a few key internal endorsements that I can offer, but these individuals (while well respected) aren't as influential as these other people are at their respective companies.

Pierre's endorsement is actually the biggest of all of them because JPMC is a huge customer of ours and we are in the midst of negotiating a 9 figure deal with them. Pierre and I had lunch on Wednesday (we get together every 6 months to catch up) and when he found out about this he proactively offered to assist in any way he can.
Post edited by Questor at 10/25/2013 8:58:02 AM

well, at least the wheels are still turning.

good!

nice man. it's tough to get a leg up and make moves.
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The right is more virtuous than the left. They have twice as many virtues because they have double the standards.

I received positive responses from everyone but Kurt Rao, who is currently in India if I recall correctly for a week or two touring the offshore sites they have.

Edit: and Kurt just emailed his positive response this morning.
Post edited by Questor at 10/28/2013 9:12:40 AM

Well, nothing happened at the time I originally posted this. The EVP passed me on to his direct report that handles Corporate Strategy specifically. He (Michael) and I were supposed to get together but a snow storm prevented it, then Christmas was here, etc. Michael doesn't live locally so when he's in town he's in a crapton of meetings.

So we rescheduled our initial meeting...for today, when we're supposed to have a high of 23 degrees and (at least near my place) the high side of the 6" - 10" range of snow. Go fucking figure. My commute on a normal day to the Manhattan office is 90m - today will be insane, and there's no fucking way I'm leaving the house.

I think someone is trying to give me a hint. :/
Post edited by Questor at 1/21/2014 9:36:42 AM