Product Pruning: Treasury’s Key Role
Reversing the longtime trend of bigger is better, multinational companies (MNCs) have been trimming brands and business divisions and, in some cases, spinning off units to shareholders or selling major chunks of their businesses. The departing assets may be outside the company’s core businesses, but there’s a more pressing financial factor most if not all the transactions have in common.
“A big driver for these transactions is that these companies have realized that the sum of the parts – from a market capitalisation perspective – may be greater than how they’re valued in the market today,” says Melissa Cameron, global leader of treasury advisory services at Deloitte.
Corporate treasury executives can play a role in that valuation process leading up to the decision whether to pursue the strategy, which typically is made by the C-suite executives. Then, finance executives play a critical role in addressing a range of issues in areas such as tax, foreign exchange (FX) and hedging that must be resolved to untether the departing businesses.
Proctor & Gamble (P&G) is a poster child for the shrinking company strategy. By this summer it is looking to sell, consolidate or spin off a total of 100 brands as a part of a strategy announced last summer. As of the company’s April 23 earnings call, the initiative had already resulted in the departure of 40 names. It is retaining 65 to 75 leading brands that the chief financial officer (CFO), Jon Moeller, described in the earnings call as “structurally attractive and play to P&G’s core strengths.”
By focusing on those leading brands, P&G will reduce complexity while retaining 94% of its before-tax profit, says Moeller. “That’s a good trade.”
Valuing the Business
The analyst most sceptical of P&G’s strategy is Ali Dibadj of AllianceBernstein. “We’ve been hearing promises that help is around the corner for years, but every year [P&G] limps across the finish line,” Dibadj says. “Maybe something bigger has to happen … maybe you really have to break up the company even further. Especially after this next promise of divestitures, how much longer do we have to wait?”
Moeller response is that without recent FX headwinds, the conversation today would likely be very different. P&G’s net sales of US$18.1bn for the quarter ended March 31 reflected a decrease of 8% year-on-year (YoY), including a negative eight-percentage point impact from FX. He believes that reducing the company’s portfolio of brands – along with consolidating manufacturing operations and making supply chains more efficient – represent “probably the biggest change this company has gone through.”
In fact, P&G has staked its future on the brand-portfolio consolidation strategy, and treasury executives’ contribution in identifying them and ensuring smooth-as-possible breakaways is key. At the consumer analyst conference in New York in late February, Moeller said that the products the company is selling, including its European pet care brands, Duracell and Noxema, are by no means bad businesses. However, they don’t fit into the company’s strengths. In the case of the retained brands, he said, P&G understands the consumers of those products, which fit neatly into the company’s brand and product models. In addition, the products are sold in P&G’s core distribution channels, and it can source them more effectively and efficiently.
“The more focused portfolio will be much simpler to manage, operate and execute in stores and in homes. It will enable more resources and attention on the biggest opportunities, resulting in faster, more profitable growth,” Moeller said. He added that the before-tax margins of the new portfolio of brands have been about two points higher than the total company over the last few years.
P&G did not make a spokesperson available by press time to discuss its treasury unit’s role in devising and implementing the new strategy. Given the company’s size, however, it’s likely to have the ability internally – in treasury or perhaps a corporate-development unit – to understand and value parts of the overall business. Companies without that capability may be approached by investment bankers or other third parties, although companies outside the Fortune 500 are increasingly developing it,
“We’ve seen a trend in the last few years in which even tier-two and tier-three size companies are developing this capability – their own business development functions,” says Volker Linde, German lead partner in Deloitte’s global treasury advisory services group stationed in Dusseldorf, Germany.
He adds that capability often resides within treasury and directly reports to the CFO and/or chief executive officer (CEO). “It’s really connected to treasury taking a more modern role and more responsibility for the business in general and important strategic decisions; not just mitigating risk and making cash available to make payments.”
A company’s strategy or corporate development groups, looking at long-term financial forecasts from financial planning and analysis (FP&A), may plant the original seed for the strategy to shrink the company. Next, it must be determined whether indeed the company’s incremental value to shareholders is more if it is broken up, requiring the business as a whole and its parts to be valued using a variety of metrics such as discounted cash flow and various earnings multiples. Typically, this is the point where treasury steps in.
“This corporate development team, which may sit within the treasury group, should be charged with thinking about this issue and developing the tools and valuations models to do it,” says Cameron. “Our position at Deloitte is that a company should evolve its internal abilities to form these conclusions to drive its own strategy.”
In the case of P&G, determining which brands to keep and which to sell proved fairly straightforward. In its annual report the company notes that the core brands it is retaining are leaders in their industries, businesses or segments, and they offer differentiated products and track records of growth. In fact, they generate nearly 90% of P&G’s current sales and more than 95% of its profit, compared to the brands it plans to exit, which have declining sales of -3% and shrinking profits of -16% – half the average margin over the past three years.
Jim Kelleher, director of research at Argus Research, says that a company’s CEO and a few trusted board members will decide its strategic direction and whether to slim it down. Identifying weaker-performing assets, or those that don’t fit into the company’s core business strategy, occurs more at the chief operating officer level. “And then they’ll turn this over to the finance guys to make it happen, so treasury will play more of an execution role.”
Rethinking the Balance Sheet
Major companies such as P&G and GE most likely have merger and acquisition (M&A) units that handle divestitures and actively search for financial and/or strategic buyers. Companies without such resources are likely to tap treasury executives to carry out the assignment, and one of the first steps will be to find the assets net present value and their cash-flow potential. Since putting the asset on the block inherently advertises that the asset has lost value, Kelleher says – and buyers are easier to come by if margins can be spruced up – treasury may be responsible for finding ways to cut costs.
Cameron notes that pursuing a shrink-the-company strategy “blows up” the balance sheet, and treasury plays a key role in figuring out where the assets and liabilities fall, from both a consolidated perspective and at the individual company level. The treasury team must work closely with the tax department to iron out the new organisation’s intercompany financing and transfer pricing strategies, and do the same for any spin-off to shareholders.
“When a company has comingled subsidiaries that may have two businesses working within them, working out how capital and cash should be allocated across the group is a very strategic issue,” Cameron says. She adds that treasury can also add significant value regarding FX risk, when under some circumstances the reorganised company’s hedging programme must be rethought. “Hedges receiving hedge accounting treatment may have to be de-designated because the hedging entity plans to sell a portion of the business.”
She added that a company with subsidiaries that comingle some business lines may require treasury to understand the parts of the business and the appropriate hedging programmes for each business division. So treasury is likely going to have to rethink the balance sheet from the perspective of the new organisation’s capital structure and hedging strategies, as well as the margins across business lines and whether the company has the right liquidity structures in place to ensure cash flow across the globe is optimal. Cash repatriation strategies may come into play as well.
All this is happening at a time when FX volatility is at a historical high, with the dollar appreciating 25% to 35% against major and minor currencies, meaning there’s a lot for treasury to deal with.
“The terms of trades and supply chains are already under stress, regardless of these strategic transactions,” Cameron says. “Making this an important time for treasury to be very strategic and to be helping the business as a close adviser to the CFO and board about these matters.”