Strategic Corporate Finance

Essential guidance for the corporate finance professional — advisor, Board Director, CFO, Treasurer, business development executive, or M&A expert—to ask the right questions and make the critical decisions. Strategic Corporate Finance is a practical guide to the key issues, their context, and their solutions. From performance measurement and capital planning to risk management and capital structure, Strategic Corporate Finance, translates principles of corporate finance theory into practical methods for implementing them. Filled with in-depth insights, expert advice, and detailed case studies, Strategic Corporate Finance will prepare you for the issues involved in raising, allocating and managing capital, and its associated risks.

Justin Pettit (New York, NY) draws on his 15 years of senior advisory experience as an investment banker and management consultant. He advises corporate boards and executives on matters of capital structure, financial policy, valuation, and strategy. He also lectures on topics in advanced corporate finance to graduate and undergraduate students at universities in the New York area.

Preface xi

List of Figures xiii

List of Tables xv

Acknowledgments xvii

About the Author xix

PART ONE Managing the Left-Hand Side of the Balance Sheet

CHAPTER 1 The Cost Of Capital 3

Calculation Pitfalls 3

Market Risk Premium (MRP) 5

Toward a Better Beta 10

The ‘‘Riskless Rate’’ 13

The Cost of Debt 14

Global Capital Costs 16

WACC and Hurdle Rates 23

CHAPTER 2 Fix: Finding Your Sources of Value 26

Why Shareowner Value? 27

Performance Measurement Pitfalls 28

Measuring Economic Profit and Value 30

Analyzing the Corporate Portfolio 35

Incorporating the Cost of Capacity 39

Value-Based Strategies and Tactics 43

Managing for Value 45

Balancing Performance with Value 52

CHAPTER 3 Sell: Creating Value Through Divestiture 54

Divestiture Creates Value 56

Sources of Value: Motives for Divestiture 58

Alternative Methods of Disposition 60

What Works Best for Whom? 63

What Happens Longer Term? 64

Practical Impediments to Divestiture 65

Financial Policy Considerations 70

Tax Considerations and Structural Refinements 70

CHAPTER 4 Grow: How To Make M&A Pay 73

M&A Today 73

Transactions that Create Value 77

M&A Fact and Fallacy 81

RX for the ‘‘Conglomerate Discount’’ 86

EVA and M&A 88

How ‘‘Serial Acquirers’’ Create Value 90

Financial Policy Considerations 93

Financing Growth 94

CHAPTER 5 Cash and The Optimal Capital Structure 97

Trends and Implications 98

How Much Is Too Much? 100

The Costs and Benefits of Excess Cash 105

How the Market Views Excess Cash 108

Optimal Capital Allocation 109

PART TWO Managing the Right-Hand Side of the Balance Sheet

CHAPTER 6 An Executive’s Guide to Credit Ratings 117

Trends and Implications 117

Empirical Evidence 123

Limitations of Quantitative Credit Analysis 123

What Metrics Matter Most? 126

Case Study: Treatment of Pension and Postretirement Liabilities 131

Multivariate Credit Models 133

Industry Considerations 135

Case Study: Property and Casualty Insurance 135

Application Issues 137

How to Manage Your Agencies 137

Case Study: Illustration of Secured and Unsecured Notching 139

CHAPTER 7 Today’s Optimal Capital Structure 141

Value-Based Financial Policy 141

Less Debt Is Now ‘‘Optimal’’ 143

Extend Duration When Rates Are Low 146

Maintain Financial Liquidity to ‘‘Insure’’ Your Equity 149

A New Perspective on Equity 151

Case Study: Does Tech Need Debt? 154

CHAPTER 8 Dividends and Buybacks: Calibrating Your Shareholder Distributions 160

The Cash Problem 162

Dividends Are Back 163

How Dividends and Buybacks Create Value 165

Should You Increase Your Dividend? 171

How Large Should Your Buyback Program Be? 178

How to Execute Your Share Repurchase Program 181

CHAPTER 9 The Stock Liquidity Handbook 187

Measuring Stock Liquidity 188

The ‘‘Liquidity Discount’’ 191

Implications of Stock Illiquidity 192

Solutions to Illiquidity 193

Stock Splits 195

PART THREE Managing the Enterprise

CHAPTER 10 Strategic Risk Management: Where ERM Meets Optimal Capital Structure 203

The Value of Risk Management 204

Mapping and Modeling Risk 209

Managing to a Benchmark 213

External Considerations and Constraints 216

ERM Case Study: Metallgesellschaft AG 219

Capital Structure Solutions 220

CHAPTER 11 Best Practices In Hedging 224

Which ‘‘Exposure’’ to Hedge 225

Hedge Horizon 230

Hedge Ratio 232

Options versus Forwards 233

Accounting Considerations 235

Implementation 236

CHAPTER 12 ERM Case Study: Reengineering The Corporate Pension 238

Why Now? 239

The Problems with Equity 240

The Case for More Bonds 243

Optimal Capital Structure Reprise 246

Capital Markets Solutions 248

The Boots Case 251

Why It Still Hasn’t Happened 252

APPENDIX A

Resources 254

Tools and Portals 254

New Research and Literature Search 254

Economic Research and Data 254

News and Market Data 254

Corporate Governance and Compensation 255

Other Agencies 255

Endnotes 256

References 268

Index 277

JUSTIN PETTIT draws on his fifteen years of senior advisory experience as an investment banker and management consultant. He advises corporate boards and executives on matters of capital structure, financial policy, valuation, and strategy. He also lectures on topics in advanced corporate finance to graduate and undergraduate students at universities in the New York area.

Sweeping changes in corporate governance and globalization of the capital markets have made the language and issues of modern corporate finance—previously left to finance executives and investment bankers—a critical point of accountability for all senior executives and board directors. Strategic Corporate Finance is not another book on financial theory; rather, it is a practical guide to the key issues, their context, and their solutions.

In Strategic Corporate Finance, author Justin Pettit—drawing on his years of corporate financial advisory experience—translates principles of corporate finance theory into practical methods for implementing them, on topical subjects ranging from performance measurement and capital planning to risk management and capital structure.

Divided into three straightforward and accessible parts, this useful guide contains important information and actionable strategies that you can use—whether you are a Board Director, CFO, Treasurer, business development executive, or M&A expert—to ask the right questions and make important financial decisions regarding your organization.

Part One outlines the essential issues of managing the left-hand side of the balance sheet—following the prevalent "fix, sell, grow" mantra used today—with an intrinsic value perspective. Here, you will learn how to resolve a variety of performance measurement and valuation issues, from estimating and applying the weighted average cost of capital (WACC) to creating value through operational improvements, divestitures, and M&A.

Part Two addresses the right-hand side of the balance sheet, including optimal capital structure, managing credit ratings, and setting dividend and share repurchase policy. Special attention is given to today's growing problem of too much cash. The issues of stock liquidity, and illiquidity, are also covered in detail.

The third, and final, part of Strategic Corporate Finance adopts an enterprise-wide perspective for capital management. You will be introduced to strategic risk management and the substitutability of capital structure and risk management choices, such as process control efforts, financial, physical, and operational hedging. You will also receive an executive education on best practices in financial hedging. Capital markets solutions are highlighted in a comprehensive pension re-engineering case study.

Filled with in-depth insights, expert advice, and detailed case studies, Strategic Corporate Finance will prepare you to ask the key questions and make the critical decisions involved in raising, allocating, and managing capital, and its associated risks.