Capital Markets Logic

1. Capital Markets Logic Jo Whitehead, Director Ashridge Strategic Management Centre

2. Pre-read • Chapter 5 of Strategy for the Corporate Level

3. United Business Media (UBM) Industry sectors Jewellery Forest products Footwear Primary care medical staff Pharmacy Global trade and transportation Electronics Medical device design Technology based manufacturing Aviation

4. Capital markets logic £, $, Euros Value under another’s ownership Value under your ownership Buy if PV of the business when owned by other owners is lower Sell if PV of the business when owned by another owner is higher PV of the business under your ownership Added PV from your parenting (Added value logic) PV of the Standalone business (Business logic) Capital markets logic

5. Capital markets may over or under valueExample: Volatile Schiller p/E ratios “Black Monday” “Black Tuesday” Dotcom bust Lehman goes bust

6. In reality, hard to out-guess the market

7. You need to have special information to outguess the market • Studies suggest: • Insiders (senior managers) do better than the average investor when buying their companies shares • Companies also do better than the market when buying or issuing their own equity • …although these finding are still debated by finance academics

8. Three challenges to capital markets logic • Are there good reasons why the capital markets might misprice this business? • Default position should be that the market has it about right • Do you have the superior insight and capabilities required to take advantage of any mispricing? • You need to have superior information, and be a superior analyst and deal-maker • Does the financial analysis suggest that the level of mispricing is significant? • Small gaps may simply be due to over-optimistic assumptions

9. Reasons why the capital markets might get it wrong • Volatile capital markets (equity and debt) • Sector or deal-specific characteristics • Imbalance in number of buyers and sellers • Characteristics of buyers and sellers • Differences in the information available to buyers and sellers • Deal process

10. Applying Capital markets logic • Better to be a seller • If you own; Sell • If you don’t own; Don’t buy HIgh Market price • No compelling Capital Markets logic for buying or selling • Better to be an owner • If you own; Hold • If you don’t own; Buy Low Low HIgh NPV of owning the business

11. Any examples? HIgh Market price Low Low HIgh NPV of owning the business

12. Implications for E.ON? • German Fossil • Ruhrgas Market price • UK • US • Sweden • Renewables • German Nuclear • Italian generation • Russian generation • Eastern Europe • Spanish generation NPV of owning the business

13. E.ON strategy shaped by capital markets logic • Capital markets offer potential challenges… • Thin market for unwanted Spanish generation assets... • Few buyers • Risky to put assets onto the market if buyers are not already secured • Significant write down unattractive to management team • Pressures to reduce or sell edge of heartland businesses in hot sectors • …but also potential opportunities • Buying in potentially undervalued markets e.g., Russia • Selling highly prized assets such as Ruhrgas to Nationalised utilities e.g., EdF, GdF/Suez

14. Capital market logic used in different ways • As a check on analysis based on business or capital markets logic • Many examples • As a primary logic driving corporate strategy e.g., • Warren Buffett • Barry Diller • Private equity companies and banks

15. Your examples? Alternative tactics

16. Which Alternative depends on the answer to the three questions… • What is reason for the mis-valuation? • E.g., if selling, and there are too few buyers, seek out more! • Do you or your advisors have the skills, experience and capabilities to pull off the strategy? • How big is the valuation gap?

17. Key messages • Capital markets logic is always important to apply, often after having evaluated the other two logics: • Evaluate whether Capital market logic is strong enough to force reconsideration of portfolio decisions • Consider if there are any alternative tactics which might deal with the specific situation • Some companies use capital markets logic more proactively to drive their acquisition or divestment strategy

18. Application to Own business • Better to be a seller • If you own; Sell • If you don’t own; Don’t buy High • Consider if there are any businesses outside the middle diagonal • For one business, evaluate the reasons for the over or under valuation (see over for list of options) • Consider whether you can employ any of the alternative tactics (see over for table) • Summarise the options worth pursuing Market price • No compelling Capital Markets logic for buying or selling • Better to be an owner • If you own; Hold • If you don’t own; Buy Low Low High NPV of owning the business 19

19. Reasons why the capital markets might get it wrong • Volatile capital markets (equity and debt) • Sector or deal-specific characteristics • Imbalance in number of buyers and sellers • Characteristics of buyers and sellers • Differences in the information available to buyers and sellers • Deal process

20. Alternative tactics (examples)