Part I of our look into the economic measures of performance and associated valuation models, which ran in the June issue of Investor Relations, focused on the two most popular measures – Cash flow return on investment (CFROI) and Economic value added (EVA) – and some of the investors and analysts who are employing them. The underlying theme sounded by the investment community is that companies should be using some sort of internal measure which evaluates business units on their ability to provide returns above a specific cost of capital.
In Part II, we talk with companies that are measuring economic profit as part of a larger effort to institute value-based management and focus on shareholder value creation. Unlike accounting-based measures, economic-based measures like Holt Value Associates’ CFROI and Stern Stewart & Co’s EVA take into account such things as goodwill amortization and spending on R&D. And, as the theory goes, they are less susceptible to manipulation.
Answering the call
Holt’s model, as noted in Part I, is primarily used by money managers, though the company is aggressively marketing it as a tool for corporations. EVA, on the other hand, has gained wide acceptance among corporations since it first emerged in the early 1980s. CSX, for example, has been using an EVA-type model since 1991. As a capital-intensive business focusing on rail and ocean shipping, the model allows the company to measure results on a return-on-invested-capital basis and on a cash basis.
‘Management began noticing that shareholder models were garnering attention in the financial press in the late 1980s, and they are now much more accepted,’ says Joseph Wilkinson, director of IR at CSX. ‘Ultimately we’ll either create value with the assets we deploy or our market cap will go nowhere.’
According to Wilkinson, it’s crucially important that investor relations officers be able to speak the language of valuation. They must be able to communicate on the same level as investors with regard to the valuation model that’s being employed. While he acknowledges that not everyone is asking about EVA results, the lack of questions does not mean they’re unconcerned. ‘Often, I’ll work with them on their earnings models, and I won’t hear them speak specifically of EVA or return on invested capital (ROIC) as an objective, but that doesn’t mean they’re not using it as a measurement,’ says Wilkinson.
A foreign look
The acceptance of value-based management is not confined to the US. Both Stern Stewart and Holt maintain offices in Europe and Asia. German electronics giant Siemens implemented EVA a year-and-a-half ago, working in conjunction with Stern Stewart. The program is used at each business level and is a factor in every aspect of the company’s decision-making process.
‘I would say Siemens is at the forefront of large German companies using EVA,’ says spokesman Gerhard Hegmann. ‘We believe that it’s important to focus on the efficient use of capital, so we’re committed to the program.’
Hegmann says that the company has received an excellent response from investors, though he is quick to concede that it is too early yet to judge success. Siemens is actively promoting the program, which it calls ‘Win’, to its employees as well as to shareholders, publishing an extensive explanation in its annual report.
Swiss-based Alusuisse Lonza Group also uses an EVA-type measure of performance (although the firm calls its measure Alva, an acronym for Alusuisse Lonza Value Added), and has made a point of referencing Alva in its reports to shareholders.
‘We started using EVA around the beginning of last year,’ says Eva Kalias, head of investor relations for Alusuisse Lonza. ‘Our chief executive is very shareholder focused, and it was something that he instituted following his move from finance director to chief executive two years ago.’
Unlike Siemens, however, Alusuisse Lonza is not using Stern Stewart to implement EVA. Kalias says that chief executive Sergio Marchionne was familiar with the measure and able to construct a program for the company without the use of consultants. While it may sound like hubris, the decision to implement an EVA-type measure independent of consultants is not so unusual.
Going it alone
The truth is, while EVA has an impressive client roster, the number of companies using EVA as a measure, if not as part of a larger valuation model tying compensation to EVA results, is much larger. Illinois-based collectibles marketer Enesco Group, for example, announced in April that it had hired Robert Thompson as controller with EVA in mind. ‘His responsibilities include spearheading the company’s EVA efforts,’ noted the April press release.
‘I believe that what EVA will do for Enesco is to create some goal congruency in terms of financial measures that will be highly beneficial to the company. By virtue of getting individual managers speaking the same language and focusing on a measure that takes in the investment on the asset side, we’ll get everyone pulling in the same direction. EVA as a management technique is a good fit; it gets everyone focused on producing financial results,’ says Thompson.
While Thompson thinks it can be helpful to have professional resources available to answer questions and to consult on implementation of a program, he also believes companies, as in the case of Enesco, can do it without a heavy reliance on an outside resource. ‘It’s our own homegrown version of EVA. We wanted to do it ourselves so that we can make absolutely certain everyone in the company understands it,’ he says.
Fit to print
Whether EVA is being implemented with or without outside help, companies also must decide how much information to provide to their shareholders and their investors. While most companies disclose that they are using EVA internally, few publish the actual results. ‘EVA is an internal measurement, so we don’t give out the numbers. We talk about how we use EVA as a tool, because it’s important for people to know we use it,’ believes CSX’s Wilkinson.
Neither Enesco nor Siemens publishes hard numbers, while Alusuisse Lonza is only considering disclosing more information on its internal EVA results. One company which has made a point of not only discussing the existence of its EVA program, but also of disclosing the results and inputs to investors, is Herman Miller.
‘We publish our results very aggressively,’ says Mark Schurman, director of external communications at Herman Miller. ‘We’ve been EVA-based for about three years, and we began publishing the EVA performance numbers soon after, initially in the annual report, and then in the quarterly report. What we’ve done is basically created some sidebar data on the first page of the report with a variety of measures, and EVA is one of them.’
Instead of relying on EVA solely as a management or incentive calculation tool, Herman Miller drives EVA down throughout the organization. The company, according to Schurman, views EVA as a business literacy tool for every employee on the bonus program. Due to the company’s widespread communication of EVA throughout the business, ‘It was a natural progression that it would be our posture toward the shareholding public,’ says Schurman.
He describes the reaction of investors as extremely positive: ‘I think EVA and similar tools have a high degree of credibility, as long as analysts think there is integrity in how you’re implementing the metrics. EVA or any like tool are pieces of the story that the Street is looking for – fundamental strategy and solid management.’
Old hand
Coca-Cola was one of the first companies to measure its returns against its cost of capital, before measures such as EVA became popular buzz words. Since 1981, when late chairman Roberto Goizueta assumed his position, Coca-Cola’s stock price has grown on average 25 percent per year, and its economic profit 21 percent. ‘We’ve been able to show investors that over the long term, our stock price and the growth of economic profit have correlated very closely,’ says Larry Mark, director of investor relations.
Mark describes EVA as a long-term measure to evaluate investments and make sure that results exceed the company’s cost of capital. ‘We use it more as an internal measure and incentive performance driver so that, throughout our organization, we’re ensuring that economic profit decisions are being made in every country we operate.’
