We’re relaunching the Capital Agenda Blog this autumn with a new editor and new themes. I’m Lee Downham, EY’s new UK&I Markets Leader and I’m looking forward to sharing my thoughts – and the thoughts of my colleagues – on how companies can manage capital and transactions in a changing world.
‘Change’ being one of the overriding themes we’ll be focusing in the next few weeks – including, but not exclusively Brexit. Because, we’ll also be talking about the underlying long-term trends affecting value creation, as the pressure increases on companies to articulate their long-term value to both society and shareholders. Corporate ‘purpose’ is a growing theme – in operations and transactions.
This summer, Business Roundtable, an influential group representing almost 200 major US corporations, stated that it no longer thought that the sole purpose of business was the delivery of “shareholder value”. Instead, the group made a “commitment to all stakeholders”, with “long-term shareholder value” ranked equally with the interests of customers, employees, suppliers and communities.
Cynics might say that these CEOs are just paying lip service to the idea of a corporate conscience; but there is evidence all around us that corporate strategies and practices are coming under scrutiny from a widening range of stakeholders. This statement is an acknowledgement of a new reality for business, in which long-term shareholder value and stakeholder interests are more closely entwined. Moreover, this trend is happening within the context of a rise in disruptive forces – technological, economic, consumer and environmental. Together these forces are reshaping value – at varying speeds in different markets – but when they combine they can bring about rapid and momentous change in the value chain.
We saw this after the BBC’s Blue Planet episode on plastic use, which led to a 500% increase in the sale of reusable coffee cups, whilst plastic straws disappeared virtually overnight from restaurants and bars. A change in stakeholder attitude – in this case consumers’ increasing environmental awareness – was rapidly accelerated by technology, in the form of social media. Together these forces are completely reshaping several markets.
“Winning alone is not enough it’s about winning with purpose.”
Paul Polman, former CEO, Unilever
A focus on long-term value
These forces make it increasingly important that companies can articulate a strategy that creates long term value through a core purpose. But this is by no means an easy task. Companies often lack the tools to measure long-term value and, as a result, struggle to effectively communicate this concept to the market. Without the tools to measure and communicate this value, companies frequently fall back on traditional financial metrics and short-term financial performance that fail to take account the potential for significant value changes in their markets, brought about by disruption.
It was to address this need that EY and the Coalition for Inclusive Capitalism established the Embankment Project for Inclusive Capitalism (EPIC). The project focused on creating a framework that would help companies think about their long-term value in the context of the increasing focus on corporate purpose and non-financial metrics. The model uses four value sets to think about value, three that go beyond traditional financial metrics.
“In a world that is changing faster than ever before, it’s not enough to simply measure the things that would have defined a company’s success in the 20th century.”
The Long-Term Value Framework aims to enable companies to better measure, compare and communicate the value they create for investors and other stakeholders. It acknowledges that the fundamental basis of corporate value has changed – and is still changing.
On average, intangible assets now represent on average over 50% of a company’s market value – and up to 80% in some sectors, compared with 17% in 1975.
Which is not to say that financial metrics are no longer important. Clearly businesses still need and want to make a profit. Shareholders still need and want returns. But, companies whose purpose becomes misaligned to the needs of their stakeholders and the changing nature of their market will not be able to generate long-term value for their shareholders or their communities. EPIC’s research shows that the best businesses are defined by more than short-term profitability, and focus on driving long-term, sustainable growth.
“Purpose is not a mere tagline or marketing campaign; it is a company’s fundamental reason for being – what it does every day to create value for its stakeholders. Purpose is not the sole pursuit of profits but the animating force for achieving them.”
Larry Fink, CEO of America’s largest shareholder, BlackRock
What does this mean for transactions?
Clearly transaction strategy and capital allocation needs to align with a company’s purpose and strategy for long-term value creation. Companies need to be assessing their portfolios regularly to match the rapidity of changes in their markets – and with more than a financial lens, to keep their long-term value metrics in mind.
Assessing portfolios through more than a financial lens can significantly impact decisions around portfolio. It’s tempting for businesses to hold onto non-core profitable businesses – so-called ‘cash cows’ – even when there is no fit with corporate purpose or long-term value creation.
2. How companies assess assets
With so much value sitting off balance sheet, M&A diligence is becoming increasingly sophisticated to consider and validate non-financial drivers of value. A company’s value is increasingly reflected not just in its short-term financial performance, but also by intangible assets such as intellectual property, talent, brand and innovation.
Respondents to EY’s most recent Capital Confidence Barometer told us that non-financial risks were the most important in executing a transaction.
When executing a transaction, what risks are you most concerned about?
3. How companies transact
M&A is not exempt from the shift towards stakeholder capitalism, with companies expected to take greater and more proactive consideration of a wider pool of interested parties when they do deals. Several countries — including France, Germany, the US and the UK — are stepping up their levels of scrutiny to ensure that M&A activity is fair and doesn’t compromise national security or public interest. This is certainly making cross-border acquisitions of digital assets more complex, for example. The UK has also introduced disclosure and monitoring rules, as well as enforcement powers, on employment-related commitments made by the bidder to non-shareholder constituencies – including employees.
4. Stakeholder engagement
Increasing public and government scrutiny of deals has implications for how and what companies communicate during and after a transaction. Given the increasing importance of stakeholder relationships, it’s vital that these are protected throughout the deal.
A clear articulation of corporate strategy – and how this aligns with purpose and long-term value – is also essential for shareholder communication. The best defence against short-termism is to present a comprehensive long-term plan.
This is a developing area for us and for companies and we’re interested in any thoughts you have on corporate purpose, the focus on long-term value and how this is influencing your sector – and how you do deals.
We’ll be exploring the topic further here – and in upcoming forums with clients – and I look forward to continuing the debate.
EY is delighted to be the lead sponsor of the FT Future of Deal Making conference on 7 November in London to discuss opportunities and challenges for deal leaders in a prolonged period of uncertainty. Find out more and register your place https://go.ey.com/FT_Dealmaking