Professional Documents
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If the value of the company's value in the future in the financial market
cannot be higher than the tangible book value of the company, investment in
that company's operations will be a disaster. The company's value in the
secondary market can only be higher than it tangible book value if the
company's investment decisions promise a higher reward.
If the ratio of the company's expected market value to tangible book value is
not greater than one, investment decisions of the firm might not be taken
rationally
this is one of
the major determinants of new investment
projects. Borrowing a proverb from John Rays Book printed in 1670, the
hand book of proverbs which offers great lessons on risk taking ''a bird in
hand is worth two in the bush an investment which does not offer twice the
power in purchasing value would be a destructive force to the investor in the
future.
Viewing these ideas with an example, let us assume that you and I are equal
owners of a business with one million shillings of net worth. The business
earns 12% on tangible book value UGX; 120,000 and its investment
expectation is the same 12% on reinvested earnings. Assuming no dividends.
An outsider who wish to buy into our business today will come set a target
figure X, which he expects to receive at a future date. He will formulate a
theory with the facts at hand which will determine a law according to which
his expected value X is to happen. The degree of his believe in receiving X at
his set date will continually approach to that law, as the results of our
company's operations are multiplied with time.
OUR OPERATIONS
The value of a company is built on two pillars the tangible assets and the
intangible assets. When the time factor operates on both the physical and the
intangible assets the future equilibrium value is derived. Though the tangible
assets value can be easily traced on the company's balance sheet the
intangible asset value has to be reflected on the company's profit and loss
account. A company whose distribution system is highly developed, the
expenditure of building that distribution system is expected to be reflected in
the company's earning power.
As trustees of the company's assets on behalf of the shareholders, the board
of directors and the management team are expected to protect the company's
balance sheet and guide in the improvement of earning power. The fastest
way one can destroy company performance and shareholder value is through
incentives. If we could find a way by which compensations depends on
performance people will get a way of relating rewords to performance.
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Most of the rewords of an organization are understood if one take a long term
view of individual units which make up the organization and how they might
perform over the long term, thinking of Uganda clays as an organization with
small units (financial unit, production unit, sale and marketing unit and the
shareholders). One is forced to think of the way these individual units will
behave and what purposes might each unit have in mind in order to archive a
common goal of building shareholder value, the behavior of each unit if a
small error compounds over time and what actions could the individual unit
take to carver up that error. In this kind of thought there lies no facts but
trying to explore all possibilities and understanding the damages which can be
caused and how these can destroy the shareholder value if a unfriendly news
reporter gets that information.
Understanding the damages, the researcher in the company's operations looks
at the behavior of the driver of shareholder value to get a crew of the
direction in which the company's market value will move. If the news
reporter's information does not guarantee (1) an increase in the ratio of sales
to total tangible assets employed in the company, (the asset value presented
on the balance sheet in most cases is historical that the replacement value of
the assets is never equal to the current value and accumulated depreciation).
(2) Confidence in the borrower over the long term especially if the company is
high leveraged. (3) Grate operating margins, obtaining wider operating
margins on sales, especially if the news cause claims on sales to be high,
these being labor, raw materials, energy and other various costs. Unless the
gap between sales and these claims can widen. But the nature of the business
in which we operate doesn't allow our company to increase its selling prices
so fast, but the claims usually move first and almost double in periods of high
inflation. The shareholder might suffer harder in times of bad news and his
benefits will snail in good times.
These performance tools are not easily altered so fast, but if we can make
building materials expansively I think we can figure out a way of doing them
cheaper without compromising quality and protecting shareholders value. If
we operationally understand how one input affects the behavior of another
and the relationship with more inputs.
We might be aware of the relationship with in inputs but understanding their
nature will help us over the long pole. Being aware that revenue is affected by
price and market share, not understanding what affects price might destroy
the company and we must also know that share prices are affected by
earnings and marketability but what is comprised in earnings and share
marketability? If we always see the big picture and all the pixels which build
P. O. Box 4990, Kampala, Tel: 0393 512 130 Fax: 0393 370 979 Email: ask@tecrauganda.com
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P. O. Box 4990, Kampala, Tel: 0393 512 130 Fax: 0393 370 979 Email: ask@tecrauganda.com
www.tecrauganda.com
P. O. Box 4990, Kampala, Tel: 0393 512 130 Fax: 0393 370 979 Email: ask@tecrauganda.com
www.tecrauganda.com
operating revenues is lower than the interest rate on its debts. If the
normalized interest rates are higher than growth rates, the company is
expected to depend too much on external sources of capital to support its
operations rather than growing organically and also most of the resources
would be diverted to service the debt.
A wiser decision by management would be to retire the debt by either paying
it off through spinning off the dormant assets, swapping debt for equity or
seeking funds from shareholders in order to reduce the heavy burden of
financing the debt to improve the company's operating results.
Though operating results improvement is important but both shareholders and
management should understand what they are giving out compared to what
they are getting. A debt for equity swap has very hidden costs paid and these
costs can sometimes look negligible due to the principles use in the
presentation of financial information of an operating unit. The value of the
assets and the depreciation figures represented on companies' balance sheets
sometimes do not reflect the actual replacement value of the assets in the
current capital goods market. And in most cases debt for equity swaps are
made in times when operating results are not good which offers a discounted
figure since stock prices are mostly influenced by operational results.
A trap we did not see; managements whose view is long term mostly
understand that the crafting of the policies by which operating actions will
gravitate in the long run is of fundamental importance in creating long term
shareholder's value. Thinking of what could affect shareholder value. Question
would be, does the mix of debt and equity affect the value of businesses? As
shareholders the value they derive from their investment is from company's
existing investments generating cash flows today and the expected value that
will be created by future investment. Including a claim on these cash flows
would reduce the value of the shareholders if the purpose for which these new
claims on cash flows does not offer equal to the existing or better cash flows
in relation to the invested funds.
Swapping debt for equity needs issuance of new shares; if we just give it a
deep thought, to transform the debt figure on the balance sheet into equity the
only logical way to do it is to more shares equivalent to the outstanding debt
and pass over those share to the claimant. But any team whose business is to
build value for its partners will not take deal of that kind if really members
gave a true thought of what they are giving up. A book value of debt on the
company's balance sheet is a cash flow machine to the claimant side and in
order for the claimant to get out the best deal for her partners he will
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capitalize all expected cash flows plus the principal and discount it to the
present with a not less than 10% premium. We should know what we are
giving out and what we are receiving.
In the process of issuing new shares; if we assume a simple business with 10
shareholders and that each shareholder owns one share or 10% of the
company. If each investor receives voting rights for company decision based
on share ownership, every shareholder has 10% control
Suppose that the company issues 10 new shares and that a single investor
buys them all, there are now 20 total shares outstanding and the new investor
owns 50% of the company. Meanwhile each original investor now owns just
5% of the company (1 share of the 20 outstanding) because their ownership
has been diluted by new share.
A DEFERENT TOOL TO THINK ABOUT.
A stock that promises to pay a fixed dividend for a given period to the holder.
A preferred stock could solve the problem of over straining the operational
results of the company if benefits are rightly presented. It is just creation, set
the terms right. Though these shares can not dilute existing ownership of the
company, they are debt instruments where company sets the terms. Company
will be with power to set the cost of financing in order to retire the current
debt obligation on the company's operations.
The holder of the shares will be able to receive a fixed dividend, but this will
be possible only if the company makes a profit. Though the unpaid dividend
may accumulate if they have a cumulative property, allowing the unpaid
dividends to be added up and paid in all or in parts when the company starts
to make profits.
Company may allow the preferred shareholders trade their shares for a fixed
number of common. These kind of shares will reduce the tension on the
company's operations. And the company will be able to retire portions of the
preferred obligation in the periods when surplus funds exist but the
opportunity set is not conducive. Image the company offers 6% dividend to
preferred stock and the opportunity set there are investments which could
only offer 4% returns per year. It would be in the shareholders' benefit if the
company just retired the preferred.
I see the future where businesses will prosper and Job markets able to handle
the growing population. But allot of competition will be seen in Uganda and
P. O. Box 4990, Kampala, Tel: 0393 512 130 Fax: 0393 370 979 Email: ask@tecrauganda.com
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Africa as a whole if we choose to send too many smart people to pursue law,
finance, politics and internet stuff. This will create a task too big to handle by
those who will be in place then. If we could all embrace the capital market
machine and work for the good of the shareholder even KIRRA EV would
have generated the financing it requires. It is all about incentives, design a
new world.
P. O. Box 4990, Kampala, Tel: 0393 512 130 Fax: 0393 370 979 Email: ask@tecrauganda.com
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