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 What are the managerial motives to diversify?

1- Spread the business risk across various industries 2-add shareholder value

Why would a company Diversify? Diversification must do more for a company than simply spread its business risk acroos various industries. In principle, diversification cannot be considered a success unless it results in added shareholder value.

When would it diversify? When there is opportunity for expanding into industry with related technology and product, or It can leverage existing competencies and capabilities, or in order to Diversifying into related business opens avenues for reducing cost, or It has powerful and well known brand names that can be transferred

What are the Modes of Entry for Diversification?

• 1- Acquiring of an existing business
• 2- Internal start-up
• 3- Joint ventures

What are the levels of Diversifications?

• - Related diversification
• - Unrelated diversification
• OR:
• - Dominant with 50-80 of core business
• - Narrowly diversified
• - Broadly diversified
• - Several unrelated groups of related businesses

Relationship between Related Diversification and integration, economies of scales, brand image and cross business collaborations?

Related diversification gives the business the opportunity to convert cross-business strategic fits into a competitive advantage over business rivals whose operations do not offer comparable strategic fit. The greatest the relatedness among sister businesses, the bigger the window for skills transfer, combining related value chain activities to achieve lower costs, leveraging use of a well-respected brand name and cross-business collaboration.

Why would a company do unrelated diversification?

Because any company or business that can be acquired on good financial terms and that has satisfactory growth and earning potential represents a good acquisition and a good business opportunity.

Merits and drawbacks of unrelated diversification

• 1- Business risk is scattered over a set of truly diverse industry
• 2- Company’s financial resources can be employed to maximum advantage by investing or diverting
• 3- Shareholder wealth can be enhanced by buying distressed business at low price
• 4- Profitability may be more stable in upswings and downswings because conditions in the industries are different.

Drawbacks

• - Demanding managerial requirements (time, resources, research)
• - Limited competitive advantage potential (limited to weakest link)

How can unrelated diversification created shareholder wealth?

• - Satisfying the attractiveness test - Diversifying into good business
• - Satisfying the cost-of-entry test - negotiating favorable acquisition prices
• - Satisfying the best-off test - Making sure new business perform at higher levels
• - Identifying when to shift resources out of business with low profits to business with above-average prospect for growth and profitability

How can you identify a company’s unrelated diversification strategy?

Having a clear fix on the company’s current corporate strategy sets the stage for evaluating how good the strategy is and proposing strategic moves to boost the company’s performance. By analyzing the company’s move to strengthen the position in existing business or building position in new industries or move to capture cross-business strategic fit.

How can you evaluate a company’s unrelated diversification strategy?

• 1- Assessing the attractiveness of the industries
• 2- Assessing the competitive strength of the company’s business units
• 3- Checking the competitive advantage potential of cross-business strategic fits
• 4- Checking whether the firm’s resources fit the requirements of its present business lineup
• 5- Ranking the performance prospects of the businesses from best to worst and determine priority for resource allocations
• 6- Crafting new strategic moves to improve overall corporate performance

What is meant by industry attractiveness and business strength?

To identify the industry attractiveness the company has to evaluate the market size and projected growth rates, the intensity of the competition in the industry, the opportunities and threats, the chances of strategic fits, the amount of resources required, the seasonal and cyclical factors of the industry, the social political and regulatory factors of the industry, the profitability of the industry and the business risk. With these different elements the company can create the attractiveness score for each of the industries where it is diversified into. The same is done to identify the strengths of each of the business units.

After a business diversifies what are the 4 main strategies?

• 1- Broaden a diversified company business base
• 2- Retrenching to a narrower diversification base
• 3- Restructuring company’s business line-up to adapt to environment
• 4- Multinational diversification strategy - more local or more countries.

 By Oren Gulasa; Notes from Strategy class with Dr. Caroline Cooper, J&W University, 2008.

Process of value creation:

1. Anything that increase operating cash flows, increase value.
2. Anything that decreases operating expenses, increase value.
3. anything that decreases variability, reduce risk associated with future development
4. Increase cash flow, due to an increase in revenue, decrease in expenses, or both.

How to increase cash flow: Increase entry berries, Reduce variability; Increase Return on Equity:

2. Opportunity Cost Concept:

An investment in business should yield a return to owners. Giving dividends it is consider being an opportunity cost decision. If the board of directors take owner’s money and retain it (not giving dividends in a certain year);

• Retained Earnings: increase the value today of future dividends: value must be greater than current dividends. This is known as Required Return On Equity.
• Thus, the return on investment (ROI) should yield higher future value then the current value.

• The required rate of return is the opportunity cost.
• Required Return On Equity: RROE

Net Present Value: the present value of cash flow - minus - the present value of cash out-flows; if the result is greater then 0, we will accept the investment decision.

• Formula: One year, at 8% interest = cost of capital 1.08 value of according to numbers of years (life of project) X Cash Flow at end of year - Cost of project.
• It is worthwhile to invest funds today, considering the return we expect to receive in future.
• Example: step by step
• 1. Cost for buying the business = $ 1,000,000,
• 2. If we put this in the bank, we get 1,065,000
• 3. Interest offer in current market condition (on investment) = 6.5% for one year = 1.065
• 4. Life of project = estimated number of year = 30
• 5. Cash flow end of year from business = $150,000
• 6. 1.065 X 30 x 150,000 - (1,000,000) = 4792500-1,000,000 = 3,792,500

After how many years we get investment back?

1.065 x N (years) X 150,000 - (1,000,000) = 0

159,750 X N - 1,000,000 = 0

159,750 X N = 1,000,000

N = 6.259 (under the assumption that interest remain 6.5%) After 6.25 years we will cover investment.

By: Oren Gulasa

An investment in business should yield a return to owners. The desired return should be higher then initial investment. For instance, when a company give oout dividends to its shareholders it is consider being an opportunity cost decision. If the board of directors take owner’s money and retain it (not giving dividends in a certain year) then this money would go back to the organization as a retained earnings.

• Retained Earnings: increase the value today of future dividends: value must be greater than current dividends. This is known as Required Return On Equity.
• Thus, the return on investment (ROI) should yield higher future value then the current value.

• The required rate of return is the opportunity cost.
• Required Return On Equity: RROE

Net Present Value: the present value of cash flow - minus - the present value of cash out-flows; if the result is greater then 0, we will accept the investment decision.

• Formula: One year, at 8% interest = cost of capital 1.08 value of according to numbers of years (life of project) X Cash Flow at end of year - Cost of project.
• It is worthwhile to invest funds today, considering the return we expect to receive in future.

Variability Concept:

If business results; profits, investments value and cash flows are variable- the business overall performance is not stable. The variability in business is associated with increasing risk.  When risk increase as a result of variability investors won’t be interest in the company.

Business can reduce variability by doing the following

•1. Diversification; Offer new products, going into new business.

•2. Capital intensity: generate more money, while using the same amount of assets.

•3. Balance Debt Financing: more debt means more variability, risk not to meet debt obligations

I.e. MacDonald restaurants serve also breakfasts. Reduce variability by diversification: any time that you can increase business during slack time is favorable.

by: Oren Gulasa

In tough economic times hotel companies looking to reduce costs eventually have to face the tough decision of lay-off.  Managers, however, would like to check other options before sending home their best employees. Mr. Chrisitian Anklin from HVS International offer other steps, beside lay-off. In article in Hospitlaity Trends (hospitalitytrends.com) Chrisitan claim that the following steps, or a cobination of the following could get the same financial impact. That include hiring freeze, reduction of bouneses,  paying out bonuses in a form of company stock, cut in base salaries and unpaid leaves as well as avoid redunduancies.

On the other hand, people who are looking for job in the industry will notice a not only less open positions posted, but also longer time period for getting reply. That actually means that companies proposed a hiring freeze. Executives from top hotel companies who support this option say it’s better to refuse to hire a talented applicant and say “No” now rather then submit a termination letter in four months.

In a personal note, I actually had to go through both lay-ff and saw the hiring freeze in practice as well. People who lost their job can’t fit into another system although there is an open position posted at the same time. This is the deepest slople in the cycle, and I guess we have to carry through.  By Oren Gulasa

In tough economic times hotel companies looking to reduce costs eventually have to face the tough decision of lay-off.  Managers, however, would like to check other options before sending home their best employees. Mr. Chrisitian Anklin from HVS International offer other steps, beside lay-off. In article in Hospitlaity Trends (hospitalitytrends.com) Chrisitan claim that the following steps, or a cobination of the following could get the same financial impact. That include hiring freeze, reduction of bouneses,  paying out bonuses in a form of company stock, cut in base salaries and unpaid leaves as well as avoid redunduancies.

On the other hand, people who are looking for job in the industry will notice a not only less open positions posted, but also longer time period for getting reply. That actually means that companies proposed a hiring freeze. Executives from top hotel companies who support this option say it’s better to refuse to hire a talented applicant and say “No” now rather then submit a termination letter in four months.

In a personal note, I actually had to go through both lay-ff and saw the hiring freeze in practice as well. People who lost their job can’t fit into another system although there is an open position posted at the same time. This is the deepest slople in the cycle, and I guess we have to carry through.  By Oren Gulasa

Just before the weekend I red an article at the associated press in hotels.com magazine about the agreement  between Starwood Worldwide hotels and resorts  and  Sam Zell company, a private equity company , which would result of increasing shares to the main holding private equity group ( currently Zell own 8% of Starwood shares. As a result of the announcement, Starwood shares acquired 16.7% gain at the time when tourism slow down and many US hotels lay-off employees.

Smith Travel performance report of the US hotel industry for the last week of December comes as a reminder for the strong connection between economy performance and the vulnerability of the hospitality business.  The research company presented an industry key elements and showed a drop in the average daily rate to $92.49 (slide of 9.5% compared to last period) and revenue per available room (RevPar; a basic measurement of performance) fell 24.3% to $33.13.

But what interesting is that this event is one of many examples of what appears to be an ongoing trend in the hospitality industry toward buyouts deals and companies going into private hands.  The Four Season hotels were bought private back in 2005 by the Saudi Sheik BinEdin El-Talal and Bill Gates and that indeed doesn’t proved to be an obstacle for the company’s expansion but the opposite. Starwood is a giant hotel company and will be hard to think about this icon removed from the stock market. The company has a plan to reach 1400 hotels by 2012 (currently Starwood own or manage 850 hotels) which is a massive expansion plan that required a lot of cash.

From a business perspective, a company wish to continue growing has two options for its required debt financing; raising cash by selling shares or taking private loans from an equity firms. I guess the real question in our time is; Will more and more companies consider going private in order to finance their growth rather then issuing stocks given the current market conditions?  Another issue could be the impact of a buyout; When a firm launch a forced buyout strategy when a single shareholder increase its share to the amount which grant it group a main shareholder position.  Whatever the strategy a hotel company will use, I believe that as long as hotel executives could fulfill their obligation to owners that should set the tone in choosing a strategy. By Oren Gulasa

It’s a new year soon, one which many of us would like to forget. But, in a rare personal note, I would like to remind everyone in which historic time we are living in. Think how fortunate we are. The world is changing so much that its almost unfamiliar to many of us.

So just for one night (or more) I would wear the optimistic hat and go out to celebrate with family and friends. May it be a wonderful year to all of you. Actually, it has to. Great time is ahead of us and there is a light in the end of the tunnel (and it’s not of the coming train).

It’s time for us to realize how the world has changed and where is our opportunity to make it a better place, each of us within his/her own experience. Happy New Year and Welcome 2009!

Personal Note, by: Oren Gulasa

A partnership is a form of business organization involving two or more owners that is not incorporated for the purpose of owning or operating a business (Dr. Cooper, 2008). This form of business hold most of advantages/disadvantages of Sole Proprietorship. Advantages of partnership:

1. Greater financial strength because there are more than one owner; more resources. 2. Flexibility in allocation of profits, losses, and taxes benefits among owners (upon agreement). 3. All taxes benefits, losses and profits passes through to the owner’s individual tax return. 4. Control resides with the partners.

Disadvantages:

1. Partners are taxed on their share of profits (even if not receive cash distribution, or re-invest). 2. The sharing decision making process might be frustrating. 3. Owners have unlimited liability for the obligation of the business. (Partnership agreement might not be in writing agreement, though, nowadays, it’s rare.)

Another form of business organization would be the Limited Partnership (also known as LLP). Definition: Limited partnership is a partnership consisting two or more individuals, having at least one general partner and one limited partner. The agreement must be in writing (defined who is limited partner / general) and a certificate of Limited Partnership must be filed with the proper authorities.

Advantages:

1. Afford limited liability to the limited partner (according to investment portion). 2. The limited partners cannot actually participate in controlling or managing the business. 3. Attractive structure for expansion (for instance a sole proprietorship owner who need to raise capital will have the option to add a limited partner).

Basic accounting procedures for partnership:

The accounting procedures for partnership would be similar to sole proprietorship. When two or more partners decide to join forces for the purpose of earning profit, they would simply need to agree to enter a partnership (no legal contract is required, although highly recommended). In addition, each partner act as an agent of the partnership (according to J.Eisen, Peter, 2007). Partners should establish loss and profit sharing-ratio in order to eliminate disputes in future. All of these claims could be provided in a contract, known as the Article of Partnership.  

Each investor (partner) would have separate capital account, under his/her name, and a separate drawing account; to record the partner’s withdraw of cash from the business(or other assets) for personal use. Since partners are not entitled for salaries, the withdrawing account acts like quasi salary account.

By: Oren Gulasa

The assets structure model help in finance decisions of how we get money, based on the capital structure of the company. The business assets provide us with Operating Cash Flow, which is primarily used to pay / finance one or portion of the following:

1. Debt: meet obligation for creditors; pay capital and interest on loans.
2. Taxes: meet tax obligations required by Federal Govt. and State Taxes.
3. Equity: Cash then used to pay dividends or re-invest in the company.

Capital structure and value of ownership: In the business world, every decision should be viewed as maximizing value for the firm’s owners. The company engaged in business first and foremost in order to make money. Increase value of ownership is the basis for business growth. The board of directors aims to increase profit for the shareholders/ business owners and maintain value of business. The board can take a decision not give dividend in a certain year (and re-invest all the profits) as long as in the long run, the value of the company increase, and thus the value of ownership.

Stockholders equity reflects the capital structure of the company. In a corporation’s capital structure there is a distinction between the money earned by the company, also known as retained earnings and the initial investment made by the corporation owners, known as common stock. Together, the retained earnings and common stock are parts of the stockholders equity section in the balance sheet.

Common stock: Refers to the main principle stock that is issued by companies to stockholders, which defines in monetary terms the ownership of investors in the company also known as preemptive rights and the share of dividends (% of total $ in the event of dividends distribution) according to Eisen Peter, (Accounting, 5^th Edition, 2007 p. 388). It has considerably greater number of shares authorized because it’s lower par-value (minimum $ value assigned by the company) makes it affordable to more investors.

The second class of stock is known as preferred stock which usually has higher price and thus, would give investors better conditions and protections. The main tow advantages of being preferred stock owner would be privilege of getting dividends first, before common stockholders, in the event of dividends distribution and an assets protection. Some preferred stock could include cumulative preferred stock rights which would grant stockholders dividend distribution for past years, if the company skipped one or more years in which dividend hasn’t been distributed, before distribution to common stockholders occurs.

Treasury stocks: a special act when company buys back its own stock. One of the reasons for reacquiring the company’s own stock would be the intention to increase earning per share (EPS). Simply because less stock in the market would drive stock price increases. Another reason is to reduce chance to takeover by other company / individual (who plan to buy stock). Since stock could be given as dividend (stock dividend) a company would buy its own stock and use it Increase value of ownership; mainly because it would be a tax efficient way to give cash to owners.  Lastly reacquiring the company’s own stock will keep the $ value of stock price, which owned by business owners/ directors etc.

 Notes from finance class with Dr. Cooper. C, J&W University, 2008; by Oren Gulasa