a case study in value destruction: eastman kodak &...
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Acasestudyinvaluedestruction:EastmanKodak&SterlingDrugs
Kodakentersbiddingwar¨ Inlate1987,EastmanKodak
enteredintoabiddingwarwithHoffmanLaRocheforSterlingDrugs,apharmaceuticalcompany.
¨ ThebiddingwarstartedwithSterlingDrugstradingatabout$40/share.
¨ At$72/share,Hoffmandroppedoutofthebiddingwar,butKodakkeptbidding.
¨ At$89.50/share,Kodakwonandclaimedpotentialsynergiesexplainedthepremium.
Kodakwins!!!!
!
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EarningsandRevenuesatSterlingDrugs
AswathDamodaran
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Sterling Drug under Eastman Kodak: Where is the synergy?
0500
1,0001,5002,0002,5003,0003,5004,0004,5005,000
1988 1989 1990 1991 1992
Revenue Operating Earnings
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KodakSaysDrugUnitIsNotforSale…but…
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¨ AnarticleintheNYTimesinAugustof1993suggestedthatKodakwaseagertosheditsdrugunit.¤ Inresponse,EastmanKodakofficialssaytheyhavenoplanstosellKodak’sSterlingWinthrop
drugunit.¤ LouisMattis,ChairmanofSterlingWinthrop,dismissedtherumorsas“massivespeculation,
whichfliesinthefaceofthestatedintentofKodakthatitiscommittedtobeinthehealthbusiness.”
¨ Afewmonthslater…Takingastrideoutofthedrugbusiness,EastmanKodaksaidthattheSanofiGroup,aFrenchpharmaceuticalcompany,agreedtobuytheprescriptiondrugbusinessofSterlingWinthropfor$1.68billion.¤ SharesofEastmanKodakrose75centsyesterday,closingat$47.50ontheNewYorkStock
Exchange.¤ SamuelD.Isalyananalyst,saidtheannouncementwas“verygoodforSanofiandverygood
forKodak.”¤ “Whenthedivestituresarecomplete,Kodakwillbeentirelyfocusedonimaging,” saidGeorge
M.C.Fisher,thecompany'schiefexecutive.¤ TherestoftheSterlingWinthropwassoldtoSmithklinefor$2.9billion.
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Theconnectiontocorporategovernance:HPbuysAutonomy…andexplainsthepremium
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Ayearlater…HPadmitsamistake…andexplainsit…
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ApplicationTest:Whoowns/runsyourfirm?
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¨ Lookat:BloombergprintoutHDSforyourfirm¨ Whoarethetopstockholdersinyourfirm?¨ Whatarethepotentialconflictsofintereststhatyousee
emergingfromthisstockholdingstructure?
Control of the firm
Outside stockholders- Size of holding- Active or Passive?- Short or Long term?
Inside stockholders% of stock heldVoting and non-voting sharesControl structure
Managers- Length of tenure- Links to insiders
Government
Employees Lenders
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Case1:SplinteringofStockholdersDisney’stopstockholdersin2003
Aswath Damodaran
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Case2:VotingversusNon-votingShares&GoldenShares:Vale
Vale Equity
Common (voting) shares3,172 million
Preferred (non-voting)1,933 million
Golden (veto) shares owned
by Brazilian govt
Valespar(54%(Non/Brazilian(
(ADR&Bovespa)(29%(
Brazilian(Ins=tu=onal(6%(
Brazilian(retail(5%( Brazilian(
Govt.(6%(
Valespar(1%(
Non.Brazilian((ADR&Bovespa)(
59%(
Brazilian(Ins<tu<onal(18%(
Brazilian(retail(18%(
Brazilian(Govt.(4%(
Litel&Participaço 49.00%Eletron&S.A. 0.03%Bradespar&S.A. 21.21%Mitsui&&&Co. 18.24%BNDESPAR 11.51%
Valespar(ownership
Vale has eleven members on its board of directors, ten of whom were nominated by Valepar and the board was chaired by Don Conrado, the CEO of Valepar.
Aswath Damodaran
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Case3:CrossandPyramidHoldingsTataMotor’stopstockholdersin2013
Aswath Damodaran
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Case4:LegalrightsandCorporateStructures:Baidu¨ TheBoard:Thecompanyhassixdirectors,oneofwhomisRobinLi,
whoisthefounder/CEOofBaidu.Mr.LialsoownsamajoritystakeofClassBshares,whichhavetentimesthevotingrightsofClassAshares,grantinghimeffectivecontrolofthecompany.
¨ Thestructure:BaiduisaChinesecompany,butitisincorporatedintheCaymanIslands,itsprimarystocklistingisontheNASDAQandthelistedcompanyisstructuredasashellcompany,togetaroundChinesegovernmentrestrictionsofforeigninvestorsholdingsharesinChinesecorporations.
¨ Thelegalsystem:Baidu’soperatingcounterpartinChinaisstructuredasaVariableInterestEntity(VIE),anditisunclearhowmuchlegalpowertheshareholdersintheshellcompanyhavetoenforcechangesattheVIE.
Aswath Damodaran
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Thingschange..Disney’stopstockholdersin2009
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II.Stockholders'objectivesvs.Bondholders'objectives
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¨ Intheory:thereisnoconflictofinterestsbetweenstockholdersandbondholders.
¨ Inpractice:Stockholderandbondholdershavedifferentobjectives.Bondholdersareconcernedmostaboutsafetyandensuringthattheygetpaidtheirclaims.Stockholdersaremorelikelytothinkaboutupsidepotential
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Examplesoftheconflict..
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¨ Adividend/buybacksurge:Whenfirmspaycashoutasdividends,lenderstothefirmarehurtandstockholdersmaybehelped.Thisisbecausethefirmbecomesriskierwithoutthecash.
¨ Riskshifting:Whenafirmtakesriskierprojectsthanthoseagreedtoattheoutset,lendersarehurt.Lendersbaseinterestratesontheirperceptionsofhowriskyafirm’sinvestmentsare.Ifstockholdersthentakeonriskierinvestments,lenderswillbehurt.
¨ Borrowingmoreonthesameassets:Iflendersdonotprotectthemselves,afirmcanborrowmoremoneyandmakeallexistinglendersworseoff.
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AnExtremeExample:UnprotectedLenders?
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III.FirmsandFinancialMarkets
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¨ Intheory:Financialmarketsareefficient.Managersconveyinformationhonestlyandandinatimelymannertofinancialmarkets,andfinancialmarketsmakereasonedjudgmentsoftheeffectsofthisinformationon'truevalue'.Asaconsequence-¤ Acompanythatinvestsingoodlongtermprojectswillberewarded.
¤ Shorttermaccountinggimmickswillnotleadtoincreasesinmarketvalue.
¤ Stockpriceperformanceisagoodmeasureofcompanyperformance.
¨ Inpractice:Therearesomeholesinthe'EfficientMarkets'assumption.
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Managerscontrolthereleaseofinformationtothegeneralpublic
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¨ Informationmanagement(timingandspin):Information(especiallynegative)issometimessuppressedordelayedbymanagersseekingabettertimetoreleaseit.Whentheinformationisreleased,firmsfindwaysto“spin”or“frame”ittoputthemselvesinthebestpossiblelight.
¨ Outrightfraud:Insomecases,firmsreleaseintentionallymisleadinginformationabouttheircurrentconditionsandfutureprospectstofinancialmarkets.
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Evidencethatmanagersdelaybadnews?
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DO MANAGERS DELAY BAD NEWS?: EPS and DPS Changes- byWeekday
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
Monday Tuesday Wednesday Thursday F r i d a y
% Chg(EPS) % Chg(DPS)
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Somecritiquesofmarketefficiency..
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¨ Investorirrationality:Thebaseargumentisthatinvestorsareirrationalandpricesoftenmovefornoreasonatall.Asaconsequence,pricesaremuchmorevolatilethanjustifiedbytheunderlyingfundamentals.Earningsanddividendsaremuchlessvolatilethanstockprices.
¨ Manifestationsofirrationality¨ Reactiontonews:Somebelievethatinvestorsoverreactto
news,bothgoodandbad.Othersbelievethatinvestorssometimesunderreacttobignewsstories.
¨ Aninsiderconspiracy: Financialmarketsaremanipulatedbyinsiders;Pricesdonothaveanyrelationshiptovalue.
¨ Shorttermism:Investorsareshort-sighted,anddonotconsiderthelong-termimplicationsofactionstakenbythefirm
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Aremarketsshortsightedandtoofocusedonthenearterm?Whatdoyouthink?
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¨ Focusingonmarketpriceswillleadcompaniestowardsshorttermdecisionsattheexpenseoflongtermvalue.a. Iagreewiththestatementb. Idonotagreewiththisstatement
¨ Allowingmanagerstomakedecisionswithouthavingtoworryabouttheeffectonmarketpriceswillleadtobetterlongtermdecisions.a. Iagreewiththisstatementb. Idonotagreewiththisstatement
¨ Neithermanagersnormarketsaretrustworthy.Regulations/lawsshouldbewrittenthatforcefirmstomakelongtermdecisions.a. Iagreewiththisstatementb. Idonotagreewiththisstatement
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Aremarketsshortterm?Someevidencethattheyarenot..
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¨ Valueofyoungfirms:Therearehundredsofstart-upandsmallfirms,withnoearningsexpectedinthenearfuture,thatraisemoneyonfinancialmarkets.Whywouldamyopicmarketthatcaresonlyaboutshorttermearningsattachhighpricestothesefirms?
¨ Currentearningsvs Futuregrowth:Iftheevidencesuggestsanything,itisthatmarketsdonotvaluecurrentearningsandcashflowsenoughandvaluefutureearningsandcashflowstoomuch.Afterall,studiessuggestthatlowPEstocksareunderpricedrelativetohighPEstocks
¨ Marketreactiontoinvestments:Themarketresponsetoresearchanddevelopmentandinvestmentexpendituresisgenerallypositive.
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Ifmarketsaresoshortterm,whydotheyreacttobiginvestments(thatpotentiallylowershorttermearnings)sopositively?
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Butwhataboutmarketcrises?
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¨ Marketsaretheproblem:Manycriticsofmarketspointtomarketbubblesandcrisesasevidencethatmarketsdonotwork.Forinstance,themarketturmoilbetweenSeptemberandDecember2008ispointedtoasbackingforthestatementthatfreemarketsarethesourceoftheproblemandnotthesolution.
¨ Thecounter:Therearetwocounterargumentsthatcanbeoffered:¤ Theeventsofthelastquarterof2008illustratethatwearemore
dependentonfunctioning,liquidmarkets,withrisktakinginvestors,thaneverbeforeinhistory.Aswesaw,nogovernmentorotherentity(bank,Buffett)isbigenoughtostepinandsavetheday.
¤ Thefirmsthatcausedthemarketcollapse(banks,investmentbanks)wereamongthemostregulatedbusinessesinthemarketplace.Ifanything,theirfailurescanbetracedtotheirattemptstotakeadvantageofregulatoryloopholes(badlydesignedinsuranceprograms…capitalmeasurementsthatmissriskyassets,especiallyderivatives)
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IV.FirmsandSociety
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¨ Intheory:Allcostsandbenefitsassociatedwithafirm’sdecisionscanbetracedbacktothefirm.
¨ Inpractice:Financialdecisionscancreatesocialcostsandbenefits.¤ Asocialcostorbenefitisacostorbenefitthataccruestosocietyasawholeandnottothefirmmakingthedecision.n Environmentalcosts(pollution,healthcosts,etc..)n QualityofLife'costs(traffic,housing,safety,etc.)
¤ Examplesofsocialbenefitsinclude:n creatingemploymentinareaswithhighunemploymentn supportingdevelopmentininnercitiesn creatingaccesstogoodsinareaswheresuchaccessdoesnotexist
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SocialCostsandBenefitsaredifficulttoquantifybecause..
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¨ Cannotknowtheunknown:Theymightnotbeknownatthetimeofthedecision.Inotherwords,afirmmaythinkthatitisdeliveringaproductthatenhancessociety,atthetimeitdeliverstheproductbutdiscoverafterwardsthatthereareverylargecosts.(Asbestoswasawonderfulproduct,whenitwasdevised,lightandeasytoworkwith…Itisonlyafterdecadesthatthehealthconsequencescametolight)
¨ Eyesofthebeholder:Theyare‘person-specific’,sincedifferentdecisionmakerscanlookatthesamesocialcostandweightthemverydifferently.
¨ Decisionparalysis:Theycanbeparalyzingifcarriedtoextremes.
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Atestofyoursocialconsciousness:Putyourmoneywhereyoumouthis…
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¨ AssumethatyouworkforDisneyandthatyouhaveanopportunitytoopenastoreinaninner-cityneighborhood.Thestoreisexpectedtoloseaboutamilliondollarsayear,butitwillcreatemuch-neededemploymentinthearea,andmayhelprevitalizeit.
¨ Wouldyouopenthestore?¤ Yes¤ No
¨ Ifyes,wouldyoutellyourstockholdersandletthemvoteontheissue?¤ Yes¤ No
¨ Ifno,howwouldyourespondtoastockholderqueryonwhyyouwerenotlivinguptoyoursocialresponsibilities?