Senior Partner & Managing Director
Related Expertise Value Creation Strategy,
TSR turnarounds are companies that deliver superior value creation after an extended period of below-average TSR performance and a below-average valuation multiple. It turns out that companies with this starting position not only deliver more TSR, on average, than the other companies in the 2014 BCG Value Creators database. They are also overrepresented among the top ten value creators in 26 industries.
To analyze the dynamics of TSR turnarounds, BCG took a look back to the TSR performance of the companies in this year’s Value Creators database during the previous five-year period from 2004 through 2008. First, we divided the companies into two groups: those that delivered TSR below their industry average during that period and those that delivered TSR above their industry average. Because not all companies in this year’s sample were public companies during that earlier period (either because they did not yet exist or were held privately), we were able to do this analysis for 1,330 out of the total 1,620 companies in our sample.
Next, we categorized these companies according to whether their valuation multiple (measured as the ratio of enterprise value to EBITDA) was either above or below the average valuation multiple for their industry at the end of 2008 (the end of the previous five-year period and the beginning of the five-year time frame of this year’s Value Creators report). This metric gives a sense of how investors were valuing the companies’ likely future performance at the time.
The result of this segmentation is the four-box matrix on the left in Exhibit 1. Note that the number of companies is largest in the lower-left quadrant (that is, those companies with below-industry-average TSR and below-industry-average multiples) and the upper-right quadrant (those with above-industry-average TSR and multiples). That outcome reflects the fact that change in a company’s valuation multiple (whether positive or negative) is an integral part of the calculation of TSR. (See “The Components of TSR.”)
TSR is the product of multiple factors. Regular readers of the Value Creators report should be familiar with BCG’s model for quantifying the relative contribution of TSR’s various sources. (See the exhibit below.) The model uses the combination of revenue (sales) growth and change in margins as an indicator of a company’s improvement in fundamental value. It then uses the change in the company’s valuation multiple to determine the impact of investor expectations on TSR. Together, these two factors determine the change in a company’s market capitalization and the capital gain (or loss) to investors. Finally, the model tracks the distribution of free cash flow to investors and debt holders in the form of dividends, share repurchases, and repayments of debt to determine the contribution of free-cash-flow payouts to a company’s TSR.
The important thing to remember is that all these factors interact with one another—sometimes in unexpected ways. A company may grow its revenue through an EPS-accretive acquisition and yet not create any TSR, because the new acquisition has the effect of eroding gross margins. And some forms of cash contribution (for example, dividends) have a more positive impact on a company’s valuation multiple than others (for example, share buybacks). Because of these interactions, we recommend that companies take a holistic approach to value creation strategy.
What is striking, however, is the way these different starting points affected the future performance of the companies in our sample. Having segmented the companies into the four groups shown in the matrix, we then calculated the average TSR performance of these four groups in 2009-2013, relative to their industry average. The results of this analysis can be seen in the matrix on the right in Exhibit 1.
Those companies that in the previous five-year period had both a below-industry-average TSR and a below-industry-average 2008 multiple performed significantly better than the rest, delivering TSR that was nearly 5 percentage points above their industry average. Meanwhile, those companies with above-industry-average TSR in the previous five-year period and above-industry-average multiples did poorest, delivering TSR that was nearly 2 percentage points less than the industry average.
What about the top-performing companies in this year’s Value Creators database? We repeated the same analyses for the 180 companies that had ten-year TSR data out of the 260 in our industry top-ten rankings. As the matrix on the left in Exhibit 5 illustrates, companies with previously poor TSR performance and a low 2008 multiple are substantially overrepresented in the top-ten rankings for 2009-2013. Seventy-five out of 369 companies in this category—or 20.3 percent—are in the industry top-ten rankings. These are the companies that we are calling TSR turnarounds. In contrast, only 31 out of 397 companies with previously high TSR performance and a high 2008 multiple made it into one of the top-ten rankings for 2009-2013—roughly 8 percent. Put simply, a company with previously poor performance and a low 2008 multiple had a 1 in 5 chance of making it into one of this year’s top-ten rankings, whereas a company with previously superior performance and a high 2008 multiple had less than a 1 in 12 chance.
Of the companies in our top-ten rankings, those in all four quadrants delivered TSR that was substantially higher than the industry average. (See the matrix on the right in Exhibit 2.) Nevertheless, the TSR-turnaround companies, in the lower-left quadrant, delivered about 4.5 percentage points more relative TSR, on average, than the companies in the other three quadrants.
This data clearly illustrates an important fact about the dynamics of TSR: a company’s starting point matters enormously. Just because a company has been performing poorly doesn’t mean it can’t become a top performer. Indeed, in some respects, it is especially well positioned to do so. And just because a company has a history of superior TSR performance, that does not mean its senior executives should be complacent. It’s not merely that past performance is no guarantee of future performance. Previous superior TSR performance can actually become an obstacle to maintaining superior TSR performance because the expectation of high performance is already priced into the stock price in the form of a high valuation multiple, and delivering superior TSR is all about beating expectations, not just meeting them.
Of course, just because a company has a period of poor TSR performance does not automatically mean that it will become a top performer later on. Bringing about a TSR turnaround depends on making a series of moves that fundamentally redirect a company’s TSR trajectory. Although each company’s story is different, we found some common patterns in the way that the TSR-turnaround companies in our sample reversed their fortunes.
Four simple lessons emerge from this analysis: