Value Pentagon (Shareholder Value Creation)

Value creation for shareholders remains the tops agenda for firm's management. According to financial theories, there are five stages in the process of shareholder value creation. This is commonly referred as Value Pentagon.

1. Current Market Value: The Current Market Value of the company is the starting point of the value analysis process. It is the summation of value of equity and value of debt. Corporate Finance deals with these aspects by computing Net Present Value (NPV) of anticipated cash flows of various projects or businesses that company is executing.
2. Value AS-IS: The Value AS-IS of the Company may be possible to value simply by managing external perceptions of the Company’s future prospects. It indicate the expectation or brief about the firm’s business or management. Management of the company should ensure that the value perceived by the market is not lower than the value AS-IS. If value AS-IS is greater than current market value, there are a good chance of hostile takeover by some other firm. The value unlocking is required to be done so that the market value increase to optimal AS-IS value.
3. Potential Value with Internal Re-structural Improvements (Re-structured Value): The management of corporate has opportunities for increasing the overall value of the company by implementing strategic improvements that increase their cash flows of individual businesses. It may include operational improvements, growth opportunities and re-positioning of businesses. Internal restructuring of variable and fixed cost could unlock value of the company. Management can figure out what all cost are controllable and uncontrollable, and then accordingly take action to convert as much of uncontrollable cost to controllable. An example of such value unlocking are outsourcing model which allow conversion of cost-plus to fixed price contract. The key idea is to increase the return on existing capital or generate same return with decreased capital.
4. Potential Value with External Improvements (Enhanced Value):After the value of the constituent businesses and company is determined, it is possible for management to make further changes in the business portfolio to increase overall company value. It could include value creation by de-merger, merger, acquisition, strategic alliance and joint venture with other firms to create value. The key idea is to improve the quality of investment made by the company in various projects and businesses. Example, an individual business could be sold for a price greater than its potential value to the company.
5. Optimum Restructured Value (Shareholder Value):Shareholders invest in order to make a return that more than reflects their perceived risk, and that return comes from dividends and growth in the share price. If a share is already over-valued, such growth is unlikely for them. Management should have Financial Strategy including aspects like equity strategy, debt strategy, financial engineering & instrument to further enhance the shareholder value. The maximum value of company is determined after exploiting all the potential gains by making internal improvements, taking advantage of external opportunities, and, changing investor perceptions. The difference between the maximum restructured value and the current market value represents the profit potential available to investors.

Seven drivers of Shareholder Value 

According to Alfred Rappaport, following are seven drivers for shareholder value creation:

1. Increase sales growth
2. Increase operating profit margin
3. Reduce cash tax rate
4. Reduce incremental investment in capital expenditure
5. Reduce investment in working capital
6. Increase time period of competitive advantage
7. Reduce cost of capital.