Realizing untapped value through data analytics
ME PoV Fall 2018 issue
Middle East market evidence shows a general trend of a decrease in business value, presenting management and business owners with an opportunity to challenge the current norms. Strong data analytics combined with an action plan focused on value creation can enhance business value through a range of situations, whether in support of a proposed transaction, a transformation program, or to capitalize on a turnaround opportunity.
Business values have been decreasing
The last few years have been challenging for regional stock markets, as demonstrated by a 20 percent decline across major regional indices. The reasons are many, including commodity market turmoil, falling consumer confidence and issues of governance and regional geopolitics. While this is evidence that markets are less confident in trading shares at historical prices, it also reflects a decreased confidence in the valuations of the businesses that underpin these indices. Furthermore, decreasing EBITDA1 to enterprise value multiples (a common valuation metric when comparing businesses) also suggests a decreasing confidence in the quality of those earnings.
There is opportunity ahead
Despite a challenging environment, the outlook provides
Signs of recovery present real opportunities for business owners and managers alike, and should sharpen the resolve to respond to the current market challenges and seek to create long-term value.
Whether preparing for an M&A event, turning around existing under-performance or simply responding to changing markets, the core drivers of value creation remain the same. Implied EBITDA:EV2 multiples are simply a product of two variables of which management can only directly control one, EBITDA. Similarly, how quickly earnings can be turned into cash is crucial. A program that focuses on increasing EBITDA and cash and working capital efficiency will enable value creation.
Considering the core drivers of business value, profit growth and capital efficiency, owners and senior management should be continually identifying improvements across a number of key areas:
- Revenue – ensuring sales are suitably targeted and executed in order to achieve the optimal volume and prices.
- Cost of sales – optimizing operational productivity and the supply chain and how that can respond to changes in demand.
- Overheads – a lean but effective overhead base to support the business with no unnecessary costs.
- Working capital and asset management – cash and working capital, including debtors, inventory and creditors should be proactively managed in order to release cash currently tied up within the balance sheet.
- Capital structure – the existing capital structure should be suitable for the business, not a constraint on cash flow, and should enable the financing of new investments.
Using Middle East sector average gross profit and EBITDA margins and assuming current EBITDA:EV multiples, the following analysis demonstrates that relatively modest initiatives such as price and volume productivity increases or cost and working capital decreases can create significant additional value.
Optimization through data analytics
Boardroom resolve to face issues head on as well as challenge existing norms is critical. A fresh impetus of rapid self-evaluation is key to identifying value creation initiatives. New initiatives most likely lie in the data analysis that is not yet being routinely performed, resulting in opportunities not being identified or fully understood. Additionally, value creation initiatives are not just focusing on improving the financial results but improving how they are operationally achieved by the business.
Commercial fact-based hypotheses can be rapidly formed to provide early insight as to where the largest challenges—and therefore opportunities—lie and experience shows that what may initially appear obvious and simple is often the most overlooked. Often, businesses do not adapt quickly enough to changing customer and supplier market conditions despite warning signs in the data. Many challenges and opportunities are often known but the solutions are rarely understood or implemented due to not being sufficiently proved.
Detailed data analytics is the key to unlocking value. For example, existing debtor days may be much greater than the credit terms offered. Only through understanding exactly which customers or customer group delay settlement and the reasons why, can a business determine a course of action suitable for those customers, without impacting the customers that do pay on time. Additionally, the challenge could even be internal and process-related i.e. due to a delay in sending invoices to customers. Value creation initiatives should be supported through detailed analysis of both, realizing gains and ensuring the successful and sustainable implementation, and minimal impact, on the rest of the business.
It is equally important to understand the size of the opportunity and the value creation that is achievable. Scenario modelling of different initiatives, including cost benefit analysis or investment case planning allows owners and managers to quantify the potential impact on current performance, thus enabling decision-makers to sequence the implementation of a number of initiatives for early, optimal benefit.
Implementation and conclusions
Achieving profit growth and optimizing capital is no simple task—just ask any business leader. But a value creation program provides the structure to identify the opportunities, evaluate them and see them through to realization. Value-creating ideas have no value if not backed up by robust analysis and action. Ideas that are not rationalized or properly implemented can even have a detrimental impact on business value. A well considered value creation program can provide business owners with the clarity and assurance of implementation and the benefits that can be realized.
Value creation can be complex, particularly where a number of levers are being addressed, however, some common enabling factors can ensure the implementation of initiatives remains on track:
- Realistically ambitious and measurable initiatives. Ambitions should not be blind but based on sound economic reality and the desired results quantifiable.
- Program management. Initiatives must be backed up by action and results monitored and evaluated regularly. This will ensure projects stay focused and are achieved on time.
- Management competencies and incentivization. Management team changes may be required and management should be rewarded for the successful implementation of initiatives.
- Robust cash and working capital controls. Value creation benefits are at risk of not being realized if cash and spending cannot be controlled. Similarly, improper capex controls can make or break the success of an initiative.
- Investment needs and sources identified. Understanding and articulating the long-term benefit and return on investment of value creation initiatives will determine the sources of funding available and also the ability to access funding.
- Stakeholder management. Differing agendas, whether of shareholders, suppliers, customers or financiers can provide undesired distraction and should be proactively identified and managed appropriately.
Businesses are extremely complex on a range of levels. Embedding the change that comes with a value creation plan will not be without hurdles, be they the availability of robust data, resistance from stakeholders or even internal organizational resistance to change. Value creation should also be seen as a shared mindset and a board level agenda: a vision to be the highest performing business achievable, backed-up by robust analysis and pragmatic action.
by Tom Bullock, Assistant Director, Financial Advisory, Deloitte Middle East
- Earnings before interest, taxes, depreciation and amortization
- The EBITDA/EV (enterprise value) multiple is a financial valuation ratio that measures a company's return on investment.