High Performance Boards

Henry D. Wolfe De La Vega Occidental & Oriental Holdings

Current State of Public Co. Governance

• Only 34% of directors surveyed agreed that the boards on which they served fully comprehended their companies’ strategies• Only 22% said their boards were completely aware of how their firms created value• Only 16% claimed their boards had a strong understanding of the dynamics of their

firms’ industries• Majority of 1500 companies surveyed, over a 20 year period, doled out the same

amount of capital to business units they did the previous year.• More than 1/3 of the $8 Trillion in invested capital in the S&P 1500 does not earn

the cost of capital• Over a 5 year period, half S&P 1500 experience a significant write-off, divest a

major business or see a decline of 50% of more in company value

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Current State of PE Governance

• McKinsey study of 70 highly successful PE deals, primary source of value creation was the out performance of the company• Even more surprising was the finding that out performance was

driven by changes to way the boards of these companies worked• Ernst & Young study – 33% better EV creation by PE firms than

publicly traded peers – again attributed to governance model• Michael Jensen comment at Morgan Stanley Roundtable on PE and Its

Import for Public Companies

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A Brief History of Governance

• 1980’s – VALUE GAPS – Poison Pill, Staggered Boards & Legislation • 90’s – complacency back• Early 00’s – Enron, Worldcom • Over reaction led to compliance overload and overemphasis on

independence for independence’s sake• Governance Community – still continues to today

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A Brief History of Governance – con’t

• 10’s – Proliferation of Activist Investors – VALUE GAP• Boards not doing their job via the value creation process and any of

its attendant aspects (selection, etc)• Governance organizations such as NACD having to put together a

“blue ribbon panel” to determine board’s role in strategy (NACD shill for the establishment)• Still too much focus on issues not related to value creation

(diversity)

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Components of a High Performance Board

• Clearly defined primary role• Non-executive chairman’s role & qualities• Selection criteria for outside board members• The primary agenda focus

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Clearly Defined Primary Role

• Defining primary role creates the context for everything else• Primary Role/Responsibility – To ensure the maximization of capital

allocation, company performance and shareholder value• Essential to understand that public companies have NOT been

defining their roles as such (their def: independence, compliance activity, too many committees, bureaucracy, etc.)• Chairman criteria, outside director criteria and agenda all flow from

this context

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Role of the Non-Executive Chairman

• Primary role is one of leadership• Learn the industry and company• Regular engagement with CEO/Mgt.• Set standards for value creation process• Ensure robust engagement by board in monitoring value creation plan

progress• Create a culture of management accountability

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Qualities of a High Performance Non-Executive Chairman

• Mindset• Demonstrated Leadership• Deep understanding of the value creation process, including, but not

limited to, capital allocation skills• Ability to view things holistically• No desire for CEO role

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Outside Director Selection Criteria – What You Don’t Want

• Independent directors for the sake of independence• “Star quality” individuals for sake of prestige• Diversity for the sake of diversity• Friends• Anyone who cannot significantly contribute to the maximization of

value of the company

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Outside Director Selection – What You Do Want

• Mindset and backbone• Specific experience, skills AND track record in the context of the

company’s value creation plan – Arctic – H - DSD• Industry experience AND track record• Broad value creation discipline, experience & track record – MEMC

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MEMC/Sun Edison

• MEMC, a silicon chip maker acquires Sun Edison, a budding solar power firm• By 2012, Chinese competition had hammered US solar businesses; stock dropped to

$1.50/share• Altai Capital builds a 7% stake; Steve Tesoreire, Altai partner, joins board with 5 year

commitment• Works with management to build trust• Two major initiatives:• Spinoff Semiconductor business • Formed a “YieldCo” in which to place its solar projects lowering cost of capital for solar

projects by 1/3 and providing steady stream of dividends to Sun Edison• Stock price has risen from $1.50 to $21.90

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Agenda

• Deep dive into the industry and business• Board needs to think like investors, i.e. develop an Investment Thesis• Clear and focused summary – grounded in the granular realities of the

company’s competitive situation, opportunities and risks – of how the company will create value over time (3 to 6 critical actions)

• Development of the value creation plan and extended year targets• Ongoing agenda primary focus is monitoring progress toward strategic,

operating and financial objective in context of the value creation plan

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“The Outsiders”

• Subtitle: 8 Unconventional CEOs & Their Radically Rational Blueprint For Success• Top book among activist investors• These CEOs, over 20 to 30 year periods on average outperformed the S&P 500

by 20 times and their peers by 7 times• Common characteristics among all of them:• Functioned like investors, not like operating executives• Were masters of capital allocation (an extremely rare skill)• What counts in long run is not growth or size but increase in per share value• Cash flow, not reported earnings, is the determiner of long term value

• Relevance of all of this to governance

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Wolfe Involved Case Studies

Public and Private Companies

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Company A – Public Company- Before

• Board in place since 2000 (as of mid-year 2012)• Had all current corporate gov. best practices covered but……• Directors lacking in value creation experience• Also lacking in any industry or company specific value add skills• Primary focus was oversight, i.e. no mistakes• No strategic or value maximization plan• Absolutely no mgt accountability• Worst of all – change of control provision for board• EBITDA declined from peak of $67 Million to $45 Million

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Company A - Now

• Completely new board• Ignore all governance “best practices”• Overall board experience and track record optimal• Sole focus is performance & value maximization• 5 Year Value Maximization Plan in place• High level of management accountability• EBITDA this year $62.5 Million; projected next year: $77 Million

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Company B – Multi-Shareholder Private Company - Before

• Company result of merger of two companies & acquisition of third• Board consists of the 3 owners and one outside director (me)• Board members know industry but completely lack value creation

understanding• By end of first year financial performance declined, Wolfe begins to agitate

for change• At the end of year two, EBITDA had decreased by 62%, debt had doubled and

as a result shareholder value had dropped by over 90%• Wolfe develops an analysis that reflects the above summarized situation. This

analysis is presented to the other board members with demands for a plan of improvement.

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Company B – Before – Cont’d

• When a plan of improvement is not forthcoming, Wolfe developed an extensive white paper which outlined the myriad problems with the company, including, but not limited to, management and governance shortfalls.• After white paper is presented, Wolfe continues to press for change

via letters, telephone calls and meetings. After over two years of agitation by Wolfe, board/owners finally relent and agree to changes.

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Company B - After

• Wolfe named non-executive chairman• 3 new outside directors recruited, one with PE experience• Focus of new board solely on performance & value maximization• Turnaround executive becomes interim CEO• After stabilization, permanent CEO hired• Value maximization plan developed with 5 year targets for EBITDA and Equity Value• Company moves from worst performer in industry to Best in Class for all key

performance measures• Targets hit one year ahead of schedule; company sold for 50% premium over target

value• Letter from VP of Sales & Marketing

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Summary

• Board quality makes a huge difference• Model reviewed in this presentation is a Capitalist model with

shareholder primacy• Do not be swayed by the Stakeholder or other non-capitalist

arguments• The absence of this high performance governance model leaves huge

amounts of value for shareholders on the table• Who is it that loses when value is left on the table, i.e. who are the

ultimate shareholders in US public companies?

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