April 21, 2004

Group #3

MWF 9:00

Beth Brown

Lanissa Lloyd

Laura Metzler

Jimmy Mitchell

Matthew Sanders

Daniel Travis

Table of Contents

  • Executive Summary...... 3
  • Recommendation #1…………...... 5
  • Recommendation #2…………...... 9
  • End Notes………………………….12
  • Appendix 1………………………...13
  • Appendix 2………………………...16
  • Appendix 3………………………...17
  • Appendix 4………………………...18
  • Appendix 5………………………...19
  • Appendix 6………………………...20
  • Appendix 7………………………...21
  • Appendix 8………………………...22

Executive Summary

Newell Rubbermaid is vying for a stronger position in the home care products industry. It sells products world-wide under the segments of Cleaning and Organization, Office, Home Fashion, Tools and Hardware, and a final category consisting of the rest of its products titled “Other”. While best known for Rubbermaid, it has a niche in many other consumer products.

Newell’s outdated strategy of acquisitions remains a lingering problem. Newell began as a corporation focused on buying small companies with strong brands, high costs, and poor marketing strategies.1 Newell would then turn these companies around into lean profitable segments. However, when Newell bought Rubbermaid and business strategies clashed, these acquisitions turned unprofitable as Newell could not integrate these segments into a core competency. Rubbermaid could not be restructured in a manner similar to previous buyouts. It had low margin products and high costs and so Newell foundered.

Newell purchased companies just for the thrill of a new acquisition, and mistakes were glossed over.1 With large amounts of cash flow, managers began acquiring companies without much thought or consideration, as these projects proved to be negative NPV investments. Newell lacked a long term focus, and concentrated solely on sales growth, operating income, cash flow, and EPS.2 The result of these poor acquisitions ended with many unprofitable deals and an eroded stockholder confidence.

Newell Rubbermaid began restructuring three years ago. The company started to divest products that did not fit into its long term strategic objective and looked for low margin products to discontinue. Newell also boosted its Research and Development (R&D) in the past three years from $67.2 million to $124.6 million. The firm is cutting costs by exiting US manufacturing sites, reducing the number of employees, and globalizing operations. Additionally, Newell reduced inventory and expenses by creating stronger supplier relationships. In 2003, Newell split the company into two divisions, Rubbermaid/Irwin and Sharpie/Calphalon. Newell created a Chief Operating Officer (COO) position for each division with the intention of improving organizational management.

Newell Rubbermaid already has a strong niche in its tools and office supplies divisions. It can capitalize on this strength by creating projects that add value to the brand name. However, Newell must avoid uninformed acquisitions that don’t add value to the firm and discontinue low margin products that no longer generate profits.

We have two recommendations for Newell in its restructuring process. First, we suggest that Newell continue to mature its core competency of “product development, brand enhancement, and selective globalization”.3 Instead of purchasing companies with its free cash flow, Newell can invest in R&D and increase the brand quality and expand the customer loyalty that currently exists. This allows the company to get leaner and reduce unnecessary costs while increasing sales. When Newell realizes higher profit margins, its net income will increase. Our second recommendation is for Newell to implement an incentive plan that ties management and executives closer to the performance of the company. Increasing managers’ stake in the firm will cause them to weigh their decisions more carefully, since they will be held liable for failures. However, any action that adds value will be magnified in their bonuses through an increase in the value of their equity.

Proposal

Newell Rubbermaid is the sixth largest company in the Household and Consumer Products Industry. While it has a potential for growth, its current financial health suffers as evidenced in its negative net income in 2003 of $46.6 million.4 Inhibiting Newell’s growth is a host of well-established competitors like Proctor & Gamble, Gillette, and Avon. Because these firms mass merchandise and become multi-divisional, Newell has been unable to realize high profits over the years.5 There is no room for waste and errors, so Newell must restructure itself to meet these pressing changes.

The problems that Newell faces are not new. Newell is now realizing the result of some bad decisions that have taken a few years to come to light. By acquiring too many companies too fast; essentially, Newell bit off more than it could chew. As a result, Newell posted a loss in net income of $46.6 and $203.4 million in 2003 and 2002 respectively. This loss can be attributed to high impairment and restructuring charges, as well as reduced sales margins. Newell did report an increase of 4% in sales from $7,453.9 million in 2002 to $7,750 million in 2003, however, its operating income fell from $629.7 million to $179.9 million, a 71% decrease.5 Newell needs to focus on increasing their profit margins to industry standards, if they are going to continuing competing as a company (Appendix 7).

Newell’s focus on short term goals is detrimental to the growth of the firm. Its strategy of spending capital, buying other companies, and hoping for a quick profit boost is not reliable. This strategy inflated its assets and reduced its returns, causing a weak return on assets (ROA). Instead, it should invest cash in long term NPV projects that add value. Newell must focus on such performance measures because “Unlike Rubbermaid, privately held companies like Sterilite Corp. don’t need to focus on strong earnings results every quarter...” 6

Another major problem affecting Newell Rubbermaid is the decrease in stock value from the viewpoint of stockholders and analysts. The company’s performance over the past several years has not been well as reflected by the stock price. While industry growth increased during 2003, Newell’s growth declined by approximately 22%. Stocks peaked at approximately $52 before the Rubbermaid acquisition in 1999. The stock closed at $24.10, as of April 20, 2004. In order to increase the value of its stock, Newell must show its commitment to change through specific actions and not just words.

Recommendation 1

The first recommendation we propose is to focus on a core competency. The three main strategies that need integration into its core competency are focusing on internal growth, continuing to increase funds toward R&D, and offering a PPO for certain segments of its company.

In 2003, Newell announced that it is going to emphasize building its current brands. However, the company’s annual report states that “The Company’s growth strategy emphasizes internal growth and acquisitions.”5 Newell must focus solely on internal growth and stabilizing its current position instead of looking for acquisitions. Executing this strategy will help Newell emerge with a stronger capital structure. Newell’s debt rose from $107.5 to $242.2 to $460 million in 2001, 2002, and 2003, respectively, due to the acquisitions of highly leveraged companies. 5 Under this strategy, Newell will no longer acquire companies with high debt. One downside is passing up an acquisition with a positive NPV. However, in its current state of restructuring and focusing on strengthening brand recognition, this should not be a source of concern for Newell. There is an opportunity cost by passing up positive NPV acquisitions, but it is crucial that it establishes and builds on what it has before seeking external projects. Cash flow spent on acquisitions should instead be invested on building its current brands to increase the value of its products and trademark. As a result, Newell reduces wasted funds and increases value and revenues.

One way to achieve internal growth is to increase R&D. Over the past three years, R&D has increased from $67.2 million to $124.6 million. Proctor and Gamble, the leader in the industry, spends roughly 3% of its revenues on R&D. While this is not a benchmark, it is an indicator that Newell can improve in this area since it only allocates about 1% of revenues (Appendix 6). Reviewing Scott Company’s restructuring, George Baker describes how cutting back capital spending would increase short term value but burn the company later. He proves his point, highlighting how management “resisted short term cutbacks in productive capital spending at Scott. In fact, as shown in Table 1(Appendix 5), capital spending, R&D, and marketing and promotional expenses all increased.”7 This along with a management incentive helped to create long term value which is essential for survival. If Newell is going to survive, it needs to focus on the long term, and R&D is an element of this.

A potential downside of R&D spending is that there could be no real payoff in terms of development. However, every firm takes the risk of a potential loss on R&D, as it is a cost of doing business. Newell can implement controls, such as testing, to terminate unsuccessful research. These controls reduce wasted resources and keep the focus on consumer needs. Another downside concerns Newell’s competitors replicating its products at lower costs.6 If Newell’s customers can get the same products for less, its customer loyalty has the potential to fade. However, in the early 90’s, Rubbermaid was a successful company because its product carried strong brand value that consumers trusted in.8 For Newell to maintain this consumer loyalty, quality must be continually proven to overcome its competitors’ prices.

Part of Newell’s restructuring and divesting strategy is focusing on enhancing its current product lines through exiting low margin products and increasing spending on R&D. Although it is divesting low margin products, there is still a heavy emphasis on the Rubbermaid division. Newell’s website states that Rubbermaid is “positioned as a market leader in new product development.”As Newell’s largest division, accounting for 26% of revenues, Rubbermaid only accounts for 12% of operating income before restructuring and impairment charges. To align Newell’s new core competency with Rubbermaid’s performance, we recommend that Newell find a better way to allocate its capital and ensure that divisions with higher margins are given the funds necessary to continue their growth. We propose that Newell offer a partial public offering (PPO) of two of its more profitable segments, which “…assure[s] more financial liquidity and flexibility going forward.”9 A PPO allows the purpose of a division to become clearer and eliminate some agency conflict. The shareholders also benefit from more detailed financial statements on the division through SEC regulations and stronger analyst coverage. This gives the stockholders a more direct measure of performance. A PPO also allows employees to have a more distinct role in the division and a greater feel for progress.7 Since the Tools and Office divisions are doing well, contributing 24.1% and 41.6% of operating income before restructuring and impairment charges, respectively, we propose that a PPO be offered for these divisions. This will ensure a better allocation of capital, which in turn will increase the value of Newell’s stock. Finance professors at PennsylvaniaStateUniversity have researched these PPO’s or “carve outs” since the 1980’s. After studying roughly ninety of these, they concluded, “The parent firms themselves exhibited improved measures of operating efficiency, such as improved return on assets and return on sales.”9 These measures do not just stem from the announcement itself, but more from the parent companies being less involved in controlling operations.

One problem with offering a PPO is that it might appear as merely “… moving chairs around, but not really adding value,” which eventually causes it to fail.9 However, Newell’s reasons for its offering are related to potential for improvement. By ensuring that high profit margin divisions are receiving cash flows, the divisions will be more autonomous and be allowed to expand on what they are already doing well. Another reason why the PPO may fail is a lack of investor confidence in the business prospects of the division, as was the case of Merck’s Medco Health Solutions unit.10 However, based on the Tool and Office division’s contribution to operating income, Newell should have no problem attracting investors with its potential for growth.

Focusing its core competency on producing stronger products, increasing R&D, and offering a PPO will allow Newell the opportunity to lay a solid foundation and develop the strength of its assets. This will require some changes in its capital spending as it shifts from external acquisitions to internal product development. As a result, the ROA should increase rather than fall, as it has over the past couple of years.

Recommendation #2

Our second recommendation is to create an incentive program that ties management bonuses closer to the performance of the company. As mentioned before, acquisitions were made just for the thrill. Managers were not being held responsible for their actions, and this led to mistakes being overlooked.1 CEO Joseph Galli has already taught several training programs to the top 300 executives about promoting brands and developing products. 1 However, managers need more fire to their feet if they are expected to turn Newell around and put out profits for the shareholders. Interestingly, at Proctor and Gamble, the leader in the industry, employees are trained to focus on their “fiduciary responsibility to shareholders” (Appendix 6). It would not hurt Newell Rubbermaid to do likewise with its employees. However, one of the most effective ways to hold the managers responsible to the shareholders is to turn them into shareholders.

Currently, the CEO and executives are compensated in four ways: base salary, annual incentive compensation, stock options and other equity based awards, and supplemental retirement benefits.2 Under the annual Incentive Compensation, payments are based on “a combination of sales growth, operating income, cash flow and earnings per share”. 2 Essentially, this encourages a focus on the short term. Managers wanted to boost their salaries, so they made outlandish acquisitions, hoping to turn them profitable. Unfortunately, this strategy crippled Newell’s financial health, causing it to incur significant restructuring charges and losses. Additionally, if one division does poorly, but the company is rewarded as a whole for doing well, then this division will never learn from its mistakes. Related to this, G. Bennett Stewart says, “Managers of high-return businesses who consistently employ much of the cash thrown off by those businesses in other ventures with low returns should be held to account for those allocation decisions, regardless of how profitable the overall enterprise is.”7

Therefore, the company should do away with cash bonuses and increase the amount of equity that each manager receives. It will be in the form of a restricted stock to prevent them from cashing out immediately. Stewart emphasizes, “Most performance measures, for example, capture the results of a single period, while stock prices capitalize the value of good management decisions over the life of the business.”7 Binding management to the firm changes its motivation to seek long term success. Since managers have higher stakes in the company, they weigh their options more carefully.

The downside to this is that managers might cash out as soon as the restrictive covenant is up. Also, they may want to leave if most of their salary comes in the form of equity instead of cash. However, we believe that Newell will not be affected by these issues. Galli is passionate about turning the company around. His energy should inspire others to accept this change. Also, if managers do not support this strategy, they send a negative message about their current belief in the value of the firm. If they don’t believe the company can be turned around, Newell should seek new management. Secondly, although management may risk higher losses, there also exists an opportunity for greater returns. Over the past three years, only the CEO and one other executive officer’s salaries were over one million dollars. However, ownership in equity can increase management’s gains exponentially. Furthermore, when managers take equity-based compensation, it sends a strong signal to the market that management stands behind its company.

The determination of bonus size is important, because it needs to be awarded on a decentralized level, not only on the results of the company.7 Scott Company instituted a bonus payoff structure based on three areas: the corporation, the division, and the manager’s individual performance goals. Following Scott’s example, we recommend that bonuses be awarded 40% on divisional performance, 35% on company performance, and 25% on individual performance. Concerning the executives, Scott split the ratio equally between the company’s performance and managers’ individual performance goals.7

One downside of divisional bonuses is that competition between divisions becomes so fierce that it results in internal strife. However, our recommendation overcomes this problem, since the company’s overall health is taken into strong consideration when determining the bonus amount. Healthy competition can keep Newell responsive to the industry, while rewarding each division for their individual success.