Strategic Risk and Performance management by Strategy@Risk Ltd.

1. S@R Examples and Overview
application areas
Value based Strategic Risk and Performance Management achieves a
sustainable increase in enterprise value over time.
It represents an important tool for planning as well as for performance
measurement and for controlling purposes .
“S@R has set out to create models that boost income and save our clients time and money. Our models can give answers to
both deterministic and stochastic questions, by linking dedicated ebitda models to holistic balance simulation taking into
account all important factors describing the company. The basis is a real balance simulation model – not a simple cash flow
forecast model.”
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© Copyright 2006 Strategy@Risk Ltd. All rights reserved

2. I
II i. III
IV
Examples Application Areas
I. Budgeting
II. Strategic Risk and Performance
Management
III. Valuation under Uncertainty
IV. Investments
V. Mergers & Acquisitions
VI. Working Capital Strategy
VII.Selecting strategy (or M&A candidate)
VIII. Overview application areas
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3. I
Example: The EBITDA model used for Budgeting II i. III
Stress testing – creating better budget targets IV
Budget and simulation forecast are they 1
close or far off the actual result, and do
you know what is your realistic window of 0,8
Probability
opportunity? 0,6
Expected
Budget to low, but relatively small Actual 2007 0,4
deviation
Budget 0,2
1
310 320 330 340 350 360 370 380 390
Budget 0,8 EBITDA (NOK mill.)
Probability
Expected 0,6
Actual 2007 0,4 Budget to high and large absolute
deviation
0,2
400 500 600 700 800 900 100011001200 Location will give an absolute ranking of Alternatives.
EBIT (SEK 1000) Shape will give important information
on risk and opportunities – and show cost of
increasing sales targets
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4. Risk awareness gives better predictability I
II i. III
The learning effect – Steeper curve: decrease in IV
uncertainty
1
0,8
Probability
2007
0,6 2008
2009
0,4
0,2
0
-200 -150 -100 -50 0 50 100 150
Normalized Budget Uncertainty
Well organized enterprise risk management enables running the
business at a higher risk level in a controlled manner with a higher
company value as result.
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5. I
II ii. III
IV
ii. Strategic Risk and Performance
Management
5

6. I
II ii. III
S@R gives you the capability to achieve results IV
through your ERM
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7. I
Value creation with S@R – Guide to why SRM II ii. III
IV
should be on top managements agenda
Placing SRM in the corporate risk and finance
lancscape can be tricky. S@R has developed the U3
(Upper partial moment UPM1)
Shareholder value upside
The Board's risk U2
necessary methods and tools for securing better indifference curves U1
decision making, revealing total risk and (Risk aversion)
increasing shareholder value towards corporate
goals. Enterprise
M
c R Risk efficiency frontier
The figure depicts the relations between risk at egi
S tr
tolerance, the board’s risk indifference curves,
risk appetite, risk capacity and the risk efficiency ERM
frontier.
The risk efficiency frontier is found as the locus of
upside potential ratios where all unwanted
risk/uncertainty have been mitigated. What is left
is residual risk, assuming that the mitigation is 0
0 Downside Risk
effective. Risk reduction Risk appetite (Lower partial moment LPM2)
The enterprise utility function gives the board’s
preferences between risk and value.
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8. I
II ii. III
Enterprise risk exposure are used to define IV
risk appetite
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9. I
Risk appetite and Risk appetite is not II ii. III
IV
always the same …..
0,025 0,1
Spectral Risk = -86,2
0,02 Risk aversion weighted risk 0,08
Spectral Risk Weights
Probbability
0,015 0,06
0,01 0,04
Extended Tail Loss = -82,8
Average value of the area
0,005 0,02
0 0
-140 -120 -100 SR ETL
-80 VaR -60
Enterprise Value
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10. I
II ii. III
Benchmarking of sales channels IV
‐100 0 100 200 300 400 500
After simulations the result could 1 1
look like this: Ch #1
Ch #2
1. The blue curve is like a “cash 0.8 Ch #3 0.8
Ch #4
cow” doing good income
Probability
0.6 0.6
2. Green and brown curves are
challenging. By identifying the
0.4 0.4
critical success factors there are
great challenges to improve 0.2 0.2
businesses, but great uncertainty
1. Green from 100 up to 350
0 0
2. Brown from 50 up to 350 ‐100 0 100 200 300 400 500
Total income pr channel
3. Light blue is bad business and
may need a decision to go further
or not to go
Dog ‘Problem’ children Cash cow
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11. I
Benchmarking EBITDA profiles II ii. III
IV
We are finding that our clients are ‐100
1
0 100 200 300
1
increasingly addressing operational risk
Issues:
What is the future cash‐flow volatility of my 0.8 0.8
company and the individual BU’s?
Probability
What are the drivers of operational volatility 0.6 0.6
(Ebitda) and which drivers can we actively
Country # 1
manage and how? Country # 2 0.4
0.4 Country # 3
Which operational options should I Country # 4
pursue/prioritize? Country # 5
Economic i.e. hedge commodity prices, 0.2 0.2
contract product price, etc.?
Operational i.e. product/production 0 0
and single points of failure, etc.? ‐100 0 100 200 300
EBIT (mill.)
and strategic risk issues:
What are the expected value volatility of my company (equity/entity)?
What are the drivers of value volatility and which drivers should we actively manage and how?
Which strategic options should I pursue/prioritize?
Should I hedge exchange rates, commodity prices, etc.?
What are the expected effects of translation hedges?
In which BU’s should I continue to invest?
What Cost of Capital should I charge to the BU’s?
What financial leverage is most appropriate for my firm?
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12. I
The uncertainty of Debt and Equity II ii. III
IV
NPV distribution of Equity Transactions
100 100
The cumulative Debt and Equity 80 80
transactions and their yearly
Probability
60 60
probability distributions over the
simulated time period forms the 40 40
foundation for financial planning
20 20
They will give confidence intervals 0
‐200 0 200 400 600 800
0
1000
for future capital requirements for
both Debt and Equity NPV distribution of Debt Transactions
100 100
They will also form the basis for
80 80
contingency planning – if series of
probable but not likely events
Probability
60 60
should manifest capital
requirements in the right tail of the 40 40
distributions
20 20
0 0
6000 8000 10000 12000 14000 16000
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13. I
Uncertainty of Currency Rates , Tax and II ii. III
IV
Translation Risk
Currency Effects analyzed
Agio /Disagio from Operations: Balance Sheet Effects:
Currency effects On Cost Domestic or Functional Currency
Agio /Disagio on Cost Translation Effects
Currency effects On Sales Valuation Variation on
Agio /Disagio on Sales Debt and Assets
Translation Hedges
Financial Agio /Disagio: Tax Effects analyzed:
On Debt Balance Tax effects on cost of debt and equity
On Debt Interest Payments Tax effects on Exchange rate forecasts
On Debt Repayment Tax shields effects on debt
Tax Effects of Agio /Disagio Tax effects on enterprise
on Interest Payments Current and deferred taxes
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14. I
Translation Risk II ii. III
IV
Four methods for Translation Hedging are Each strategy will then change
provided: the probability distribution for equity
1. Fixed Gearing, value:
2. Proportional Debt to Assets,
3. All Debt in one Currency and Base or
functional currency and
4. All Debt in one Currency,
Given the Hedge ratio (0‐100 %)
This gives a number of different possible
strategies. Each strategy will have different
probabilities for Loss/Gain:
… adding further uncertainty to the
distribution for equity value
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15. I
II iii. III
IV
iii. Valuation under Uncertainty
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16. I
Valuation II iii. III
IV
2008 2009 2010 2011 2012
Invested Capital at Beg. of Period 14.339,6 16.714,9 18.719,4 20.650,6 22.411,9
Excess Marketable Securities ,0 ,0 ,0 ,0 ,0
OB - Excess Marketable Securities 925,1 ,0 ,0 ,0 ,0
Capital Charge 988,5 1.012,6 1.045,9 1.097,1 1.284,5
NPV of Translation Gain/(Loss) ,0 ,0 ,0 ,0 ,0
NPV of Forecasted EP (2.651,1) (2.802,5) (3.156,1) (3.437,2) (3.749,5)
NPV of Continuing Value (2.814,3) (2.984,8) (3.151,6) (3.319,0) (3.509,2)
--- -- ---------- ----- --------- --------- --------- --------- ---------
Value of Entity by EP 10.787,8 11.940,2 13.457,7 14.991,5 16.437,7
Book Value of Debt (7.860,7) (9.680,0)(11.681,8)(13.488,2)(13.829,6)
--- ----- -- ---- --------- ---------------------------------------
Value of Equity by EP 2.927,1 2.260,2 1.775,9 1.503,3 2.608,1
===== == ====== == == ======= ======= ======= ======= =======
And the corresponding probability distributions:
1
0,8
Probability
Value of Entity
0,6 Value of Debt
0,4
Value of Equity
0,2
0
0 100 200 300 400 500 600
USD
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17. I
Pricing of Capital II iii. III
Correct estimation of WACC is essential IV
Wacc is a stochastic variable thru volatility 16 1
Relative Cumulative Frequency
in earnings, interest rates, exchange rates, 14
0,8
expected return to equity etc: 12
% Frequency
10 0,6
8
6 0,4
Mean 5,08 4
0,2
S.D. 1,43 2
Minimum 1,44
0 0
Maximum 9,26 0 2 4 6 8 10
Lower Confidence Limit of Mean 4,90 Wacc
Upper Confidence Limit of Mean 5,25
This is a by product from the S&R simulation model
Most WACC calculations uses book values for debt and equity and fixed WACC for the next 3‐
5 years. Correct WACC can only be found thru simulation, solving for market value weights
giving changes in WACC from period to period.
S@R: http://www.strategy‐at‐risk.com/2010/02/08/wacc‐and‐infrastructure‐regulation/
http://www.strategy‐at‐risk.com/2008/09/08/the‐weighted‐average‐cost‐of‐capital/
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18. I
II iii. III
Uncertainty simulations and Sensitivity analysis IV
• Since the range (and their probabilities) are given for all variables in
the uncertainty analysis, the need for sensitivity analysis is greatly
reduced.
• By stopping the simulation and print a complete set of reports when
set criteria's has been exceeded the combined and simultaneous
effect of all variables can be studied.
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19. I
II iv. III
IV
iv. Investments
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20. I
II iv. III
Analyze and compare strategic Investments IV
If you are looking at investing alternatives or contemplating
possible M&A, the Equity Value distribution’s:
Probability Distribution for Enterprise Value of (mill USD)
Current operations, +Alt#1, +Alt#2 and +Alt#3
300 400 500 600 700 800
1 1
0,9 0,9
+Alt#3
1. Location will give an absolute 0,8
+Alt#2
0,8
ranking of alternatives 0,7 0,7
+Alt#1
2. Shape will give important 0,6 0,6
Probability
Probability
information on risk and 0,5
Current
0,5
operations
opportunities
0,4 0,4
3. Together the give all necessary
0,3 0,3
information for selecting1 the
0,2 0,2
dominant alternative
0,1 0,1
0 0
300 400 500 600 700 800
Enterprise Value (mill. USD)
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21. I
What is the probability of a strategy giving Loss? II iv. III
IV
Probability distribution for Value of Equity at Current Operations Probability distribution for Added value by
and with Strategic Project Added
Strategic Project and the Value of Commitments
80
80
70 70
60 60
Value added by Strategic Project
Probability
Current Operation 50
50
+Strategic Project
Probability
40
40 Cost of Commitments
30
30
20
20
10
Current
10
Operations
0
‐500 500 1500 2500 3500 4500
0 Value of Equity
-500 500 1500 2500 3500 4500
Value of Equity
Probability for Gain and Loss by Strategic Project
80
70
Area of Probable Gain
The important part now is the area below at 60
Probability
the point of intersection: 50
40
• Is it lower or above the company's Area of Probable Loss
30
accepted risk level ?
20
• Large potential, but – there is a 10
probability of 60% for loss – is it a sound 0
‐500 500 1500 2500 3500 4500
strategy ? Value of Equity
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22. I
II v. III
IV
v. Mergers & Acquisitions
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23. I
Acquisitions II v. III
IV
Probability Distribution for Value of
Company
1 1
If you have the distribution for Enterprise
0,8 0,8
or Equity value you can calculate the
Probability
0,6 0,6 Probability of loss from the acquisition
Expected Value = 153,42
0,4 0,4
OR
The bid price given the probability of gain.
0,2 0,2
0 0
0 50 100 150 200 Expected Loss from Acquisition
Enterprise Value
1 200
Expected Value = 153,4
‐Price (70%) = 167,4
Expected Loss =‐ 14,0 150
0,8
70%
100
Gain/(Loss)
0,6
Probability 167,4
50
0 50 100 150 200
0,4
0
‐14,0
0,2 Expected value‐Price ‐50
0 ‐100
Enterprise Value/Price
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24. I
Driving value through integration II v. III
IV
Does synergies exist and do they have a value?
… the company rated the likelihood of achieving each of the synergies at this point as
“unproven,” “possible” or “probable.” By updating its progress against its full set of
synergies — and the potential value of each synergy — the company was able to better
prioritize its efforts going forward.
Revenue increasing synergies: Cost decreasing synergies:
The more risk averse the less should The more risk averse the more can
be paid as merger premium be paid as merger premium
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25. I
II vi. III
IV
vi. Working Capital Strategy
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26. I
Working Capital II vi. III
IV
Different working capital strategies
will give different return on invested
capital and thus on company value.
It is however not straight forward to
find the best strategy since many
considerations regarding suppliers
and customers must be taken into
account and since most of those are
stochastic.
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27. I
II vii. III
IV
vii. Selecting strategy (or M&A candidate)
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28. I
Selecting strategy (or M&A candidate) II vii. III
IV
Selecting between strategies can be
Simple when the choices look s like this:
… but the choices can be difficult:
And you will need both theory and
methods to discern between them
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29. I
II III
IV
iiiv. Overview Application Areas
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30. Strategy@Risk
YOUR CONSULTING PARTNER IN RISK
Services Application area Use Results
Budgeting Stress‐testing
Cost and capital savings. Stabilize results.
Align budgets and results better.
Upside/downside potential Get an organization that better hits targets, reveal
Multi period uncertainties
and risk over‐or under achievements.
Make correct market/outlet choices.
Financial Communicate better with the investors and financial
market.
Planning and Know your expected multi‐period investments
testing necessary to increase sales.
Evaluate your market position Reveal market/product potential.
Financial planning Evaluate financial hedging strategies.
and potential for growth
Understand the future cash‐flow volatility of
company and the individual BU’s.
Find the financial leverage that is most appropriate
for the firm.
Analyzing Financial risk:
1. Currency risk
2. Transaction risk
3. Translation risk
4. Interest rate risk
5. Credit risk Making the company capable to perform detailed
6. Financing risk strategic planning.
Executing earlier and more apt actions against risk
Financial Balance simulation, holistic
Analyzing Operational risk: factors.
modeling Risk/opportunity models 1. Implementation risk Make the right and most profitable strategic choices
2. Country risk in line with company risk appetite and tolerance.
3. Repatriation of funds risk Get precise and correct multi‐period market
weighted cost of capital.
Balance risk:
1. Liquidity
2. Solvency
3. Equity/entity value
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31. Strategy@Risk
YOUR CONSULTING PARTNER IN RISK
Services Application area Use Results
Production processes
Compare strategic choices. Make the right investment choice.
Compare investments, M&A actions, their individual
Business Estimate necessary capital and value, necessary commitments and impact on
Development Plant location and plant sizing
investment requirements. company
Get todays and future capital requirements right.
Investments Comparing business units, country
units or product lines – decide Be able to compare effectiveness, robustness and
Choice of sales channel allocation and need for resources. results from different sales channels and suppliers.
Choice of supplier Be able to chose focus and invest resources in the
Compare risk, opportunity and right products, countries and production by
Markets uncertainty expected profitability. understanding their requirements and contribution to
Business
the group.
Strategy Carry out professional demand Be able to make better investment/divestment
modeling. decisions.
Boost results by analyzing and acting on revealed and
Demand modeling
Be able to analyze and incorporate transparent risk and opportunity simulations.
markets uncertainties. Risk priced transactions ‐ Improved allocation ‐
Optimized costs and efficiencies
Product pricing – asset pricing
Benchmark M&A candidates profiles, M&A initial and
M&A Valuations, capital cost and
future estimated capital requirements
requirements, individually and
Decision Contracts Identify and benchmark an investment portfolio
effect on company
support and/or individual business units’ risk profiles
Improve predictability in operating earnings at risk
Due Diligence
Divestments/ Asset sales that may impact corporate financial position and
performance
Risk/ Strategic Risk And
Act on and plan based on your Plan and act according to risk strategy
Opportunity Performance Management
whole Risk‐opportunity situation Establish risk tolerance and risk appetite
Management ERM quantification Develop risk mitigating strategies
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