Headquartered in Texas, Teletech Corporation operates under two main business segments: the Telecommunications Services segment, providing various telephone services to business and residential customers and the Products & Systems segment, which manufactures computing and telecommunications equipment. In late 2005, the Securities & Exchange Commission revealed that billionaire Victor Yossarian acquired a 10% stake in Teletech and demanded two seats on the board of directors. He felt that the firm was misusing their resources and not earning a sufficient return. He stated that Teletech should sell off its Product & Systems segment and focus on creating value for the company’s shareholders. A detailed analysis will reveal whether or not Teletech should follow Mr. Yossarian’s requests. Analysis
When focusing on value creation, the company needs to assess economic profit and net present value for each of its business units. As exhibited in the graph (Figure 1, page 224) prepared by Vice President of the Telecom Segment, Rick Phillips, the firm currently utilizes a constant hurdle rate attained through an estimate of Teletech’s corporate Weighted Average Cost of Capital (WACC). The WACC for Teletech Corp (as a whole) is calculated at 9.30%, which is then applied to all investment and performance-measurement analyses of the firm. When looking strictly at this, the Telecommunications Services is under performing with a return on capital of 9.10%. The Products & Systems segments is well over the required rate of return and appears to be the part of the company with no financial problems, earning a return on capital of 11.0%. Mr. Phillips suggests that multiple hurdle rates should be implemented since different business units have different risks. Utilizing one hurdle rate assumes equal risk in investing in either the Telecommunications segment or the P&S segment. He feels that the two segments are different in nature (risk and return) and because of that a risk-adjusted hurdle rate system should be required. Investors seek higher returns for riskier investments and would reasonably so, expect a lower return for investments with less risk. As such, the hurdle rates should be adjusted accordingly. The Products & Systems division is considered to have higher risk than the Telecommunications segment (high R&D and fixed asset costs, many write-offs due to the fast pace of technological changes, and financing of capital through high yielding debt and a greater proportion of equity). Therefore, the P&S segment should have a higher hurdle rate than the telecom hurdle rate. Referring back to the graph Mr. Phillips prepared, the Telecom and P&S segments are graphed in their respective places based on their adjusted risk. Looking at this, Telecom now is providing an acceptable return on investment while the P&S sector is not. Telecom is operating almost 1% over the adjusted hurdle while P&S is operating roughly 2% under the adjusted hurdle. This could be troubling for the P&S segment. . In favor of the current methodology is Helen Buono, Executive Vice President of the P&S segment. While Mr. Phillips feels the risk-adjusted rates best serves the company, Ms. Buono argues the constant hurdle rate produces the best results. She summarizes her opinion with the notion that “all money is green.” Ms. Buono implies that it doesn’t matter by what means you are profitable, it just matters that you are profitable. She states that investors are concerned with the company as a whole, rather than its individual parts. She feels that multiple hurdle rates are illogical and will destroy shareholder value since the company will not be meeting the corporate hurdle rate. Since Ms. Buono is VP of the P&S segment there is concern that her defending the single hurdle rate is an agency problem. Economic Profit is an important measure when considering manager promotions and incentive compensation packages. If her...
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