Lee Coppack discusses the problems that have eroded shareholder value for ABB
The biggest risk to shareholder value is corporate insolvency, since holders of ordinary equity rank very far down in the list of creditors if a business is wound up. When the directors of a company state that the management has been forced to concentrate intensely on ensuring the company's ability to continue on a going concern basis, it is clear that their ability to manage risk has become critical.
ABB, a power and automation technology group, followed the now familiar pattern of a business led by a charismatic individual growing to global status by merger and acquisition. Former chairman and CEO of ABB, Percy Barnevik was for a time one of the most admired business people in the world. He was credited with having overseen the cross-border merger of Asea and Brown Boveri in 1988 to create ABB, a Swedish-Swiss group with over $19bn annual revenues in 2000.
By then, however, the trail of acquisitions had also resulted in a mountain of debt, unsustainable diversification and asbestos liabilities from a now inactive US subsidiary, Combustion Engineering, which have cost the company nearly $1bn in additional provisions in the last three years alone.
Market capitalisation peaked in 2000 with the share price at SFr53 ($91.4 at contemporary rates) and then made an alpine descent. The price finally hit SFr1.63 ($1.10) in October 2002 when the company revealed it would miss its target of earnings before interest and tax (EBIT) for the year. The economic slowdown was affecting the underlying business in addition to longer term problems, and ABB ultimately reported a loss of $787m for 2002, following a similar loss in 2001. Shareholders' equity fell from $5.2bn at 31 December 2000 to just $1.0bn two years later.
Today, a different group of directors and senior managers has the job of trying to restore ABB to health. Barnevik resigned unexpectedly as non-executive chairman and board member in November 2001, taking 'my share of responsibility for the less good performance of ABB in recent years.' Jürgen Dormann, an ABB board member often described as a company doctor, took over as chairman from Barnevik, and in September 2002, also assumed the role of CEO. A new chief financial officer, Peter Voser, joined from Shell Worldwide Oil Products in early 2002.
As Worldcom and Enron unravelled on the other side of the Atlantic, it emerged that Barnevik and his successor as CEO, Göran Lindahl (who left the group in January 2001), had received exceptionally generous pension and other rights, unbeknown to the board. In February 2002, Barnevik and Lindahl agreed to hand back a total of SFr137m, but in the charged atmosphere, the damage was done.
Risk reporting
In the company's 2000 annual report, Barnevik was bullish about prospects for growth, and there was no warning sounded in the group or statutory auditors' report. Then president and CEO Jörgen Centerman predicted that in 2001 revenues would increase and EBIT and cash flow would be 'well above' the 2000 levels. Uncertainty over the asbestos exposure was covered in a note headed 'contingencies related to former power generation businesses', which warned that although the resolution of the litigation could have a material effect on the company's results for a particular period, 'management believes the litigation should not have a materially adverse effect on the company's consolidated financial position or liquidity.'
"I think the evidence that ABB could be in serious trouble only came out with the 20-F," says Alex Migliorini, a sector analyst with Pictet in Geneva, referring to the document that ABB filed with the US Securities and Exchange Commission (SEC) ahead of its listing on the New York Stock Exchange less than two months later. "That was when the company really began to speak openly about the asbestos problem, and other things became clear, such as the degree to which capital gains on asset sales were supporting profits. Combined with the switch to US GAAP, which required a lot more information, this gave us a totally different picture of where the underlying business was going."
A whole section of the 20-F is devoted to risk factors. Likewise, the company's SEC filings for 2001 and 2002 include a section on risk factors. The report and accounts do not, but there is no mistaking the scale of the risks set out in the 2002 financial report. The management overview is brief but clear: 'Our low equity base, high debt levels and the uncertainty with respect to the timing of the resolution to the asbestos issue have impacted our ability to finance our core and non-core operations and to repay maturing debt.'
The group auditors Ernst & Young are blunt: "The existence of the asbestos-related issues of the company's subsidiary, Combustion Engineering, and the restrictive aspects relating to the company's credit facility, as discussed above, result in uncertainty as to ABB Ltd's ability to continue as a going concern."
The primary listing of ABB's shares is on the SWX Swiss Exchange and the Stockholm bourse. Neither the Swiss nor the Swedish codes of corporate governance specify risk reporting requirements. The Swiss Code of Best Practice for Corporate Governance, published in July 2002, says only that the board of directors should provide systems for internal control and risk management suitable for the company, and that, depending on the nature of the company, the internal control system should cover risk management. This should apply to both financial and operational risks.
Sweden's Corporate Governance Guidelines for Better Control and Transparency for owners of companies quoted on the Swedish stock market, published in October 2001, are even briefer on the subject. They say only that the board is responsible for ensuring that the company's internal and external accounting fulfils the highest possible requirements concerning, among other things, audit, control and risk management.
Richard Nash, executive director with Heath Lambert global business solutions with responsibility for Scandinavia, comments: "Swedish companies still tend to see risk management along traditional lines, with the treasury function completely separate from other risks, and other risks generally looked at in terms of insurance, fire, explosion, and so on - those that you can buy a policy for."
ABB, nevertheless, got high marks for its 'triple bottom line' reporting - economic, environmental and social performance - in a study of risk reporting standards by major European companies in 2001, conducted by Chris Lajtha and Pierre Bordage of the Schlumberger Risk & Insurance Management Team in Paris and students of the Institut de Management des Risques at Bordeaux Business School and published in October 2003.
Restoring shareholder value
In July 2003, ABB reported a first half loss of $55m, but made a profit on continuing operations, and Dormann's comments were positive. A US court approved a settlement of Combustion Engineering's asbestos liabilities and, with progress on disposal of non-core businesses, the share price climbed. By autumn, however, confidence had began to falter as opponents of the asbestos settlement appealed to a higher court.
The end of October brought more encouragement. With the announcement of its nine months results for 2003, ABB revealed a recapitalisation plan to secure long term financing, and announced that it had signed a preliminary agreement to sell most of its upstream business in the oil, gas and petrochemicals division to a private consortium. A hearing of the asbestos case has been set for 16 December.
Just ahead of the announcement, Alex Migliorini had a neutral rating on the shares. He is cautious and warns that the balance sheet is still very stretched but says: "I still believe that Dormann will be able to turn it around, as long as asbestos disappears. He has done it before at Hoechst, and there is value in the strong franchises."
Transparency has improved, he says, although not to the level he would like. He is also sympathetic to a management concentrating on fixing the problems rather than talking about them. "They have a lot of work to do."
The extent to which corporate governance can address the sort of risks that have so eroded shareholder value at ABB is doubtful, according to Steve Marshall, the last CEO and former finance director of Britain's short-lived, privatised rail network operating company, Railtrack. He believes that although current corporate governance priorities are right, they only address about 10% of the issues that lead to destruction of shareholder value.
Speaking on the theme of 'The pursuit of value: managing risk, regulation and reputation', at the Institute of Risk Management annual conference in October 2003, he said: "The precursors to value-destructive errors are usually the same. The lead cause is almost always a blurring of the board's focus on value, rather than a failure of corporate governance process or compliance."
Lee Coppack is a risk management writer and analyst, E-mail: lee@coppack.co.uk
