For most companies, the arrival of a cash-oriented strategy has followed a particular sequence. Before the fall of 2008, the economy was flush with cash, and businesses sought to boost their sales as fast as they could. At that point Lehman Brothers collapsed, followed by a widespread loss of economic liquidity. Revenues dried up, and companies sought to recoup the lost sales through cutbacks and efficiencies.
But for Leggett & Platt, a large diversified manufacturer, the strategy preceded the downturn. Ironically, the company had been pursuing a growth-at-all-costs approach for more than a century. Launched in 1883, the maker of engineered parts and products used in homes, offices, and cars achieved average annual sales growth of about 15% for many of those years, according to Matthew Flanigan, Leggett’s finance chief since 2003. By 2005, however, the company had been experiencing lower growth numbers over the previous three years. “We had stalled out,” Flanigan said in an interview with CFO earlier this month.
After some intense soul-searching, Flanigan and a group of senior managers led by a then-new chief executive officer, David Haffner, decided to take the company in a completely new direction. At the beginning of 2008, Leggett launched a strategy focused more on rewarding shareholders than increasing corporate revenues. Total shareholder return (TSR), the percentage increase in share price plus dividends over a given period, became the guiding metric.
By the time the economy turned south, the manufacturer had sold many of the flagging businesses it had acquired in its lust for revenue. Just in time for the downturn, cash became king. From January 1, 2008, through November 2, 2010, Leggett’s TSR has been 37%, noted Flanigan, adding that the company has ranked in the top 20% of the S&P 500 in terms of the metric over that time.
In this edited version of CFO’s interview with Flanigan, the finance chief told how Leggett put its cash-oriented strategy into practice.
What was the thinking behind the company’s strategic shift?
We weren’t creating much value for our shareholders, and that was a problem. Another was that our traditional growth story wasn’t coming together. Why was that? We concluded, after a lot of introspection, that we were no longer in markets that were growing at the rate we had seen. We weren’t able to do nearly as much M&A work in some of those markets, because we had grabbed market share through that kind of activity previously. We stepped back and said: ultimately, the people we report to are the folks who own this company, our shareholders. And we’re not generating a lot of value for the capital they are putting in our care.
As a result, we changed our focus from being all about growth — although growth is still important to us — to a TSR orientation. We concluded that we need to really use all four tools of TSR generation: margin improvement, dividend yield, revenue growth, and stock buyback.
How did you put the strategy into effect?
When we were very heavily oriented toward growing the company’s top line, we ended up spending quite a bit of our capital in pursuit of revenue growth that did not create a lot of value. That’s because either we made acquisitions that weren’t as valuable as we thought they would be or their margins or asset utilization were not acceptable.
One of the key changes we made in late 2007 was to look at all of what were then our 28 business units. We decided to sell some of them because they didn’t have a good competitive advantage and were more valuable to someone else. Now we have 19 business units.
We then decided to fund the businesses we retained that have a growth orientation. In the businesses we retained that were in markets that didn’t allow them to grow very significantly, we’ve tried to get the managers to focus on cash-flow generation and returns on capital. We’ve told them that since it’s not their mission anymore to try to grow 10% or 15% a year, they shouldn’t chase after growth if it’s not profitable.
Did you provide more concrete incentives?
One thing we did was to align TSR with the pay of a lot of our key managers: if we’re going to move to total shareholder return as a benchmark, we’re going to have part of their compensation tied to that over a three-year period. In that way, the anomalies of the equity markets would be smoothed out over a fairly long time frame so that the managers could get a clear picture of how their efforts in improving TSR have affected their compensation.
For example, if we determined that their units didn’t need to tie up a lot of money in working capital in order to grow sales, let’s reward them for not investing that capital through an adjustment in our compensation policies.
The easiest way to increase the top line is to lower prices. But if you’re not careful, the margins may not be what they need to be from a return standpoint. Some of our managers were glad to see us change that dynamic and focus on the capital you need to run your business well.
What have you done with the extra capital you’ve gained by shrinking your business?
Our aim has been to redeploy that capital towards our goal of more profitably growing business units or giving it back to our shareholders. And to a great extent that’s what has happened over the past two or three years. We’ve bought back about 18% of our outstanding shares over the past three years. As part of our strategic realignment on January 1, 2008, we increased our dividend 39% in one fell swoop.
That reinforced the message to our investor base that we are going to be more careful in our allocation of capital. Ultimately, we want to be able to tell shareholders that we will be paying them a higher dividend because we will only go into those opportunities that have cash-flow and capital-return potential.