Euromoney Institutional Investor PLC

Turnaround Value and Valuation: Reassessing Scott Paper

Author(s): Joseph Calandro, Jr.
Source: The Journal of Private Equity, Vol. 15, No. 1 (WINTER 2011), pp. 67-78
Published by: Euromoney Institutional Investor PLC
Stable URL: https://www.jstor.org/stable/43503701
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Joseph Calandro, Jr.
is a faculty member in the
Finance Department at the
University of Connecticut
in Storrs, CT.
joseph.calandro@business.uconn.edu
Winter 2011 The Journal of Private Equity 67
Turnaround Value and Valuation:
Reassessing Scott Paper
Joseph Calandro, Jr.
after buying Scott." However, Weston, et al.
returns to decline due to reduced [1998] observed that "At the time of the Scott
acquisition [July of 1995], Kimberly-Clark 's
consumer demand and lower prices,
Economic resulting returns consumerresulting
to distress demand in decline lowerin
can and duelower
cause market lower to corporate
market reduced valua- prices, valua-
stock price was about $60. On August 29,
tions. Managements unable to address such
1997, it had risen to $110." It is not our objec-
tive to become embroiled in the controversy
situations are replaced, frequently by someone
skilled in turnaround management, which is surrounding
the Dunlap; rather, we use the Scott
process of changing - sometimes radicallycase
- a to illustrate an approach for assessing
firm's structure (operating and/or capital)turnaround
to value that includes pre- and post-
return it to profitability. There have beenturnaround valuation considerations, as well
many successful turnarounds in history, such
as exit planning. The timing of this approach
as at Chrysler (Iacocca [2007 (1984)]), IBM
could be significant because, according to
(Gerstner [2002]), and Bank One (Marshallsome observers, there is a scarcity of pro-
and Thedinga [2006a, 2006b]), but one of fessionals
the skilled in turnaround analysis and
most dramatic arguably occurred at the Scott
management.1 If that observation is correct,
Paper Company (Scott) in the mid-1990s. turnaround-related opportunities could
emerge if current economic risks manifest
Scott's turnaround was led by "Chainsaw"
Al Dunlap. At Scott, Dunlap lived up to hisand corporate returns decline.
nickname as that turnaround involved firing Before presenting the approach we first
provide an overview of the distress that gen-
35% of the firm's workforce (or 11,000 people;
erated the need for a turnaround at Scott.
Weissman [1999]). However, the results it pro-
duced were dramatic: In slightly more than
one year the market value of Scott increased
SCOTT PAPER COMPANY
from approximately $2.8 billion to approxi-
mately $9.4 billion, which is the price Kim- In 1990, the economic prospects at Scott
berly-Clark paid to acquire Scott. seemed very positive: After seven profitable
Following Scott's acquisition, Dunlapyears the firm decided to expand capacity to
was appointed CEO of Sunbeam where produce more of its consumer paper products
performance issues led to his dismissal and
(such as toilet tissue, paper towels, and paper
continue to shroud him in controversy. Thenapkins). This expansion seemed rational given
controversy even extends to his turnaroundthe firm's performance at the time, a profile
of Scott; for example, Weissman [1999] of which is provided in the left-hand por-
claims that "Kimberly-Clark stumbled badly
tion of Exhibit 1. However, Scott's expansion
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Exhibit 1
Scott's Sales and Operating Margin History

$5,500 T I t20%

! [g] p
16.1% [3I i ® S g ra
$4,500 - [AI 1 1 ~ « õ> s 2
A' [AI 5- I ~ * a «
/ S S 13.0% /|'» S S 1 * a
$3,500 11-1* 11.1% y4AA„ ' .
A-^IO.rA^Ť

/ ri 2 ' 10% ■§ o
7.8% / lo I cö ai V 3
g jy / RH a « co ' » 8.1% ~
I
W g ¿
$2,500 - v
5 s Si nň RH
' W s 5 8
¿ S » Si ! v V
:'/''
i Vi.o% '
» ' -0%
$500 -- j '
' l'I ' I ' ' l'I I'* I'* 1 I 1 ^ 1 ^ 1 V-3,2%
1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
-$500 1 i-5%

Data: Gilson [1997a, p. 13]; all calculations are the author's.

In most
turned out to be poorly timed in that valuations,
"1990 EPV will reconcile with NAV
marked
because
the 'beginning of one of the tissue most firms do worst
industry's not operate with either a sus-
downturns.'"2 That downturn mirrored the national tainable competitive advantage or with significant per-
economy's, which was in recession from July 1990 toformance issues; as such, a level of income is earned
March 1991. 3 Scott's management responded to the that is commensurate with the reproduction value of
the assets. We refer to this relationship as "base case
downturn by initiating a variety of operational improve-
value" (Calandro [2009]), which is illustrated in Panel
ment initiatives, but none took hold. Therefore, in April
of 1994, the firm appointed Dunlap its chairman of the A of Exhibit 2. Notwithstanding the common occur-
board and CEO. rence of this pattern, it can reflect a lucrative acquisi-
At the time of Dunlap's appointment, Scott's tion opportunity if the target is available at a reasonable
market value was approximately $2.8 billion.4 To assessdiscount from estimated value (or margin of safety);
this value for turnaround opportunity purposes, we examples
sub- include Berkshire Hathaway 's acquisitions of
Burlington Northern Railroad (Calandro [2010a]) and
ject Scott to formal valuation using the modern Graham
and Dodd approach. Well known to "value investors," Clayton Homes (Calandro [2010b]). However, some
this approach begins by reproducing a firm's balance valuations can result in different patterns:
sheet to derive a more economically consistent net asset
value (NAV). It then estimates a firm's earnings power • If EPV is significantly greater than NAV - Panel B
value (EPV) by selecting a level of past earnings that areof Exhibit 2 - it suggests the firm is a "franchise"
expected to be sustainable into perpetuity. The relation-if it is operating with a sustainable competitive
ship between these two values is fundamental to the type advantage (which is what over time drives the
of firm being valued, including a turnaround. EPV to NAV spread). Franchises are attractive
acquisitions when priced reasonably, such as

68 Turnaround Value and Valuation: Reassessing Scott Paper Winter 2011

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Exhibit 2
Valuation Patterns

Panel A: Panel B: Panel C:

Base Case Value Franchise Value Turnaround Value

EPV

Note: NAV = net asset value; EPV = earnings power value.

Exhibit 3
Scotťs Pre-Turnaround Valuation

$8,000 -,

$7,000 -

$6,000 -
$5,125
$5,000-

$2^84

jQ

NAV EPV MV

Notes: MV = market value (Gilso

NAV represents the preliminary va

Berkshire Hathaway 's

consistent with the EPV. As an example, consider 1
(Calandro [2011,
our pre-turnaround valuation 2009])
of Scott illustrated
• If EPV is in Exhibit 3.
significantly
of Exhibit 2 - it reflects
opportunity. To understa
which represents
PRE-TURNAROUND VALUATION the
without performance issu
stands to Based on Exhibit 3,
reason Scott's market value
that the is v
at least preliminarily, re
tually identical to our EPV, which is considerabl
between NAV and EPV when the market value is than our NAV, thereby signaling a potential turn

Winter 2011 The Journal of Private Equity 69

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opportunity. To explain how we derived this valuation
we begin with NAV as shown in Exhibit 4, a paren-
thetical note designating an adjustment that is discussed
below.
Note (1 A) adds the bad debt provision - from page
91 of Scott's 1993 Form 10-K - to estimate the repro-
duction value of receivables. It is necessary to add this
provision back for reproduction purposes because:
A new firm starting out is even more likely to
get stuck by customers who for some reason or
another do not pay their bills, so the cost of repro-
ducing an existing firm's accounts receivables is
probably more than the book amount. Many
financial statements will specify how much has
been deducted to arrive at this net figure. That
amount should be added back (Greenwald, et al.
[2001, p. 56]).

Exhibit 4
Scotťs Pre-Turnaround NAV

$ in 000,000s
1993 Adjustment Value Notes
Assets
Current assets $1 ,609.9 $1 ,761 .8
Cash and cash equivalents $133.6 100% $133.6
Receivables $600.3 $25.3 $625.6 (1A)
Inventories $523.7 $126.6 $650.3 (2A)
Deferred income tax asset $277.9 100% $277.90
Prepaid items and other $74.4 100% $74.40
Plant assets, at cost $7,298.9 $7,298.9
Accumulated depreciation -$3,275.0 $3,275.0 $0.0 (3A)
Timber resources, at cost less timber harvested $1 1 3.0 1 00% $1 1 3.0
Investments in international equity affiliates $223.8 100% $223.8
Investments in and advances to other equity affiliates $84.1 100% $84.1
Construction funds held by trustees $87.1 100% $87.1
Notes receivable, goodwill and other assets $483.3 -$220.0 $263.3 (4A)
Goodwill adjustment $1 ,246.4 $1 ,246.4 (5A)
TOTAL ASSETS $6,625. 1 $11 ,078.4

Liabilities

Current liabilities

Payable to suppliers and others $891.5 100% $891.50

Accruals for restructuring programs $639.0 100% $639.00
Current maturities of long-term debt $180.2 100% $180.20
Accrued taxes on income $59.1 100% $59.10

Long-term debt , $2,366.2 100% $2,366.2

Deferred income taxes and other liabilities $913.4 0.8100 $739.9 (6A)
Preferred stock $7.1 100% $7.1
Operating leases $194.5 $194.5 (7A)
Stock options - $180.3 $180.3 (8A)
Total Projected Benefit Obligation (Pension) - $695.2 $695.2 (9A)
TOTAL LIABILITIES & PREFERRED STOCK $5,056.5 $5,952.9

NET ASSET VALUE (NAV) $1 ,568.6 $5,125.4

Source: Scott 1993 Form 10-K; all adjustments are the author's.

70 Turnaround Value and Valuation: Reassessing Scott Paper Winter 2011

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 Note (2A) adds back the LIFO reserve of ment of $1,246.4 million.8 This is another adjustment
$126.6 million to estimate the reproduction value ofthat could be validated if this was a live valuation, pos-
Scotťs inventories.5 sibly by a consulting or marketing firm.
Note (3A) adds accumulated depreciation onto the Note (6A) discounts deferred taxes and other lia-
balance sheet to estimate the reproduction value of Scott's bilities by an 11.11% discount rate at an assumed duration
plant assets. If this was a live valuation, licensed appraisers of two years.9
could be retained to validate this adjustment. Note (7A) adds operating leases onto the balance
Note (4A) subtracts a $220 million note receiv- sheet from the footnotes of the Form 10-K (p. 99).
able (from Crown Pacific Ltd.), on the assumption that Note (8A) adds the option liability onto the balance
such a note is not needed for reproduction purposes.6 sheet as the product of options outstanding at the end of
In other words, if one had to reconstruct Scott Paper the year (4,365) and the average price ($41.30). 10 Finally,
from scratch, this note would not be required in that note (9A) is the pension obligation that was estimated
reconstruction. as the difference of accumulated benefits exceeding the
Note (5A) pertains to goodwill , which in a modern assets ($1,128.2) and assets that exceed accumulated ben-
Graham and Dodd context refers to the intangible assets efits ($433). 11 In practice, pension actuaries could be
retained to validate adjustments like this one.
a firm uses to create value, such as its product portfolio,
brands, and so on, which in this case were significant. Subtracting the reproduction value of the assets
from the reproduction value of liabilities gives our NAV
To explain why, consider that "Scott invented the paper
of $5,125.4 million. As this value is driven by several
towel," thereby creating significant brand recognition
in what became a sizeable industry.7 Scott also engaged
significant assumptions - such as estimated plant assets
in extensive advertising that further strengthened its(3A) and goodwill (5 A) - it will be validated by earnings
power. Proceeding therefore to the EPV, it is presented
brand, which was strategically significant because con-
sumer paper products are commodities. According to in Exhibit 5 and divided into three blocks: the first block
D'Alessandro [2001]: encompasses notes (IE) to (6E) inclusive, the second
pertains to notes (7E) to (11E), and the third, notes
You can trade in commodities and try to win on (12E) to (18E).
price alone, a depressing downward spiral, given The first block begins with an estimate of Scott's
the almost limitless competition most businesses sustainable operating earnings. Because EPV is based on
face today. That's why, in many industries, the a level of past earnings that is expected to be sustainable
smart commodities producers are turning their into perpetuity, we conservatively based this estimate on
commodities into brands and commanding a Scott's average operating margin from 1984 to 1989 and
premium for them. Increasingly, consumers no the amount of its then most recent (1993) annual sales,
longer just reach for milk; they reach for Horizon which gives $574.5 million (note (IE)).12
Organic milk at almost twice the price. They Note (2E) pertains to the depreciation adjustment,
don't drink unbranded water from the well or the mechanics of which are presented in Exhibit 6.13 The
from the reservoir; they drink Evian or one of calculations are self-explanatory except for one: as rev-
hundreds of other brands of bottled water at over enue fell from 1992 to 1993, we used the revenue change
a dollar for a little bottle, (p. 13) from 1991 to 1992 in the calculation on the assumption
« it is relatively sustainable over time.
When valuing goodwill like Scott's, the modern Note (3E) deducts interest earned on cash: As the
Graham and Dodd approach "add[s] some multiple of present value of interest is the amount of cash on the
the selling, general, and administrative line, in most cases balance sheet, we deduct interest earned (from p. 100
between one and three years' worth, to the reproduc- of the Form 10-K) and will add cash in later (note (17E)
tion of the assets" (Greenwald, et al. [2001, pp. 61-62]). below).
Multiplying Scott's 1993 marketing and distribution Note (4E) is the options expense, which was derived
expense of $598.7 million and its research, adminis- by multiplying the change in options outstanding over
tration, and general expense of $232.2 million by the the year (605.2 = 4,365 - 3,759.8) by the average price
middle ofthat range, or 1.5, gives our goodwill adjust- ($41. 30).14

Winter 2011 The Journal of Private Equity 71

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 Exhibit 5
Scotťs Pre-Turnaround EPV

$ in 000,000s

Expected Sustainable Operating Earnings $574.5 (1 E)

Depreciation Adjustment $31 .7 (2E)
Interest Earned on Cash $14.6 (3E)
Options Expense $25.0 (4E)
Accrued Post Retirement Benefit Cost $78.1 (5E)
Sustainable Pre-Tax Earnings before NOLs $488.5 (6E)

Percent of Sustainable Realized 50% 75% 100% (7E)

Pre-Tax Earnings $244.3 $366.4 $488.5 (8E)
Net Operating Loss (NOL) Carryforwards $105.2 $35.1 $0.0 (9E)
Taxes $37.6 $89.5 $131.9 (10E)
Preliminary Earnings $206.7 $276.9 $356.6 (1 1 E)

Discount Rate 11.11% 11.11% 11.11% (12E)

Earnings $206.7 $276.9 $3,209.8 (13E)
Present Value Factor 0.9000 0.8100 0.7290 (14E)
Present Value of Earnings 186.0 224.3 2,340.0 (15E)
Earnings Power 2,750.3 (16E)
Cash 133.6 (17E)
Earnings Power Value (EPV) 2,883.9 (18E)

Note: Restructuring charges are not explicitly accounted for in order to simplify the analysis; in prac
to assess the required accounting.
Source: Scott 1993 Form 10-K; all calculations are the author's.

Exhibit 6 Note (5E) reflects the accrued post-retirement

benefit cost from the footnotes of the Form 10-K
Scotťs Depreciation Adjustment
(p. 103).
Calculation $ in 000,000s Adding the depreciation adjustment (2E) to
(a) Plant, Net $7,298.9 expected sustainable operating income (IE) and
(b) 1 992 Revenue $5,091 .3 then subtracting interest earned on cash (3E), the
(c) 1991 Revenue $4,959.3 options expense (4E), and the retirement benefit
(e) dépréciation & Amortization $300.3 cost (5E) gives our Sustainable Pre-Tax Earnings
(f) CAPEX $457.8 before NOLs (net operating losses) of $488. 5 million
(9) = [(a)/(b)] X [(b)- (c)] Growth CAPEX $1 89.2
(note (6E)).
(h) = (f) - (g) Zero Growth CAPEX $268.6
Turning to the middle block of calculations:
(i) = (d) + (e) - (h) Depreciation Adjustment $31 .7 Note (7E) pertains to the percentage of earnings
that are expected to be realized each year of the
Source: Scott 1993 Form Î0-K, all calculations are the author's. turnaround. Because turnarounds often take time
to implement, it is frequently necessary to develop,
or layer in, earnings over time. For purposes of this

72 Turnaround Value and Valuation: Reassessing Scott Paper Winter 2011

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valuation we developed earnings sequentially over three Turning to EPV, our expected sustainable oper
years. In practice, performance management consultants earnings for Scott (note (IE) in Exhibit 5) is ba
could be retained to help formulate or validate adjust- its average operating margin from 1984 to 1989 (
ments like this. and the amount of sales booked in 1993. As D
Note (8E) is simply the product of the percent- was known to drastically cut costs, for purpo
ages reflected in note (7E) and the earnings given in this valuation we estimated a sustainable 45% ma
note (6E). improvement from Scott's highest historical mar
Note (9E) pertains to NOL carryforwards as 16.1% (see Exhibit l),16 and applied it against the
reflected in Scott's 1993 Form 10-K (p. 96): 75% of second highest sales prior to its 1990 expansion.17
the NOLs were applied in 1994 with the remainder so resulted in expected sustainable operating ear
applied in 1995 for illustration purposes. In practice, of $1,061.8 million (= 23.3% X 1998 sales of $4
tax accountants and/or attorneys could be retained to as shown in Exhibit 8. 18
ensure NOLs are applied in a manner consistent with Dunlap also had the reputation for quick t
all rules and regulations. arounds (Dunlap and Andelman [1997], p. 11); ther
Taxes (note (10E)) were derived by first subtracting we developed earnings more quickly as shown in
NOLs (note (9E)) from pre-tax earnings (note (8E)), (7E) of Exhibit 8. Holding all other assumptions
and then multiplying by an assumed effective tax rate of Exhibit 5 constant gives an EPV of $5,899.3 mill
27%.15 Preliminary earnings, note (11E), are simply the Because our post-turnaround EPV is greater
difference of pre-tax earnings (6E) and taxes (10E). our NAV, it reflects a potential franchise (Pa
Note (12E) is our aforementioned discount rate, Exhibit 2). To validate the franchise, consider our
and note (13E) is our earnings estimate: for the years comments regarding Scott's goodwill and the stre
1994 and 1995 the earnings are simply carried down from its brand, which was built up over a considerable
(11E); for 1996, the preliminary earnings were capital- of time: Scott was formed in 1879, and by the beg
ized at the discount rate ($3,209.8 = $356.6/11.11%). of the 20th century had formulated a strategy "t
Note (14E) is the present value discount factor only a few high-quality products, to sell them at
that, when multiplied by earnings (note (13E)), gives a cost as possible, and to keep them in the publi
the present value of earnings (note (15E)), which when with high-profile advertising."19 Significantly, D
summed equals earnings power (note (16E)). Adding turnaround was consistent with this strategy via its
the cash from the balance sheet (note (17E)) gives our on core products (e.g., divesting non-core asse
EPV (note (18E)). cutting costs (assuming Scott's marketing effort
Based on this valuation, Scott's preliminarily turn- be continued); therefore, it is reasonable to co
around opportunity amounts to a return of approxi- that the turnaround would transform Scott back into a
mately 82% based on improving its market value (via franchise upon its successful completion.
earnings improvement) to a level commensurate with its In light of this, Scott's growth value can be assessed
NAV. However, this return assumes the turnaround will as shown in Exhibit 9. In Graham and Dodd valuation,
occur off of the asset base and cost structure reflected in growth only creates value when a firm's EPV is greater
the valuation, which is not consistent with how Dunlap than its NAV, and thus growth is only applicable to fran-
approached Scott. Therefore, it is necessary to value the chises. As shown in the exhibit, our estimated growth
impact of his expected turnaround actions. value of $7,380.4 million is significantly greater than
Scott's $2,810 million market value at the time, but it
POST-TURNAROUND VALUATION is not the figure we would have suggested targeting in
exit planning.
Starting with NAV, Dunlap stated that he sold
approximately $2.4 billion of Scott's non- core
EXIT assets to AND CONCLUSION
PLANNING
pay off its debt (Dunlap and Andelman [1997], p. 69),
which could have been anticipated for valuationOur growth value assumes a reinvestment rate
purposes.
In Exhibit 7, we adjust the NAV presented in approximately
Exhibit 4 to 14% (note (c) in Exhibit 9), which
reflect these actions, which did not changesubstantial
the value.hurdle for a firm in a mature industry

Winter 2011 The Journal of Private Equity 73

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Exhibit 7
Scott's Post-Turnaround NAY

$ in 000,000s
1993 Adjustment Value Notes
Assets
Current assets $1 ,609.9 $1 ,761 .8
Cash and cash equivalents $1 33.6 1 00% $1 33.6
Receivables $600.3 $25.3 $625.6
Inventories $523.7 $126.6 $650.3
Deferred income tax asset $277.9 100% $277.90
Prepaid items and other $74.4 100% $74.40
Plant assets, at cost $7,298.9 -$2,400.0 $4,898.9 (1A)
Accumulated depreciation -$3,275.0 $3,275.0 $0.0
Timber resources, at cost less timber harvested $1 1 3.0 1 00% $1 1 3.0
Investments in international equity affiliates $223.8 100% $223.8
Investments in and advances to other equity affiliates $84. 1 1 00% $84. 1
Construction funds held by trustees $87. 1 1 00% $87. 1
Notes receivable, goodwill and other assets $483.3 -$220.0 $263.3
Goodwill adjustment $1 ,246.4 $1 ,246.4
TOTAL ASSETS $6,625.1 $8,678.4

Liabilities
Current liabilities $1 ,769.8 $1 ,736.0
Payable to suppliers and others $891 .5 1 00% $891 .50
Accruals for restructuring programs $639.0 100% $639.00
Current maturities of long-term debt $180.2 -$33.8 $146.40 (2A)
Accrued taxes on income $59. 1 1 00% $59. 1 0
Long-term debt $2,366.2 -$2,366.2 $0.0 (2A)
Deferred income taxes and other liabilities $91 3.4 0.81 00 $739.9
Preferred stock $7.1 100% $7.1
Operating leases $194.5 $194.5
Stock options - $180.3 $180.3
Total Projected Benefit Obligation (Pension) - $695.2 $695.2
TOTAL LIABILITIES & PREFERRED STOCK $5,056.5 $3,552.9

NET ASSET VALUE (NAV) $1,568.6 $5,125.4

Source: Scott 1993 Form 10-K, all calculations are the author's.

Scott. Therefore, for exit planning Conservatism is a fundamental

purposes wetenetwouldof Graham
have suggested conservatively andtargeting
Dodd valuation a that
value
extends midway
to exit planning. For
between our growth value and post-turnaround EPV,
example, Neff and Mintz [1999] observed that:
as reflected by the horizontal dotted line in Exhibit 10.
Doing so results in a lower price target ($6,639.8
Instead of groping for the last million);
dollar, we gladly left
nevertheless, it still equates to a some
136% upsidereturn (based
on the table for buyers asonthey awak-
Scott's $2,812 million market value ened toatour the time).
fundamental case. Catching market

74 Turnaround Value and Valuation: Reassessing Scott Paper Winter 2011

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 Exhibit 8
Scotťs Post-Turnaround EPV

$ in 000,000s
1994 1995 1996 Notes

Expected Sustainable Operating Earnings $1,061.8 (1E)

Depreciation Adjustment $31 .7 (2E)
Interest Earned on Cash $14.6 (3E)
Options Expense $25.0 (4E)
Accrued Post Retirement Benefit Cost $78.1 (5E)
Sustainable Pre-Tax Earnings before NOLs $975.9 (6E)

Percent of Sustainable Realized 75% 100% 100% (7E)

Pre-Tax Earnings $731.9 $975.9 $975.9 (8E)
Net Operating Loss (NOL) Carryforwards $105.2 $35.1 $0.0 (9E)
Taxes $169.2 $254.0 $263.5 (10E)
Preliminary Earnings $562.7 $721.9 $712.4 (1 1 E)

Discount Rate 11.11% 11.11% 11.11% (12E)

Earnings $562.7 $721.9 $6,412.1 (13E)
Present Value Factor 0.9000 0.8100 0.7290 (14E)
Present Value of Earnings 506.4 584.7 4,674.6 (15E)
Earnings Power 5,765.7 (16E)
Cash 133.6 (17E)
Earnings Power Value (EPV) 5,899.3 (18E)

Source: Scott 1993 Form Ì0-K, all calculations are the author's.

A 136% return is significant, but it pales in com

Exhibit 9
parison to the return Scott earned when Kimberly-Cl
Scotťs Post-Turnaround Growth Value
acquired it at the windfall price of $9.4 billion. Inve
ments sometimes result in windfalls, which may arise du
Calculation $ in 000,000s
to the emergence of a "greater fool" or for valid strateg
(a) = (9A) Net Asset Value $5,125.4
reasons. For example, Porter [2008] argued that, "Th
(b) = (1 1 E) Earnings $712.4
best companies realize they are not just acquiring com
(c) = (b)/(a) Return on Net Asset Value 1 3.9%
nies but restructuring an industry" (pp. 153-154), wh
(d) = (1 2E) Discount Rate 11.1%
(e) = (c)/(d) Growth Multiple 1 .25 was possibly a consideration of Kimberly-Clark 's in t
(f) = (18E) Earnings Power Value $5,899.3 case. Consider, for example, its following comments

(g) = (e) X (f) Growth Value (GV) $7,380.4

Since 1995, the year of our merger with Scott
Paper, Kimberly-Clark 's return on invested capital
S
has climbed
(n more than four percentage points to a
robust
(n 18.6 percent. We accomplished this feat by
steadily increasing profits, making prudent capital
spending decisions
t and driving down inventory
and other working capital.
t We re striving to reduce
working capitaln
further from 14.1 percent of sales
in 2000 to 12 percent
g within three years.20

Winter 2011 The Journal of Private Equity 75

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Exhibit 10
Scotťs Post-Turnaround Valuation

$8,000 n
$7,380

MM

NAV EPV GV

Notes: GV = growth value. All calc

Windfalls are exceeding

Eastman Koda
occur, but they general
reorganization
Although firms
strategic can mit
consider
are subject approaching
to planning, th
should be conservative
conservativelyb
conservativetheir
targets "can p
business
exceeded" (Klarman [199
conservativeENDNOTES
targets result
implementation objectives
open to an The author would like to thank wind
occasional Bill O'Farrell, Dani
on one. Schwarzmann, and Tracy Lefteroff for helpful
Furthermore, con questio
of aggressivecomments, and suggestions on early drafts of this art
performance
Thanks also to Chris Goulakos for research assistance. The
in behavior that stretches
opinions expressed in this article are solely the author's and
ethics beyond acceptable (a
do not necessarily represent the views of any organization he
Allegations like
was or is affiliated with.
this were
he was at Sunbeam, which
^"True Turnaround Specialists' Are Poised to Survive
turnaround in after his
Today's Challenging Private Equity wind
Market," Knowledge
ently, he encountered diff
at Wharton, July 23, 2009: http://knowledge.wharton.upenn.
for Sunbeam so he
edu/article.cfm?articleid=2303 allege
gaming to achieve2 Scott Paper Company History, the aggr
http://www.fundinguniverse.
which led to his dismissal
com/company-histories/Scott-Paper-Company-Company-
PerformanceHistory.html gaming can
cution risk 3 National Bureau of Economic Research, http: //www.like
initiatives
of the risks nber.org/cycles .html
inherent in tur
Dunlap s 4$38
appointment per share X 74,000,000 shares (Gilson [1997a]). at Sc
5Scott 1993 Form 10-K, p. 91.
initiatives all failed, which
6Scott 1993 Form 10-K, p. 70.
for instance, the contempo

76 Turnaround Value and Valuation: Reassessing Scott Paper Winter 2011

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 7Dunlap as quoted by Ettorre [1995], p. 27. 21In the words ofDunlap and Andelman [1997]: "Here's
8Scott 1993 Form 10-K, p. 84; calculations are the what you need to do:
author's.
1. "Set major goals that make a difference, goals that are
9Gilson [1997b] bases his Scott cost savings analysis on sustainable."
a multiple of 9 times (p. 21), which equates to a discount
2. "Don't let people stray from these goals. Hold them
rate of 11.11%.
accountable with great tenacity."
10Scott 1993 Form 10-K, p. 102; calculations are the
3. "Focus , focus, focus on your handful of goals. If you set
author's.
too many goals, you will fail. Your intentions become
"Scott 1993 Form 10-K, p. 104.
diffuse." (p. 40; italics original).
12Scotťs margin was relatively stable during this time
(see Exhibit 1), which was prior to the firm's aforementioned
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To order reprints of this article, please contact Dewey Palmieri

at dpalmieri@iijournals.com or 2Î2-224-3675.

78 Turnaround Value and Valuation: Reassessing Scott Paper Winter 2011

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