Transcript Slide 0

Corporate Directors Forum
October 8, 2013
Disclaimer
These materials are designed to complement a verbal presentation and do not constitute an offer to sell or a solicitation of an offer to purchase an interest in Relational
Investors LLC (“Relational”), or any of its affiliated funds. These materials are also not a solicitation for investment advisory services offered by Relational.
This presentation is intended to serve as an example of Relational’s investment process and strategy. It is based on actual investments in target companies’ stock that
Relational made for and on behalf of Relational’s clients. Past performance is no guarantee of future returns and investments in securities involve the risk of loss.
This presentation has been prepared by Relational for informational and discussion purposes only. This presentation is not intended to serve as the basis for any investment
decision.
Except as otherwise indicated herein, the information provided is based on matters as they exist as of the date of preparation and not as of any future date, and will not be
updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after the date hereof. Certain
economic and market information contained herein has been obtained from published sources prepared by other parties. While such sources are believed to be reliable,
Relational, and its respective affiliates assume no responsibility for and have not verified, such information and do not represent that such information is accurate or
complete. Statements contained in this presentation that are not historical facts are based on current expectations, estimates, projections, opinions and/or beliefs of
Relational. Due to various risks and uncertainties, actual events or results may differ materially from those reflected in such opinions. These materials should be read with
reference to all footnotes which are provided on certain pages.
These materials may not be distributed in any jurisdiction where such distribution would constitute a violation of applicable laws and regulations.
Introduction
 Relational formed in 1996
 First activist investor with institutional monies
 Started with $200 Million – now $6 Billion
 Over 100 Projects
 Principals have been on 24 public company boards
including Home Depot, Waste Management, Mattel,
HP and Intuit
 When not on the board, working behind the scenes
with management and the board at companies like
Pepsi, ITW, Deere and SPX
Introduction con’t.
 Clients are large public pension funds – generally
indexed
 Historically passive
 1976 – KKR founded, leading to an era of LBO’s
 Sell low/buy high
 Institutional S/H’s – Largely passive, largely indexed
needed a way to “fix” companies while remaining public
 1987 – CalPERS starts focus list
 1994 – CalPERS effect shows outperformance
 1996 – CalPERS funds first activist fund – Relational
Investors
Characteristics of an Active Investor
 Concentrated portfolio – generally less than 20 stocks
 Invests with an agenda designed to correct
undervaluation
 Galvanizes support of institutional shareholder base
around agenda
 Prepared to seek board representation using short slate
rule (1992) if necessary
Average Cumulative Relative
Return of Engaged Companies
Relational, on average, improves stock performance of
underperforming companies through active engagement.
Average Cumulative Relative Return1 vs. the S&P 500 Index2
40%
28%
Average Relative Return
30%
18%
20%
16%
10%
2%
0%
-10%
-20%
-16%
-17%
-16%
During RI
engagement
After RI exit3
-30%
Prior to RI engagement
-40%
5 Year
Relative
3 Year
Relative
1 Year
Relative
Relative
Return
1 Year
Relative
3 Year
Relative
5 Year
Relative
1 Average cumulative relative return of the Engaged Companies gross of fees and expenses ((total return of each Engaged Company minus the S&P 500 Index benchmark return for the same period)/number of Engaged
Companies for the same period). The average relative returns do not reflect any actual or model performance results for any portfolio managed by Relational. Additionally, past performance is not a guarantee of future returns.
Source: FactSet
2 The S&P 500 Index is an unmanaged capitalization-weighted index comprised of 500 companies traded in the U.S. markets and is intended to reflect general stock market performance rather than the particular strategy
employed by Relational. Source: IDC.
3 Does not include any company that, as of Relational’s exit date, ceases to exist due to a merger, spin-off or other form of acquisition.
1-Year Share Price Underperformance of 54%
40%
TSR Relative to S&P MidCap 400
Proxy Peers
28%
30%
20%
10%
S&P MidCap 400
Industrials
3%
-(10%)
(20%)
(30%)
SPW
(26%)
(40%)
Note: Peer group is based on companies specified in 2013 proxy: ITT, ROK, CMI, CR, TKR, FLS, PH, DOV, TXT, IR, CSL, DHR, ROP, HSC, PNR, PLL,
SNA, ETN, and GLW.
3-Year Share Price Underperformance of 47%
TSR Relative to S&P MidCap 400
30%
20%
S&P MidCap 400
Industrials
16%
10%
--
Proxy Peers
7%
(10%)
(20%)
(30%)
(40%)
SPW
(40%)
(50%)
Note: Peer group is based on companies specified in 2013 proxy: ITT, ROK, CMI, CR, TKR, FLS, PH, DOV, TXT, IR, CSL, DHR, ROP, HSC, PNR, PLL,
SNA, ETN, and GLW.
5-Year Share Price Underperformance of 85%
TSR Relative to S&P MidCap 400
40%
20%
--
(20%)
Proxy Peers
2%
S&P MidCap 400
Industrials
2%
(40%)
(60%)
(80%)
SPW
(83%)
(100%)
Note: Peer group is based on companies specified in 2013 proxy: ITT, ROK, CMI, CR, TKR, FLS, PH, DOV, TXT, IR, CSL, DHR, ROP, HSC, PNR, PLL,
SNA, ETN, and GLW.
3 Most Common Root Causes of
Underperformance
 Capital allocation – balancing growth versus returns
 Compensation structure
 Succession planning
Temptation to Chase Growth
Valuation vs. Growth
60x
P/E Multiple
50x
40x
30x
20x
10x
0
.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5
Perpetual Growth Rate (%)
Note: Assumes 9% cost of equity and 20% ROE.
Growth at Lower Returns Will Be
Value Destructive
Valuation vs. Returns
25x
P/E Multiple
20x
15x
10x
5x
0x
30
28
26
24
22
20
18
16
14
12
10
Return on Equity (%)
Note: Assumes 9% cost of equity and 5% growth.
8
6
4
2
Home Depot Chases Growth
 Opened another 500 stores – most with returns below
their cost of capital
 Expanded into the wholesale business, acquiring their
way in with returns of about 8%. Again, below their
cost of capital
 Squeezed profitability from their retail stores by –
 Reducing staffing
 Under – investing in distribution and IT
Growth at Lower Returns
Will be Value Destructive
Valuation vs. Returns
16x
Core Retail Business
Implied P/E Multiple
14x
12x
HD Supply
Business
10x
8x
6x
New Stores
4x
2x
0
25
23
21
19
17
15
13
11
Return on Equity (%)
Note: Assumes 9% cost of equity and 3% growth.
Capital Allocation Best Practice
STEP 1
Forecast Long-term Growth and Return Targets
Establish Valuation Based on Business Plan
STEP 2
Establish Credit Characteristics and Liquidity
Objectives, and Adjust Debt/Cash as Indicated
STEP 3
F
Fund Maintenance Capex, Pension
and Benefit Plans, and Regular Dividend
STEP 4
Allocate Excess Capital to Highest Riskadjusted Return Alternative that Exceeds WACC
STEP 5
Organic
Growth
Initiatives
Acquisitions
Repurchase
Shares
Increase
Regular
Dividend or
Pay Special
Allocate capital to the most accretive alternative using share repurchase as a benchmark
Components of Executive Compensation
 Base salary
 Annual cash bonus – short-term (1 year) metrics
 Long-term incentive plan –
• Stock options – time vested
• Restricted stock – effectively time vested
 Performance units – payable in cash and/or
restricted stock – metrics range from 1 to 3 years;
performance measured by growth in revenue,
operating income, EPS, ROIC and/or TSR.
Intuit Example
Base Salary
Annual Bonus
Metrics:
Long-Term Incentive Plans
Stock Options-time
vested
Restricted stock-time
vested
Time Based
Performance Units
Metrics
Before Relational
Yes
Yes
Revenue
Non GAAP Operating Income
After Relational
Same
Same
Same
Same
40%
15%
30%
15%
70%
30%
30%
70%
Revenue Growth over 1 year Revenue growth over 3 years* (35%).
TSR over 3 years* (35%)
*Based upon rolling 3 year business
plan
Home Depot Example
Base Salary
Bonus
Metrics
Restricted Stock Time Vested
Performance Vested
Metric
Stock Options Time Vested
Performance Vested
Performance Units
Metric
Other
Total
Severance Package
CEO Before Relational
$2,200,000
$7,000,000
Annual Revenue Growth
Annual EPS Growth
CEO After Relational
$1,000,000
$500,000
Annual Revenue Growth
Annual EPS Growth
$14,700,000
$3,000,000
3 Year TSR
$8,100,000
$2,400,000
EPS Growth over 3 years
$3,500,000
$37,900,000
$2,000,000
$1,300,000
EPS & ROIC Growth over 3 years
$500,000
$8,300,000
$210,000,000
$15,000,000
Conference Board Succession Plan
Recommendations
 Assign responsibility to a standing board committee




of independent directors
Make succession planning continuous and integral
to business strategy and culture
Integrate succession planning into the top-executive
compensation policy
Integrate succession planning into risk management
Make succession planning transparent, internally
and externally
Hess Board Composition
Before
After
Chairman
J. Hess (35)
M. Williams
Insiders
F. Walker (9)
Replaced
G. Hill (4)
Replaced
J. Hess
Independents
O&G Experience
T. Kean (23)
Replaced
E. Holiday (20)
Same
N. Brady (19)
Replaced
R. Wilson (17)
Same
F. Olson (15)
Replaced
C. Matthews (11)
Replaced
E. Von Metzsch (10)
Replaced
R. Mourey (9)
Same
J. Mullin (6)
Same
S. Bodman (4)
Replaced
S. Nunn (1)
Replaced
3 of 14
7 of 14
All Insiders
Including CEO
What can you do to avoid a call from an
activist investor?
 Adopt a sound capital allocation philosophy carefully




risk adjusting acquisitions
Require a rolling 3-year business plan tied to
compensation
Include a return metric in L/T comp
Tie succession planning to comp
Communicate all of the above to your shareholders