Teletech

Corporation
JACK REILLY, JAKE DIESU
Overview of the Company
 "Provider of integrated information movement and management"
 Teletech is headquartered in Dallas, Texas
 CEO is Maxwell Harper
 CFO is Margaret Weston
 Consists of two business segments:
 Telecommunication Services: provides long distance, local, and cellular
telephone service to business and residential customers
 Products and Systems: engages in the manufacturing of computing and
telecommunications equipment
Division Performance (2004)
 Telecommunications Services
 75% of Teletech's market value
 Return on capital: 9.1%
 Net assets: $11.4 billion
 Revenue: $11 billion
 NOPAT: $1.18 billion
 3% YOY revenue growth from 2000-2004
 Products and Systems
 25% of Teletech's market value
 Return on capital: 11%
 Net assets: $4.6 billion
 NOPAT: $480 million
 Sales grew 40% in 2004
 Market Performance
 Teletech's shares have been lagging
behind the overall stock market as well as
indexes for telephone, equipment, and
computer stocks
 Analysts contributed this to the firms
lackluster earnings growth, citing increased
competition in telecommunications, as well
as disappointing performance in the P&S
division
Situation at Hand
 Victor Yosarian has acquired a 10% stake in Teletech
 Demanded two seats on the firms board of directors
 Believes the firm is misusing its resources and not earning adequate
returns
 A single hurdle rate is starving Telecommunication Services of capital
 Says Teletech should sell the P&S division because it is causing the firm to
lose value
 If Teletech consisted of only Telecom it would be worth $16.58 billion, the
value with P&S only is $15.23 billion

 Teletech management must decide whether to use a single or multiple

hurdle rates
 Q:1
Risk Adjusted Rates
 Reflects the relationship between risk and return
 Higher risk should be rewarded with higher return
 K= Krf+(Km-Krf)b
 Uses the pure play method: use the beta of a company in the same
business as the venture you are considering
 The pure play company has to be solely in the business of the venture or
the beta won't be appropriate
 Because Teletech's divisions operate in such different markets,
management can't use the beta of a competitor to accurately calculate
risk adjusted rates
 Q: 2
EVA and MVA

 Economic value added:

 Measures economic profit a company is able to generate over a
specific time
 Takes into account opportunity cost of alternative investments

 Market value added:

 "Simple metric" of the operational capability of a business
 Represents open market value of a business, used by investors to
determine a company's accumulation of wealth over time.
 Does NOT incorporate opportunity cost of alternative investments
 Q:2.2

How is Teletech Using EVA

 Managers needed help understanding what creating value meant.

 Only objective measure of value was the securities prices of
Teletech.
 The company adopted a measure of value creation for use at the
segment and business-unit level.
 Segment and business-unit executives were evaluated on the basis
of economic profit.
 Used in determining capital allocation, manager promotion,
incentive compensation
 Economic Profit = (ROC – Hurdle rate) x Capital employed
 Q: 3.2

History of WACC and Capital

Budgeting
 WACC and Capital budgeting originally created for homogeneous
companies.
 financial markets assess the company as a whole and establish the
company’s debt and equity rates, establishing a true value
 As heterogeneous conglomerates grew, the true rate loses
accuracy.
 Q: 3

Effect of Single Hurdle Rate on

Teletech
 Using a single hurdle rate with capital rationing, the P&S division gets
260% more funding than Telecom
 P&S has 5 projects accepted while Telecom only has 2 accepted
 A single hurdle rate is starving the largest division in the company of
capital
 Q:3.2
Rick Phillips Argument

 Divisions must compete differently and must draw on capital

differently.
 P&S sales growth and profitability are strong, its risks are high.
 Hurdle rate should reflect the high costs of funds
 Telecom Lowers the risk of the entire corporation and should not be
penalized for that.
 If money flows into safer investments, over time the cost of their
loans will decrease.
 Multiple hurdle rates allows equity capital to be rationed striving for
the best returns on equity.
 Q: 3.3

Rick Phillips' Assessment of Constant

vs. Risk Adjusted Hurdle Rates
 Grey line represents corporate hurdle
rate of 9.30%
 Solid black line represents risk-adjusted
hurdle
 Telecomm. Can earn 9.10% on capital,
P&S promises 11%
 With adjusted hurdle rates, Telecomm.
Is profitable. Opposite is true for P&S.
 Stockholders are equally concerned
with risk and will not pay as high a
price for earnings.
 Security market line- shows whether a
security offers a return against its level
of risk.

Risk Free Low Risk Teletech. Higher Risk

 Q:4

Conflict Between Single vs. Multiple

Hurdle Rates
 Having a single rate among a diverse corporation will hurt the less
risky, lower return divisions
 Having multiple hurdle rates allows each division to have a separate
hurdle rate. This ideally will insure that money is allocated fairly.
 The management of each division has incentive to want either
single or multiple hurdle rates
 Each division will be impacted differently depending on what
system Teletech uses
 Q: 6

How Multiple Rates Are Derived

And Implemented
 Multiple rates can be derived from establishing the weighted
average cost of capital for each department individually
 Teletech was being held at a certain standard with single rates,
Implementing multiple rates will require organizational and
operational changes among the company.
 Verbal, written, communications to employees
 New measurement systems, training
 New evaluation methods based on return, based on the risk of the
individual divisions.
 Q: 5

Argument Against Multiple Rates

 If the segment hurdle rate is lower than the corporate hurdle rate,
shareholder value is being lost
 A single hurdle rate will deprive under profitable divisions of funding in
order to move funds into a more profitable one
 Allows the company to earn the highest absolute rate of return
 A single rate allows NPV and economic profit calculations to be
compared across divisions
 Q:7

How Multiple Rates Threaten The

Capital Budgeting Concept
 The rate the corporation receives is set by the market
 The corporation is judged as a whole
 The corporation then arbitrarily assigns risk to each division and sets
a rate for each one
 Reality is lost because the divisions rates are not set by the market
 Assessing projects against a subjective rate
Effect of Multiple Rates on Teletech

 Holding each division to their own hurdle rate allows Telecom to

receive adequate funding
 These hurdle rates better reflect the risk level of each division
 Telecom will receive $1.2 billion
 P&S still receives $800 million but it doesn’t starve Telecom of funding
Why Multiple Rates Should Be Used
 Each division holds different levels of risk and the rates they are held to
should reflect that
 A single hurdle rate starves Telecom of capital because its projects
yield lower returns compared to P&S
 Telecom makes up 75% of Teletech so depriving it of investment will
severely hurt Teletech
 Multiple rates allow more money to flow into safer investments which
will lower the corporations cost of capital over time
 P&S projects are very risky and have a higher chance of failing in the long
run
 The P&S division is causing Teletech to lose value, multiple rates
prevent the firm from allocating too much capital to a division that is
destroying shareholder value