Teletech Corporation

Background Headquartered in Texas, Teletech Corporation operates under two main business segments: the Telecommunications Services segment, providing various telephone services to business and residential customers and the Products & Systems segment, which manufactures computing and telecommunications equipment. In late 2005, the Securities & Exchange Commission revealed that billionaire Victor Yossarian acquired a 10% stake in Teletech and demanded two seats on the board of directors. He felt that the firm was misusing their resources and not earning a sufficient return.

Hire a custom writer who has experience.
It's time for you to submit amazing papers!

order now

He stated that Teletech should sell off its Product & Systems segment and focus on creating value for the company’s shareholders. A detailed analysis will reveal whether or not Teletech should follow Mr. Yossarian’s requests. Analysis When focusing on value creation, the company needs to assess economic profit and net present value for each of its business units. As exhibited in the graph (Figure 1, page 224) prepared by Vice President of the Telecom Segment, Rick Phillips, the firm currently utilizes a constant hurdle rate attained through an estimate of Teletech’s corporate Weighted Average Cost of Capital (WACC).

The WACC for Teletech Corp (as a whole) is calculated at 9. 30%, which is then applied to all investment and performance-measurement analyses of the firm. When looking strictly at this, the Telecommunications Services is under performing with a return on capital of 9. 10%. The Products & Systems segments is well over the required rate of return and appears to be the part of the company with no financial problems, earning a return on capital of 11. 0%. Mr. Phillips suggests that multiple hurdle rates should be implemented since different business units have different risks.

Utilizing one hurdle rate assumes equal risk in investing in either the Telecommunications segment or the P&S segment. He feels that the two segments are different in nature (risk and return) and because of that a risk-adjusted hurdle rate system should be required. Investors seek higher returns for riskier investments and would reasonably so, expect a lower return for investments with less risk. As such, the hurdle rates should be adjusted accordingly. The Products & Systems division is considered to have higher risk than the Telecommunications segment (high R&D and fixed sset costs, many write-offs due to the fast pace of technological changes, and financing of capital through high yielding debt and a greater proportion of equity). Therefore, the P&S segment should have a higher hurdle rate than the telecom hurdle rate. Referring back to the graph Mr. Phillips prepared, the Telecom and P&S segments are graphed in their respective places based on their adjusted risk. Looking at this, Telecom now is providing an acceptable return on investment while the P&S sector is not. Telecom is operating almost 1% over the adjusted hurdle while P&S is operating roughly 2% under the adjusted hurdle.

This could be troubling for the P&S segment. . In favor of the current methodology is Helen Buono, Executive Vice President of the P&S segment. While Mr. Phillips feels the risk-adjusted rates best serves the company, Ms. Buono argues the constant hurdle rate produces the best results. She summarizes her opinion with the notion that “all money is green. ” Ms. Buono implies that it doesn’t matter by what means you are profitable, it just matters that you are profitable. She states that investors are concerned with the company as a whole, rather than its individual parts.

She feels that multiple hurdle rates are illogical and will destroy shareholder value since the company will not be meeting the corporate hurdle rate. Since Ms. Buono is VP of the P&S segment there is concern that her defending the single hurdle rate is an agency problem. Economic Profit is an important measure when considering manager promotions and incentive compensation packages. If her segment is found to be detrimental, she along with the rest of the P&S segment may very well find themselves out of a job. While both Mr. Phillips and Ms.

Buono make strong arguments for their respective sides of the debate, further analysis is needed to decide which methodology is the best fit for Teletech. Comparable companies were needed in order to calculate the WACC for each business segment. The comparable companies were chosen using the following measurements: similar product lines, revenues, and bond ratings. Alltel Corporation, Sprint Corporation, and Bellsouth Corporation were determined to be comparable companies for Teletech’s Telecommunications Segment. Avaya Inc. , Lucent Technologies, and Commscope Inc. ere comparable comps for the Product and Systems Segment. (see Exhibit 1). The three comps for each segment were than averaged to create an appropriate WACC for each separate segment of Teletech. The market risk premium of 5. 5% and the risk free rate of 4. 62% (30-year U. S. Treasury) were given in the case. The beta and the pre-tax cost of debt are based on our averaged comparative company analysis. Using the averaged beta of 1. 05, the pretax cost of debt of 5. 79%, (based on bond ratings) and the weighted average of debt & equity, the telecommunications segmented hurdle rate is calculated at 8. 4% (see Exhibit 2). Using the same market risk premium and risk free rate (5. 5% & 4. 62% respectively) given in the case, the averaged beta of 1. 40, the pretax cost of debt of 7. 65%, and the weighted average of debt & equity, the products & systems segmented hurdle rate is calculated at 10. 87%. Both the beta and the bond rating represent increased risk from the telecom segment and the corporate hurdle rates. (see Exhibit 2). As stated earlier, Teletech determines value by using a corporate-wide hurdle rate of 9. 3%. Using this and the company-wide return on invested capital of 9. 8%, the company exhibits profitability. (see Exhibit 3). Implementing multiple hurdle rates will help management discover whether or not each segment is contributing value to the corporation. As it stands, a single hurdle rate may be misleading as it does not take into account any additional risk associated with the P&S segment. After breaking the company into two different segments (see Exhibits 4 & 5), WACC’s and return on invested capital are computed on an individual basis clearly revealing that the telecommunications sector is very profitable.

While the P&S segment remains profitable, it reports well below the original economic profit that had been calculated using the company-wide hurdle rate. To analyze the effects that both the cost of debt and the leverage ratio have on the cost of capital, a sensitivity analysis was performed for the company and each business segment individually (see Exhibit 6). The WACC was recalculated using a range of debt to capital ratios and appropriate cost of debt figures (pre-tax basis) based on the risk associated with each segment and the ability to obtain financing through debt.

As the cost of debt increases (due to bond rating) the cost of capital increases. By using more leverage, Teletech can reduce its cost of capital. The analysis clearly shows that debt is easily obtainable and cheaper for the Telecom Segment as compared to the P&S segment. Using the NOPAT and ROC values of $1. 66 billion and 9. 58% respectively given in the case, approximately $17. 3 billion has been invested in the company as a whole (Exhibit 3). Using the corporate WACC of 9. 3% as a hurdle rate, the company makes a $48 million economic profit under its current capitalization structure.

Under current operating conditions the Telecommunications Services segment has NOPAT of $1. 18 billion and ROIC of 9. 1% with just under $13 billion of capital employed. The Telecom business unit generates an economic profit of almost $60 million (Exhibit 4). Given the relatively low risk for this unit, the Telecom segment will remain economically profitable under a wide range of capital structures and debt financing possibilities (See Exhibit 7). For Telecom to remain profitable they will need to have leverage of more than 15%.

With the appropriate debt level the pretax cost of debt can rise to 7% and the sector will still be economically profitable. Unlike the Telecom segment, the P&S unit has a fair amount of risk associated with it. This risk materializes as the cost of capital increases. With current NOPAT of $480 million, ROC of 11% and a segmented hurdle rate of 10. 87% the P&S sector only generates a $5 million profit (see Exhibit 5). An important factor to note is that debt for this sector can be difficult to obtain, which will ultimately result in a WACC that is much higher than the Telecom segment.

Exhibit shows that for this segment to generate higher profits, they’ll need to find more sources of debt, at a rate of less than 9% depending on the amount of leverage they can obtain. After this analysis it is clear that post re-evaluation of the Product & Systems segment, its contributions to company profitability come with a greater amount of risk than expected. After applying a risk adjusted WACC, it is clear that future investments made in the Products and Systems segment would have to exceed 10. 87%.

In response to Victor Yossarian threat against management we advise that Mr. Yossarian be made aware of changes that will be made to our business. Given the differing natures of the two segments and the differing risk associated with each segment we have moved to measuring projects against hurdles rates determined by the segment that the project falls under. Using a flat hurdle rate undervalues the required rate of return for projects in our P+S segment. As a result, Teletech runs the risk of taking on projects that do not produce economic profit on a risk adjusted basis.

It is in our opinion that using the proper hurdle rates will provide Teletech with the opportunity to make better investment decisions, continue to develop and diversify its P+S business, have a more accurate assessments on value added to shareholders and to be able to manage its cost of capital effectively. We understand what Mr. Yossarian sees in our company and the opportunity to invest more of our dollars into Telecommunications however we value diversifying our business because that is what puts us in the best position to grow.

We will continue to have two segments however we will amend the way we invest our dollars into the various projects to ensure that we are adding value to the enterprise. On a forward looking basis new hurdles rate of 8. 64% and 10. 87% have been applied to the Telecommunications and P+S segments respectively. A close examination and analysis of projects will be undertaken to ensure that forecasted ROC exceeds the hurdle of the respective business segment. We are confident in this amendment and what this will mean for the future growth of Teletech.


I'm Heather

Would you like to get such a paper? How about receiving a customized one?

Check it out