It's been a brutal period for wealth creation. Yet some CEOs have managed to improve their performance. In its second year, the wealth creation index developed by Chief Executive, Applied Finance Group, and Drew Morris, CEO of Great Numbers!, seeks to identify those business leaders who have done the best job of creating true economic value. The Index (see "Ranking CEO Wealth Creation," p. 46) leans heavily on Economic Margin (operating cash flow less an appropriate capital charge over invested capital) as a metric to get at what really counts, which accounting measures such as EPS and even ROC are less able to do. Creating value is, after all, what the CEO is hired for. And as an objective measure of real value EM holds up better than most, even when share prices tank as they have over the last 18 months. To get a fair assessment of management's impact on value creation, we only rank CEOs who have been in their jobs for a minimum of three years.
Topping the rankings in 2009 is MasterCard's Robert W. Selander, up from third place last year. Both Selander and runner-up Federated Investors' J. Christopher Donahue run very high EM companies (24.5 percent and 20.6 percent three-year averages, respectively). Interestingly, both have been able to improve in a bad economy. The projected EM for both companies for 2010 is close to 28 percent. To paraphrase the old Memorex TV commercial, is Selander's success real or is it the business model? In other words, does MasterCard excel because of the leadership skills of Selander (and his team) or thanks to an operating system developed sometime in the late 1960s and honed since?
After all, the credit card payments system now operates in 200 countries, with 1.6 billion credit card holders around the world. Still, Selander suggests the laurels are equally shared. "We operate in a good industry," he allows, "but we have been able to adapt and adjust our execution as consumer spending fell." Among other things, he points to 8 percent growth in transactions in the second quarter of 2009--the pit of the recession for consumers--compared to the same period last year. During the same period the company lowered operating expenses 13 percent.
Since becoming CEO in 1997, Selander has been a big believer in scenario planning and values adaptability when economic conditions change. When the company consolidated with Europay, its European operation, MasterCard became a global brand and had to get its payments technology infrastructure under control. In 2006, it became a public company. In creating value for shareholders, the company seeks to get net income and operating margin at acceptable return levels. Once that is achieved, "we look for growth in net income and improvements in operating margin. After that we look to revenue growth rates," says Selander.
There are obvious advantages to the MasterCard business model. Unlike most industries, it is not capital intensive and doesn't worry about balance sheet, or plant and equipment risks, so much as it does counterparty settlement risk. It mitigates that by having collateral provided or insisting on guarantees that lower its risk profile. "Our focus on improving operating margins enables us to improve operating cash flow as well," says Selander. "We have a multiyear objective of a 3 to 5 percent improvement annually in operating margin, which we've met or exceeded during the last several years. And we expect to do so again this year."
Although Visa is its major brand rival, both operations still compete with cash and checks for payment market share. The next frontier is the migration of payment transactions to platforms other than plastic cards, such as mobile phones.
The reasons that companies such as MasterCard and Federated Investors rank near the top are clear, but there is a good lesson to be learned from Paychex, ranked 14 on the WCI index. Since being founded by Thomas Golisano in 1971, the company consistently grew while building up its competitive advantage through scale, training and selling additional services to its existing client base. It currently gets an A rating for MV/IC, three-year EM and EM change, but receives a C grade for its inability to grow its profitable business recently. If history repeats itself, Paychex will come out of the downturn stronger, with less competition and additional opportunities for growth. Likewise, Textron provides lessons about toxicity of leverage (over 60 percent) and what it can do to one's value. In early March, shares bottomed at $3.72 from its December 2007 high of $70.49. After stabilizing some of its business units, shares of this company have rebounded nicely this year to near $20 per share.
Commenting on underlying lessons from this year's WCI Index, AFG senior analyst Michael Burdi quotes multibillionaire investor Warren E. Buffett, who told an audience at Notre Dame that debt and alcohol were ever-present culprits in financial demise. "I've seen more...