Mensa, INC.
(A fictional company)
Mensa, Inc. was a firm with a long and uneven history. It was started in 1974 and at one time or another had been a competitor in more than two dozen industries with varied success. Each of the several CEOs had developed a different strategy and over the decades the firm had had many manifestations. The only real constant in Mensas strategy had been a commitment to the packaging business in its several forms. But, even in this business there had been any number of changes in direction which diluted the impact of capital spending and had the effect of Mensa never achieving a strong position in any of the packaging segments although, briefly, in the early 1980s Mensas total packaging revenues made it the largest packaging company in the world. The lack of a competitive advantage in any of the large packaging segments resulted in Mensa being pushed into producing commodity products which had them penned between powerful steel and tinplate suppliers and powerful food and beverage producers as customers. Also, as their large customers grew there was pressure for them, especially in the low margin food business, to build their own packaging facilities, especially can plants. The long term effect of this was to cause Mensas packaging profitability to lag its better positioned competitors.
At one time or another during the 1980s and 1990s the company produced auto parts, electrical equipment, power equipment, electric motors, metal alloys, airplane wings, furniture, appliances, communications equipment, specialty chemicals, and consumer products, to name only the most important of their many businesses. They also bought several regional retail chains. None of these businesses worked out well and all were either sold or liquidated at a loss. The financial and human capital devoted to these businesses was largely lost. Further, the problems they caused diverted capital and management attention from better opportunities.
NEW STRATEGIES FOR THE 21st Century
By the late 1990s under still another new CEO a management consensus had developed. The consensus was to (1) reduce holdings in operations that fall short of performance goals or do not fit the long-term strategy of the company; a target of realizing $600-$700 million from the sale of such assets was established, (2) reinvest these funds in areas promising profitable growth, (3) improve return on equity over the long term as a consequence of this reinvestment strategy, and
(4) strengthen Mensas balance sheet and credit standing. The new benchmarks for the firm included having a well balanced BCG matrix that considered fast growing industries to be those that were growing at more than 10% per year. The end result would be a firm with four main businesses: financial services, energy, packaging and forest products. The latter was primarily a paper, fiber drum, and cardboard business that also generated about 25% of revenues from selling lumber and wood chips.
This strategy was followed and many businesses were sold although the amount of money received for the businesses fell short of the $700 million target by almost $250 million. The businesses sold were all either small competitors in their industry or were in industries that suffered from overcapacity and low returns.
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The New Mensa
By 2XX1 the sales were complete and most of the realized funds had been redeployed into Mensas four main business groups, resulting in a firm that management thought met their goals. The Chairman stated in the 2XX0 Annual Report that Mensa was ready to move on to a new phase:
Our primary task is now the efficient production of quality goods and services within our restructured business segments: packaging, forest products, insurance, and energy. Further details on Mensas posture are contained in the attached operating and financial statements. Our overall strategy is to achieve the competitive advantages that can result from increased productivity, market focus, and innovation.
By the beginning of 2XX5 management believed that it was well positioned strategically for future growth and profitability. They had pared their operations to four main businesses: Financial Services, Energy, Packaging, and Forest products. The review for each segment was done by top management with the assistance of outside consultants who were all experienced top-level executives in each industry. Some of the consultants were retired and some of them were still active, but they all had long and successful experience in the industry they were consulting on. There is also an outlook section for each industry segment that includes estimates of profitability, cash flow, and needed investment in the next 10 years. The outlooks were done entirely by the consultants.
Financial Services
Mensas first foray into financial services came in the early 2000s when a large investment bank brought the opportunity to buy Columbus Financial Corporation to the attention of the firm. Mensa had hired the investment banker to help with the sale of the unwanted businesses and they knew that Mensa was looking to redeploy the assets generated from the sale of the assets. Initially Mensa was cool to the idea because it was so far removed from their expertise, but on examination it appeared that the insurance business had good profitability and cash flow characteristics so when the existing management was persuaded to stay on the purchase was made. From this base the Financial Services group added more insurance operations to include American Life Insurance Company, with its 49 master brokerage general agents and 13,000 independent brokers and agents. The firm also added a mortgage company, a mortgage insurance company, a number of title insurance companies and several title companies to form the core of the real estate-related financial services area. By the end of 2XX2 Mensa Financial Services underwrote insurance in three broad segments: life and real estate as well as property and casualty insurance. The firm was strongly positioned in the Financial Services business, but competition was tough.
Mensas Financial Services division was not large by national standards, but the firm was a surprisingly nimble and successful middleweight in the industry. The management of this business had done an efficient job of integrating their many acquisitions into the financial services operation, had proven their ability to pick their target markets, and avoided serious
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head-to- head competition with bigger and more powerful rivals. The future prospects of the division looked good.
Financial Services Outlook. The consultants that looked at the financial services business believed that the financial services business would be a good one for a long time. It was, relatively speaking, a low capital intensity industry with improving returns and strong positive cash flow characteristics. Although Mensa invested more capital per dollar of sales than most of their competitors the consultants thought this problem would be solved by increasing the size of the operation. They believed that Mensa could increase their sales in the division by about 15% per year and increase returns on segment assets to between 15% and 18%. They also expected division sales to increase by at least 15% per year for the next decade if they made the needed investment in the business. They recommended that the firm invest heavily in the business because they were small and would benefit from additional size. Their largest competitor was about double the size of Mensa and growing at about 10% per year. The consultants believed that for the firm to remain successful in the business which means increasing the segment earnings to assets ratio from the current 13% to 18%, they would need to invest at least, and they stressed at least, $250,000,000 per year in the business initially and increase gradually to $300,000,000 in 5-7 years at which time investment could probably decline to $100,000,000 per year. This investment would more than double the assets committed to the business within five years. They forecast cash flow from the division, assuming the recommended investments are made by the company to be negative $250,000,000 per year for years 1-3, negative $50,000,000 in years 4 and 5, positive $200,000,000 in years 6 and 7, and positive $300,000,000 in future years. The consultants believed that Mensa could sell the financial services business for about $1,000,000,000 if it were put up for sale and if the firm was patient.
Energy
In 2XX4 Mensa made its first major acquisition in the energy business when they bought EasyGas Energy which became the core of their Energy Division. This acquisition allowed Mensa to enter several areas of the energy business. EasyGas was active in exploration, development, and production of oil and gas, operated an interstate natural gas pipeline system extending from the Texas-Mexico border to the southern tip of Florida, and also extracted and sold propane and butane from natural gas. Prior to the acquisition of EasyGas, Mensa had small working interests in offshore and onshore gas and oil properties in the Gulf of Mexico and in Mississippi which they purchased in the late 1990s to try to develop a better understanding of the business. These were merged into the new energy division. EasyGas was the sole supplier of natural gas to peninsular Florida and was one of only six U.S. companies selected by PEMEX, the Mexican National Oil Company, to purchase gas from that prime source. The companys pipeline operations offered a strong cash flow at relatively low risk.
Prior to the purchase of EasyGas Mensas nascent energy division had begun investigating a number of major and very expensive projects including a 1,500-mile slurry pipeline that would transport coal from Eastern Appalachia and the Illinois basin to the Southeast. If approved, this project would call for $2-3 billion in financing over seven years. The company was also considering joining with Shell and Mobil in the construction of a 502-rnile carbon dioxide pipeline in which the company would have a 13% interest at a cost to Mensa of $50,000,000 per
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year for 5 years, and was considering converting an 890-mile segment of its 4,300-mile natural gas pipeline to petroleum products (while maintaining its natural gas deliveries to the Florida market), at a cost of $100,000,000 spread evenly over 5 years. They were also considering participating in four major offshore natural gas pipeline projects in the Gulf of Mexico to connect into the Florida Gas Transmission system. Their share of these projects would cost about $400,000,000 spread over 10 years. The senior management of the firm was reluctant to curb the enthusiasm of the pipeline managers, but they were worried about the possible risks of such large ventures and were counting on the management of EasyGas, who had agreed to join Mensa and run the Energy Division, to advise them on these possible investments.
Exploration and Production. Mensa undertook a joint acquisition (with Allied Corporation) of Suppan Energy Corp. at a cost of more than $400 million. This acquisition increased the companys proven reserves of oil and gas by approximately 50% and its undeveloped acreage by 50%. Suppans emphasis on development drilling also complemented Mensas activities and strengthened its position in domestic natural gas. In joint ventures with Shell Oil, Mensa acquired additional offshore leases and participated in extensive exploratory drilling activities. In 2XX6 it spent some $400 million on exploration, but was now focusing on developing existing fields to improve the firms cash flow to try to offset the impact of all the investments in the energy business. An industry analyst said of Mensas energy business:
Although the company is a baby to the industry giants, it has a strong position in some segments. It is the largest supplier of energy to the State of Florida, one of the nations fastest growing states and that is a good business. However, in exploration and production they have no such protected position in an industry that is rapidly consolidating into giant firms with the financial resources to make, and lose, big bets in exploration. With the looming oil shortage proven reserves is where the money will be and Mensa is probably just too small to make the needed investments and, more importantly, take the risks associated with exploring in deep water and/or hostile environments like Siberia. They have the right idea, but their small size, their major competitors were 8 to 10 times the size of Mensas exploration and production unit, makes an inherently risky business even more risky. A loss that would be immaterial to an
Exxon Mobil could sink Mensas exploration business.
Energy Outlook. In 2XX8 the future of the energy business looked pretty bright and this view was emphasized by the consultants that Mensa brought in to review their energy business. Growth in China and India practically guaranteed that worldwide demand would grow much faster than was true in the past. The supply problem for the U. S. was exacerbated by the fact that China was negotiating long-term contracts to buy oil and gas from countries that had traditionally been U. S. suppliers, Canada, Mexico, Venezuela, and Norway. China was rapidly ensuring their future access to oil and the effect could be to cause future shortages for everyone else. The consultants believed that the long-term, worldwide supply and demand picture for oil and gas was extremely favorable for those firms that had either reserves or the cash flow to find and develop them. They felt that oil prices would not drop below $50 per barrel for very long and 10%-15% annual price increases was a minimum estimate and the possibility of much larger price increases was also more likely than anyone could have guessed even in 2XX7. They
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stressed that this forecast did not envision any significant disruption in supplies from the middle-east or elsewhere. In the event of a major disruption prices could easily exceed $175 per barrel. Their view was that only a really huge new oil field discovery, which was unlikely, or a world-wide recession of major proportions would derail their forecast and even the recession would only delay the increase in the price of oil. They also mentioned that U. S. oil production had peaked in the early 1970s and that one reasonable estimate was that worldwide oil production would peak in the early 2000s (2002-2010). If this latter prediction were true future increases in the price of oil would be hard to predict but could be ruinous until a transition to some other energy source was complete. The consultants stressed that given their size Mensa could never hope to grow to a competitive size in the industry, but their existing proven reserves and promising land holdings would only become more valuable as time passed and the supply/demand situation became tighter and tighter. They did not recommend major new investment in either exploration or production for the reasons given by the analyst quoted above.
