Finance-The company is faced with major issues and decisions

| January 30, 2017

Question
1.The company is faced with major issues and decisions need to be made. Spend no time on corporate history, the analysis and recommendations should be forward looking. Using the the cash flow, book value, revenue estimates from each of the 4 business, and the attached financial data, what is the best plan of action for each of these businesses (e.g., sell or invest).

THE LOCKWOOD GROUP, INC.
(A fictional company)
The Lockwood Group was a firm with a long and uneven history. It was started in 1904 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 Lockwood’s 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 Lockwood never achieving a strong position in any of the packaging segments
although, briefly, in the 1970s Lockwood’s 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 Lockwood 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 Lockwood’s packaging
profitability to lag its better positioned competitors.
At one time or another during the second half of the 20th century 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 Lockwood Group’s 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 Lockwood
By 2001 the sales were complete and most of the realized funds had been redeployed into
Lockwood’s four main business groups, resulting in a firm that management thought met their
goals. The Chairman stated in the 2000 Annual Report that Lockwood 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 Lockwood’s 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 2005 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
Lockwood’s 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.
Lockwood had hired the investment banker to help with the sale of the unwanted businesses and
they knew that Lockwood was looking to redeploy the assets generated from the sale of the
assets. Initially Lockwood 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 2002 Lockwood
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.
Lockwood’s 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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headto- 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 Lockwood 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 Lockwood 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 Lockwood 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 Lockwood 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 2004 Lockwood 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
Lockwood 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, Lockwood 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 company’s
pipeline operations offered a strong cash flow at relatively low risk.
Prior to the purchase of EasyGas Lockwood’s 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

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pipeline in which the company would have a 13% interest at a cost to Lockwood of $50,000,000
per 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 Lockwood and run the Energy Division, to advise them on these possible investments.
Exploration and Production. Lockwood undertook a joint acquisition (with Allied Corporation)
of Suppan Energy Corp. at a cost of more than $400 million. This acquisition increased the
company’s proven reserves of oil and gas by approximately 50% and its undeveloped acreage by
50%. Suppan’s emphasis on development drilling also complemented Lockwood’s activities and
strengthened its position in domestic natural gas. In joint ventures with Shell Oil, Lockwood
acquired additional offshore leases and participated in extensive exploratory drilling activities. In
2006 it spent some $400 million on exploration, but was now focusing on developing existing
fields to improve the firm’s cash flow to try to offset the impact of all the investments in the
energy business. An industry analyst said of Lockwood’s 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 nation’s 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 Lockwood 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 Lockwood’s exploration and production unit, makes an
inherently risky business even more risky. A loss that would be immaterial to an
Exxon Mobil could sink Lockwood’s exploration business.”
Energy Outlook. In 2008 the future of the energy business looked pretty bright and this view was
emphasized by the consultants that Lockwood 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

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price increases was also more likely than anyone could have guessed even in 2007. They 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 Lockwood 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.
Florida Pipeline. They felt that for Lockwood to prosper in the new energy environment they
would need to build pipeline capacity into Florida because of the tremendous population growth
in the state. Their estimate of capital investment needs in the Florida market was about
$50,000,000 per year for the next 4 years. Beyond that time the investment needs would be
determined by the longer term population growth. Some demographic and real estate experts
believe that the recent rapid increase in housing prices in Florida would cause population growth
to moderate from the current 365,000 people per year to a more sustainable rate of maybe 150,
000 per year. If these estimates proved to be true the consultants expected cash flow to be
negative $50,000,000 per year for years 1-4 and increase slowly to positive $300,000,000 from a
positive $100,000,000 in year 5.
Exploration and Production. The experts believed that Lockwood was too small to compete long
term in the exploration and production area unless they were willing to build oil reserves and
production capacity simultaneously. This would be an expensive undertaking that could easily
take $500,000,000-$600,000,000 per year for the next decade but the impact on earnings and
cash flow could be expected to be dramatic, but probably not for 5-7 years because of the long
lead time for investments in reserves and refinery capacity to come on line. And, they noted,
investments in exploration were risky investments and there could be many dry holes. They
thought that returns on assets would improve from the recent 5% level to the 8%-12% level at
best. They also felt that the value of the proven reserves could easily increase from the present
$500,000,000 to the $1,000,000,000 to $1,500,000,000 level over the nest 8-12 years. The entire
division could probably be sold for about $1,560,000,000 at the present time and could be worth
as much as $2,000,000,000 within 5 to 6 years. They expected revenues to increase by about 8%
per year in the absence of the major investment outlined for the exploration and production
division. If the recommended investments were made they expected revenues to increase
annually from the 10% range to the 15% range during the next 10 years. They were further
advised against frittering away capital on non-energy enterprises and focus on building supplies
of both oil and gas. Given the needed investments the expert consultants expected the
exploration and production operation, assuming the needed investments were made, to be cash
flow negative by at least $400,000,000 per year for the next 6-9 years after which it would turn

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cash flow positive within 2-3 years and generate cash flow of about $150,000,000 per year for
the foreseeable future.
Packaging
In December 2002, the Lockwood Packaging Division had been reorganized to facilitate a new
strategy stressing market rather than product orientation. As the Packaging Division Vice
President told New England Business:
“We will start to look at our franchise not as the manufacture of blow-molded
bottles, or twopiece aluminum cans, but as our relationship with the big package
group marketers. Hitching Packaging’s wagon to big customers like General
Foods makes more sense than latching on to a particular technology or shape or
structure that will inevitably change. We do understand that such a relationship
will require substantial capital expenditures every time a new packaging
technology is demanded by our customers but we believe that the firm will
generate cash flow adequate to the division needs.”
The new packaging organization operated in three major markets: Food and Beverage, Specialty
Packaging, and International. Its cost reduction and productivity programs included closing a
number of plants, which were unable to meet long-term profitability standards, while improving
capacity utilization and line efficiencies at other facilities. Basic research expenditures were
reduced and emphasis directed towards business development and marketing. Lockwood
Packaging had a major position in the fastest growing segment of the can industry the-two-piece
aluminum can. However, both the short and long-term results of the packaging business would
be determined by (1) the success of new product introductions, (2) continued emphasis on cost
cutting even after demand reaccelerated, (3) whether or not metal cans would be besieged by
another fundamental change in design and (4) the bargaining power of their customers. Those 7
issues were very uncertain and hard to forecast especially given the strategic focus on a relatively
few very large customers who would have substantial bargaining power.
Packaging Outlook. The packaging business was, in the main, an economically sensitive
oligopolistic industry that mainly sold commodity products. It was very difficult to establish any
kind of long-term competitive advantage other than cost and delivery reliability and other firms
were positioned to do this as effectively as Lockwood. The firm’s decision to tie themselves to
large customers while understandable and probably wise was likely to create serious pressures to
reduce price and also make the packaging division less flexible because of the location decisions
needed to cater to largecustomers. The consultants did not believe that either sales growth or
profitability would grow much faster than GDP in the future and felt that the cash needs of the
division could be very high when the customers demanded new technology. Building the new
technology into the plants would not reduce the push for lower prices by customers. The
consultants felt that profitability would not increase over the next 10 years but would decline by
about 50% and the Packaging Division’s cash flow would decline rapidly, from about
$230,000,000 currently to zero by year five and be negative $100,000,000 in year 6 and get
worse by about 20% per year thereafter. They forecast revenues to increase at the recent rate for

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the next decade. If the entire division were to be sold it would probably bring about
$1,200,000,000 or about 70% of book value.
Forest Products
The Vice President of the Forest Products Division told The Wall Street Journal at the time some
of the lumber operations were sold off:
“Our forest products business will be reduced in scale but will now be made up of
specialty businesses in which we are competitive and we will work to develop
world class and to some extent proprietary positions backed by a natural resource
of immense and growing value.”
Lockwood was a large producer of bleached folding carton board and ranked sixth in total
production of bleached paperboard in the U.S. Lockwood’s largest competitors in this business
had more than twice the sales of Lockwood. Its bleached paperboard plants had an annual
capacity of 430,000 tons and were carried on the books at $500 million. The firm thought they
could sell them for about $650,000,000. They were also a major factor in the production of fiber
drums with 12 plants which had a book value of $120,000,000. It still owned 1.45 million acres
of timberland located in the Southeast (of which 868,000 acres were in pine plantation targeted
for continuing harvest that began in 1998), carried on the books at $115 million but with a
market value (conservatively estimated by management) of at least $600 million. Lockwood’s
2007 Annual Report noted that the timberland which previously supplied the divested mills could
now be managed as a non-integrated profit center.
Forest Products’ activities were balanced as follows:
Fibre Drum 25%

Fibre drum shipping containers, steel drums, plastic pails, laminator paper,
fiber partition and DualPak (polyethylene bottle in corrugated box) for the
chemical, pharmaceutical, plastic, food and other industries.

Bleach System 46% Bleached Folding carton grades for folding carton manufacturers; coated
bleached bristols and cover stock for the domestic and international
printing industry; and cup and other stock for the food service industry.
Woodlands 29%

Wood raw materials for paper mills and sawmills.

Forest Products Outlook:
Paperboard. The experts hired by Lockwood had some reservations about this rosy outlook. In
their report they wrote that they had visited the bleached paperboard plants and concluded that
many of them were using near obsolete technology. They further said that Lockwood’s plants
showed signs of poor preventive maintenance practices and some signs of inadequate training.
They doubted that the plants could produce 430,000 tons per year. In their opinion the plants
would do well to produce 380,000 tons on a consistent basis. Based on this they believed that the
market value of the plant was overstated by at least $200,000,000 and that the value would

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decline by about $8,000,000 per year for the next five years and then decline even more rapidly
as plants in the planning and design neared completion. The consultants said that competitors
were building two paperboard plants in the south with expected completion dates of 2011 and
2012 and two more in the planning and design stage that should be on line by 2013/2014. All of
these plants would produce higher quality products at costs 10%-20% lower than Lockwood’s
plant. When these plants and two more planned for the western U. S. came fully on line in the
next 10 years total paper board capacity in the U. S. would be increased by at least 50% or much
more than the expected increase in demand of 35%. They did not consider that the fiber drum
and cardboard box businesses would be able to maintain either their current level of profitability
or cash flow. In fact, their estim…

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