Strategic Analysis of Power Corporation of Canada

Worldwide Power:

A Strategic Analysis of Power Corporation of Canada


EXECUTIVE SUMMARY 2
2.1 HISTORY 3
2.2 STRATEGIC GOALS 3
2.3 ORGANIZATION CHART 3
EXTERNAL ANALYSIS 4
3.1 THE GENERAL ENVIRONMENT 4
Global 4
Demographic 4
Political/Legal 4
Economic 4
Socio-cultural 5
Technological 5
3.2 THE INSURANCE INDUSTRY 5
3.4 TURNING THREATS INTO OPPORTUNITIES 7
INTERNAL ANALYSIS 7
4.1 VALUE CHAIN ANALYSIS 7
PRIMARY ACTIVITIES 7
4.2 FINANCIAL RATIOS 7
4.3 TURNING WEAKNESSES INTO STRENGTHS 8
STRATEGY FORMULATION 8
5.1 KEY ISSUES 8
6.2 DECISION CRITERIA 9
RECOMMENDATION 10
IMPLEMENTATION 10
POWER CORPORATION OF CANADA - ORGANIZATION CHART 11


Context
2.1 History
Power Corporation of Canada (Power), Canada’s fourth largest company in revenues , was founded on a vision. In 1925, facing foreign takeover threats from the U.S. in the Canadian electric industry, two Montreal under writers – A.J. Nesbitt and P.A. Thomson – took action to protect Canadian power utilities. They established Power Corporation of Canada, a holding group that would consolidate Canadian power companies under an umbrella organization. Over the years, Power began picking up considerable interests in power utilities across Canada and expanded globally with interests in the United States, Brazil, and China. Throughout the 1950s and ‘60s, Power was deeply hit by a trend of nationalized energy and diversified into other industries such as pulp and paper and finance. In 1968, Paul Desmarais joined the company in a merger and would be Power’s CEO until 1996. This would be the beginning of Power’s strategy to hold large, concentrated investments in a diverse portfolio and to leverage their managerial capital. During Desmarais’ tenure, Power’s corporate assets have increased by over 1500% (C$165 million to C$2.7 billion) and net earnings have grown by 6500% (C$3 million to C$200 million) .

2.2 Strategic Goals
Power has always been characterized by strong and consistent leadership. The company has operated under a romantic view that the leader is critical in shaping an organization to achieve success. Thus, strategic goals are critically important in communicating the message down the hierarchy from vision to mission to objectives. Power is built around a well-defined vision based on its core values of a corporate family.
Power has stated its mission as “enhancing shareholder value through the active management of long-term investments and responsible corporate citizenship”. This mission is outlined with the strategic objective to minimize risk by diversifying across sectors and geographic segments .

2.3 Organization Chart
Power’s principal asset is its 66.4% holding in Power Financial Corporation (Power Financial) which controls Great-West Lifeco Inc. and IGM Financial Inc. Through Power Financial, Power controls a deep network of wholly-owned subsidiaries offering insurance and wealth management across Canada, in the northern United States, and in European nations such as Germany and the United Kingdom. Power remaining portfolio includes seven daily newspapers in Ontario and Quebec, magazines, and websites operated by Gesca Limitée (Gesca) and investments in global technology companies and funds through Power Technology Investment Corporation (Refer to Appendix 1).

External Analysis
3.1 The General Environment
Global
In recent years, market shocks around the world have demonstrated the vast international linkages that are shared between economies. The Asian Financial Crisis of 1997 saw the stock markets across Southeast Asia in near synchronization. The ongoing worldwide slowdown can be attributed back to rotten mortgages in the United States. Multinational corporations now need to be aware of geographic vulnerabilities in a world of free capital mobility. The failure of one foreign subsidiary affects the corporation’s balance sheet as a whole and puts a crunch on other owned subsidiaries around the world.

Demographic
The effects of the baby boom generation are starting to show however the coming years could bring a major demographic shift. In the 2006 Canadian census, 49.5% of Canadians were above the age of 40. That implies almost half of the country will be retired in 20 years. The demographic required to replace the baby boomers in 20 years, age 0-24, represents only 30.9% of Canada and is not sufficient enough to cover the major labour outflow. Considering that Canada has a positive net migration rate (more people are leaving the country than arriving), there could be a major worker shortage in the coming years. This factor affects the insurance industry because the sales of insurance policies will not be enough to cover the increasing insurance claims and payments that will result in an aging population .

Political/Legal
The 2009 Canadian federal budget, which is currently in legislature, proposed a broad stimulus of cash across several sectors. Through the Extraordinary Financing Framework, $200 billion will be injected into the economy to ease credit markets and loosen liquidity. For Canadian insurers, the Canadian Life Assurance Facility was created to level Canadian insurers with foreign competitors who have received government protection through guaranteed programs. The 2009 budget also plans to repeal Section 18.2 of the Income Tax Act, which will allow Canadian multinational companies to deduct interest earned for certain investments in foreign subsidiaries . These measures, along with the various tax cuts and positive externalities from the budget proposals should be very beneficial to Canadian firms, particularly the multinationals.

Economic
Economists are mixed on forecasts for growth in Canada in 2009. The most optimistic outlook has the Canadian economy posting modest growth by the 3rd quarter. Nevertheless, the worldwide economic slowdown has left damaged balance sheets and cash flows in its wake, the effects of which shall be seen as companies release their 2008 annual reports.

Socio-cultural
Most Canadians are automatically covered by insurance through their family or work. The ability to sell extra packages or gain new customers is hindered by the different propensities to save among culture groups. For example, Chinese citizens typical have higher savings rates than western nations. In Canada, South Asians are the largest visible minority with a population of 1.23 million followed by Chinese at 1.16 million and Black at 0.78 million. These visible minorities are primarily situation in urban centres along the border. These cities continue to diversify culturally and understanding differences in culture translates to success in those vast markets.

Technological
Rapid advancement in processing speed of computers is making world a small place. Internet, telephone, and faxes have created a 24-hour global market where at any point in time, shares are bought and sold somewhere in the world. For a company that invests most of its income, this is a crucial factor for Power. In a changing landscape, the latest technologies may be an easy source of competitive advantage.

3.2 The Insurance Industry
The Canadian insurance market was valued at $95.6 billion in 2007. Non-life insurance such as health and property insurance comprised 56.7% of the market’s value. The remaining 43.4% represents life insurance premiums. The 5-year compound annual industry growth (measured 2001-2006) was 5%.

Porter Five Forces

The Threat of New Entrants
There are few barriers to entering the Canadian insurance industry however the market is highly mature and competitive. At 117 firms, a few companies have gained significant market share while the rest have found profitable niches. The market is increasingly complex and requires experienced management and personnel. There is the potential for other financial service providers such as commercial banks and mutual funds to offer insurance.

The Bargaining Power of Buyers
In the insurance industry, the buyers are known as policy holders. Policy holders vary between individual and group consumers. There are many policy holders relative to insurance companies which weakens the buying power. Furthermore, policies are locked into term contracts so the buyer is restricted from switching. Policies that allow “exceptions” usually require high enough costs to disincentive the buyer from switching. While insurance is not an essential need, many businesses involved with risk require insurance policies to function. However, since group policies can include thousands of individual policies, businesses have a little more buying power than individuals.

The Bargaining Power of Suppliers
The suppliers of Canadian insurers are makers of financial computer software and IT service. The market for computer systems is dominated by major firms such as IBM, adding to supplier power. There is little threat of vertical integration because insurance companies do not have the resources and personnel to develop and maintain computer software in-house. However, insurance companies can outsource certain back-office tasks, decreasing the supplier’s demand.

The Threat of Substitute Products or Services
There are no pure substitutes that offer the same features as an insurance policy. Buyers can invest in other savings options however they do not offer the same guaranteed protection that insurance does.

The Competitive Rivalry
There are three main Canadian insurance companies: ING Groep, Sun Life Financial Inc., and Power’ Great-West Lifeco Inc. Alongside these companies, are many smaller firms both domestic and international. Insurers’ assets are protected by regulations creating high exit barriers. With a large threat of new entrants and high exit barriers, the competitive rivalry intensifies as struggling companies continue operating .

3.4 Turning Threats into Opportunities
It is essential for managers to analyze the external environment looking for threats and opportunities. That alone, however, does not guarantee success. Threats should be identified and developed into opportunities. Current opportunities should be capitalized on now to support further opportunities. There is a worldwide economic slowdown. Credit markets are down as are asset prices. While this may be threatening, it is also a rare opportunity. Companies are undervalued during this recession and can be bought for cheap. In years past, government has been actively regulating the financial industry. The very same regulations that people complained about in the past were now being lauded for saving Canadian banks from crashing. Government regulation has help insurance companies with the double taxation of income trusts. Income trusts were a savings vehicle that could be considered a competitor to insurance policies. The double taxation law that was passed makes them less attractive as investments.

Internal Analysis
4.1 Value Chain Analysis
Primary Activities
Inbound Logistics: Financial computer software is purchased from suppliers. Training and maintenance may be required constantly.
Operations: Premium income is invested in financial markets. Financial software and expert analysts help generate returns on the invested income.
Outbound Logistics: Insurance policies are offered at providers of financial services such as commercial banks and wealth managers or physical branches can offer the entire product line.
Marketing and Sales: Online and phone distribution channels lead consumers to physical agents. Wide product range. Aiming for focus on customer service and quick response.

4.2 Financial Ratios
Although Power holds companies in many sectors, the bulk of its income is from its insurance subsidiaries. Thus, when analyzing Power’s financial ratios, it is helpful to view Power as an insurance company. The most important financial statement for an insurance company is the balance sheet. Great-West has important liabilities to its policyholders and it is critical to be able to cover those obligations. The current ratio can determine if Power is too leveraged to handle these obligations. Power has a debt/equity ratio of 0.78 which is well below the industry average of 1.41. Power also has a below industry average leverage ratio, showing that it is well positioned for the current credit crunch. Power’s return ratios are generally better than the industry average however trail competitor Sun Life on return on assets and return on equity. The most concerning ratio is the -32.1% drop in sales from the same time last year. However, Power’s two main competitors, ING and Sun Life, also saw 30% drops in sales. From these ratios, it is clear that Power has been hit by a slowdown in demand across the insurance industry. Since Power has strong leverage and liquidity ratios, it is capable of weathering the storm until sales start growing.

4.3 Turning Weaknesses into Strengths
The organizational chart shows that almost all of Power’s subsidiaries are in the business of insurance. Aside from holdings in Gesca and Pargesa, these insurance subsidiaries are also all based in Canada. These are weaknesses that need to be developed into strengths. Power has an excellent distribution network in Canada and can ented it into the United States. Power also has fresh new investments in China to make it a truly global company. These initiatives are being led by Paul Desmarais Jr., the son of former CEO Paul Desmarais. Strong and consistent leadership is an important value proposition for Power.

Strategy Formulation
5.1 Key Issues
As a holding company, Power is faced with issues of creating value for its subsidiaries.

Diversification
The current economic climate is full of under-valued assets. Given Power’s strong financial position and the extra credit available from the Extraordinary Financing Framework, an acquisition could be a good option for expansion. With an expansion, there arises the question of where and how much. For simplicity sake, the alternatives for expansion are: no expansion, related diversification, unrelated diversification. With related diversification, Power would expand into more insurance companies in North America. Power could capitalize on synergies between sales forces, brand names, and product offerings. An unrelated diversification spreads the vulnerability that Power has to the insurance industry. Power can still create synergies through shared support activities and talent pooling.

Sagging Subsidiary Profits
On October 11, 2008 both Great-West Lifeco and IGM Financial recorded lower quarterly profits. In total, earnings from subsidiaries decreased from $338 million in 2007 to $293 million. Power also received lower earnings from its operations in China through the Power Technology Investment Corporation. Given the strategy of cutting assets and focusing on major investments, Power may look to sell underperforming assets to free up capital. The alternatives are to keep all current subsidiaries, sell insurance subsidiaries, or sell other subsidiaries. Selling insurance subsidiaries would mean less focus on Power’s core business. Power may be too invested in insurance with subsidiaries cannibalizing each other’s sales. Power’s other subsidiaries include interests in television, newspapers, energy, and wines and spirits. Selling these assets will also bring the benefit of extra capital to spend on other investments.

International Expansion
Power’s international portfolio includes Gesca and Power Technology which are concentrated in Europe and China respectively but Power Financial is still based in North America. Power has had a long history of investment in China and Paul Desmarais has influential connections throughout Europe. These would be the two ideal locations for an international expansion of Power Financial. Power Financial already owns Pargesa Holding S.A. which owns major European energy, minerals, and building materials companies. Power Financial could benefit from this market presence by offering a line of insurance policies through a subsidiary.

6.2 Decision Criteria
At the 1999 annual meeting, Paul Desmarais Jr. defined the principles that would guide Power into the new millennium. He reiterated the mission to enhance shareholder value and to focus on companies that had the long-term potential to dominate their markets. This value must be sustainable in the long-term. To do so, companies need to have strong balance sheets to be able to grow autonomously.

Enhances
shareholder value Long-term
sustainability of profits Maintain healthy balance sheet Potential to dominate industry
Related Diversification Y Y Y Y
Unrelated Diversification Y N N Y
No change N N Y N
Sell insurance subsidiaries N N Y N
Sell other subsidiaries Y N Y Y
Expand to Europe Y Y N N
Expand to China Y Y N N

Recommendation
The only alternative that satisfies each of the decision criteria is for related diversification. By choosing to diversify though, Power is also implicitly deciding not to sell any current subsidiaries. An international expansion is not recommended because of the ramifications on the balance sheet and the lack of potential to dominate those markets. International expansions are very costly and would add more liabilities in the short-run. Furthermore, the insurance markets in Europe and China are already developed with their own respective barriers of entry. Therefore, the related diversification would have to occur in North America. In Canada, Power is already a leading insurer through Great-West and London Life but Power’s interests south of the border are less developed. The recommendation is to acquire a controlling interest (all shares if possible) of an insurance company in the United States.

Implementation
Analysts will search the American insurance industry for undervalued assets. Amidst the collapse of AIG, a lack of confidence in American insurance firms has dropped their value. Power should look for cheap companies that possess strong balance sheets such as those exhibiting low price-to-book ratios. Once a suitable company has been found, Power will offer a friendly takeover by buying the company’s shares. If a deal cannot be reached, alternative companies will be approached. Once assuming control of the American firm, expert management will be assigned to oversee the integration of the new company. In the short-term, support activities can be consolidated as well as marketing and sales functions. Over the long-term, the subsidiary will be left with a healthy balance sheet and autonomous control. During the integration, constant reports of financial statements and synergies created will be prepared and evaluated by managers.

Appendices

Power Corporation of Canada - Organization Chart











Drivers of Supplier Power in Canadian Insurance Industry, 2007


Factors of Threat of New Entrants in Canadian Insurance Industry, 2007


Factors of the Threat of Substitutes in Canadian Insurance Industry, 2007



Factors of the Degree of Rivalry in the Canadian Insurance Industry, 2007


Selected Financial Ratios for Power and its Competitors
Power Corporation ING Groep Sun Life Financial Industry
Debt/Equity Ratio 0.78 5.05 0.76 1.41
Leverage Ratio 13.9 48.7 3.9 14.2
Return on Equity 14.8 -0.5 28.9 12.3
Return on Assets 2.2 0 6.6 2.2
Sales (qtr vs. qtr last year) -32.10 -31.10 -30.6 -21.10

SWOT Analysis
Strengths
- diversified portfolio
- experienced leadership
- high brand recognition and goodwill
- well-connected and global executives
Weaknesses
- too exposed to insurance market
- lack of strength out side of canada
Opportunities
- under-valued assets
- government stimulus
- double-taxation of income trusts Threats
- excessive regulation of financial industry
- state-owned competitors
- credit crunch
- market volatility in wealth management industry
- accusations of political interests