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 atone time or another had been a competitor in more than two dozen industries with variedsuccess. Each of the several CEOs had developed a different strategy and over the decades thefirm had had many manifestations. The only real constant in Lockwood’s strategy had been acommitment to the packaging business in its several forms. But, even in this business there hadbeen any number of changes in direction which diluted the impact of capital spending and hadthe effect of Lockwood never achieving a strong position in any of the packaging segmentsalthough, briefly, in the 1970s Lockwood’s total packaging revenues made it the largestpackaging company in the world. The lack of a competitive advantage in any of the largepackaging segments resulted in Lockwood being pushed into producing commodity productswhich had them penned between powerful steel and tinplate suppliers and powerful food andbeverage producers as customers. Also, as their large customers grew there was pressure forthem, 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 packagingprofitability to lag its better positioned competitors. At one time or another during the second half of the 20th century the company produced autoparts, 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 regionalretail chains. None of these businesses worked out well and all were either sold or liquidated at aloss. The financial and human capital devoted to these businesses was largely lost. Further, theproblems they caused diverted capital and management attention from better opportunities. NEW STRATEGIES FOR THE 21st CenturyBy the late 1990s under still another new CEO a management consensus had developed. Theconsensus was to (1) reduce holdings in operations that fall short of performance goals or do notfit the long-term strategy of the company, a target of realizing $600-$700 million from the saleof 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 forthe firm included having a well balanced BCG matrix that considered fast growing industries tobe those that were growing at more than 10% per year. The end result would be a firm with fourmain businesses: financial services, energy, packaging and forest products. The latter wasprimarily a paper, fiber drum, and cardboard business that also generated about 25% of revenuesfrom selling lumber and wood chips. This strategy was followed and many businesses were sold although the amount of moneyreceived for the businesses fell short of the $700 million target by almost $250 million. Thebusinesses sold were all either small competitors in their industry or were in industries thatsuffered from overcapacity and low returns. 1The New LockwoodBy 2001 the sales were complete and most of the realized funds had been redeployed intoLockwood’s four main business groups, resulting in a firm that management thought met theirgoals. The Chairman stated in the 2000 Annual Report that Lockwood was ready to move on to anew phase: “Our primary task is now the efficient production of quality goods and serviceswithin our restructured business segments: packaging, forest products, insurance,and energy. Further details on Lockwood’s posture are contained in the attachedoperating and financial statements. Our overall strategy is to achieve thecompetitive advantages that can result from increased productivity, market focus,and innovation. ”By the beginning of 2005 management believed that it was well positioned strategically forfuture growth and profitability. They had pared their operations to four main businesses: Financial Services, Energy, Packaging, and Forest products. The review for each segment wasdone by top management with the assistance of outside consultants who were all experiencedtop-level executives in each industry. Some of the consultants were retired and some of themwere still active, but they all had long and successful experience in the industry they wereconsulting on. There is also an outlook section for each industry segment that includes estimatesof profitability, cash flow, and needed investment in the next 10 years. The outlooks were doneentirely by the consultants. Financial ServicesLockwood’s first foray into financial services came in the early 2000s when a large investmentbank 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 andthey knew that Lockwood was looking to redeploy the assets generated from the sale of theassets. Initially Lockwood was cool to the idea because it was so far removed from theirexpertise, but on examination it appeared that the insurance business had good profitability andcash flow characteristics so when the existing management was persuaded to stay on thepurchase was made. From this base the Financial Services group added more insuranceoperations to include American Life Insurance Company, with its 49 master brokerage generalagents and 13,000 independent brokers and agents. The firm also added a mortgage company, amortgage insurance company, a number of title insurance companies and several title companiesto form the core of the real estate-related financial services area. By the end of 2002 LockwoodFinancial Services underwrote insurance in three broad segments: life and real estate as well asproperty and casualty insurance. The firm was strongly positioned in the Financial Servicesbusiness, but competition was tough. Lockwood’s Financial Services division was not large by national standards, but the firm was asurprisingly nimble and successful middleweight in the industry. The management of thisbusiness had done an efficient job of integrating their many acquisitions into the financialservices operation, had proven their ability to pick their target markets, and avoided serious2headto- head competition with bigger and more powerful rivals. The future prospects of thedivision looked good. Financial Services Outlook. The consultants that looked at the financial services businessbelieved 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 positivecash flow characteristics. Although Lockwood invested more capital per dollar of sales than mostof their competitors the consultants thought this problem would be solved by increasing the sizeof the operation. They believed that Lockwood could increase their sales in the division by about15% per year and increase returns on segment assets to between 15% and 18%. They alsoexpected division sales to increase by at least 15% per year for the next decade if they made theneeded investment in the business. They recommended that the firm invest heavily in thebusiness because they were small and would benefit from additional size. Their largestcompetitor was about double the size of Lockwood and growing at about 10% per year. Theconsultants believed that for the firm to remain successful in the business which meansincreasing the segment earnings to assets ratio from the current 13% to 18%, they would need toinvest at least, and they stressed at least, $250,000,000 per year in the business initially andincrease gradually to $300,000,000 in 5-7 years at which time investment could probably declineto $100,000,000 per year. This investment would more than double the assets committed to thebusiness within five years. They forecast cash flow from the division, assuming therecommended investments are made by the company to be negative $250,000,000 per year foryears 1-3, negative $50,000,000 in years 4 and 5, positive $200,000,000 in years 6 and 7, andpositive $300,000,000 in future years. The consultants believed that Lockwood could sell thefinancial services business for about $1,000,000,000 if it were put up for sale and if the firm waspatient. EnergyIn 2004 Lockwood made its first major acquisition in the energy business when they boughtEasyGas Energy which became the core of their Energy Division. This acquisition allowedLockwood 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 systemextending from the Texas-Mexico border to the southern tip of Florida, and also extracted andsold propane and butane from natural gas. Prior to the acquisition of EasyGas, Lockwood hadsmall working interests in offshore and onshore gas and oil properties in the Gulf of Mexico andin Mississippi which they purchased in the late 1990s to try to develop a better understanding ofthe business. These were merged into the new energy division. EasyGas was the sole supplier ofnatural 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’spipeline operations offered a strong cash flow at relatively low risk. Prior to the purchase of EasyGas Lockwood’s nascent energy division had begun investigating anumber of major and very expensive projects including a 1,500-mile slurry pipeline that wouldtransport coal from Eastern Appalachia and the Illinois basin to the Southeast. If approved, thisproject would call for $2-3 billion in financing over seven years. The company was alsoconsidering joining with Shell and Mobil in the construction of a 502-rnile carbon dioxide3pipeline in which the company would have a 13% interest at a cost to Lockwood of $50,000,000per year for 5 years, and was considering converting an 890-mile segment of its 4,300-milenatural gas pipeline to petroleum products (while maintaining its natural gas deliveries to theFlorida market), at a cost of $100,000,000 spread evenly over 5 years. They were alsoconsidering participating in four major offshore natural gas pipeline projects in the Gulf ofMexico to connect into the Florida Gas Transmission system. Their share of these projects wouldcost about $400,000,000 spread over 10 years. The senior management of the firm was reluctantto curb the enthusiasm of the pipeline managers, but they were worried about the possible risksof such large ventures and were counting on the management of EasyGas, who had agreed tojoin 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 thecompany’s proven reserves of oil and gas by approximately 50% and its undeveloped acreage by50%. Suppan’s emphasis on development drilling also complemented Lockwood’s activities andstrengthened its position in domestic natural gas. In joint ventures with Shell Oil, Lockwoodacquired additional offshore leases and participated in extensive exploratory drilling activities. In2006 it spent some $400 million on exploration, but was now focusing on developing existingfields to improve the firm’s cash flow to try to offset the impact of all the investments in theenergy business. An industry analyst said of Lockwood’s energy business: “Although the company is a baby to the industry giants, it has a strong positionin some segments. It is the largest supplier of energy to the State of Florida, oneof the nation’s fastest growing states and that is a good business. However, inexploration and production they have no such protected position in an industrythat is rapidly consolidating into giant firms with the financial resources tomake, and lose, big bets in exploration. With the looming oil shortage provenreserves is where the money will be and Lockwood is probably just too small tomake the needed investments and, more importantly, take the risks associatedwith exploring in deep water and/or hostile environments like Siberia. Theyhave the right idea, but their small size, their major competitors were 8 to 10times the size of Lockwood’s exploration and production unit, makes aninherently risky business even more risky. A loss that would be immaterial to anExxon Mobil could sink Lockwood’s exploration business. ”Energy Outlook. In 2008 the future of the energy business looked pretty bright and this view wasemphasized by the consultants that Lockwood brought in to review their energy business. Growth in China and India practically guaranteed that worldwide demand would grow muchfaster than was true in the past. The supply problem for the U. S. was exacerbated by the fact thatChina was negotiating long-term contracts to buy oil and gas from countries that hadtraditionally been U. S. suppliers, Canada, Mexico, Venezuela, and Norway. China was rapidlyensuring their future access to oil and the effect could be to cause future shortages for everyoneelse. The consultants believed that the long-term, worldwide supply and demand picture for oiland gas was extremely favorable for those firms that had either reserves or the cash flow to findand develop them. They felt that oil prices would not drop below $50 per barrel for very longand 10%-15% annual price increases was a minimum estimate and the possibility of much larger4price increases was also more likely than anyone could have guessed even in 2007. They stressedthat this forecast did not envision any significant disruption in supplies from the middle-east orelsewhere. In the event of a major disruption prices could easily exceed $175 per barrel. Theirview was that only a really huge new oil field discovery, which was unlikely, or a world-widerecession of major proportions would derail their forecast and even the recession would onlydelay the increase in the price of oil. They also mentioned that U. S. oil production had peaked inthe early 1970s and that one reasonable estimate was that worldwide oil production would peakin the early 2000s (2002-2010). If this latter prediction were true future increases in the price ofoil would be hard to predict but could be ruinous until a transition to some other energy sourcewas complete. The consultants stressed that given their size Lockwood could never hope to growto a competitive size in the industry, but their existing proven reserves and promising landholdings would only become more valuable as time passed and the supply/demand situationbecame tighter and tighter. They did not recommend major new investment in either explorationor production for the reasons given by the analyst quoted above. Florida Pipeline. They felt that for Lockwood to prosper in the new energy environment theywould need to build pipeline capacity into Florida because of the tremendous population growthin 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 bedetermined by the longer term population growth. Some demographic and real estate expertsbelieve that the recent rapid increase in housing prices in Florida would cause population growthto 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 benegative $50,000,000 per year for years 1-4 and increase slowly to positive $300,000,000 from apositive $100,000,000 in year 5. Exploration and Production. The experts believed that Lockwood was too small to compete longterm in the exploration and production area unless they were willing to build oil reserves andproduction capacity simultaneously. This would be an expensive undertaking that could easilytake $500,000,000-$600,000,000 per year for the next decade but the impact on earnings andcash flow could be expected to be dramatic, but probably not for 5-7 years because of the longlead 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. Theythought that returns on assets would improve from the recent 5% level to the 8%-12% level atbest. 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 entiredivision could probably be sold for about $1,560,000,000 at the present time and could be worthas 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 productiondivision. If the recommended investments were made they expected revenues to increaseannually from the 10% range to the 15% range during the next 10 years. They were furtheradvised against frittering away capital on non-energy enterprises and focus on building suppliesof both oil and gas. Given the needed investments the expert consultants expected theexploration and production operation, assuming the needed investments were made, to be cashflow negative by at least $400,000,000 per year for the next 6-9 years after which it would turn5cash flow positive within 2-3 years and generate cash flow of about $150,000,000 per year forthe foreseeable future. PackagingIn December 2002, the Lockwood Packaging Division had been reorganized to facilitate a newstrategy stressing market rather than product orientation. As the Packaging Division VicePresident told New England Business: “We will start to look at our franchise not as the manufacture of blow-moldedbottles, or twopiece aluminum cans, but as our relationship with the big packagegroup marketers. Hitching Packaging’s wagon to big customers like GeneralFoods makes more sense than latching on to a particular technology or shape orstructure that will inevitably change. We do understand that such a relationshipwill require substantial capital expenditures every time a new packagingtechnology is demanded by our customers but we believe that the firm willgenerate cash flow adequate to the division needs. ”The new packaging organization operated in three major markets: Food and Beverage, SpecialtyPackaging, and International. Its cost reduction and productivity programs included closing anumber of plants, which were unable to meet long-term profitability standards, while improvingcapacity utilization and line efficiencies at other facilities. Basic research expenditures werereduced and emphasis directed towards business development and marketing. LockwoodPackaging had a major position in the fastest growing segment of the can industry the-two-piecealuminum can. However, both the short and long-term results of the packaging business wouldbe determined by (1) the success of new product introductions, (2) continued emphasis on costcutting even after demand reaccelerated, (3) whether or not metal cans would be besieged byanother fundamental change in design and (4) the bargaining power of their customers. Those 7issues were very uncertain and hard to forecast especially given the strategic focus on a relativelyfew very large customers who would have substantial bargaining power. Packaging Outlook. The packaging business was, in the main, an economically sensitiveoligopolistic industry that mainly sold commodity products. It was very difficult to establish anykind of long-term competitive advantage other than cost and delivery reliability and other firmswere positioned to do this as effectively as Lockwood. The firm’s decision to tie themselves tolarge customers while understandable and probably wise was likely to create serious pressures toreduce price and also make the packaging division less flexible because of the location decisionsneeded to cater to largecustomers. The consultants did not believe that either sales growth orprofitability would grow much faster than GDP in the future and felt that the cash needs of thedivision could be very high when the customers demanded new technology. Building the newtechnology into the plants would not reduce the push for lower prices by customers. Theconsultants felt that profitability would not increase over the next 10 years but would decline byabout 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 getworse by about 20% per year thereafter. They forecast revenues to increase at the recent rate for6the 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 ProductsThe Vice President of the Forest Products Division told The Wall Street Journal at the time someof the lumber operations were sold off: “Our forest products business will be reduced in scale but will now be made up ofspecialty businesses in which we are competitive and we will work to developworld class and to some extent proprietary positions backed by a natural resourceof immense and growing value. ”Lockwood was a large producer of bleached folding carton board and ranked sixth in totalproduction of bleached paperboard in the U. S. Lockwood’s largest competitors in this businesshad more than twice the sales of Lockwood. Its bleached paperboard plants had an annualcapacity of 430,000 tons and were carried on the books at $500 million. The firm thought theycould sell them for about $650,000,000. They were also a major factor in the production of fiberdrums with 12 plants which had a book value of $120,000,000. It still owned 1. 45 million acresof timberland located in the Southeast (of which 868,000 acres were in pine plantation targetedfor continuing harvest that began in 1998), carried on the books at $115 million but with amarket value (conservatively estimated by management) of at least $600 million. Lockwood’s2007 Annual Report noted that the timberland which previously supplied the divested mills couldnow 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 thechemical, pharmaceutical, plastic, food and other industries. Bleach System 46% Bleached Folding carton grades for folding carton manufacturers, coatedbleached bristols and cover stock for the domestic and internationalprinting 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. Intheir report they wrote that they had visited the bleached paperboard plants and concluded thatmany of them were using near obsolete technology. They further said that Lockwood’s plantsshowed 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 plantswould do well to produce 380,000 tons on a consistent basis. Based on this they believed that themarket value of the plant was overstated by at least $200,000,000 and that the value would7decline by about $8,000,000 per year for the next five years and then decline even more rapidlyas plants in the planning and design neared completion. The consultants said that competitorswere building two paperboard plants in the south with expected completion dates of 2011 and2012 and two more in the planning and design stage that should be on line by 2013/2014. All ofthese plants would produce higher quality products at costs 10%-20% lower than Lockwood’splant. When these plants and two more planned for the western U. S. came fully on line in thenext 10 years total paper board capacity in the U. S. would be increased by at least 50% or muchmore than the expected increase in demand of 35%. They did not consider that the fiber drumand cardboard box businesses would be able to maintain either their current level of profitabilityor cash flow. In fact, their estim. . .