The only real constant in Mensa’s strategy had been a commitment to

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 oranother had been a competitor in more than two dozen industries with varied success. Each ofthe several CEOs had developed a different strategy and over the decades the firm had had manymanifestations. The only real constant in Mensa’s strategy had been a commitment to thepackaging business in its several forms. But, even in this business there had been any number ofchanges in direction which diluted the impact of capital spending and had the effect of Mensanever achieving a strong position in any of the packaging segments although, briefly, in the early1980s Mensa’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 Mensabeing pushed into producing commodity products which had them penned between powerfulsteel and tinplate suppliers and powerful food and beverage producers as customers. Also, astheir large customers grew there was pressure for them, especially in the low margin foodbusiness, to build their own packaging facilities, especially can plants. The long term effect ofthis was to cause Mensa’s packaging profitability to lag its better positioned competitors.At one time or another during the 1980s and 1990s the company produced auto parts, electricalequipment, power equipment, electric motors, metal alloys, airplane wings, furniture, appliances,communications equipment, specialty chemicals, and consumer products, to name only the mostimportant of their many businesses. They also bought several regional retail chains. None ofthese businesses worked out well and all were either sold or liquidated at a loss. The financialand human capital devoted to these businesses was largely lost. Further, the problems theycaused 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 Mensa’s balance sheet and credit standing. The new benchmarks for the firmincluded having a well balanced BCG matrix that considered fast growing industries to be thosethat were growing at more than 10% per year. The end result would be a firm with four mainbusinesses: financial services, energy, packaging and forest products. The latter was primarily apaper, fiber drum, and cardboard business that also generated about 25% of revenues fromselling 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 MensaBy 2XX1 the sales were complete and most of the realized funds had been redeployed intoMensa’s four main business groups, resulting in a firm that management thought met theirgoals. The Chairman stated in the 2XX0 Annual Report that Mensa 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 Mensa’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 2XX5 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 ServicesMensa’s first foray into financial services came in the early 2000s when a large investment bankbrought 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 theyknew 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 onexamination it appeared that the insurance business had good profitability and cash flowcharacteristics so when the existing management was persuaded to stay on the purchase wasmade. From this base the Financial Services group added more insurance operations to includeAmerican Life Insurance Company, with its 49 master brokerage general agents and 13,000independent brokers and agents. The firm also added a mortgage company, a mortgage insurancecompany, a number of title insurance companies and several title companies to form the core ofthe real estate-related financial services area. By the end of 2XX2 Mensa Financial Servicesunderwrote insurance in three broad segments: life and real estate as well as property andcasualty insurance. The firm was strongly positioned in the Financial Services business, butcompetition was tough.Mensa’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 serious2head-to- 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 Mensa invested more capital per dollar of sales than most oftheir competitors the consultants thought this problem would be solved by increasing the size ofthe 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 expecteddivision sales to increase by at least 15% per year for the next decade if they made the neededinvestment in the business. They recommended that the firm invest heavily in the businessbecause they were small and would benefit from additional size. Their largest competitor wasabout double the size of Mensa and growing at about 10% per year. The consultants believed thatfor the firm to remain successful in the business which means increasing the segment earnings toassets ratio from the current 13% to 18%, they would need to invest at least, and they stressed atleast, $250,000,000 per year in the business initially and increase gradually to $300,000,000 in 57 years at which time investment could probably decline to $100,000,000 per year. Thisinvestment would more than double the assets committed to the business within five years. Theyforecast cash flow from the division, assuming the recommended investments are made by thecompany to be negative $250,000,000 per year for years 1-3, negative $50,000,000 in years 4and 5, positive $200,000,000 in years 6 and 7, and positive $300,000,000 in future years. Theconsultants 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.EnergyIn 2XX4 Mensa made its first major acquisition in the energy business when they boughtEasyGas Energy which became the core of their Energy Division. This acquisition allowedMensa 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, Mensa had smallworking interests in offshore and onshore gas and oil properties in the Gulf of Mexico and inMississippi which they purchased in the late 1990s to try to develop a better understanding of thebusiness. 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 Mensa’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 dioxidepipeline in which the company would have a 13% interest at a cost to Mensa of $50,000,000 per3year for 5 years, and was considering converting an 890-mile segment of its 4,300-mile naturalgas pipeline to petroleum products (while maintaining its natural gas deliveries to the Floridamarket), at a cost of $100,000,000 spread evenly over 5 years. They were also consideringparticipating in four major offshore natural gas pipeline projects in the Gulf of Mexico toconnect 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 theenthusiasm of the pipeline managers, but they were worried about the possible risks of such largeventures and were counting on the management of EasyGas, who had agreed to join Mensa andrun the Energy Division, to advise them on these possible investments.Exploration and Production. Mensa undertook a joint acquisition (with Allied Corporation) ofSuppan 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 Mensa’s activities andstrengthened its position in domestic natural gas. In joint ventures with Shell Oil, Mensaacquired additional offshore leases and participated in extensive exploratory drilling activities. In2XX6 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 Mensa’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 Mensa 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 Mensa’s exploration and production unit, makes an inherentlyrisky business even more risky. A loss that would be immaterial to anExxon Mobil could sink Mensa’s exploration business.”Energy Outlook. In 2XX8 the future of the energy business looked pretty bright and this viewwas 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 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 largerprice increases was also more likely than anyone could have guessed even in 2XX7. They4stressed that this forecast did not envision any significant disruption in supplies from the middleeast 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 worldwide recession of major proportions would derail their forecast and even the recession wouldonly delay the increase in the price of oil. They also mentioned that U. S. oil production hadpeaked in the early 1970s and that one reasonable estimate was that worldwide oil productionwould peak in the early 2000s (2002-2010). If this latter prediction were true future increases inthe price of oil would be hard to predict but could be ruinous until a transition to some otherenergy source was complete. The consultants stressed that given their size Mensa could neverhope to grow to a competitive size in the industry, but their existing proven reserves andpromising land holdings would only become more valuable as time passed and thesupply/demand situation became tighter and tighter. They did not recommend major newinvestment in either exploration or production for the reasons given by the analyst quoted above.Florida Pipeline. They felt that for Mensa to prosper in the new energy environment they wouldneed to build pipeline capacity into Florida because of the tremendous population growth in thestate. Their estimate of capital investment needs in the Florida market was about $50,000,000 peryear for the next 4 years. Beyond that time the investment needs would be determined by thelonger term population growth. Some demographic and real estate experts believe that the recentrapid increase in housing prices in Florida would cause population growth to moderate from thecurrent 365,000 people per year to a more sustainable rate of maybe 150, 000 per year. If theseestimates proved to be true the consultants expected cash flow to be negative $50,000,000 peryear for years 1-4 and increase slowly to positive $300,000,000 from a positive $100,000,000 inyear 5.Exploration and Production. The experts believed that Mensa 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 turncash flow positive within 2-3 years and generate cash flow of about $150,000,000 per year forthe foreseeable future.5PackagingIn December 2XX2, the Mensa 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. Mensa Packaginghad a major position in the fastest growing segment of the can industry the-two-piece aluminumcan. However, both the short and long-term results of the packaging business would bedetermined 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 Mensa. The firm’s decision to tie themselves to largecustomers 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 large customers. 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 forthe 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.6Forest 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.”Mensa was a large producer of bleached folding carton board and ranked sixth in totalproduction of bleached paperboard in the U.S. Mensa’s largest competitors in this business hadmore than twice the sales of Mensa. Its bleached paperboard plants had an annual capacity of430,000 tons and were carried on the books at $500 million. The firm thought they could sellthem for about $650,000,000. They were also a major factor in the production of fiber drumswith 12 plants which had a book value of $120,000,000. It still owned 1.45 million acres oftimberland located in the Southeast (of which 868,000 acres were in pine plantation targeted forcontinuing harvest that began in 1998), carried on the books at $115 million but with a marketvalue (conservatively estimated by management) of at least $600 million. Mensa’s 2XX7 AnnualReport noted that the timberland which previously supplied the divested mills could now bemanaged 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 Mensa had some reservations about this rosy outlook. In theirreport they wrote that they had visited the bleached paperboard plants and concluded that manyof them were using near obsolete technology. They further said that Mensa’s plants showed signsof poor preventive maintenance practices and some signs of inadequate training. They doubtedthat the plants could produce 430,000 tons per year. In their opinion the plants would do well toproduce 380,000 tons on a consistent basis. Based on this they believed that the market value ofthe plant was overstated by at least $200,000,000 and that the value would decline by about$8,000,000 per year for the next five years and then decline even more rapidly as plants in theplanning and design neared completion. The consultants said that competitors were building two7paperboard plants in the south with expected completion dates of 2XX1 and 2XX2 and two morein the planning and design stage that should be on line by 2XX3/2XX4. All of these plants wouldproduce higher quality products at costs 10%-20% lower than Mensa’s plant. When these plantsand two more planned for the western U. S. came fully on line in the next 10 years total paperboard capacity in the U. S. would be increased by at least 50% or much more than the expectedincrease in demand of 35%. They did not consider that the fiber drum and cardboard boxbusinesses would be able to maintain either their current level of profitability or cash flow. Infact, their estimate was that ROI would rapidly decline to near zero over the next 5 or 6 years,and decline rapidly afterwards and would become uneconomic and would need to be closed. Thecost to bui…