In 2018, 55% of S&P 500 companies utilized Total Shareholder Return (TSR or RTSR) in their long-term incentive plans. Among these companies, 82% used RTSR (Relative Total Shareholder Return) as a discrete metric, while 18% utilized it as a modifier. The S&P 500 index was used as a benchmark by 23% of companies employing RTSR. Ever since, the number of companies using this metric has grown, making this metric prevalent in M&A conversations.
Total Shareholder Return (TSR) is a performance metric used to compare the financial gains, in percentage terms, that an investor receives from holding shares in a company over a specific period. It is a comprehensive metric that accounts for capital gains and dividends. To be clear, another version of this metric, called RTSR (Relative Total Shareholder Return), has a difference between them. Still, they are related, as the name suggests. The first measures the total return of a company's stock to its shareholders, encompassing both price appreciation and dividends. It's calculated as the change in stock price plus any dividends paid, divided by the initial stock price. However, the RTSR compares a company's TSR to the TSR of a peer group or benchmark (like an index). It's a relative measure that helps to understand a company's performance in comparison to others or to the market as a whole. Again, having a context helps to make more out of it.
The calculation is a pretty straightforward formula that can be reflected with the following equation:
((FinalStockPrice+Dividends)/ /InitialStockPrice) −1 × 100
Remember that the metric focuses on stock price fluctuations, precisely its gains over the period and dividends that stocks can offer their shareholders during the same period. For the same reason, this metric gained substantial attention within the financial sector over the years. Its adoption and relevance can be traced back to its ability to provide a comprehensive view of shareholder value creation.
There is a good reason behind the historical relevance and adoption of this metric. First and foremost, the metric started gaining traction as a definitive metric for gauging corporate performance. The early recognition as a critical metric was hinged on encapsulated direct financial gains that shareholders received, making it an attractive metric for both companies and investors. The other reason behind high adoption is the prevalence of consultative practice, using the metric to rank companies based on their performance. For instance, Boston Consulting Group (BCG) has been ranking companies based on TSR for the past 23 years, which indicates the metric's long-standing relevance in evaluating corporate performance. Another is the metric's relativity to other metrics. This acts almost as a validation of other metrics that sometimes get you too deep into the weeds. Historically, TSR was often juxtaposed with other financial metrics, although the reporting standards do not require it. For instance, McKinsey discussed the relationship between Economic Profit (EP) and Total Return to Shareholders (TRS, synonymous with TSR), highlighting how TSR offered a more direct reflection of shareholder value creation than other metrics. According to McKinsey, TSR, which considers capital appreciation and dividend yield, provides a market-oriented performance metric. On the other hand, Economic Profit, derived from Net Operating Profit Less Adjusted Taxes (NOPLAT) minus (Capital × Cost of Capital), offers an accounting-based perspective on performance. So, yes, combining these two metrics can provide a holistic view of a company's financial health and long-term value-creation potential. Another reason behind the adoption is investors' expectations. Since the metric reflects the historical stock price and dividend, both derivatives of the market sentiment. The TSRs in this use case capture investor expectations for the future, thereby gaining a significant position in the financial sector's toolkit for evaluating companies.
In recent years, a deeper understanding of the TSR and its components has evolved, revealing its strengths and limitations. This modern approach to this metric opened the doors for a better metrics combination, including TSR/ RTSR combined with EBIT, EP, P/E, D/E, ROE, COSR, and FCF. Understanding the combinations between these metrics helps in better interpreting the metric and utilizing it effectively for corporate valuation and performance assessment.
Finally, the obvious suspect is the M&A due diligence process. The metric is used to evaluate a company's performance and business opportunities.
Let's focus on the last reason behind the TSR adoption, the due diligence process, and its impact on the potential acquisition process. So, the metric stands as a critical metric in the M&A domain, offering a multifaceted lens through which the historical and prospective value of a target company can be scrutinized. The role in assessing historical performance is pivotal; by contrasting the TSR of the target firm with others in the same sector, a relative performance measure is derived. This comparative analysis forms a foundation based on which valuation negotiations may continue. A robust historical result could empower the target company to argue for a higher valuation. Conversely, a buyer might leverage lower results to negotiate a significantly lower price.
Moreover, when examined alongside other financial indicators and market conditions, it reveals market expectations surrounding the targeted company. However, the readout is more complex than you might think. Often, the analysis extends to understanding market reactions to the target’s past strategic decisions or acquisitions, thus providing a backdrop against which future strategies might be evaluated. This is where your product, key initiatives, and strategic decisions will be evaluated, filling the gaps. None of these conversations stop with the metric, and they are just the beginning of the conversation about the future and how the company might want to change the trajectory of the stock price.
During the same process, executive compensation is being evaluated. The metric's relevance is underscored. The acquirers go after the executive compensation structures, and using TSR in these metrics can offer insights into management incentives and their alignment with shareholder interests. This part of the evaluation brings a broader examination of strategic fit and projections of future performance post-acquisition ("what if" scenarios).
Additionally, understanding the metric drivers can open discussion about potential synergies and enable a thorough assessment of the acquisition's impact on post-acquisition metrics performance.
Lastly, the metric serves as a "sniff test." A dwindling or low TSR may flag potential underlying issues or risks within the target company, necessitating a deeper investigation during the due diligence phase. This aspect of TSR analysis is crucial as it unveils hidden pitfalls that could alter the acquisition strategy or the perceived value of the target company.
Acquisition of Qualtrics by Silverlake (it has happened, but since not all information is publicly available, I used assumptions, therefore hypothetical - please be nice to me).
In assessing the viability and potential of acquiring Qualtrics, Silverlake employed a set of evaluative metrics to derive an insightful understanding of the company's performance and market position. The TSR painted a picture of Qualtrics' stock performance, including stock price appreciation and dividends. Since I don't have that data, I need to calculate the data backward.
Here is what we know about the final price. The acquisition of Qualtrics by Silver Lake, in partnership with CPP Investments, was valued at $12.5 billion. This deal was an all-cash acquisition, where Silver Lake and CPP Investments acquired all the remaining shares of Qualtrics, paying out $18.15 in cash for every share. This acquisition occurred after Qualtrics had been a publicly traded company for two years, having gone public in 2021 after separating from its former parent company, SAP. The acquisition is a private equity buyout involving one of Canada's most significant pension funds alongside Silver Lake. It's also known that the agreed-upon acquisition price was $18.15 per share, representing a substantial premium of 73% to the 30-day volume-weighted average price on January 25, 2023, before SAP's announcement to explore a sale of its stake in Qualtrics.
So, assuming the $18.15 price represents a 73% premium over the 30-day volume-weighted average price, we can estimate the average price before the premium as follows:
AVG Price = Acquisition Price/ 1+Premium = $18.15/ 1 + 0.73 = 10.49
Okay, now let's use this as the beginning price and the acquisition price of $18.15 as the ending price and assume no dividends were paid (the company very likely wasn't paying that, considering the stage and maturity level):
TSR = ((($18.15 + $0 - $10.49) / $10.49)*100) = 73%
Here is your calculation. However, that's only a piece; as we said above, the context comes from the other metrics that help to create a big-picture view. Silver Lake likely analyzed the P/E ratio, EBITDA numbers, and projections to evaluate the company's efficiency. Growth rates are critical contextual data that they took under consideration for the next 3-5 years, ensuring there is a basis for what the Qualtrics team provided. Another part of important indices are market share and position against the leading competitors. A lot of that sounds obvious, but it's a good reminder that there is no silver bullet in the decision-making process like the M&A. This is, by default, a multi-dimensional conversation.
Conclusion: Let's wrap this up. So, I'm not a lawyer or the CPA to explain which framework should go through or the legal implications of this process. However, what I do know is that every process starts and ends somewhere within the window of opportunity. The reason behind stating the obvious is that we must realize a couple of things while creating the windows of opportunity. One that windows will only sometimes be open and available. They come, and they go. I'm sure every investment banker advising on this will disagree with me, considering their nature of work. However, if you are COO or CFO, you know that I'm right about that. Your work is a game of windows in which you know you can do certain things otherwise, it will be simply too much for the organization to swallow with everything else done in parallel. Disruption is good, but once out of control, it converts to disaster. Nobody wants that. Second is that these decision windows have a limited time as well. That means you must move quickly with selecting the correct entity for the potential acquisition. One of the metrics is the TSR/ rTSR, which helps you select potential companies and compare them to other publicly traded entities. As we have said many times here, context is everything, so drilling down to the financials and other operational metrics should be easier knowing where you started and where you are going.
Finally, remember that the selling entity must be ready to engage in this process. Even if you are a privately held company, you must be able to engage meaningfully on that front. That might not necessarily be your preference or a great metric, but acquisition should always be in the mix of scenarios you consider. When you refresh your mid-year planning numbers, ensure your acquisition story is tested based on the metrics you know you will be asked to present. As the acquisition season starts now with many companies unable to access the capital or extra funding, understanding the evaluation process can help everyone seal the deal faster.
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