Scott Downsizing

How will the stock market value the downsizing program? Do you think Dunlap restructuring plan is an optimal solution for Scott's employees and for Scott's shareholders?

In analyzing the stock market reaction to the downsizing program it is useful to break this plan down into its component parts, namely: management, cost structure and debt reduction, strategy and compensation. Each will affect stock market valuation in a distinct manner and combined they will have a net effect which we can evaluate both in terms of employee and shareholder interests.

Dunlap's plan, in so far as management is concerned, is likely to have a positive effect on the stock market valuation of the firm. The replacing of mission critical staff in the areas of finance and procurement places the company on a firm footing to affect the change it desperately requires. At the same time Dunlap has wisely also retained some of the key executives which have operated with the firm for some time, in the finance and international departments. This mix allows also for consistency and stability through the difficult downsizing process and is likely to be viewed by analysts in a positive light.

The cost structuring and debt reduction which Dunlap proposes to employ is clearly the aspect of the downsizing plan which will have the most immediate and arguably, pervasive effect on the company's stock price. Lowering costs implies a higher profit margin and this relates directly to valuations and stock price performance (through the mechanism of the P/E ratio).

Moreover, by reducing the debt burden which the firm currently carries, Dunlap is able to affect a reduced cost of borrowing and thus in turn a reduced cost of capital which will result in an increased valuation of the firm (through the WACC approach since as debt decreases, equity will become less riskier and cost of equity will decrease).

Furthermore, reducing debt has associated benefits like lowered bankruptcy and agency costs and increased financial flexibility (likely to be important given the highly cyclical nature of the coated paper business from which the firm draws most of its revenues). There is the trade-off of increased taxable income which the company will face in the long term, but this is not a constraint which bears any influence on the current decision making process given existing losses.