THE INVESTMENT PERFORMANCE DASHBOARD
As is appropriate for a book on ERM cases, we have focused much of the chapter on AOL's ERM Framework. But since our goal is to show how it is used in practice to make risk-based investment decisions on a portfolio of foreign investee companies, we now turn our attention to the investment side of the equation. Exhibit 35.13 illustrates AOL's formula to build its investment performance dashboard.
The investment performance dashboard is a matrix that allows comparing the operating entities in the portfolio to one another using their current investment value on one axis and their total investment performance score (TIPS) on the other (see Exhibit 35.13). The former is obtained through recognized valuation methodologies such as the discounted cash flow (DCF) method, while the latter is the sum of two risk scores: the qualitative investment risk score and the quantitative financial risk score.
The qualitative investment risk score is obtained by using the risk map of the top 10 risks of the investee company. AOL's approach to obtain this score is to multiply the probability by the impact for each of the top 10 risks and to add them up. A lower score means a safer investment with a lower risk profile (safer from an investment standpoint). The maximum score possible is 10 x 4 x 4 = 160.
Exhibit 35.13 Investment Performance Dashboard Formula
Exhibit 35.14 Investment Performance Dashboard
The quantitative financial risk score is obtained by looking at the deviations from the plan of four financial metrics: gross revenue; profit after tax and minority interests (PATMI); earnings before interest, taxes, depreciation, and amortization (EBITDA); and free cash flow. For each metric, a score is derived from the variance between its budgeted amount and the actual number realized. The score can range from 0 (when there is a positive variance or no variance) to 10 (when the variance is -50 percent). A lower score is indicative of a more robust financial management and means a safer investment from a financial point of view.
As stated earlier, the investment performance dashboard (Exhibit 35.14) allows AOL to compare its portfolio of operating companies based on their value on the vertical axis and their total investment performance score on the horizontal axis. In the matrix, the higher the value of the investment, the more sensitive AOL is to its risk score. Investments of low value (bottom row) are in the green zone as long as they don't reach the 240 TIPS point. Conversely, investments of USD 50 million or more are never in the green zone and require a regular monitoring of their risk score – from both an ERM and a financial variance point of view. Note: Since the exhibit is printed in grayscale, yellow appears as the lightest shade in the exhibit, green as the middle shade, and red as the darkest shade.
Exhibit 35.14 places the hypothetical AOL investee company, Trex Radio (investee company B1 in the chart), alongside eight others on the investment performance dashboard for comparison purposes. We can see that Trex Radio is in the green zone and that AOL would probably track more closely other subsidiaries such as B9 (TV Manila), B4 (Channel 2 HK), and B5 (IPTV Dubai).
As the legend states, the color-coding of the dashboard is based on:
♦ The value of AOL's investment
♦ The financial performance and risk management of the investee company
♦ The effectiveness and timeliness of key risk action plans
The green zone (the lightest shade of gray) represents investee companies where the potential impact on AOL is low due to the size of the investment and/or there are adequate controls in terms of risk management and financial performance. The yellow zone (the middle shade) indicates a medium potential impact due to the investment's size and/or deficiencies in management (e.g., not meeting targets or delays in completion of plans). The red zone (darkest shade) indicates a need for urgent attention because of a high potential impact due to the size of the investment and /or performance is far below expectations – the company cannot produce results and suffers major delays in the completion of action plans.
Of course, these are simplified guidelines that need to be filtered through sound business acumen. A large investment that performs impeccably might not require urgent attention but consistent monitoring and review, while a smaller one that performs poorly may fall in the red zone instead of the yellow one. These guidelines have proved useful over time in assisting with the management of AOL's portfolio of investee companies.
AOL tracks its portfolio's investment performance dashboard on a quarterly basis (see Exhibit 35.15). Exhibit 35.16 displays a hypothetical variation from one quarter to the next. AOL's ERM Team is able to explain the variations in terms of either the valuation of the investment, the financial risk variance, or the investment risk score. It should be noted that a reduction in value of the investment is considered positive insofar as it is voluntary, for instance, when AOL sells a portion of its participation. If the reduction in value happens without a change in AOL's stake in the company, further investigation is required to determine the risk associated with such a negative change and to make adequate investment recommendations to the board of directors, as will be shown in the next exhibit.