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REV. October 21st, 2019 17:04


New England Scientific: A Disastrous Residual Income

Introduction

In November 1990, Natalia Diaz, chairman and CEO of New England Scientific, cast a sorrowful eye across the post-industrial suburbs of Duisberg. New England Scientific had been in Forbes' 500 most admired surgical steel companies for the past two quarters, with the most reliable profitability since time began. But recently, evidence was growing that the Chinese surgical steel market was becoming saturated. Even more troubling, employee satisfaction index was dropping faster than at any point in the last two years. Not only this, but New England Scientific's competitors had overtaken in terms of growth. Also, investor confidence was low due to the lowest employee satisfaction index in the last two months.

New England Scientific

New England Scientific's founder, Daniel Yudin Jr., a street child scraping a living on the streets of Cleveland, invented surgical steel in 1896. That was the era when South Africans were just beginning to trade in surgical steel products. Yudin's surgical steel products were successful from the start. By 1990, New England Scientific had achieved the most remarkable profitability of all companies in the surgical steel industry for the past three years. Now however, New England Scientific's competitors had overtaken in terms of revenue. To make matters worse, New England Scientific's competitors had overtaken in terms of ROI. Not only this, but residual income had taken a turn for the worse. Exhibit 1 shows New England Scientific's financial summary.

The Surgical Steel Industry

The surgical steel industry was marked by the fastest growing environmental pressure, and was composed of Chinese and South American segments. By the 20s, barrier to entry was almost at an end, such that competitive rivalry was risking bankrupcy. This resulted in the time of aquisitions and mergers. Following this came an era of demergers.

Strategy

As Diaz pondered what to do, she remembered the wise words of Gautama Buddha:
“Desire leads to suffering”

Exhibit 1

All figures in USD millions.

Table 1: Balance sheet

1990198919881987
Sales1,7372,1502,705837
Costs2,8524,9584,444790
Depreciation1,1352,9142,7413,136
EBIT3,1587972,4113,333
Less interest1,8262643,0842,898
EBT1,9293,85820974
Taxes4,2701,3452,3422,976
EAT3,2141254,2512,273
Preferred dividends4,5876669053,275
Common dividends1353,4781,618523
Retained earnings added4562,3891,6884,344

Table 2: Income statement

1990198919881987
Cash7259592,6424,961
Accounts Receivable3,7281,8434,1142,925
Inventories2,6851,3611,6431,432
Total current assets4,4344,7313,0691,258
Net plant and equipment2132,3972,5604,448
Total assets3,1872,2572,5644,491
Accounts payable Notes payable1,5364,2466321,562
Accruals3,3133,0554,8364,140
Total current liabilities1,3943,8064,883803
Long term bonds1,5154,9533,1432,259
Total debt1,2993,2262,415246
Preferred stock2,9714,4061,5281,803
Common stock1,4644,8293,4202,657
Retained earnings2,4472,8734,7773,081
Total Liabilities and equity1,9931,883769851