Friday, September 27, 2013

Rebirth and Reincarnation: Escaping the corporate death spiral

The Chinese saying (  = you are born, get old, get sick and die) that I quoted in my last post may be realistic, but it is not exactly an uplifting calling for life and it is no wonder that you look for an escape from its strictures. One option that almost every religion offers is the possibility of an afterlife, cleverly tied to how closely you follow that religon's edicts. For corporations approaching the end stages of their life cycle, this option is a non-starter, since there is no corporate heaven (unless you count starring in a Harvard case study or in a TV show as heavenly) or hell (though bankruptcy court comes awfully close). The other option is the possibility of a rebirth or reincarnation, in a different life, if you are Shirley Maclaine, or in the same life, if you manage to redefine yourself. After all, we are uplifted by stories of people who having experienced that rebirth; athletes who transition to successful business people (Magic Johnson) or actors who become presidents (Ronald Reagan). On this count, corporations have an advantage over individuals since they are legal entities that can reinvent themselves, while holding on to their corporate identities. 

Looking back at history, there are companies that have beaten the odds of the business life cycle, fought off decline, and been reborn as successful ventures. Two examples that were noted in the comments section of the last post come to mind: IBM’s fall from glory in the 1980s and its subsequent rebirth as a vibrant corporation and Apple’s climb back from the dark days of 1997 to the top of the market capitalization table in 2012. As we think of these and other examples (and they are the favorites for obvious reasons for case study writers), it is worth noting that the very fact that we can name these companies suggests that they are the exceptions rather than the rule. Notwithstanding that sobering reality, it is still useful to put these success stories under the microscope, not only to get an understanding of what allowed these companies to succeed, but also to develop forward-looking criteria that we may be able to use in investing. 

At the outset, I have to admit my trepidation about this exercise. First, I am not a corporate historian or strategist and I am sure that there is much that I am glossing over as I make my list of “rebirth” criteria. Second, I am always wary of drawing big lessons from anecdotal evidence, recognizing how easy it is to reach the wrong conclusions. Nevertheless, here are the common factors that I see in these success stories: 
  1. Acceptance that the old ways don’t work any more: To have a corporate rebirth, a company still has to get through the three step reaction to corporate aging that I noted in my last post and come to an acceptance that the old ways, successful though they might have been in the past, don’t work any more. That acceptance, as I noted, does not come easily or quickly and the longer and more hoary the history of the company, the longer it takes. Thus, while there are many younger investors whose experience with IBM has generally been positive, I remember the late 1980s when a series of CEOs at the company raised denial to an art form and almost pushed the company into irrelevance. Acceptance also requires more than lip service to change and has to be backed up by actions that indicate that the company is indeed willing to jettison big portions of its past.
  2. A Change Agent: This may be a cliché but change has to start at the top. In fact, change at IBM really began when Lou Gerstner became CEO of the company in 1993. At Apple, the change agent was obviously Steve Jobs, a man who had been banished from Apple for his lack of focus a decade prior, but returned as CEO in 1997. It would be simplistic to say that the change agent always has to come from outside the company, because there have been companies where insiders who have spent a lifetime in the company have been willing to shake it up. (Bob Goiuzeta at Coca Cola and Jack Welch at GE were company men who still revolutionized their companies.) I think it is safe to say, though, that change agents are usually not shrinking violets and that they are ready to shake up the status quo. 
  3. A Plan for Change: Pointing out that the existing ways don’t work any more is important but it is futile unless accompanied by a new mission and focus. At IBM, Gerstner changed the mindset of the company (and its employees) early in his tenure, an incredible accomplishment given how deeply entrenched it was in the existing ways. Coming from RJR Nabisco, he brought both a customer-focus and a willingness to let go of IBM’s past mistakes (Anyone remember OS/2?) and this allowed him to create the modern IBM. Steve Jobs shocked Apple employees by entering into a détente with Microsoft, where in return for $150 million in cash and a promise by Microsoft that it would continue producing Office for the Mac, he essentially gave Microsoft a free legal pass to borrow from the Mac OS in updating Windows. He used the breathing room that this agreement gave him to redefine Apple as an entertainment rather than a computer company and the rest as they say is history.
  4. Luck: Much as we would like to attribute success to great skill and failure to poor management, it remains true that the X factor in business success is luck. Gerstner was lucky that he made his changes at IBM in the 1990s, a decade of not only robust overall economic growth but especially so for technology companies. Steve Jobs was helped by the ineptitude of his competition, so blinded by their investment in the status quo (music companies to selling us music on CDs and cell phone companies thinking of cell phones as extensions of landline phones) that they either did not react or reacted too slowly to Apple's innovations.
I am sure that this is not a comprehensive list and that I have missed a few items but I want the list to be tractable because I intend to use it in my investment analysis. Companies that have been value traps can become great investments, if they can find a path to rebirth; an investor who bought IBM shares in 1993 or Apple shares in 1997 would have profited immensely from their reincarnations. So, as an investment exercise, you could prepare a list of the companies where stock prices have stagnated for long periods and check to see which of them have the ingredients in place for rebirth: an acceptance that the old ways don’t work (with tangible evidence in investment, financing and dividend decisions to back it up) and a change agent (new management), a new focus (with actions to back it up). The last factor, luck, is immune from assessment but you can consult your astrological signs or read the tea leaves, if it helps to make the right choices.

Putting this approach to use on Microsoft, Cisco and Merck, let's look at whether these companies have the ingredients for rebirth (and thus not be the value traps that I made them out to be). In the table below, I have listed the three ingredients (leaving out luck) and how each of the companies measures up on each ingredient.

Not sure. The company still believes that it can produce hardware (smart phones, tablets), using the same strategy that worked for it on software (overload the product with features and overwhelm the opposition).
This is a company that had incredible success in the 1990s with its strategy of buying small technology companies and converting them into commercial successes. That strategy failed over most of the last decade. The company seems to be suggesting that it will scale back in the future, but while it has announced layoffs, its acquisition pace has not slackened.
Merck has been a mature pharmaceutical company for two decades but its R&D policies suggest that it sees itself differently. While there are noises coming from the company that are good (increased buyback, accountability in R&D), the company has been slow to adapt.
Change Agent
Steve Ballmer is leaving and a new CEO is coming in. That is the good news.  The bad news is that this new CEO is being picked by the same board of directors at Microsoft that seems convinced that nothing is wrong with the company.
The CEO who built this company up in the late 1990s was John Chambers. The CEO who made bad acquisitions during the last decade was also John Chambers. The CEO of the company that claims to have seen the error of its ways is once again John Chambers. Unless he has multiple personalities, I don't see how he can pull this off.
Who is Merck’s CEO? This may just be ignorance on my part but I had to look it up: it is Ken Frazier, who has worked at Merck since 1992.  I compliment the gentleman for keeping a low profile but change agents are not sell-effacing characters.
None that I can see (yet). The acquisition of Nokia suggests that Microsoft is going to keep trying to go after the smartphone business. Even if it succeeds, that strikes me as more opportunistic and 'me too" than visionary.
The company has told us it will not go for growth for the sake of growth, but it continues to do large acquisitions
The evidence suggests that Merck is slowly coming to an acceptance that its historic model is running out of steam (stock buyback, talk about cutting R&D) but there is little sense of what is going to replace the existing model.
Rebirth Assessment
Change in CEO provides hope, at least for the moment.
Actions speak louder than words. If Cisco can go a year without major acquisition & a new focus emerges, chances improve.
Looks like the best case scenario is that it is heading to the equivalent of corporate “senior” living.
Of the three companies, I would argue that Microsoft offers the most in terms of possibilities simply because it is getting a new CEO, Cisco is talking the talk (of changing) but is not walking the walk and Merck seems to be stuck in a rut. You are welcome to disagree with me on my conclusions but even if you do, there is no reason why you cannot use the framework to make your own judgments. 

Speaking of Apple, I am sure that there are many frustrated stockholders who are wondering whether the company is ready for another rebirth. Much as I like the company as an investment (and I value it at $600), I don't see the ingredients in place yet. While the company has capitulated on the financial front (agreeing to borrow money & buy back more stock) it still seems to be caught in the smartphone rat race with no end in sight. Tim Cook has shown his operating acumen but he does not strike me as a change agent and I am still unsure about his vision for the company. Maybe that will all change in the next few months, but I am not holding my breath!


Jim said...

Does that mean you no longer own AAPL, professor?

sampath said...

Aswath, I have been a big fan after reading some of your Articles and seen you on CNBC few times. If you look at Apple's products they have consistently tried to surprise the consumers with innovative products and they have loved it.

Apple is a massive money machine. For fiscal 2012, which closed end-of-September, Apple revenue reached $156.51 billion, up 140 percent from fiscal 2010. During the same time period, Apple's net income rose to $41.733 billion from $14.01 billion. No tech company comes close. Google and Microsoft combined generated less revenue for calendar Q1 (same as Apple fiscal second quarter) -- $34.46 billion.

For irrational reasons that make no sense to me, analysts and investors are hung up on the something new, while ignoring key fundamentals. First: Apple's real, spectacular performance. Second: How the company historically launches products. The latter is crucial.
Apple typically announces category-creating or reinventing products then takes them to maturity over many years. Examples are everywhere. Among them:
OS X (January 2001-present), there's still no OS XI
Apple Store (May 2001-present)
iPod (October 2001-present)
iTunes Store (April 2003-present)
iPhone (June 2007-present)
App Store (July 2008-present)
iPad (April 2010-present)
Few companies create more than one industry-changing product. None as many as Apple. So the market's expectations are unrealistic and ignore the fundamental stewardship inherited by current leadership.
Right now, Cook's charge is managing two relatively new product lines, which make up the bulk of profits. During fiscal Q1, iOS devices represented close to three-quarters of all revenue. His first responsibility is to manage these maturing businesses before committing Apple to some new or redefining category. But investors want the feel-good thing that creates allusions, perhaps illusions, about Apple as sitting-at-the-right-hand-of-God innovator. Some people may think that's a position where Jobs is today. Perhaps they should lower such esteem about him and raise that of Cook, whose task is harder, for how much bigger is the Apple crop today than three years ago.
Please read this following Article which talks about How Tech Industry evolved in last 25 years.

Aswath Damodaran said...

I own Apple. I like it as an investment. I just don't have unrealistic expectations about something happening at the company that is going to be revolutionary. I think part of the problem, as sampath points out, is that investors seem to keep hoping for revolutionary change and getting disappointed. This may be a case where investors need to learn acceptance of one of the most profitable companies in the world and value them as such.

Anonymous said...

Hi...and Thanks

Is YAHOO in a Rebirth?

UniverseofRisks said...

Great post! From what little I gather, the chart listed really suits companies with products dependent on constant research and development. Can the same be applicable for companies like General Mills and lets say JC Penny. Whose products largely rely heavily perception and marketing?

confused dude said...

Well you may like to read "The Outsiders by William N. Thorndike".... Very much inline with the topic of this blog.... Im sure you will like it..

By the way its also a suggested reading by Warren Buffett....

Also there is one more company you might like to add "Berkshire Hathway".... The outside change in it was Warren Buffett ofcourse....

Anonymous said...

For Apple as an investment, it is not what it was but what it is going to be. True it gave the most innovative products to the world. But,for now the question is how many new (market disruptive) products it can give which will retain/increase its competitive advantages and barriers to competitor entry. When you have too much cash and don't know how to use it, the right thing to do is to return it back to the owners.
I see Apple as a cash-rich firm, which can't find avenues to spend profitably. Now, owners have 2 choices: One, to let Apple keep cash where the risk of Apple spending it wrong is higher. Two, to ask Apple to return cash and let owners decide where to invest to get better returns.

Lowering expectations from Apple is a good thing but today the competition seems to be much smarter. It is far better to ask cash back (too much of owners' money that is lying with the agent). A lesson from history: Don't keep high trust in the agent!

One can compare Apple to one's very-rich-but-clueless-uncle who needs a good money manager.

Sampath said...

Aswath I agree that Apple is a great investment and products recently released could be called revolutionary because the new iPhone 5S with their upgrade to 64 bit Architecture & M7 Chip may be a basis for many more new wearable products, banking products, E-commerce products, Gaming Products, Healthcare Devices & lot more iDevices around the Body, Home & Business Applications.

I feel Wall Street is more focused on companies making less then a billion dollar in profit & who does not have a track record of double digit revenue & profit growth for longer duration of time like Apple.

Aswath how do you really Value Companies like NFLX, AMZN, FB, TSLA, LNKD, GOOG whose PE is much higher then their growth. My thought process is that Companies are priced on their net earnings performance for a considerable period of time.

Then Should Apple float startups with their new product launches so that those small firms can grow 30% -40% every year and get the multiple it deserves, which would indirectly benefit Apple Shareholders.

If you look at iTunes Software & Services, their growth is around 25-30% TTM as well as for the last 5 years, compared to Google's growth in Software Services which is around 15-18% for the same period.

Another topic which I don't understand is MarketShare VS ProfitShare in Smartphones, Tablets or PC's. Apple has much higher ProfitShare then MarketShare for the 3 product categories mentioned above. So why do you think Wall Street is more worried about MarketShare then ProfitShare.

I feel you are expert in Valuation and would like your opinion.

Aswath Damodaran said...

There is no reason why you cannot value any of these companies. The fact that the PE is higher than the growth is not only irrelevant but a distraction since it matters little in the context of valuation. I will be posting on the process of valuing companies like these where uncertainty is front and center in the next few weeks. Stay tuned.

Anonymous said...

How does one describe a slam dunk?.... a quality company that can borrow funds at close to zero, to buy back shares with an earning yield close to 10%.

Buy the dips.

Anonymous said...

Anon, R. "Bob" Dobbs says,

How interesting was that to see today, Mr Icahn agree completely with my analysis above....

Borrow at zero, and buy back shares sporting an earnings yield well over 12%!

All you can eat.

Kylie said...

Great post Professor! I definitely could use some rebirth in my stocks.

Kristin said...

You can't have UNrealistic expectations of a company like Apple to constantly be revolutionary. They have had revolutionary products and have to ride on that while they come up with the next revolutionary idea. It doesn't happen overnight.

marketing consultants in florida said...

Excellent comparisons, how about other comparisons with other companies such as Apple, IBM and others.


I guess the old saying you are born grow old and than die applies to companies as well as to people.

Anirudh Kumar Satsangi said...

“Unaccomplished activities of past lives are also one of the causes for reincarnation. Some of us reincarnate to complete the unfinished tasks of previous birth. The is evident from my own story of reincarnation:
“My most Revered Guru of my previous life His Holiness Maharaj Sahab, 3rd Spiritual Head of Radhasoami Faith had revealed this secret to me during trance like state of mine. This was sort of REVELATION.
HE told me, “Tum Sarkar Sahab Ho” (You are Sarkar Sahab). Sarkar Sahab was one of the most beloved disciple of His Holiness Maharj Sahab. Sarkar Sahab later on became Fourth of Spiritual Head Radhasoami Faith.
Since I don’t have any direct realization of it so I can not claim the extent of its correctness. But it seems to be correct. During my previous birth I wanted to sing the song of ‘Infinite’ (Agam Geet yeh gawan chahoon tumhri mauj nihara, mauj hoi to satguru soami karoon supanth vichara) but I could not do so then since I had to leave the mortal frame at a very early age. But through the unbounded Grace and Mercy of my most Revered Guru that desire of my past birth is being fulfilled now.”
I am one the chief expounder and supporter of Gravitation Force Theory of God. This is most scientific and secular theory of God. This is the Theory of Universal Religion. I have given Higher Theory of Everything. Sometimes back I posted this as comments to a blog on:
‘Fighting of the Cause of Allah by Governing a Smart Mathematics Based on Islamic Teology’
By Rohedi of Rohedi Laboratories, Indonesia. Rohedi termed my higher theory of everything more wonderful than which has been developed by Stephen Hawking. Some details are quoted below:
@anirudh kumar satsangi
Congratulation you have develop the higher theory of everything more wonderful than which has been developed by Stephen Hawking. Hopefully your some views for being considered for Unified Field Theory are recognized by International Science Community, hence I soon read the fundamental aspect proposed by you.
I have posted my comments to the Blog of Syed K. Mirza on Evolutionary Science vs. Creation Theory, and Intellectual Hypocrisy. Syed Mirza seems to be a very liberal muslim. He responded to my comments as mentioned below.
“Many thanks for your very high thought explanations of God.
You said:
“Hence it can be assumed that the Current of Chaitanya (Consciousness) and Gravitational Wave are the two names of the same Supreme Essence (Seed) which has brought forth the entire creation. Hence it can be assumed that the source of current of consciousness and gravitational wave is the same i.e. God or ultimate creator.
(i) Gravitation Force is the Ultimate Creator, Source of Gravitational Wave is God”
Whatever you call it, God is no living God of any religion. Yes, when I call it “Mother Nature” is the God generated from all Natural forces and Gravitational force is the nucleus of all forces or we can presume that Gravitation is the ultimate guiding principle of this Mother Nature we call it non-living God unlike living personal God of religions. I can not believe any personal God would do so much misery created for its creation. Hence, only non-living natural God can explain everything in the Universe. When we think of any living personal God, things do not ad up!”
I have also discovered the mathematical expression for emotional quotient (E.Q.) and for spiritual quotient (S.Q.).
Austrian Scientist Rudolf Steiner says,
“Just as an age was once ready to receive the Copernican theory of the universe, so is our age ready for the idea of reincarnation to be brought into the general consciousness of humanity”.

M@unil... said...

After reading your post on re-birth and re-incarnation, do u think start of a CAPEX cycle forms an important factor for getting a sense of re-birth?

Also, is Reliance (India) falling in the same league?