A few weeks ago, I posted on the corporate life cycle, the subject of my latest book. I argued that the corporate life cycle can explain what happens to companies as they age, and why they have to adapt to aging with their actions and choices. In parallel, I also noted that investors have to change the way they value and price companies, to reflect where they are in the life cycle, and how different investment philosophies lead you to concentrated picks in different phases of the life cycle. In the closing section, I contended that managing and investing in companies becomes most difficult when companies enter the last phases of their life cycles, with revenues stagnating or even declining and margins under pressure. While consultants, bankers and even some investors push companies to reinvent themselves, and find growth again, the truth is that for most companies, the best pathway, when facing aging, is to accept decline, shrink and even shut down. In this post, I will look at three high profile companies, Intel, Starbucks and Walgreens, that have seen market turmoil and management change, and examine what the options are for the future.
Setting the stage
The three companies that I picked for this post on decline present very different portraits. Intel was a tech superstar not that long ago, a company founded by Gordon Moore, Robert Noyce and Arthur Rock in 1968, whose computer chips have helped create the tech revolution. Walgreens is an American institution, founded in Chicago in 1901, and after its merger with Alliance Boots in 2014, one of the largest pharmacy chains in the country. Finally, Starbucks, which was born in 1971 as a coffee bean wholesaler in Pike Place Market in Seattle, was converted into a coffee shop chain by Howard Schultz, and to the dismay of Italians, has redefined espresso drinks around the world. While they are in very different businesses, what they share in common is that over the recent year or two, they have all not only lost favor in financial markets, but have also seen their business models come under threat, with their operating metrics (revenue growth, margins) reflecting that threat.
The Market turns
With hundreds of stocks listed and traded in the market, why am I paying attention to these three? First, the companies are familiar names. Our personal computes are often Intel-chip powered, there is a Walgreen's a few blocks from my home, and all of us have a Starbucks around the corner from where we live and work. Second, they have all been in the news in the last few weeks, with Starbucks getting a new CEO, Walgreens announcing that they will be shutting down hundreds of their stores and Intel coming up in the Nvidia conversation, often as a contrast. Third, they have all seen the market turn against them, though Starbucks has had a comeback after its new CEO hire.
A Tech Star Stumbles: Intel’s Endgame
In my book on corporate life cycles, I noted that even superstar companies age and lose their luster, and Intel could be a case study. The company is fifty six years old (it was founded in 1968) and the question is whether its best years are behind it. In fact, the company's growth in the 1990s to reach the peak of the semiconductor business is the stuff of case studies, and it stayed at the top for longer than most of its tech contemporaries. Intel's CEO for its glory years was Andy Grove, who joined the company on its date of incorporation in 1968, and stayed on to become chairman and CEO before stepping down in 1998. He argued for constant experimentation and adaptive leadership, and the title of his book, "Only the Paranoid Survive", captured his management ethos.
To get a measure of why Intel's fortunes have changed in the last decade, it is worth looking at its key operating metrics - revenues, gross income and operating income - over time:
As you can see in this graph, Intel's current troubles did not occur overnight, and its change over time is almost textbook corporate life cycle. As Intel has scaled up as a company, its revenue growth has slackened and its growth rate in the last decade (2012-21) is more reflective of a mature company than a growth company. That said, it was a healthy and profitable company during that decade, with solid unit economics (as reflected in its high gross margin) and profitability (its operating margin was higher in the last decade than in prior periods). In the last three years, though, the bottom seems to fallen out of Intel's business model, as revenues have shrunk and margins have collapsed. The market has responded accordingly, and Intel, which stood at the top of the semiconductor business, in terms of market capitalization for almost three decades, has dropped off the list of top ten semiconductor companies in 2024, in market cap terms:
Intel's troubles cannot be blamed on industry-wide issues, since Intel's decline has occurred at the same time (2022-2024) as the cumulative market capitalization of semiconductor companies has risen, and one of its peer group (Nvidia) has carried the market to new heights.
Before you blame the management of Intel for not trying hard enough to stop its decline, it is worth noting that if anything, they have been trying too hard. In the last few years, Intel has invested massive amounts into its chip manufacturing business (Intel Foundry), trying to compete with TSMC, and almost as much into its new generation of AI chips, hoping to claim market share of the fastest growing markets for AI chips from Nvidia. In fact, a benign assessment of Intel would be that they are making the right moves, but that these moves will take time to pay off, and that the market is being impatient. A not-so-benign reading is that the market does not believe that Intel can compete effectively against either TSMC (on chip manufacture) or Nvidia (on AI chip design), and that the money spent on both endeavors will be wasted. The latter group is clearly winning out in markets, at the moment, but as I will argue in the next section, the question of whether Intel is a good investment at its current depressed price may rest in which group you think has right on its side.
Drugstore Blues: Walgreen Wobbles
From humble beginnings in Chicago, Walgreen has grown to become a key part of the US health care system as a dispenser of pharmacy drugs and products. The company went public in 1927, and in the century since, the company has acquired the characteristics of a mature company, with growth spurts along the way. Its acquisition of a significant stake in Alliance Boots gave it a larger global presence, albeit at a high price, with the acquisition costing $15.3 billion. Again, to understand, Walgreen's current position, we looked at the company's operating history by looking revenue growth and profit margins over time:
After double digit growth from 1994 to 2011, the company has struggled to grow in a business, with daunting unit economics and slim operating margins, and the last three years have only seen things worsen on all fronts, with revenue growth down, and margins slipping further, below the Maginot line; with an 1.88% operating margin, it is impossible to generate enough to cover interest expenses and taxes, thus triggering distress.
While management decisions have clearly contributed to the problems, it is also true that the pharmacy business, which forms Walgreen's core, has deteriorated over the last two years, and that can be seen by comparing its market performance to CVS, its highest profile competitor.
On my last visit to Italy, I did make frequent stops at local cafes, to get my espresso shots, and I can say with confidence that none of them had a caramel macchiato or an iced brown sugar oatmilk shaken espresso on the menu. Much as we make fun of the myriad offerings at Starbucks, it is undeniable that the company has found a way into the daily lives of many people, whose day cannot begin without their favorite Starbucks drink in hand. Early on, Starbucks eased the process by opening more and more stores, often within blocks of each other, and more recently, by offering online ordering and pick up, with rewards supercharging the process. Howard Schultz, who nursed the company from a single store front in Seattle to an ubiquitous presence across America, was CEO of the company from 1986, and while he retired from the position in 2000, he returned from 2008 to 2017, to restore the company after the financial crisis, and again from 2022 to 2023, as an interim CEO to bridge the gap between the retirement of Kevin Johnson in 2022 and the hiring of Laxman Narasimhan in 2023. To get a measure of how Starbucks has evolved over time, I looked the revenues and margins at the company, over time:
Unlike Intel and Walgreens, where the aging pattern (of slowing growth and steadying margins) is clearly visible, Starbucks is a tougher case. Revenue growth at Starbucks has slackened over time, but it has remained robust even in the most recent period (2022-2024). Profit margins have actually improved over time, and are much higher than they were in the first two decades of the company's existence. One reason for improving profitability is that the company has become more cautious about store openings, at least in the United States, and sales have increased on a per-store basis:
In fact, the shift towards online ordering has accelerated this trend, since there is less need for expansive store locations, if a third or more of sales come from customers ordering online, and picking up their orders. In short, these graphs suggest that it is unfair to lump Starbuck with Intel and Walgreens, since its struggles are more reflecting of a growth company facing middle age.
So, why the market angst? The first is that there are some Starbucks investors who continue to hold on to the hope that the company will be able to return to double digit growth, and the only pathway to get there requires that Starbucks be able to succeed in China and India. However, Starbucks has had trouble in China competing with domestic lower-priced competitors (Luckin' Coffee and others), and there are restrictions on what Starbucks can do with its joint venture with the Tata Group in India. The second problem is that the narrative for the company, that Howard Schultz sold the market on, where coffee shops become a gathering spot for friends and acquaintances, has broken down, partly because of the success of its online ordering expansion. The third problem is that inflation in product and employee costs has made its products expensive, leading to less spending even from its most loyal customers.
A Life Cycle Perspective
It is undeniable that Intel and Walgreens are in trouble, not just with markets but operationally, and Starbucks is struggling with its story line. However, they face different challenges, and perhaps different pathways going forward. To make that assessment, I will more use my corporate life cycle framework, with a special emphasis on the the choices that agin companies face, with determinants on what should drive those choices.
The Corporate Life Cycle
I won't bore you with the details, but the corporate life cycle resembles the human life cycle, with start-ups (as babies), very young companies (as toddlers), high growth companies (as teenagers) moving on to mature companies (in middle age) and old companies facing decline and demise:
The phase of the life cycle that this post is focused on is the last one, and as we will see in the next section, it is the most difficult one to navigate, partly because shrinking as a firm is viewed as failure., and that lesson gets reinforced in business schools and books about business success. I have argued that more money is wasted by companies refusing to act their age, and much of that waste occurs in the decline phase, as companies desperately try to find their way back to their youth, and bankers and consultants egg them on.
The Choices
There is no more difficult phase of a company's life to navigate than decline, since you are often faced with unappetizing choices. Given how badly we (as human beings) face aging, it should come as no surprise that companies (which are entities still run by human beings) also fight aging, often in destructive ways. In this section, I will start with what I believe are the most destructive choices made by declining firms, move on to a middling choice (where there is a possibility of success) before examining the most constructive responses to aging.
a. Destructive
- Denial: When management of a declining business is in denial about its problems, attributing the decline in revenues and profit margins to extraordinary circumstances, macro developments or bad luck, it will act accordingly, staying with existing practices on investing, financing and dividends. If that management stays in place, the truth will eventually catch up with the company, but not before more money has been sunk into a bad business that is un-investable.
- Desperation: Management may be aware that their business is in decline, but it may be incentivized, by money or fame, to make big bets (acquisitions, for example), with low odds, hoping for a hit. While the owners of these businesses lose much of the time, the managers who get hits become superstars (and get labeled as turnaround specialists) and increase their earning power, perhaps at other firms.
- Survival at any cost: In some declining businesses, top managers believe that it is corporate survival that should be given priority over corporate health, and they act accordingly. In the process, they create zombie or walking dead companies that survive, but as bad businesses that shed value over time.
- Me-too-ism: In this choice, management starts with awareness that their existing business model has run out of fuel and faces decline, but believe that a pathway exists back to health (and perhaps even growth) if they can imitate the more successful players in their peer groups. Consequently, their investments will be directed towards the markets or products where success has been found (albeit by others), and financing and cash return policies will follow. Many firms adopt this strategy find themselves at a disadvantage, since they are late to the party, and the winners often have moats that are difficult to broach or a head start that cannot be overcome. For a few firms, imitation does provide a respite and at least a temporary return to mature growth, if not high growth.
- Acceptance: Some firms accept that their business is in decline and that reversing that decline is either impossible to do or will cost too much capital. They follow up by divesting poor-performing assets, spinning off or splitting off their better-performing businesses, paying down debt and returning more cash to the owners. If they can, they settle in on being smaller firms that can continue to operate in subparts of their old business, where they can still create value, and if this is not possible, they will liquidate and go out of business.
- Renewals and Revamps: In a renewal (where a company spruces up its existing products to appeal to a larger market) or a revamp (where it adds to its products and service offering to make them more appealing), the hope is that the market is large enough to allow for a return to steady growth and profitability. To pull this off, managers have to be clear eyed about what they offer customers, and recognize that they cannot abandon or neglect their existing customer base in their zeal to find new ones.
- Rebirths: This is perhaps every declining company's dream, where you can find a new market or product that will reset where the company in the life cycle. This pitch is powered by case studies of companies that have succeeded in pulling off this feat (Apple with the iPhone, Microsoft with Azure), but these successes are rare and difficult to replicate. While one can point to common features including visionary management and organic growth (where the new business is built within the company rather than acquired), there is a strong element of luck even in the success stories.
The Determinants
Clearly, not all declining companies adopt the same pathway, when faced with decline, and more companies, in my view, take the destructive paths than the constructive one. To understand why and how declining companies choose to do what they do, you may want to consider the following:
- The Business: A declining company in an otherwise healthy industry or market has better odds for survival and recovery than one that is in a declining industry or bad business. With the three companies in our discussion, Intel's troubles make it an outlier in an otherwise healthy and profitable business (semiconductors), whereas Walgreens operates in a business (brick and mortar retail and pharmacy) that is wounded. Finally, the challenges that Starbucks faces of a saturated market and changing customer demands is common to large restaurants in the United States.
- Company's strengths: A company that is in decline may have fewer moats than it used to, but it can still hold on to its remaining strengths that draw on them to fight decline. Thus, Intel, in spite of its troubles in recent years, has technological strengths (people, patents) that may be under utilized right now, and if redirected, could add value. Starbucks remains among the most recognized restaurant brands in the world, but Walgreens in spite of its ubiquity in the United States, has almost no differentiating advantages.
- Governance: The decisions on what a declining firm should do, in the face of decline, are not made by its owners, but by its managers. If managers have enough skin in the game, i.e., equity stakes in the company, their decisions will be often very different than if they do not. In fact, in many companies with dispersed shareholding, management incentives (on compensation and recognition) encourage decision makers to go for long-shot bets, since they benefit significantly (personally) if these bets pay off and the downside is funded by other people's money.
- Investors: With publicly traded companies, it is the investors who ultimately become the wild card, determining time horizon and feasible options for the company. To the extent that the investors in a declining company want quick payoffs, there will be pressure for companies to accept aging, and shrink or liquidate; that is what private equity investors with enough clout bring to the table. In contrast, if the investors in a declining company have much longer time horizons and see benefits from a turnaround, you are more likely to see revamps and renewals. All three of the companies in our mix are institutionally held, and even at Starbucks, Howard Schultz owns less than 2% of the shares. and his influence comes more from his standing as founder and visionary than from his shareholding.
- External factors: Companies do not operate in vacuums, and capital markets and governments can become determinants of what they do, when faced with decline. In general, companies that operate in liquid capital markets, where there are multiple paths to raise capital, have more options than companies than operate in markets where capital is scare or difficult to raise. Governments too can play a role, as we saw in the aftermath of the 2008 crisis, when help (and funding) flowed to companies that were too large to fail, and that we see continually in businesses like the airlines, where even the most damaged airline companies are allowed to limp along.
- Luck: Much as we would like to believe that our fates are in our own hands, the truth is that even the best-thought through response to decline needs a hefty dose of luck to succeed.
In the figure below, I summarize the discussion from this section, looking at both the choices that companies can make, and the determinants:
With this framework in place, I am going to try to make my best judgments (which you may disagree with) on what the three companies highlighted in this post should do, and how they will play out for me, as an investor:
- Intel: It is my view that Intel's problems stem largely from too much me-too-ism and aspiring for growth levels that they cannot reach. On both Ai and the chip manufacturing business, Intel is going up against competition (Nvidia on AI and TSMC on manufacturing) that has a clear lead and significant competitive advantages. However, the market is large enough and has sufficient growth for Intel to find a place in both, but not as a leader. For a company that is used to being at the top of the leaderboard, that will be a step down, but less ambition and more focus is what fits the company, at this stage in the life cycle. It is likely that even if it succeeds, Intel will revert to middle age, not high growth, but that should still make it a good investment. In the table below, you can see that at its prevailing stock price of $18.89 (on Sept 8, 2024), all you need is a reversion back towards more normal margins for the price to be justified:
With 3% growth and 25% operating margins, Intel's value per share is already at $23.70 and any success that the company is in the AI chip market or benefits it derives from the CHIPs act, from federal largesse, are icing on the cake. I do believe that Intel will derive some payoff from both, and I am buying Intel, to twin with what is left of my Nvidia investment from six years ago.
Download Intel valuation - Walgreens: For Walgreens, the options are dwindling, as its core businesses face challenges. That said, and even with its store closures, Walgreens remains the second largest drugstore chain in the United States, after CVS. Shrinking its presence to its most productive stores and shedding the rest may be the pathway to survival, but the company will have to figure out a way to bring down its debt proportionately. There is the risk that a macro slowdown or a capital market shock, causing default risk and spreads to widen, could wipe out equity investors. With all of that said, and building in a risk of failure to the assessment, I estimated the value per share under different growth and profitability assumptions:
The valuation pivots entirely on whether operating margins improve to historical levels, with margins of 4% or higher translating into values per share that exceed the stock price. I believe that the pharmacy business is ripe for disruption, and that the margins will not revert back to pre-2021 levels, making Walgreens a "no go" for me.
Download Walgreens valuation - Starbucks: Starbucks is the outlier among the three companies, insofar as its revenue growth is still robust and it remains a money-making firm. Its biggest problem is that it has lost its story line, and it needs to rediscover a narrative that can not only give investors a sense of where it is going, but will redirect how it is managed. As I noted in my post on corporate life cycle, story telling requires visionaries, and in the case of Starbucks, that visionary also has to understand the logistical challenges of running coffee shops. I do not know enough about Brian Niccol to determine whether he fits the bill. As someone who led Taco Bell and Chipotle, I think that he can get the second part (understanding restaurant logistics) nailed down, but is he a visionary? He might be, but visionary CEOs generally do not live a thousand miles from corporate headquarters, and fly corporate jets to work part time at their jobs, and Niccol has provided no sense of what he sees as the new Starbucks narrative yet. For the moment, thought, there seems to be euphoria in the market that change is coming, though no one seems clear on what that change is, and the stock price has almost fully recovered from its swoon to reach $91 on September 8, 2024. That price is well above any value per share that I can get for the company, even assuming that they go back to historic norms:
I must be missing some of the Starbucks magic that investors are seeing, since there is no combination of historical growth/margins that gets me close to the current stock price. In fact, the only way my value per share reaches current pricing levels is if I see the company maintaining its revenue growth rates from 2002-2011, while delivering the much higher operating margins that it earned between 2012-2021. That, to me, is a bridge too far to cross.
The Endgame
There is a reason that so many people want to be entrepreneurs and start new businesses. Notwithstanding the high mortality rate, building a new business is exciting and, if successful, hugely rewarding. A healthy economy will encourage entrepreneurship, providing risk capital and not tilting the playing field towards established players; it remains the strongest advantage that the United States has over much of the rest of the world. However, it is also true that the measure of a healthy economy is in how it deals with declining businesses and firms. If as Joseph Schumpeter put it, capitalism is all about creative destruction, it follows that companies, which are after all legal entities that operate businesses, should fade away as the reasons for their existence fade. That is one reason I critique the entire notion of corporate sustainability (as opposed to planet sustainability), since keeping declining companies alive, and supplying them with additional capital, redirects that capital away from firms that could do far more good (for the economy and society) with that capital.
If there is a subtext to this post, it is that we need a healthier framing of corporate decline, as inevitable at all firms, at some stage in their life cycle, rather than something that should be fought. In business schools and books, we need to highlight not just the empire builders and the company saviors, i.e., CEOs who rescued failing companies and made their companies bigger, but the empire shrinkers, i.e., CEOs who are brought into declining firms, who preside over an orderly (and value adding) shrinkage or breaking of their firms. In investing, it is true that the glory gets reserved for the Mag Seven and the FANGAM stocks, companies that seem to have found the magic to keep growing even as they scale up, but we should also pay attention to companies that find their way to deliver value for shareholders in bad businesses.
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