Growth fixes a multitude of sins. If you grow revenues enough (you don’t even need profits, as Amazon has proven) investors will look past a lot of things. With revenue growth high enough, companies can offer employees free meals and massages. Executives and senior managers can fly around in private jets. Companies can build colossal buildings as testaments to their brand, or pay to have thier names on public buildings. R&D budgets can soar, and product launches can fail. Acquisitions are made with no concerns for price. Bonuses can be huge. All is accepted if revenues grow enough.
Just look at Facebook. Today Facebook announced today that for the quarter ended March, 2016 revenues jumped to $5.4B from $3.5B a year ago. Net income tripled to $1.5B from $500M. And the company is basically making all its revenue – 82% – from 1 product, mobile ads. In the last few years Facebook paid enormous premiums to buy WhatsApp and Instagram – but who cares when revenues grow this fast.
Anticipating good news, Facebook’s stock was up a touch today. But once the news came out, after-hours traders pumped the stock to over $118//share, a new all time high. That’s a price/earnings (p/e) multiple of something like 84. With growth like that Facebook’s leadership can do anything it wants.
But, when revenues slide it can become a veritable poop puddle. As Apple found out.
Rumors had swirled that Apple was going to say sales were down. And the stock had struggled to make gains from lows earlier in 2016. When the company’s CEO announced Tuesday that sales were down 13% versus a year ago the stock cratered after-hours, and opened this morning down 10%. Breaking a streak of 51 straight quarters of revenue growth (since 2003) really sent investors fleeing. From trading around $105/share the last 4 days, Apple closed today at ~$97. $40B of equity value was wiped out in 1 day, and the stock trades at a p/e multiple of 10.
The new iPhone 6se outsold projections, iPads beat expectations. First year Apple Watch sales exceeded first year iPhone sales. Mac sales remain much stronger than any other PC manufacturer. Apple iBeacons and Apple Pay continue their march as major technologies in the IoT (Internet of Things) market. And Apple TV keeps growing. There are about 13M users of Apple’s iMusic. There are 1.5M apps on the iTunes store. And the installed base keeps the iTunes store growing. Share buybacks will grow, and the dividend was increased yet again. But, none of that mattered when people heard sales growth had stopped. Now many investors don’t think Apple’s leadership can do anything right.
Yet, that was just one quarter. Many companies bounce back from a bad quarter. There is no statistical evidence that one bad quarter is predictive of the next. But we do know that if sales decline versus a year ago for 2 consecutive quarters that is a Growth Stall. And companies that hit a Growth Stall rarely (93% of the time) find a consistent growth path ever again. Regardless of the explanations, Growth Stalls are remarkable predictors of companies that are developing a gap between their offerings, and the marketplace.
Which leads us to Chipotle. Chipotle announced that same store sales fell almost 30% in Q1, 2016. That was after a 15% decline in Q4, 2015. And profits turned to losses for the quarter. That is a growth stall. Chipotle shares were $750/share back in early October. Now they are $417 – a drop of over 44%.
Customer illnesses have pointed to a company that grew fast, but apparently didn’t have its act together for safe sourcing of local ingredients, and safe food handling by employees. What seemed like a tactical problem has plagued the company, as more customers became ill in March.
Whether that is all that’s wrong at Chipotle is less clear, however. There is a lot more competition in the fast casual segment than 2 years ago when Chipotle seemed unable to do anything wrong. And although the company stresses healthy food, the calorie count on most portions would add pounds to anyone other than an athlete or construction worker – not exactly in line with current trends toward dieting. What frequently looks like a single problem when a company’s sales dip often turns out to have multiple origins, and regaining growth is nearly always a lot more difficult than leadership expects.
Growth is magical. It allows companies to invest in new products and services, and buoy’s a stock’s value enhancing acquisition ability. It allows for experimentation into new markets, and discovering other growth avenues. But lack of growth is a vital predictor of future performance. Companies without growth find themselves cost cutting and taking actions which often cause valuations to decline.
Right now Facebook is in a wonderful position. Apple has investors rightly concerned. Will next quarter signal a return to growth, or a Growth Stall? And Chipotle has investors heading for the exits, as there is now ample reason to question whether the company will recover its luster of yore.
Netflix has been a remarkable company. Because it has accomplished something almost no company has ever done. It changed its business model, leading to new growth and higher profits.
Almost nobody pulls that off, because they remain stuck defending and extending their old model until they become irrelevant, or fail. Think about Blackberry, that gave us the smartphone business then lost it to Apple and its creation of the app market. Consider Circuit City, that lost enough customers to Amazon it could no longer survive. Sun Microsystems disappeared after PC servers caught up to Unix servers in capability. Remember the Bell companies and their land-line and long distance services, made obsolete by mobile phones and cable operators? These were some really big companies that saw their market shifts, but failed to “pivot” their strategy to remain competitive.
Netflix built a tremendous business delivering physical videos on tape and CD to homes, wiping out the brick-and-mortar stores like Blockbuster and Hollywood Video. By 2008 Netflix reached $1B revenues, reducing Blockbuster by a like amount. By 2010 Blockbuster was bankrupt. Netflix’ share price soared from $50/share to almost $300/share during 2011. By the end of 2012 CD shipments were dropping precipitously as streaming viewership was exploding. People thought Netflix was missing the wave, and the stock plummeted 75%. Most folks thought Netflix couldn’t pivot fast enough, or profitably, either.
But in 2013 Netflix proved the analysts wrong, and the company built a very successful – in fact market leading – streaming business. The shares soared, recovering all that lost value. By 2015 the company had more than doubled its previous high valuation.
But Netflix may be breaking entirely new ground in 2016. It is becoming a market leader in original programming. Something we long attributed to broadcasters and/or cable distributors like HBO and Showtime.
Today’s broadcast companies, like NBC, CBS and ABC, are offering less and less original programming. Overall there are 3 hours/night of prime time television which broadcasters used to “own” as original programming hours. Over the course of a year, allowing for holidays and one open night per week, that meant about 900 hours of programming for each network (including reruns as original programming.) But that was long ago.
These days most of those hours are filled with sports – think evening games of football, basketball, baseball including playoffs and “March Madness” events. Sports are far cheaper to program, and can fill a lot of hours. Next think reality programming. Showing people race across countries, or compete to survive a political battlefield on an island, or even dancing or dieting, uses no expensive actors or directors or sets. It is far, far less expensive than writing, casting, shooting and programming a drama (like Blacklist) or comedy (like Big Bang Theory.) Plan on showing every show twice in reruns, plus intermixing with the sports and reality shows, and most networks get away with around 200-250 hours of original programming per year.
Against that backdrop, Netflix has announced it will program 600 hours of original programming this year. That will approximately double any single large broadcast network. In a very real way, if you don’t want to watch sports or reality TV any more you probably will be watching some kind of “on demand” program. Either streamed from a cable service, or from a provider such as Netflix, Hulu or Amazon.
When it comes to original programming, the old broadcast networks are losing their relevancy to streaming technology, personal video devices and the customer’s ability to find what they want, when they want it – and increasingly at a quality they prefer – from streaming as opposed to broadcast media.
To complete this latest “pivot,” from a video streaming company to a true media company with its own content, Morgan Stanley has published that Netflix is now considered by customers as the #1 quality programming across streaming services. 29% of viewers said Netflix was #1, followed by long-time winner HBO now #2 with 21% of customers saying their programming is best. Amazon, Showtime and Hulu were seen as the best quality by 4%-5% of viewers.
So a decade ago Netflix was a CD distribution company. The largest customer of the U.S. Postal Service. Signing up folks to watch physical videos in their homes. Now they are the largest data streaming company on the planet, and one of the largest original programming producers and programmers in the USA – and possibly the world. And in this same decade we’ve watched the network broadcast companies become outlets for sports and reality TV, while cutting far back on their original shows. Sounds a lot like a market shift, and possibly Netflix could be the game changer, as it performs the first strategy double pivot in business history.
Leading tech tracking companies IDC and Gartner both announced Q1, 2016 PC sales results, and they were horrible. Sales were down 9.5%-11.5% depending on which tracker you asked. And that’s after a horrible Q4, 2015 when sales were off more than 10%. PC sales have now declined for 6 straight quarters, and sales are roughly where they were in 2007, 9 years ago.
Oh yeah, that was when the iPhone launched – June, 2007. And just a couple of years before the iPad launched. Correlation, or causation?
Amazingly, when Q4 ended the forecasters were still optimistic of a stabilization and turnaround in PC sales. Typical analyst verbage was like this from IDC, “Commercial adoption of Windows 10 is expected to accelerate, and consumer buying should also stabilize by the second half of the year. Most PC users have delayed an upgrade, but can only maintain this for so long before facing security and performance issues.” And just to prove that hope springs eternal from the analyst breast, here is IDC’s forecast for 2016 after the horrible Q1, “In the short term, the PC market must still grapple with limited consumer interest and competition from other infrastructure upgrades in the commercial market. Nevertheless….things should start picking up in terms of Windows 10 pilots turning into actual PC purchases.”
Fascinating. Once again, the upturn is just around the corner. People have always looked forward to upgrading their PCs, there has always been a “PC upgrade cycle” and one will again emerge. Someday. At least, the analysts hope so. Maybe?
Microsoft investors must hope so. The company is selling at a price/earnings multiple of 40 on hopes that Windows 10 sales will soon boom, and re-energize PC growth. Surely. Hopefully. Maybe?
The world has shifted, and far too many people don’t like to recognize the shift. When Windows 8 launched it was clear that interest in PC software was diminishing. What was once a major front page event, a Windows upgrade, was unimportant. By the time Windows 10 came along there was so little interest that its launch barely made any news at all. This market, these products, are really no longer relevant to the growth of personal technology.
Back when I predicted that Windows 8 would be a flop I was inundated with hate mail. It was clear that Ballmer was a terrible CEO, and would soon be replaced by the board. Same when I predicted that Surface tablets would not sell well, and that all Windows devices would not achieve significant share. People called me “an Apple Fanboy” or a “Microsoft hater.” Actually, neither was true. It was just clear that a major market shift was happening in computing. The world was rapidly going mobile, and cloud-based, and the PC just wasn’t going to be relevant. As the PC lost relevancy, so too would Microsoft because it completely missed the market, and its entries were far too tied to old ways of thinking about personal and corporate computing – not to mention the big lead competitors had in devices, apps and cloud services.
I’ve never said that modern PCs are bad products. I have a son half way through a PhD in Neurobiological Engineering. He builds all kinds of brain models and 3 dimensional brain images and cell structure plots — and he does all kinds of very exotic math. His world is built on incredibly powerful, fast PCs. He loves Windows 10, and he loves PCs — and he really “doesn’t get” tablets. And I truly understand why. His work requires local computational power and storage, and he loves Windows 10 over all other platforms.
But he is not a trend. His deep understanding of the benefits of Windows 10, and some of the PC manufacturers as well as those who sell upgrade componentry, is very much a niche. While he depends heavily on Microsoft and Wintel manufacturers to do his work, he is a niche user. (BTW he uses a Nexus phone and absolutely loves it, as well. And he can wax eloquently about the advantages he achieves by using an Android device.)
Today, I doubt I will receive hardly any comments to this column. Because to most people, the PC is nearly irrelevant. People don’t actually care about PC sales results, or forecasts. Not nearly as much as, say, care about whether or not the iPhone 6se advances the mobile phone market in a meaningful way.
Most people do their work, almost if not all their work, on a mobile device. They depend on cloud and SaaS (software-as-a-service) providers and get a lot done on apps. What they can’t do on a phone, they do on a tablet, by and large. They may, or may not, use a PC of some kind (Mac included in that reference) but it is not terribly important to them. PCs are now truly generic, like a refrigerator, and if they need one they don’t much care who made it or anything else – they just want it to do whatever task they have yet to migrate to their mobile world.
The amazing thing is not that PC sales have fallen for 6 quarters. That was easy to predict back in 2013. The amazing thing is that some people still don’t want to accept that this trend will never reverse. And many people, even though they haven’t carried around a laptop for months (years?) and don’t use a Windows mobile device, still think Microsoft is a market leader, and has a great future. PCs, and for the most part Microsoft, are simply no more relevant than Sears, Blackberry, or the Encyclopedia Britannica. Yet it is somewhat startling that some people have failed to think about the impact this has on their company, companies that make PC software and hardware – and the impact this will have on their lives – and likely their portfolios.
Tesla started taking orders for the Model 3 last week, and the results were remarkable. In 24 hours the company took $1,000 deposits for 198,000 vehicles. By end of Saturday the $1,000 deposits topped 276,000 units. And for a car not expected to be available in any sort of volume until 2017. Compare that with the top selling autos in the U.S. in 2015:
Remarkably, the Model 3 would rank as the 6th best selling vehicle all of last year! And with just a few more orders, it will likely make the top 5 – or possibly top 3! And those are orders placed in just one week, versus an entire year of sales for the other models. And every buyer is putting up a $1,000 deposit, something none of the buyers of top 10 cars did as they purchased product widely available in inventory. [Update 7 April – Tesla reports sales exceed 325,000, which would make the Model 3 the second best selling car in the USA for the entire year 2015 – accomplished in less than one week.]
Even more astonishing is the average selling price. Note that top 10 cars are not highly priced, mostly in the $17,000 to $25,000 price range. But the Tesla is base priced at $35,000, and expected with options to sell closer to $42,000. That is almost twice as expensive as the typical top 10 selling auto in the U.S.
Tesla has historically been selling much more expensive cars, the Model S being its big seller in 2015. So if we classify Tesla as a “luxury” brand and compare it to like-priced Mercedes Benz C-Class autos we see the volumes are, again, remarkable. In under 1 week the Model 3 took orders for 3 times the volume of all C-Class vehicles sold in the U.S. in 2015.
[Car and Driver top 10 cars; Mercedes Benz 2015 unit sales; Tesla 2015 unit sales; Model 3 pricing]
Although this has surprised a large number of people, the signs were all pointing to something extraordinary happening. The Tesla Model S sold 50,000 vehicles in 2015 at an average price of $70,000 to $80,000. That is the same number of the Mercedes E-Class autos, which are priced much lower in the $50,000 range. And if you compare to the top line Mercedes S-Class, which is only slightly more expensive at an average $90,0000, the Model S sold over 2 times the 22,000 units Mercedes sold. And while other manufacturers are happy with single digit percentage volume growth, in Q4 Tesla shipments were 75% greater in 2015 than 2014.
In other words, people like this brand, like these cars and are buying them in unprecedented numbers. They are willing to plunk down deposits months, possibly years, in advance of delivery. And they are paying the highest prices ever for cars sold in these volumes. And demand clearly outstrips supply.
Yet, Tesla is not without detractors. From the beginning some analysts have said that high prices would relegate the brand to a small niche of customers. But by outselling all other manufacturers in its price point, Tesla has demonstrated its cars are clearly not a niche market. Likewise many analysts argued that electric cars were dependent on high gasoline prices so that “economic buyers” could justify higher prices. Yet, as gasoline prices have declined to prices not seen for nearly a decade Tesla sales keep going up. Clearly Tesla demand is based on more than just economic analysis of petroleum prices.
People really like, and want, Tesla cars. Even if the prices are higher, and if gasoline prices are low.
Emerging is a new group of detractors. They point to the volume of cars produced in 2015, and first quarter output of just under 15,000 vehicles, then note that Tesla has not “scaled up” manufacturing at anywhere near the necessary rate to keep customers happy. Meanwhile, constructing the “gigafactory” in Nevada to build batteries has slowed and won’t meet earlier expectations for 2016 construction and jobs. Even at 20,000 cars/quarter, current demand for Model S and Model 3 They project lots of order cancellations would take 4.5 years to fulfill.
Which leads us to the beauty of sales growth. When products tap an under- or unfilled need they frequently far outsell projections. Think about the iPod, iPhone and iPad. There is naturally concern about scaling up production. Will the money be there? Can the capacity come online fast enough?
Of course, of all the problems in business this is one every leader should want. It is certainly a lot more fun to worry about selling too much rather than selling too little. Especially when you are commanding a significant price premium for your product, and thus can be sure that demand is not an artificial, price-induced variance.
With rare exceptions, investors understand the value of high sales at high prices. When gross margins are good, and capacity is low, then it is time to expand capacity because good returns are in the future. The Model 3 release projects a backlog of almost $12B. Booked orders at that level are extremely rare. Further, short-term those orders have produced nearly $300million of short-term cash. Thus, it is a great time for an additional equity offering, possibly augmented with bond sales, to invest rapidly in expansion. Problematic, yes. Insolvable, highly unlikely.
On the face of it Tesla appears to be another car company. But something much more significant is afoot. This sales level, at these prices, when the underlying economics of use seem to be moving in the opposite direction indicates that Tesla has tapped into an unmet need. It’s products are impressing a large number of people, and they are buying at premium prices. Based on recent orders Tesla is vastly outselling competitive electric automobiles made by competitors, all of whom are much bigger and better resourced. And those are all the signs of a real Game Changer.
Starboard Value last week sent a letter to Yahoo’s Board of Directors announcing its intention to ask shareholders to replace the entire Board. That is why Starboard is called an “activist” fund. It is not shy about seeking action at the Board level to change the direction of a company – by changing the CEO, seeking downsizings and reogranizations, changing dividend policy, seeking share buybacks, recommending asset sales, or changing other resource allocations. They are different than other large investors, such as pension funds or mutual funds, who purchase lots of a company’s equity but don’t seek to overtly change the direction, and management, of a company.
Activists have been around a long time. And for years, they were despised. Carl Icahn made himself famous by buying company shares, then pressuring management into decisions which damaged the company long-term while he made money fast. For example, he bought TWA shares then pushed the company to add huge additional debt and repurchase equity (including buying his position via something called “green mail”) in order to short-term push up the earnings per share. This made Icahn billions, but ended up killing the company.
Similarly, Mr. Icahn bought a big position in Motorola right after it successfully launched the RAZR phone. He pushed the board to shut down expensive R&D and product development to improve short-term earnings. Then borrow a lot of money to repurchase shares, improving earnings per share but making the company over-leveraged. He then sold out and split with his cash. But Motorola never launched another successful phone, the technology changed, and Motorola had to sell its cell phone business (that pioneered the industry) in order to pay off debt and avoid bankruptcy. Motorola is now a fragment of its former self, and no longer relevant in the tech marketplace.
So now you understand why many people hate activists. They are famous for
- cutting long-term investments on new products leaving future sales pipelines weakened,
- selling assets to increase cash while driving down margins as vendors take more,
- selling whole businesses to raise cash but leave the company smaller and less competitive,
- cutting headcount to improve short-term earnings but leaving management and employees decimated and overworked,
- increasing debt massively to repurchase shares, but leaving the company financially vulnerable to the slightest problem,
- doing pretty much anything to make the short-term look better with no concern for long-term viability.
Yet, they keep buying shares, and they have defenders among shareholders. Many big investors say that activists are the only way shareholders can do anything about lousy management teams that fail to deliver, and Boards of Directors that let management be lazy and ineffective.
Which takes us to Yahoo. Yahoo was an internet advertising pioneer. Yet, for several years Yahoo has been eclipsed by competitors from Google to Facebook and even Microsoft that have grown their user base and revenues as Yahoo has shrunk. In the 4 years since becoming CEO Marissa Mayer has watched Yahoo’s revenues stagnate or decline in all core sectors, while its costs have increased – thus deteriorating margins. And to prop up the stock price she sold Alibaba shares, the only asset at Yahoo increasing in value, and used the proceeds to purchase Yahoo shares. There are very, very few defenders of Ms. Mayer in the investment community, or in the company, and increasingly even the Board of Directors is at odds with her leadership.
The biggest event in digital marketing is the Digital Content NewFronts in New York City this time every year. Big digital platforms spend heavily to promote themselves and their content to big advertisers. But in the last year Yahoo closed several verticals, and discontinued original programming efforts taking a $42M charge. It also shut is online video hub, Screen. Smaller, and less competitive than ever, Yahoo this year has cut its spending and customer acquisition efforts at NewFronts, a decision sure to make it even harder to reverse its declining fortunes. Not pleasant news to investors.
And Yahoo keeps going down in value. Looking at the market the value of Yahoo and Alibaba, and the Alibaba shares held in Yahoo, the theoretical value of Yahoo’s core business is now zero. But that is an oversimplification. Potential buyers have valued the business at $6B, while management has said it is worth $10B. Only in 2008 Ballmer-led Microsoft made an offer to buy it for $45B! That’s value destruction to the amount of $35B-$39B!
Yet management and the Board remains removed from the impact of that value destruction. And the risk remains that Yahoo leadership will continue selling off Alibaba value to keep the other businesses alive, thus bleeding additional investor value out of the company. There are reports that CEO Mayer never took seriously the threat of an activist involving himself in changing the company, and removing her as CEO. Ensconced in the CEO’s office there was apparently little concern about shareholder value while she remained fixated on Quixotic efforts to compete with much better positioned, growing and more profitable competitors Google and Facebook. Losing customers, losing sales, and losing margin as her efforts proved reasonable fruitless amidst product line shutdowns, bad acquisitions, layoffs and questionable micro-management decisions like eliminating work from home policies.
There appear to be real buyers interested in Yahoo. There are those who think they can create value out of what is left. And they will give the Yahoo shareholders something for the opportunity to take over those business lines. Some want it as part of a bigger business, such as Verizon, and others see independent routes. Even Microsoft is reportedly interested in funding a purchase of Yahoo’s core. But there is no sign that management, or the Board, are moving quickly to redirect the company.
And that is why Starboard Value wants to change the Board of Directors. If they won’t make changes, then Starboard will make changes. And investors, long weary of existing leadership and its inability to take positive action, see Starboard’s activism as the best way to unlock what value remains in Yahoo for them. After years of mismanagement and underperformance what else should investors do?
Activists are easy to pick at, but they play a vital role in forcing management teams and Boards of Directors to face up to market challenges and internal weaknesses. In cases like Yahoo the activist investor is the last remaining player to try and save the company from weak leadership.
United Continental Holdings is the most recent public company to come under attack by hedge funds. Last week Altimeter Capital and PAR Capital announced they were using their combined 7.1% ownership of United to propose a slate of 6 new directors to the company’s board. As is common in such hedge fund moves, they expressed strongly their lack of confidence in United’s board, and pointed out multiple years of underperformance.
United’s leadership is certainly in a tough place. The airline consistently ranks near the bottom in customer satisfaction, and on-time performance. It has struggled for years with labor strife, and the mechanics union just rejected their proposed contract – again. The flight attendant’s union has been in mediation for months. And few companies have had more consistently bad public relations, as customers have loudly complained about how they are treated – including one fellow making a music and speaking career out of how he was abused by United personnel for months after they destroyed his guitar.
But is changing the directors going to change the company? Or is it just changing the guest list for an haute couture affair? Should customers, employees, suppliers and investors expect things to really improve, or is this a selection between the devil and the deep blue sea?
Much was made of the fact that one of the proposed new directors is the former CEO of Continental, Gordon Bethune, who was very willing to speak out loudly and negatively regarding United’s current board. But Mr. Bethune is 74 years old. Today most companies have mandatory director retirement somewhere between age 68 and 72. Retired since 2004, is Mr. Bethune really in step with the needs of airline customers today? Does he really have a current understanding of how the best performing airlines keep customers happy while making money?
And, don’t forget, Mr. Bethune hand picked Mr. Jeff Smisek to replace him at Continental. Mr. Smisek was the fellow who took over Mr. Bethune’s board seat in 2004 after being appointed President and COO when Mr. Bethune retired. Smisek became CEO in 2010, and CEO of United Continental after the merger, and led the ongoing deterioration in United’s performance as well as declining employee moral. And then there’s that pesky problem of Mr. Smisek bribing government officials to improve United’s gate situation in Newark, NJ which caused him to be fired by the current board. Is it coincidental that this attack on the Board did not happen for years, but happens now that there is a new CEO – who happens to be recently recovering from a heart replacement?
Although Mr. Bethune has commented that the new board would be one that understands the airline industry, the slate does not reflect this. Mr. Gerstner is head of Altimiter and by all accounts appears to be a finance expert. That was the background Ed Lampert brought to Sears, another big Chicago company, when he took over that board. And that has not worked out too well at all for any constituents – including investors.
One can give great kudos to the hedge funds for proposing a very diverse slate. Half the proposed directors are either female or of color. And, other than Mr. Bethune, the slate is pretty young – with 2 proposed directors under age 50. Congratulations on achieving diversification! But a deeper look can cause us to wonder exactly what these directors bring to the challenges, and what they are likely to want to change at United.
Rodney O’Neal was the former CEO of Delphi Automotive. A lifelong automotive manager and executive, he graduated from the General Motors Institute and spent his career at GM before going to the parts unit GM had created in 1997 as a Vice President. Many may have forgotten that Delphi famously filed for bankruptcy in 2005, and proceeded to close over half its U.S. plants, then close or sell almost all of the other half in 2006. Mr. O’Neal became CEO in 2007, after which the company closed its plants in Spain despite having signed a commitment letter not to do so. He was CEO in 2008 when the company sued its shareholders. And in 2009 when the company sold its core assets to private investors, then dumped assets into the bankrupt GM, cancelled the stock and renamed the old Delphi DPH Holdings. Cutting, selling and reorganizing seem to be his dominant executive experience.
Barney Harford is a young, talented tech executive. He headed Orbitz, where Mr. Gerstner was on the board. Orbitz was originally created as the Travelocity and Expedia killer by the major airlines. Unfortunately, it never did too well and Mr. Harford actually changed the company direction from primarily selling airline tickets to selling hotel rooms.
It is always good to see more women proposed for board positions. However, Ms. Brenda Yester Baty is an executive with Lennar, a very large Florida-based home builder. And Ms. Tina Stark leads Sherpa Foundry which has a 1 page web site saying “Sherpa Foundry builds
bridges between the world’s leading Corporations and the Innovation Economy.” What that means leaves a lot of room for one’s imagination, and precious little specifics. What either of these people have to do with creating a major turnaround in the operations of United is unclear.
There is no doubt that United is ripe for change. Replacing the CEO was clearly a step in the right direction – if a bit late. But one has to wonder if the new directors are there to make some specific change? If so, what kind of change? Despite the rough rhetoric, there has been no proclamation of what the new director slate would actually do differently. No discussion of a change in strategy – or any changes in any operating characteristics. Just vague statements about better governance.
Historically most activists take firm aim at cutting costs. And this is probably why the 2 largest unions have already denounced the new slate, and put their full support behind the existing board of directors. After so many years of ill-will between management and labor at United, one would wonder why these unions would not welcome change. Unless they fear the new board will be mostly focused on cost-cutting, and further attempts at downsizing and pay/benefits reductions.
Investors will most likely get to vote on this decision. Keep existing board members, or throw them out in favor of a new slate? One would like to see United’s reputation, and operations, improve dramatically. But is changing out 6 directors the answer? Or are investors facing a vote that has them selecting between 2 less than optimal options? It would be good if there was less rhetoric, and more focus on actual proposals for change.
Walmart announced quarterly financial results last week, and they were not good. Sales were down $500million vs the previous year, and management lowered forecasts for 2016. And profits were down almost 8% vs. the previous year. The stock dropped, and pundits went negative on the company.
But if we take an historical look, despite how well WalMart’s value has done between 2011 and 2014, there are ample reasons to forecast a very difficult future. Sailors use small bits of cloth tied to their sails in order to get early readings on the wind. These small bits, called telltales, give early signs that good sailors use to plan their navigation forward. If we look closely at events at WalMart we can see telltales of problems destined to emerge for the retailing giant:
1 – In March, 2008 WalMart sued a brain damaged employee. The employee was brain damaged by a truck accident. WalMart’s insurance paid out $470,000 in health care cost. The employee’s family sued the trucking company, at their own expense, and won a $417,000 verdict for lost future wages, pain and suffering and future care needs. Then, WalMart decided it would sue the employee to recover the health care costs it had previously paid. As remarkable as this seems, it is a great telltale. It demonstrates a company so focused on finding ways to cut costs, and so insensitive to its employees and the plight of its customers that it loses all common sense. Not to mention the questionable ethics of this action, it at the very least demonstrates blatant disregard for the PR impact of its actions. It shows a company where management feels it is unquestionable, and a believe its brand is untouchable.
2 – In March, 2010 AdAge ran a column about WalMart being “stuck in the middle” and effectively becoming the competitive “bulls-eye” of retailing. After years of focusing on its success formula, “dollar store” competition was starting to undermine it on cost and price at the low end, while better merchandise and store experience boxed WalMart from higher end competitors – that often weren’t any more expensive. This was the telltale sign of a retailer that had focused on beating up its suppliers for years, cutting them out of almost all margin, without thinking about how it might need to change its business model to grow as competitors chopped up its traditional marketplace.
3 – In October, 2010 Fortune ran an article profiling then-CEO Mike Duke. It described an executive absolutely obsessive about operational minutia. Banana pricing, underwear inventory, cereal displays – there was no detail too small for the CEO. Another telltale of a company single-mindedly focused on execution, to the point of ignoring market shifts created by changing consumer tastes, improvements at competitors and the rapid growth of on-line retailing. There was no strategic thinking happening at WalMart, as executives believed there would never be a need to change the strategy.
4 – In April, 2012 WalMart found itself mired in a scandal regarding bribing Mexican government officials in its effort to grow sales. WalMart had never been able to convert its success formula into a growing business in any international market, but Mexico was supposedly its breakout. However, we learned the company had been paying bribes to obtain store sites and hold back local competitors. A telltale of a company where pressure to keep defending and extending the old business was so great that very highly placed executives do the unethical, and quite likely the illegal, to make the company look like it is performing better.
5 – In July, 2014 a WalMart truck driver hits a car seriously injuring comedian Tracy Morgan and killing his friend. While it could be taken as a single incident, the truth was that the driver had been driving excessive hours and excessive miles, not complying with government mandated rest periods, in order to meet WalMart distribution needs. This telltale showed how the company was stressed all the way down into the heralded distribution environment to push, push, push a bit harder to do more with less in order to find extra margin opportunities. What once was successful was showing stress at the seams, and in this case it led to a fatal accident by an employee.
6 – In January, 2015 we discovered traditional brick-and-mortar retail sales fell 1% from the previous year. The move to on-line shopping was clearly a force. People were buying more on-line, and less in stores. This telltale bode very poorly for all traditional retailers, and it would be clear that as the biggest WalMart was sure to face serious problems.
7 – In July, 2015 Amazon’s market value exceeds WalMart’s. Despite being quite a bit smaller, Amazon’s position as the on-line retail leader has investors forecasting tremendous growth. Even though WalMart’s value was not declining, its key competition was clearly being forecast to grow impressively. The telltale implies that at least some, if not a lot, of that growth was going to eventually come directly from the world’s largest traditional retailer.
8 – In January, 2016 we learn that traditional retail store sales declined in the 2015 holiday season from 2014. This was the second consecutive year, and confirmed the previous year’s numbers were the start of a trend. Even more damning was the revelation that Black Friday sales had declined in 2013, 2014 and 2015 strongly confirming the trend away from Black Friday store shopping toward Cyber Monday e-commerce. A wicked telltale for the world’s largest store system.
9 – In January, 2016 we learned that WalMart is reacting to lower sales by closing 269 stores. No matter what lipstick one would hope to place on this pig, this telltale is an admission that the retail marketplace is shifting on-line and taking a toll on same-store sales.
10 – We now know WalMart is in a Growth Stall. A Growth Stall occurs any time a company has two consecutive quarters of lower sales versus the previous year (or two consecutive declining back-to-back quarters.) In the 3rd quarter of 2015 Walmart sales were $117.41B vs. same quarter in 2014 $119.00B – a decline of $1.6B. Last quarter WalMart sales were $129.67B vs. year ago same quarter sales of $131.56B – a decline of $1.9B. While these differences may seem small, and there are plenty of explanations using currency valuations, store changes, etc., the fact remains that this is a telltale of a company that is already in a declining sales trend. And according to The Conference Board companies that hit a Growth Stall only maintain a mere 2% growth rate 7% of the time – the likelihood of having a lower growth rate is 93%. And 95% of stalled companies lose 25% of their market value, while 69% of companies lose over half their value.
WalMart is huge. And its valuation has actually gone up since the Great Recession began. It’s valuation also rose from 2011- 2014 as Amazon exploded in size. But the telltale signs are of a company very likely on the way downhill.
USAToday alerted investors that when Sears Holdings reports results 2/25/16 they will be horrible. Revenues down another 8.7% vs. last year. Same store sales down 7.1%. To deal with ongoing losses the company plans to close another 50 stores, and sell another $300million of assets. For most investors, employees and suppliers this report could easily be confused with many others the last few years, as the story is always the same. Back in January, 2014 CNBC headlined “Tracking the Slow Death of an Icon” as it listed all the things that went wrong for Sears in 2013 – and they have not changed two years later. The brand is now so tarnished that Sears Holdings is writing down the value of the Sears name by another $200million – reducing intangible value from the $4B at origination in 2004 to under $2B.
This has been quite the fall for Sears. When Chairman Ed Lampert fashioned the deal that had formerly bankrupt Kmart buying Sears in November, 2004 the company was valued at $11billion and 3,500 stores. Today the company is valued at $1.6billion (a decline of over 85%) and according to Reuters has just under 1,700 stores (a decline of 51%.) According to Bloomberg almost no analysts cover SHLD these days, but one who does (Greg Melich at Evercore ISI) says the company is no longer a viable business, and expects bankruptcy. Long-term Sears investors have suffered a horrible loss.
When I started business school in 1980 finance Professor Bill Fruhan introduced me to a concept that had never before occurred to me. Value Destruction. Through case analysis the good professor taught us that leadership could make decisions that increased company valuation. Or, they could make decisions that destroyed shareholder value. As obvious as this seems, at the time I could not imagine CEOs and their teams destroying shareholder value. It seemed anathema to the entire concept of business education. Yet, he quickly made it clear how easily misguided leaders could create really bad outcomes that seriously damaged investors.
As a case study in bad leadership, Sears under Chairman Lampert offers great lessons in Value Destruction that would serve Professor Fruhan’s teachings well:
1 – Micro-management in lieu of strategy. Mr. Lampert has been merciless in his tenacity to manage every detail at Sears. Daily morning phone calls with staff, and ridiculously tight controls that eliminate decision making by anyone other than the top officers. Additionally, every decision by the officers was questioned again and again. Explanations took precedent over action as micro-management ate up management’s time, rather than trying to run a successful company. While store employees and low- to mid-level managers could see competition – both traditional and on-line – eating away at Sears customers and core sales, they were helpless to do anything about it. Instead they were forced to follow orders given by people completely out of touch with retail trends and customer needs. Whatever chance Sears and Kmart had to grow the chain against intense competition it was lost by the Chairman’s need to micro-manage.
2 – Manage-by-the-numbers rather than trends. Mr. Lampert was a finance expert and former analyst turned hedge fund manager and investor. He truly believed that if he had enough numbers, and he studied them long enough, company success would ensue. Unfortunately, trends often are not reflected in “the numbers” until it is far, far too late to react. The trend to stores that were cleaner, and more hip with classier goods goes back before Lampert’s era, but he completely missed the trend that drove up sales at Target, H&M and even Kohl’s because he could not see that trend reflected in category sales or cost ratios. Merchandising – from buying to store layout and shelf positioning – are skills that go beyond numerical analysis but are critical to retail success. Additionally, the trend to on-line shopping goes back 20 years, but the direct impact on store sales was not obvious until customers had long ago converted. By focusing on numbers, rather than trends, Sears was constantly reacting rather than being proactive, and thus constantly retreating, cutting stores and cutting product lines.
3 – Seeking confirmation rather than disagreement. Mr. Lampert had no time for staff who did not see things his way. Mr. Lampert wanted his management team to agree with him – to confirm his Beliefs, Interpretations, Assumptions and Strategies — to believe his BIAS. By seeking managers who would confirm his views, and execute, rather than disagree Mr. Lampert had no one offering alternative data, interpretations, strategies or tactics. And, as Mr. Lampert’s plans kept faltering it led to a revolving door of managers. Leaders came and went in a year or two, blamed for failures that originated at the Chairman’s doorstep. By forcing agreement, rather than disagreement and dialogue, Sears lacked options or alternatives, and the company had no chance of turning around.
4 – Holding assets too long. In 2004 Sears had a LOT of assets. Many that could likely be redeployed at a gain for shareholders. Sears had many owned and leased store locations that were highly valuable with real estate prices climbing from then through 2008. But Mr. Lampert did not spin out that real estate in a REIT, capturing the value for SHLD shareholders while the timing was good. Instead he held those assets as real estate in general plummeted, and as retail real estate fell even further as more revenue shifted to e-commerce. By the time he was ready to sell his REIT much of the value was depleted.
Additionally, Sears had great brands in 2004. DieHard batteries, Craftsman tools, Kenmore appliances and Lands End apparel were just 4 household brands that still had high customer appeal and tremendous value. Mr. Lampert could have sold those brands to another retailer (such as selling DieHard to WalMart, for example) as their house brands, capturing that value. Or he could have mass marketd the brand beyond the Sears store to increase sales and value. Or he could have taken one or more brands on-line as a product leader and “category killer” for ecommerce customers. But he did not act on those options, and as Sears and Kmart stores faded, so did these brands – which largely no longer have any value. Had he sold when value was high there were profits to be made for investors.
5 – Hubris – unfailingly believing in oneself regardless the outcomes. In May, 2012 I wrote that Mr. Lampert was the 2nd worst CEO in America and should fire himself. This was not a comment made in jest. His initial plans had all panned out very badly, and he had no strategy for a turnaround. All results, from all programs implemented during his reign as Chairman had ended badly. Yet, despite these terrible numbers Mr. Lampert refused to recognize he was the wrong person in the wrong job. While it wasn’t clear if anyone could turn around the problems at Sears at such a late date, it was clear Mr. Lampert was not the person to do it. If Mr. Lampert had been as self-analytical as he was critical of others he would have long before replaced himself as the leader at Sears. But hubris would not allow him to do this, he remained blind to his own failings and the terrible outcome of a failed company was pretty much sealed.
From $11B valuation and a $92/share stock price at time of merging KMart and Sears, to a $1.6B valuation and a $15/share stock price. A loss of $9.4B (that’s BILLION DOLLARS). That is amazing value destruction. In a world where employees are fired every day for making mistakes that cost $1,000, $100 or even $10 it is a staggering loss created by Mr. Lampert. At the very least we should learn from his mistakes in order to educate better, value creating leaders.
Verizon tipped its hand that it would be interested to buy Yahoo back in December. In the last few days this possibility drew more attention as Verizon’s CFO confirmed interest on CNBC, and Bloomberg reported that AOL’s CEO Tim Armstrong is investigating a potential acquisition. There are some very good reasons this deal makes sense:
First, this acquisition has the opportunity to make Verizon distinctive. Think about all those ads you see for mobile phone service. Pretty much alike. All of them trying to say that their service is better than competitors, in a world where customers don’t see any real difference. 3G, 4G – pretty soon it feels like they’ll be talking about 10G – but users mostly don’t care. The service is usually good enough, and all competitors seem the same.
So, that leads to the second element they advertise – price. How many different price programs can anyone invent? And how many phone or tablet give-aways. What is clear is that the competition is about price. And that means the product has become generic. And when products are generic, and price is the #1 discussion, it leads to low margins and lousy investor returns.
But a Yahoo acquisition would make Verizon differentiated. Verizon could offer its own unique programming, at a meaningful level, and make it available only on their network. And this could offer price advantages. Like with Go90 streaming, Verizon customers could have free downloads of Verizon content, while having to pay data fees for downloads from other sites like YouTube, Facebook, Vine, Instagram, Amazon Prime, etc. The Verizon customer could have a unique experience, and this could allow Verizon to move away from generic selling and potentially capture higher margins as a differentiated competitor.
Second, Yahoo will never be a lead competitor and has more value as a supporting player. Yahoo has lost its lead in every major competitive market, and it will never catch up. Google is #1 in search, and always will be. Google is #1 in video, with Facebook #2, and Yahoo will never catch either. Ad sales are now dominated by adwords and social media ads – and Yahoo is increasingly an afterthought. Yahoo’s relevance in digital advertising is at risk, and as a weak competitor it could easily disappear.
But, Verizon doesn’t need the #1 player to put together a bundled solution where the #2 is a big improvement from nothing. By integrating Yahoo services and capabilities into its unique platform Verizon could take something that will never be #1 and make it important as part of a new bundle to users and advertisers. As supporting technology and products Yahoo is worth quite a bit more to Verizon than it will ever be as an independent competitor to investors – who likely cannot keep up the investment rates necessary to keep Yahoo alive.
Third, Yahoo is incredibly cheap. For about a year Yahoo investors have put no value on the independent Yahoo. The company’s value has been only its stake in Alibaba. So investors inherently have said they would take nothing for the traditional “core” Yahoo assets.
Additionally, Yahoo investors are stuck trying to capture the Alibaba value currently locked-up in Yahoo. If they try to spin out or sell the stake then a $10-12Billion tax bill likely kicks in. By getting rid of Yahoo’s outdated business what’s left is “YaBaba” as a tracking stock on the NASDAQ for the Chinese Alibaba shares. Or, possibly Alibaba buys the remaining “YaBaba” shares, putting cash into the shareholder pockets — or giving them Alibaba shares which they may prefer. Etiher way, the tax bill is avoided and the Alibaba value is unlocked. And that is worth considerably more than Yahoo’s “core” business.
So it is highly unlikely a deal is made for free. But lacking another likely buyer Verizon is in a good position to buy these assets for a pretty low value. And that gives them the opportunity to turn those assets into something worth quite a lot more without the overhang of huge goodwill charges left over from buying an overpriced asset – as usually happens in tech.
Fourth, Yahoo finally gets rid of an ineffectual Board and leadership team. The company’s Board has been trying to find a successful leader since the day it hired Carol Bartz. A string of CEOs have been unable to define a competitive positioning that works for Yahoo, leading to the current lack of investor enthusiasm.
The current CEO Mayer and her team, after months of accomplishing nothing to improve Yahoo’s competitiveness and growth prospects, is now out of ideas. Management consulting firm McKinsey & Company has been brought in to engineer yet another turnaround effort. Last week we learned there will be more layoffs and business closings as Yahoo again cannot find any growth prospects. This was the turnaround that didn’t, and now additional value destruction is brought on by weak leadership.
Most of the time when leaders fail the company fails. Yahoo is interesting because there is a way to capture value from what is currently a failing situation. Due to dramatic value declines over the last few years, most long-term investors have thrown in the towel. Now the remaining owners are very short-term, oriented on capturing the most they can from the Alibaba holdings. They are happy to be rid of what the company once was. Additionally, there is a possible buyer who is uniquely positioned to actually take those second-tier assets and create value out of them, and has the resources to acquire the assets and make something of them. A real “win/win” is now possible.
The three highest valued publicly traded companies today (2/3/16) are Google/Alphabet, Apple and Microsoft. All 3 are tech companies, and they compete – although with different business models – in multiple markets. However, investor views as to their futures are wildly different. And that has everything to do with how the leadership teams of these 3 companies have explained their recent results, and described their futures.
Looking at the financial performance of these companies, it is impossible to understand the price/earnings multiple assigned to each. Apple clearly had better revenue and earnings performance in all but the most recent year. Yet, both Alphabet and Microsoft have price to earnings (P/E) multiples that are 3-4 times that of Apple.
Much was made this week about Alphabet’s valuation exceeding that of Apple’s. But the really big story is the difference in multiples. If Apple had a multiple even half that of Alphabet or Microsoft it’s value would be much, much higher.
But, as we can see, investors did the best over both 2 years and 5 years by investing in Microsoft. And Apple investors have fared the poorest of all 3 companies regardless of time frame. Looking at investment performance, one would think that the revenue and earnings performance of these companies would be the reverse of what’s seen in the first chart.
The missing piece, of course, is future expectations. In this column a few days ago, I pointed out that Apple has done a terrible job explaining its future. In that column I pointed out how Facebook and Amazon both had stratospheric P/E multiples because they were able to keep investors focused on their future growth story, even more than their historical financial performance.
Alphabet stole the show, and at least briefly the #1 valuation spot, from Apple by convincing investors they will see significant, profitable growth. Starting even before earnings announcements the company was making sure investors knew that revenues and profits would be up. But even more they touted the notion that Alphabet has a lot of growth in non-monetized assets. For example, vastly greater ad sales should be expected from YouTube and Google Maps, as well as app sales for Android phones through Google Play. And someday on the short horizon profits will emerge from Fiber transmission revenues, smart home revenues via Nest, and even auto market sales now that the company has logged over 1million driverless miles.
This messaging clearly worked, as Alphabet’s value shot up. Even though 99% of the company’s growth was in “core” products that have been around for a decade! Yes, ad revenue was up 15%, but most of that was actually on the company’s own web sites. And most was driven by further price erosion. The number of paid clicks were up 30%, but price/click was actually down yet another 15% – a negative price trend that has been happening for years. Eventually prices will erode enough that volume will not make up the difference – and what will investors do then? Rely on the “moonshot” projects which still have almost no revenue, and no proven market performance!
But, the best performer has been Microsoft. Investors know that PC sales have been eroding for years, that PC sales will continue eroding as users go mobile, and that PC’s are the core of Microsoft’s revenue. Investors also knows that Microsoft missed the move to mobile, and has practically no market share in the war between Apple’s iOS and Google’s Android. Further, investors have known forever that gaming (xBox,) search and entertainment products have always been a money-loser for Microsoft. Yet, Microsoft investors have done far better than Apple investors, and long-term better than Google investors!
Microsoft has done an absolutely terrific job of constantly trumpeting itself as a company with a huge installed base of users that it can leverage into the future. Even when investors don’t know how that eroding base will be leveraged, Microsoft continually makes the case that the base is there, that Microsoft is the “enterprise” brand and that those users will stay loyal to Microsoft products.
Forget that Windows 8 was a failure, that despite the billions spent on development Win8 never reached even 10% of the installed base and the company is even dropping support for the product. Forget that Windows 10 is a free upgrade (meaning no revenue.) Just believe in that installed base.
Microsoft trumpeted that its Surface tablet sales rose 22% in the last quarter! Yay! Of course there was no mention that in just the last 6 weeks of the quarter Apple’s newly released iPad Pro actually sold more units than all Surface tablets did for the entire quarter! Or that Microsoft’s tablet market share is barely registerable, not even close to a top 5 player, while Apple still maintains 25% share. And investors are so used to the Microsoft failure in mobile phones that the 49% further decline in sales was considered acceptable.
Instead Microsoft kept investors focused on improvements to Windows 10 (that’s the one you can upgrade to for free.) And they made sure investors knew that Office 365 revenue was up 70%, as 20million consumers now use the product. Of course, that is a cumulative 20million – compared to the 75million iPhones Apple sold in just one quarter. And Azure revenue was up 140% – to something that is almost a drop in the bucket that is AWS which is over 10 times the size of all its competitors combined.
To many, this author included, the “growth story” at Microsoft is more than a little implausible. Sales of its core products are declining, and the company has missed the wave to mobile. Developers are writing for iOS first and foremost, because it has the really important installed base for today and tomorrow. And they are working secondarily on Android, because it is in some flavor the rest of the market. Windows 10 is a very, very distant third and largely overlooked. xBox still loses money, and the new businesses are all relatively quite small. Yet, investors in Microsoft have been richly rewarded the last 5 years.
Meanwhile, investors remain fearful of Apple. Too many recall the 1980s when Apple Macs were in a share war with Wintel (Microsoft Windows on Intel processors) PCs. Apple lost that war as business customers traded off the Macs ease of use for the lower purchase cost of Windows-based machines. Will Apple make the same mistake? Will iPad sales keep declining, as they have for 2 years now? Will the market shift to mobile favor lower-priced Android-based products? Will app purchases swing from iTunes to Google Play as people buy lower cost Android-based tablets? Have iPhone sales really peaked, and are they preparing to fall? What’s going to happen with Apple now? Will the huge Apple mobile share be eroded to nothing, causing Apple’s revenues, profits and share price to collapse?
This would be an interesting academic discussion were the stakes not so incredibly high. As I said in the opening paragraph, these are the 3 highest valued public companies in America. Small share price changes have huge impacts on the wealth of individual and institutional investors. It is rather quite important that companies tell their stories as good as possible (which Apple clearly has not, and Microsoft has done extremely well.) And likewise it is crucial that investors do their homework, to understand not only what companies say, but what they don’t say.