Microsoft is buying Linked-In, and we should expect this to be a disaster.
It is clear why Linked-in agreed to be purchased. As revenues have grown, gross margins have dropped precipitously, and the company is losing money. And LInked-in still receives 2/3 of its revenue from recruiting ads (the balance is almost wholly subscription fees,) unable to find a wider advertiser base to support growth. Although membership is rising, monthly active users (MAUs, the most important gauge of social media growth) is only 9% – like Twitter, far below the 40% plus rate of Facebook and upcoming networks. With only 106M MAUs, Linked in is 1/3 the size of Twitter, and 1/15th the size of Facebook. And its $1.5B Lynda acquisition is far, far, far from recovering its investment – or even demonstrating viability as a business.
Even though the price is below the all-time highs for LNKD investors, Microsoft’s offer is far above recent trading prices and a big windfall for them.
But for Microsoft investors, this is a repeat of the pattern that continues to whittle away at their equity value.
Once upon a time, in a land far away, and barely remembered by young people, Microsoft OWNED the tech marketplace. Individuals and companies purchased PCs preloaded with Microsoft Windows 95, Microsoft Office, Microsoft Internet Explorer and a handful of other tools and trinkets. And as companies built networks they used PC servers loaded with Microsoft products. Computing was a Microsoft solution, beginning to end, for the vast majority of users.
But the world changed. Today PC sales continue their multi-year, accelerating decline, while some markets (such as education) are shifting to Chromebooks for low cost desktop/laptop computing, growing their sales and share. Meanwhile, mobile devices have been the growth market for years. Networks are largely public (rather than private) and storage is primarily in the cloud – and supplied by Amazon. Solutions are spread all around, from Google Drive to apps of every flavor and variety. People spend less computing cycles creating documents, spreadsheets and presentations, and a lot more cycles either searching the web or on Facebook, Instagram, WhatsApp, YouTube and Snapchat.
But Microsoft’s leadership still would like to capture that old world. They still hope to put the genie back in the bottle, and have everyone live and work entirely on Microsoft. And somehow they have deluded themselves into thinking that buying Linked-in will allow them to return to the “good old days.”
Microsoft has not done a good job of integrating its own solutions like Office 365, Skype, Sharepoint and Dynamics into a coherent, easy to use, and to some extent mobile, solution. Yet, somehow, investors are expected to believe that after buying Linked-in the two companies will integrate these solutions into the LInked-in social platform, enabling vastly greater adoption/use of Office 365 and Dynamics as they are tied to Linked-in Sales Navigator. Users will be thrilled to have their personal information analyzed by Microsoft big data tools, then sold to advertisers and recruiters. Meanwhile, corporations will come back to Microsoft in droves as they convert Linked-in into a comprehensive project management tool that uses Lynda to educate employees, and 365 to push materials to employees – and allow document collaboration – all across their mobile devices.
Do you really believe this? It might run on the Powerpoint operating system, but this vision will take an enormous amount of code integration. And with Linked-in operated as separate company within Microsoft, who is going to do this integration? This will involve a lot of technical capability, and based on previous performance it appears both companies lack the skills necessary to pull it off. How this mysterious, magical integration will happen is far, far from obvious, or explained in the announcement documents. Sounds a lot more like vaporware than a straightforward software project.
And who thinks that today’s users, from individuals to corporations, have a need for this vision? While it may sound good to Microsoft, have you heard Linked-in users saying they want to use 365 on Linked in? Or that they’ll continue to use Linked-in if forced to buy 365? Or that they want their personal information data mined for advertisers? Or that they desire integration with Dynamics to perform Linked-in based CRM? Or that they see a need for a social-network based project management tool that feeds up training documents or collaborative documents? Are people asking for an integrated, holistic solution from one vendor to replace their current mobile devices and mobile solutions that are upgraded by multiple vendors almost weekly?
And, who really thinks Microsoft is good at acquisition integration? Remember aQuantive? In 2007 Microsoft spent $6B (an 85% premium to market price) to purchase this digital ad agency in order to build its business in the fast growing digital ad space. Don’t feel bad if you don’t remember, because in 2012 Microsoft wrote it off. Of course, there was the buy-it-and-write-it-off pattern repeated with Nokia. Microsoft’s success at taking “bold moves” to expand beyond its core business has been nothing less than horrible. Even the $1.2B acquisition of Yammer in 2012 to make Sharepoint more collaborative and usable has been unsuccessful, even though rolled out for free to 365 users. Yammer is adding nothing to Microsoft’s sales or value as competitor Slack has reaped the growth in corporate messaging.
The only good news story about Microsoft acquisitions is that they missed spending $44B to buy Yahoo – which is now on the market for $5B. Whew, thank goodness that one got away!
Microsoft’s leadership primed the pump for this week’s announcement by having the Chairman talk about investing outside of the company’s core a couple of weeks ago. But the vast majority of analysts are now questioning this giant bet, at a price so high it will lower Microsoft’s earnings for 2 years. Analysts are projecting about a $2B revenue drop for $90B Microsoft next year, and this $26B acquisition will deliver only a $3B bump. Very, very expensive revenue replacement.
Despite all the lingo, Microsoft simply cannot seem to escape its past. Its acquisitions have all been designed to defend and extend its once great history – but now outdated. Customers don’t want the past, they are looking to the future. And no matter how hard they try, Microsoft’s leaders simply appear unable to define a future that is not tightly linked to the company’s past. So investors should expect Linked-In’s future to look a lot like aQuantive. Only this one is going to be the most painful yet in the long list of value transfer from Microsoft investors to the investors of acquired companies.
My last column focused on growth, and the risks inherent in a Growth stall. As I mentioned then, Apple will enter a Growth Stall if its revenue declines year-over-year in the current quarter. This forecasts Apple has only a 7% probability of consistently growing just 2%/year in the future.
This usually happens when a company falls into Defend & Extend (D&E) management. D&E management is when the bulk of management attention, and resources, flow into protecting the “core” business by seeking ways to use sustaining innovations (rather than disruptive innovations) to defend current customers and extend into new markets. Unfortunately, this rarely leads to high growth rates, and more often leads to compressed margins as growth stalls. Instead of working on breakout performance products, efforts are focused on ways to make new versions of old products that are marginally better, faster or cheaper.
Using the D&E lens, we can identify what looks like a sea change in Apple’s strategy.
For example, Apple’s CEO has trumpeted the company’s installed base of 1B iPhones, and stated they will be a future money maker. He bragged about the 20% growth in “services,” which are iPhone users taking advantage of Apple Music, iCloud storage, Apps and iTunes. This shows management’s desire to extend sales to its “installed base” with sustaining software innovations. Unfortunately, this 20% growth was a whopping $1.2B last quarter, which was 2.4% of revenues. Not nearly enough to make up for the decline in “core” iPhone, iPad or Mac sales of approximately $9.5B.
Apple has also been talking a lot about selling in China and India. Unfortunately, plans for selling in India were at least delayed, if not thwarted, by a decision on the part of India’s regulators to not allow Apple to sell low cost refurbished iPhones in the country. Fearing this was a cheap way to dispose of e-waste they are pushing Apple to develop a low-cost new iPhone for their market. Either tactic, selling the refurbished products or creating a cheaper version, are efforts at extending the “core” product sales at lower margins, in an effort to defend the historical iPhone business. Neither creates a superior product with new features, functions or benefits – but rather sustains traditional product sales.
Of even greater note was last week’s announcement that Apple inked a partnership with SAP to develop uses for iPhones and iPads built on the SAP ERP (Enterprise Resource Planning) platform. This announcement revealed that SAP would ask developers on its platform to program in Swift in order to support iOS devices, rather than having a PC-first mentality.
This announcement builds on last year’s similar announcement with IBM. Now 2 very large enterprise players are building applications on iOS devices. This extends the iPhone, a product long thought of as great for consumers, deeply into enterprise sales. A market long dominated by Microsoft. With these partnerships Apple is growing its developer community, while circumventing Microsoft’s long-held domain, promoting sales to companies as well as individuals.
And Apple has shown a willingness to help grow this market by introducing the iPhone 6se which is smaller and cheaper in order to obtain more traction with corporate buyers and corporate employees who have been iPhone resistant. This is a classic market extension intended to sustain sales with more applications while making no significant improvements in the “core” product itself.
And Apple’s CEO has said he intends to make more acquisitions – which will surely be done to shore up weaknesses in existing products and extend into new markets. Although Apple has over $200M of cash it can use for acquisitions, unfortunately this tactic can be a very difficult way to actually find new growth. Each would be targeted at some sort of market extension, but like Beats the impact can be hard to find.
Remember, after all revenue gains and losses were summed, Apple’s revenue fell $7.6B last quarter. Let’s look at some favorite analyst acquisition targets to explain:
- Box could be a great acquisition to help bring more enterprise developers to Apple. Box is widely used by enterprises today, and would help grow where iCloud is weak. IBM has already partnered with Box, and is working on applications in areas like financial services. Box is valued at $1.45B, so easily affordable. But it also has only $300M of annual revenue. Clearly Apple would have to unleash an enormous development program to have Box make any meaningful impact in a company with over $500B of revenue. Something akin of Instagram’s growth for Facebook would be required. But where Instagram made Facebook a pic (versus words) site, it is unclear what major change Box would bring to Apple’s product lines.
- Fitbit is considered a good buy in order to put some glamour and growth onto iWatch. Of course, iWatch already had first year sales that exceeded iPhone sales in its first year. But Apple is now so big that all numbers have to be much bigger in order to make any difference. With a valuation of $3.7B Apple could easily afford FitBit. But FitBit has only $1.9B revenue. Given that they are different technologies, it is unclear how FitBit drives iWatch growth in any meaningful way – even if Apple converted 100% of Fitbit users to the iWatch. There would need to be a “killer app” in development at FitBit that would drive $10B-$20B additional annual revenue very quickly for it to have any meaningful impact on Apple.
- GoPro is seen as a way to kick up Apple’s photography capabilities in order to make the iPhone more valuable – or perhaps developing product extensions to drive greater revenue. At a $1.45B valuation, again easily affordable. But with only $1.6B revenue there’s just not much oomph to the Apple top line. Even maximum Apple Store distribution would probably not make an enormous impact. It would take finding some new markets in industry (enterprise) to build on things like IoT to make this a growth engine – but nobody has said GoPro or Apple have any innovations in that direction. And when Amazon tried to build on fancy photography capability with its FirePhone the product was a flop.
- Tesla is seen as the savior for the Apple Car – even though nobody really knows what the latter is supposed to be. Never mind the actual business proposition, some just think Elon Musk is the perfect replacement for the late Steve Jobs. After all the excitement for its products, Tesla is valued at only $28.4B, so again easily affordable by Apple. And the thinking is that Apple would have plenty of cash to invest in much faster growth — although Apple doesn’t invest in manufacturing and has been the king of outsourcing when it comes to actually making its products. But unfortunately, Tesla has only $4B revenue – so even a rapid doubling of Tesla shipments would yield a mere 1.6% increase in Apple’s revenues.
- In a spree, Apple could buy all 4 companies! Current market value is $35B, so even including a market premium $55B-$60B should bring in the lot. There would still be plenty of cash in the bank for growth. But, realize this would add only $8B of annual revenue to the current run rate – barely 25% of what was needed to cover the gap last quarter – and less than 2% incremental growth to the new lower run rate (that magic growth percentage to pull out of a Growth Stall mentioned earlier in this column.)
Such acquisitions would also be problematic because all have P/E (price/earnings) ratios far higher than Apple’s 10.4. FitBit is 24, GoPro is 43, and both Box and Tesla are infinite because they lose money. So all would have a negative impact on earnings per share, which theoretically should lower Apple’s P/E even more.
Acquisitions get the blood pumping for investment bankers and media folks alike – but, truthfully, it is very hard to see an acquisition path that solves Apple’s revenue problem.
All of Apple’s efforts big efforts today are around sustaining innovations to defend & extend current products. No longer do we hear about gee whiz innovations, nor do we hear about growth in market changing products like iBeacons or ApplePay. Today’s discussions are how to rejuvenate sales of products that are several versions old. This may work. Sales may recover via growth in India, or a big pick-up in enterprise as people leave their PCs behind. It could happen, and Apple could avoid its Growth Stall.
But investors have the right to be concerned. Apple can grow by defending and extending the iPhone market only so long. This strategy will certainly affect future margins as prices, on average, decline. In short, investors need to know what will be Apple’s next “big thing,” and when it is likely to emerge. It will take something quite significant for Apple to maintain it’s revenue, and profit, growth.
The good news is that Apple does sell for a lowly P/E of 10 today. That is incredibly low for a company as profitable as Apple, with such a large installed base and so many market extensions – even if its growth has stalled. Even if Apple is caught in the Innovator’s Dilemma (i.e. Clayton Christensen) and shifting its strategy to defending and extending, it is very lowly valued. So the stock could continue to perform well. It just may never reach the P/E of 15 or 20 that is common for its industry peers, and investors envisioned 2 or 3 years ago. Unless there is some new, disruptive innovation in the pipeline not yet revealed to investors.
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.
We all like to think the world is a meritocracy, where hard work is important and results matter.
As we watched Mitt Romney, and others, frontally assault Donald Trump this week it was clear they were saying Mr. Trump is not the right person to be President. They are pointing out his use of bankruptcies to protect his personal wealth, while leaving investors holding the empty bag. And his flip-flopping on various issues, including how he would deploy military forces. And his use of misogynistic language against women, while simultaneously referring to most Mexicans and lawbreakers and all Muslims as terrorists, are gross generalities they say are not supported by facts.
Yet, while many sober-minded leaders are denouncing Mr. Trump, it is not clear that it matters. His followers seem to remain passionately loyal, and completely unmoved by any factual representation of their candidate as anything other than a savior for America. The “Super Saturday” delegate selection resulted in Mr. Trump winning 2 more contests (Louisiana and Kentucky) while coming in second in 2 others (Kansas and Maine.) And it demonstrated the ongoing pattern of Mr. Trump winning the popular vote in primaries.
Everyone remembers a situation where a very hard working, smart, industrious person did things well for years. But they weren’t promoted, or even given large pay increases. Or, worse, they made one mistake and lost their position, or job.
Simultaneously, we all also can think of at least one, or more, person who simply wasn’t that good, and often didn’t work that hard, but was promoted (often beyond their competency) and given large pay increases. And every time this person made a mistake it was explained away as a “learning experience” that would make them a better future performer. They were blessed with continuous upward mobility, and could seemingly do no wrong.
For each of us these experiences seemed unique, and we often tied them to the specific individuals involved – including not only the person at the center of these experiences but their superiors, subordinates and peers. And many people are saying the political rise of Donald Trump is unique to him and the current state of his political party.
But rather than each being unique, these experiences all have something in common. The actual frequency of these experiences belies the notion that they are all unique. Rather, what all of these demonstrate is the implementation of selective bias. They demonstrate that very often we prefer people because they reinforce our bias, and their past results do not matter.
Bosses who promote incompetency don’t really care about the competency as much as they care that the individual reinforces their inherent Beliefs, Interpretations, Assumptions and Strategies about the world. There is often a familial, geographic, academic, business relationship, religious or gender trait (or often multiple traits) which reinforces in these bosses that their view of the world is right, and should be promoted.
This may be due to the person being very much similar to the boss. But, not always. It just requires that the target be a visible, walking, talking implementation of how they think the world works. Whether or not the person is successful really does not matter. If they are different from the boss’s viewpoint, no success will be great enough to have the boss support them. If they fulfill the boss’s bias then they often can do no wrong.
Donald Trump has been leading his candidate competitors not because he was wildly successful. Rather, he is attracting a larger group of people who identify with him; who share his basic Beliefs, Interpretations of the world, Assumptions about how people behave, and Strategies for how to succeed. They share his bias, and thus they select him. As Mr. Trump said himself “I could stand in the middle of 5th Avenue and shoot somebody and I wouldn’t lose voters.”
Regardless of the robustness of the American economy and the ongoing growth in jobs creation, they Believe America is in terrible shape, and that almost all media participants are liars. No matter what the truth is about the value of immigrants on the economy, they Interpret all immigrants as job-stealing bad people that have made their lives worse. No matter the truth about the spirit of Islam and the goodness of Muslims, they Assume all of them terrorists out to blow up the world. And they agree with Strategies like stopping immigrants with walls, killing civilian Muslims as collateral damage in a religious war, torturing prisoners of war (possibly to death,) eliminating international trade, and depriving poor people of health care and other services.
Thus, selective bias ties these voters to Mr. Trump with a bind that is not breakable by discussing his performance, or pointing out his failings. Facts are not relevant. Their judgement is not based on historical facts, but rather a clear alignment with their bias. No matter who says Mr. Trump may have lied, or exaggerated, or misinterpreted history that messenger will not be believed. Because the real results don’t matter. What matters is reinforcing their bias.
Unfortunately we see this selective bias all too often in business. Leaders that favor some over others simply because of bias, rather than results. It has long been a problem which has restricted diversity in the workforce, and inhibited equal pay. It has long created a caste system for admission to top schools and places of employment. And because selective bias is so rampant in American business, it is second nature to Mr. Trump. It is easy for him to say what is on his mind, and expect that lots of people will agree with him. It’s how he sees the world, it is his bias, and he’s used to having it reinforced by those who wish to work with him.
Whatever happens in this Presidential campaign, as business leaders we can learn from this situation that if we allow selective bias to sway us then we are no longer really paying attention to results. As leaders which of the following should be important – promoting those who reinforce our beliefs, interpretations, assumptions and strategies, or finding the best people to do the job and rewarding those who really have worked hard for good results?
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.
2015 was not short on bad decisions, nor bad outcomes. But there are 5 major leadership themes from 2015 that can help companies be better in 2016:
1 – Cost cutting, restructurings and stock buybacks do not increase company value – Dow/DuPont
There was no shortage of financial engineering experiments in 2015 intended to increase short-term shareholder returns at the expense of long-term value creation. Companies continued borrowing money to buy back their own stock – spending more on repurchases than they made in profits.
Unfortunately, too many companies continue to increase earnings per share (EPS) via financial machinations rather than creating and introducing new products, or creating new markets.
In a grand show of value reducing financial re-engineering, 2015 is ending with the massive merger between Dow and DuPont. There is no intent of introducing new products or entering new markets via this merger. Rather, to the contrary, the plan is to merge these beasts, lay off tens of thousands of employees, cut the R&D staff, cut new product introductions and “rationalize” the company into 3 new businesses intended to be relaunched as new companies, with fewer products, less business development and less competition.
Massive cost cutting will weaken both companies, put thousands out of work and leave the marketplace with fewer new products. All just to create 3 new, different profit and loss statements in the hopes of improving the EPS and price to earnings (P/E) multiple. This story has become all too familiar the last few years, and the only winners are the bankers, who will make massive fees, and hedge fund managers that rapidly dump the stock in the terrible companies they leave behind.
2 – Doing more of the same is not innovative and does not create value – McDonald’s
McDonald’s has been losing market share to fast casual restaurants for over a decade. Yet, leadership insists on constantly maintaining its undying focus on the fast food success formula upon which the company was launched some 60 years ago.
As the number of customers continued declining, McDonalds kept closing more stores. Yet, sales per store remained weak even as the denominator grew smaller. Unwilling to actually update McDonald’s to make it fit modern trends, in 2015 leadership decided the path to growth was serving breakfast all-day. Really. It is still hard to believe. No new products, just the same McMuffins and sausage biscuits, but now offered for more hours.
Because of McDonald’s size and legacy the media covered this story heavily in 2015. Yet, as 2016 starts we all can look back and see that this was no story at all. Doing more of the same is not in any way innovative or revolutionary. Defending and extending an outdated success formula does not fix a company strategy that is out of date and rapidly losing relevancy.
3 – Hiring the wrong CEO is a BIG problem – Yahoo
We would like to think that Boards are really good at hiring CEOs. Unfortunately, we are regularly reminded they are not. The Board at Yahoo has spent a decade making bad CEO selections, and now the company’s core business is valueless.
In 2015 we saw that the decision by Yahoo’s board to hire a CEO based on political correctness (gender advantages), and limited experience with a well known company (a short Google career) rather than leadership capability could be deadly. Although Marissa Mayer was hired in 2012 amid much fanfare, we learned in 2015 that Yahoo is worth only the value of its Alibaba shareholdings, and no more. Yahoo as it was founded is now worth – nothing.
After 3 years of Mayer leadership it became clear that “there was no there, there” at Yahoo (to quote Gertrude Stein.) The value of the company’s “core” search and content accumulation businesses dropped to zero. Although 3 years have passed, practically no progress has been made toward developing a new business able to compete in the market shifted to social media and instant communications. Investors now realize Ms. Mayer has failed to grow future revenue and profits for the historical internet leader. Following a decade of incompetent CEOs, Yahoo has been left almost wholly irrelevant.
What was once Yahoo will soon be Alibaba USA, as the company gets rid of its old businesses – in some fashion, although who would want them is unclear – in order to allow shareholders to preserve their value in Alibaba stock purchased by Jerry Yang in 2005.
Yahoo has become irrelevant, replaced by its minority stake in Alibaba, largely due to a Board unable to identify and hire a competent CEO – ending with the wholly unqualified selection of Ms. Mayer, who will achieve at least a footnote in history for the outsized compensation package she received and the huge severance that will come her way, wildly out of proportion to her poor performance, when leaving Yahoo.
4 – Even 1 dumb leadership decision can devastate a company — Turing Pharmaceuticals and CEO Shkreli
In 2015 former hedge fund manager Martin Shkreli raised a lot of money, and obtained control of an anit-parasitic pharmaceutical product. Recognizing that his customers either paid up or died, and being young, naïve, enormously greedy and without much oversight he decided to raise product pricing 70-fold. This would leave his customers either dead, bankrupt or bankrupting the insurance companies paying for his product – but he infamously said he did not care.
Thumbing your nose at customers, and regulators, is never a good idea. And even if they could not roll back the price quickly, they could target the CEO and his company for further investigation. It didn’t take long until Mr. Shrkeli was indicted for stock manipulation, leaving Turing Pharmaceuticals in disrepair as it rapidly cut staff and tried to determine what it will do next. Now KaloBios Pharma, controlled by Turing, is forced to file bankruptcy.
Never forget that Al Capone did not go to prison for stealing, bribing police, bootlegging, number running, murder or other gangster behavior. He went to prison for tax evasion. The simple lesson is, when you think you are smarter than everyone else, can do whatever you want and thumb your nose at those with government powers you’ll soon find yourself under the microscope of investigation, and most likely in really big trouble. And in the desire to take down the unwise CEO corporations become mere fodder.
The pharma industry is a regular target of consumers and politicians. Now not only are the investors in Turing damaged by this foolishly incompetent CEO, but the entire industry will once again be under close scrutiny for its pricing practices. Arrogantly making brash decisions, based on ill-formed thinking and juvenile egotism, without careful, thoughtful consideration can create enormous damage.
5 – Putting short-term results above good business practice will hurt you very badly long-term – Volkswagen and Takata
VW cheated on its emissions tests. Takata sold deadly, exploding airbags. Both companies are large organizations with layers of management. How could judgemenetal errors so big, so costly and so deadly happen?
These outcomes did not happen because of just “one bad apple.” Cultural acceptance of lying takes years of leadership focused on short-term results, even when it means operating unethically or illegally, to be inculcated. It took years for layers of management to learn how to turn away from problems, falsify test results, fake outcomes, lie to customers and even lie to regulators. It took years to create a culture of tolerated deception and willful misrepresentation.
Unfortunately, the auto industry is a tough place to make money. There is a lot of regulation, and a lot of competition. When it becomes too hard to make money honestly, cheating can become far too easily accepted. Rather than trying to revolutionize the auto making process, or the product itself, it can be a lot easier to push managers all the way down to the front-line of procurement, manufacturing or sales to simply cheat.
“Make your numbers” becomes a mantra. If you want to keep your job, or even more importantly if you want to move up, do whatever it takes to tell those above you what they want to hear. And those above don’t ask too many questions, don’t try to figure out how results happen – just keep applying pressure to those below to do what’s necessary to make the numbers.
As VW and Takata showed us, eventually the company will be caught. And the consequences are severe. Now those companies, their customers, their employees and their shareholders are suffering. And industry regulations will tighten further to make it harder to cheat. Everyone loses when short-term results are the top goal, rather than building a sustainable long-term business.
Let’s hope for better leadership in 2016.
Marissa Mayer’s reign as head of Yahoo looks to be ending like her predecessors. With a serious flop. Only this may well be the last flop – and the end of the internet pioneer.
It didn’t have to happen this way, but an inability to manage Status Quo Risk doomed Ms. Mayer’s leadership – as it has too many others. And once again bad leadership will see a lot of people – investors, employees and even customers – pay the price.
Yahoo was in big trouble when Ms. Mayer arrived. Growth had stalled, and its market was being chopped up by Google and Facebook. It’s very relevancy was questionable as people no longer needed news consolidation sites – which had ended AOL, for example – and search had long gone to Google. The intense internet users were already clearly mobile social media fans, and Yahoo simply did not compete in that space.
In other words, Yahoo desperately needed a change of direction and an entirely new strategy the day Ms. Mayer showed up. Only, unfortunately, she didn’t provide either. Instead Ms. Meyer offered, at best, a series of fairly meaningless tactical actions. Changing Yahoo’s home page layout, cancelling the company’s work-from-home policy and hiring Katie Couric, amidst a string of small and meaningless acquisitions, were the business equivalent of fiddling while Rome burned. Tinkering with the tactics of an outdated success formula simply ignored the fact that Yahoo was already well on the road to irrelevancy and needed to change, dramatically, quickly.
The saving grace for Yahoo was when Alibaba went public. Suddenly a long-ago decision to invest in the Chinese company created a vast valuation increase for Yahoo. This was the opportunity of a lifetime to shift the business fast and hard into something new, different and much more relevant than the worn out Yahoo strategy. But, unfortunately, Ms. Mayer used this as a curtain to hide the crumbling former internet leader. She did nothing to make Yahoo relevant, as fights erupted over how to carve up the Alibaba windfall.
When it became public that Ms. Mayer had hired famed strategy firm McKinsey & Co. to decide what businesses to close in its next “restructuring” it lit up the internet with cries to possibly just get rid of the whole thing! After 3 years, and more than one layoff, it now appears that Ms. Mayer has no better idea for creating value out of Yahoo than doing another big layoff to, once again, improve “focus on core offerings.” Additional layoffs, after 3 years of declining sales, is not the way to grow and increase shareholder value.
Analysts are pointing out that Yahoo’s core business today is valueless. The company is valued at less than its remaining Alibaba stake. And this is not outrageous, since in the ad world Yahoo has become close to irrelevant. Nobody would build an on-line ad campaign ignoring Google or Facebook, and several other internet leaders. But ignoring Yahoo as a media option is increasingly common.
Investors are rightly worried that the IRS will take much of the remaining Alibaba value as taxes in any spinoff, leaving them with far less money. Giving up on the CEO, and its increasingly irrelevant “core business” they are asking if it wouldn’t be smarter to sell what we think of as Yahoo to Softbank so the Japanese company can obtain the rest of Yahoo Japan it does not already own. Ostensibly then Yahoo as it is known in the USA could simply start to disappear – like AOL and all the other on-line news consolidators.
It really did not have to happen this way. Yahoo’s troubles were clearly visible, and addressable. But CEO Mayer simply chose to keep doing more of the same, making small improvements to Yahoo’s site and search tool. By keeping Yahoo aligned with its historical Status Quo risk of irrelevance, obsolescence and failure grew quarter-by-quarter.
Now Status Quo Risk (the risk created by not adapting to shifting market needs) has most likely doomed Yahoo. Investors are no longer interested in waiting for a turn-around. They want their Alibaba valuation, and they could care less about Yahoo’s CEO, employees or customers. Many have given up on Ms. Mayer, and simply want an exit strategy so they can move on.
Ms. Mayer’s leadership has shown us some important leadership lessons:
- Hiring an executive from Google (or another tech company) does not magically mean success will emerge. Like Ron Johnson from Apple to JCP, Ms. Mayer showed that even tech execs often lack an ability to understand market trends and the skills to adapt an organization.
- It is incredibly easy for a new leader to buy into an historical success formula and keep tweaking it, rather than doing the hard work of creating a new strategy and adapting. The lure of focusing on tactics and hoping the strategy will take care of itself is remarkably easy fall into. But investors need to realize that tactics do not fix an outdated success formula.
- Youth is not the answer. Ms. Mayer was young, and identified with the youthfulness of Google and internet users. But, in the end, she woefully lacked the strategy and leadership skills necessary to turn around the deeply troubled Yahoo. Young, new and fresh is no substitute for critical thinking and knowing how to lead.
- Boards give CEOs too much time to fail. It was clear within months Ms. Mayer had no strategy for making Yahoo relevant. Yet, the Board did not recognize its mistake and replace the CEOs. There still are not sufficient safeguards to make sure Boards act when CEOs fail to lead effectively.
- CEOs too often have too much hubris. Ms. Mayer went from college to a rapid career acceleration in largely staff positions to CEO of Yahoo and a Board member of Wal-Mart. It is easy to develop hubris, and an over-abundance of self-confidence. Then it is easy to require your staff agree with you, and pledge so support you (as Ms. Mayer recently did.) All of this indicates a leader running on hubris rather than critical thinking, open discourse and effective decision-making. Hubris is not just a weakness of white male leaders.
Could there have been a different outcome. Of course. But for Yahoo’s employees, suppliers, customers and investors the company hired a string of CEOs that simply were not up to the job of redirecting the company into competitiveness. Each one fell victim to trying to maintain the Status Quo. And, unfortunately, Ms. Mayer will be seen as the most recent – and possibly last – CEO to lead Yahoo into failure. Ms. Mayer simply was not up to the job – and now a lot of people will pay the price.
Microsoft recently announced it was offering Windows 10 on xBox, thus unifying all its hardware products on a single operating system – PCs, mobile devices, gaming devices and 3D devices. This means that application developers can create solutions that can run on all devices, with extensions that can take advantage of inherent special capabilities of each device. Given the enormous base of PCs and xBox machines, plus sales of mobile devices, this is a great move that expands the Windows 10 platform.
Only it is probably too late to make much difference. PC sales continue falling – quickly. Q3 PC sales were down over 10% versus a year ago. Q2 saw an 11% decline vs year ago. The PC market has been steadily shrinking since 2012. In Q2 there were 68M PCs sold, and 66M iPhones. Hope springs eternal for a PC turnaround – but that would seem increasingly unrealistic.
The big market shift to mobile devices started back in 2007 when the iPhone began challenging Blackberry. By 2010 when the iPad launched, the shift was in full swing. And that’s when Microsoft’s current problems really began. Previous CEO Steve Ballmer went “all-in” on trying to defend and extend the PC platform with Windows 8 which began development in 2010. But by October, 2012 it was clear the design had so many trade-offs that it was destined to be an Edsel-like flop – a compromised product unable to please anyone.
By January, 2013 sales results were showing the abysmal failure of Windows 8 to slow the wholesale shift into mobile devices. Ballmer had played “bet the company” on Windows 8 and the returns were not good. It was the failure of Windows 8, and the ill-fated Surface tablet which became a notorious billion dollar write-off, that set the stage for the rapid demise of PCs.
And that demise is clear in the ecosystem. Microsoft has long depended on OEM manufacturers selling PCs as the driver of most sales. But now Lenovo, formerly the #1 PC manufacturer, is losing money – lots of money – putting its future in jeopardy. And Dell, one of the other top 3 manufacturers, recently pivoted from being a PC manufacturer into becoming a supplier of cloud storage by spending $67B to buy EMC. The other big PC manufacturer, HP, spun off its PC business so it could focus on non-PC growth markets.
And, worse, the entire OEM market is collapsing. For the largest 4 PC manufacturers sales last quarter were down 4.5%, while sales for the remaining smaller manufacturers dropped over 20%! With fewer and fewer sales, consolidation is wiping out many companies, and leaving those remaining in margin killing to-the-death competition.
Which means for Microsoft to grow it desperately needs Windows 10 to succeed on devices other than PCs. But here Microsoft struggles, because it long eschewed its “channel suppliers,” who create vertical market applications, as it relied on OEM box sales for revenue growth. Microsoft did little to spur app development, and rather wanted its developers to focus on installing standard PC units with minor tweaks to fit vertical needs.
Today Apple and Google have both built very large, profitable developer networks. Thus iOS offers 1.5M apps, and Google offers 1.6M. But Microsoft only has 500K apps largely because it entered the world of mobile too late, and without a commitment to success as it tried to defend and extend the PC. Worse, Microsoft has quietly delayed Project Astoria which was to offer tools for easily porting Android apps into the Windows 10 market.
Microsoft realized it needed more developers all the way back in 2013 when it began offering bonuses of $100,000 and more to developers who would write for Windows. But that had little success as developers were more keen to achieve long-term sales by building apps for all those iOS and Android devices now outselling PCs. Today the situation is only exacerbated.
By summer of 2014 it was clear that leadership in the developer world was clearly not Microsoft. Apple and IBM joined forces to build mobile enterprise apps on iOS, and eventually IBM shifted all its internal PCs from Windows to Macintosh. Lacking a strong installed base of Windows mobile devices, Microsoft was without the cavalry to mount a strong fight for building a developer community.
In January, 2015 Microsoft started its release of Windows 10 – the product to unify all devices in one O/S. But, largely, nobody cared. Windows 10 is lots better than Win8, it has a great virtual assistant called Cortana, and it now links all those Microsoft devices. But it is so incredibly late to market that there is little interest.
Although people keep talking about the huge installed base of PCs as some sort of valuable asset for Microsoft, it is clear that those are unlikely to be replaced by more PCs. And in other devices, Microsoft’s decisions made years ago to put all its investment into Windows 8 are now showing up in complete apathy for Windows 10 – and the new hybrid devices being launched.
AM Multigraphics and ABDick once had printing presses in every company in America, and much of the world. But when Xerox taught people how to “one click” print on a copier, the market for presses began to die. Many people thought the installed base would keep these press companies profitable forever. And it took 30 years for those machines to eventually disappear. But by 2000 both companies went bankrupt and the market disappeared.
Those who focus on Windows 10 and “universal windows apps” are correct in their assessment of product features, functions and benefits. But, it probably doesn’t matter. When Microsoft’s leadership missed the mobile market a decade ago it set the stage for a long-term demise. Now that Apple dominates the platform space with its phones and tablets, followed by a group of manufacturers selling Android devices, developers see that future sales rely on having apps for those products. And Windows 10 is not much more relevant than Blackberry.
This week McDonald’s and Microsoft both reported earnings that were higher than analysts expected. After these surprise announcements, the equities of both companies had big jumps. But, unfortunately, both companies are in a Growth Stall and unlikely to sustain higher valuations.
McDonald’s profits rose 23%. But revenues were down 5.3%. Leadership touted a higher same store sales number, but that is completely misleading.
McDonald’s leadership has undertaken a back to basics program. This has been used to eliminate menu items and close “underperforming stores.” With fewer stores, loyal customers were forced to eat in nearby stores – something not hard to do given the proliferation of McDonald’s sites. But some customers will go to competitors. By cutting stores and products from the menu McDonald’s may lower cost, but it also lowers the available revenue capacity. This means that stores open a year or longer could increase revenue, even though total revenues are going down.
Profits can go up for a raft of reasons having nothing to do with long-term growth and sustainability. Changing accounting for depreciation, inventory, real estate holdings, revenue recognition, new product launches, product cancellations, marketing investments — the list is endless. Further, charges in a previous quarter (or previous year) could have brought forward costs into an earlier report, making the comparative quarter look worse while making the current quarter look better.
Confusing? That’s why accounting changes are often called “financial machinations.” Lots of moving numbers around, but not necessarily indicating the direction of the business.
McDonald’s asked its “core” customers what they wanted, and based on their responses began offering all-day breakfast. Interpretation – because they can’t attract new customers, McDonald’s wants to obtain more revenue from existing customers by selling them more of an existing product; specifically breakfast items later in the day.
Sounds smart, but in reality McDonald’s is admitting it is not finding new ways to grow its customer base, or sales. The old products weren’t bringing in new customers, and new products weren’t either. As customer counts are declining, leadership is trying to pull more money out of its declining “core.” This can work short-term, but not long-term. Long-term growth requires expanding the sales base with new products and new customers.
Perhaps there is future value in spinning off McDonald’s real estate holdings in a REIT. At best this would be a one-time value improvement for investors, at the cost of another long-term revenue stream. (Sort of like Chicago selling all its future parking meter revenues for a one-time payment to bail out its bankrupt school system.) But if we look at the Sears Holdings REIT spin-off, which ostensibly was going to create enormous value for investors, we can see there were serious limits on the effectiveness of that tactic as well.
MIcrosoft also beat analysts quarterly earnings estimate. But it’s profits were up a mere 2%. And revenues declined 12% versus a year ago – proving its Growth Stall continues as well. Although leadership trumpeted an increase in cloud-based revenue, that was only an 8% improvement and obviously not enough to offset significant weakness in other markets:
It is a struggle to see the good news here. Office 365 revenues were up, but they are cannibalizing traditional Office revenues – and not fast enough to replace customers being lost to competitive products like Google OfficeSuite, etc.
Azure sales were up, but not fast enough to replace declining Windows sales. Further, Azure competes with Amazon AWS, which had remarkable results in the latest quarter. After adding 530 new features, AWS sales increased 15% vs. the previous quarter, and 78% versus the previous year. Margins also increased from 21.4% to 25% over the last year. Azure is in a growth market, but it faces very stiff competition from market leader Amazon.
We build our companies, jobs and lives around successful products and services. We want these providers to succeed because it makes our lives much easier. We don’t like to hear about large market leaders losing their strength, because it signals potentially difficult change. We want these companies to improve, and we will clutch at any sign of improvement.
As investors we behave similarly. We were told large companies have vast customer bases, strong asset bases, well known brands, high switching costs, deep pockets – all things Michael Porter told us in the 1980s created “moats” protecting the business, keeping it protected from market shifts that could hurt sales and profits. As investors we want to believe that even though the giant company may slip, it won’t fall. Time and size is on its side we choose to believe, so we should simply “hang on” and “ride it out.” In the future, the company will do better and value will rise.
As a result we see that Growth Stall companies show a common valuation pattern. After achieving high valuation, their equity value stagnates. Then, hopes for a turn-around and recovery to new growth is stimulated by a few pieces of good news and the value jumps again. Only after a few years the short-term tactics are used up and the underlying business weakness is fully exposed. Then value crumbles, frequently faster than remaining investors anticipated.
McDonald’s valuation rose from $62/share in 2008 to reach record $100/share highs in 2011. But valuation then stagnated. It is only this last jump that has caused it to reach new highs. But realize, this is on a smaller number of stores, fewer products and declining revenues. These are not factors justifying sustainable value improvement.
Microsoft traded around $25/share from March, 2003 through November, 2011 – 8.5 years. When the CEO was changed value jumped to $48/share by October, 2014. After dipping, now, a year later Microsoft stock is again reaching that previous valuation ($50/share). Microsoft is now valued where it was in December, 2002 (which is half its all-time high.)
The jump in value of McDonald’s and Microsoft happened on short-term news regarding beating analysts earnings expectations for one quarter. The underlying businesses, however, are still suffering declining revenue. They remain in Growth Stalls, and the odds are overwhelming that their values will decline, rather than continue increasing.
Wal-Mart market value took a huge drop on Wednesday. In fact, the worst valuation decline in its history. That decline continued on Thursday. Since the beginning of 2015 Wal-Mart has lost 1/3 of its value. That is an enormous ouch.
But, if you were surprised, you should not have been. The telltale signs that this was going to happen have been there for years. Like most stock market moves, this one just happened really fast. The “herd behavior” of investors means that most people don’t move until some event happens, and then everyone moves at once carrying out the implications of a sea change in thinking about a company’s future.
All the way back in October, 2010 I wrote about “The Wal-Mart Disease.” This is the disease of constantly focusing on improving your “core” business, while market shifts around you increasingly make that “core” less relevant, and less valuable. In the case of Wal-Mart I pointed out that an absolute maniacal focus on retail stores and low-cost operations, in an effort to be the low price retailer, was being made obsolete by on-line retailers who had costs that are a fraction of Wal-Mart’s expensive real estate and armies of employees.
At that time WMT was about $54/share. I recommended nobody own the stock.
In May, 2011 I reiterated this problem at Wal-Mart in a column that paralleled the retailer with software giant Microsoft, and pointed out that because of financial machinations not all earnings are equal. I continued to say that this disease would cripple Wal-Mart. Six months had passed, and the stock was about $55.
By February, 2012 I pointed out that the big reorganization at Wal-Mart was akin to re-arranging deck chairs on a sinking ship and said nobody should own the stock. It was up, however, trading at $61.
At the end of April, 2012 the Wal-Mart Mexican bribery scandal made the press, and I warned investors that this was a telltale sign of a company scrambling to make its numbers – and pushing the ethical (if not legal) envelope in trying to defend and extend its worn out success formula. The stock was $59.
Then in July, 2014 a lawsuit was filed after an overworked Wal-Mart truck driver ran into a car killing James McNair and seriously injuring comedian Tracy Morgan. Again, I pointed out that this was a telltale sign of an organization stretching to try and make money out of a business model that was losing its ability to sustain profits. Market shifts were making it ever harder to keep up with emerging on-line competitors, and accidents like this were visible cracks in the business model. But the stock was now $77. Most investors focused on short-term numbers rather than the telltale signs of distress.
In January, 2015 I pointed out that retail sales were actually down 1% for December, 2014. But Amazon.com had grown considerably. The telltale indication of a rotting traditional retail brick-and-mortar approach was showing itself clearly. Wal-Mart was hitting all time highs of around $87, but I reiterated my recommendation that investors escape the stock.
By July, 2015 we learned that the market cap of Amazon now exceeded that of Wal-Mart. Traditional retail struggles were apparent on several fronts, while on-line growth remained strong. Bigger was not better in the case of Wal-Mart vs. Amazon, because bigger blinded Wal-Mart to the absolute necessity for changing its business model. The stock had fallen back to $72.
Now Wal-Mart is back to $60/share. Where it was in January, 2012 and only 10% higher than when I first said to avoid the stock in 2010. Five years up, then down the roller coaster.
From October of 2010 through January, 2015 I looked dead wrong on Wal-Mart. And the folks who commented on my columns here at this journal and on my web site, or emailed me, were profuse in pointing out that my warnings seemed misguided. Wal-Mart was huge, it was strong and it would dominate was the feedback.
But I kept reiterating the point that long-term investors must look beyond short-term reported sales and earnings. Those numbers are subject to considerable manipulation by management. Further, short-term operating actions, like shorter hours, lower pay, reduced benefits, layoffs and gouging suppliers can all prop up short-term financials at the expense of recognizing the devaluation of the company’s long-term strategy.
Investors buy and hold. They hold until they see telltale signs of a company not adjusting to market shifts. Short-term traders will say you could have bought in 2010, or 2012, and held into 2014, and then jumped out and made a profit. But, who really can do that with forethought? Market timing is a fools game. The herd will always stay too long, then run out too late. Timers get trampled in the stampede more often than book gains.
In this week’s announcement Wal-Mart executives provided more telltale signs of their problems, and the fact that they don’t know how to fix them, and therefore won’t.
- Wal-Mart is going to spend $20B to buy back stock in order to prop up the price. This is the most obvious sign of a company that doesn’t know how to keep up its valuation by growing profits.
- Wal-Mart will spend $11B on sprucing up and opening stores. Really. The demand for retail space has been declining at 4-6%/year for a decade, and retail business growth is all on-line, yet Wal-Mart is still massively investing in its old “core” business.
- Wal-Mart will spend $1.1B on e-commerce. That is the proverbial “drop in the competitors bucket.” Amazon.com alone spent $8.9B in 2014 growing its on-line business.
- Wal-Mart admits profits will decline in the next year. It is planning for a growth stall. Yet, we know that statistically only 7% of companies that have a growth stall ever go on to maintain a consistent growth rate of a mere 2%. In other words, Wal-Mart is projecting the classic “hockey stick” forecast. And investors are to believe it?
The telltale signs of an obsolete business model have been present at Wal-Mart for years, and continue.
In 2003 Sears Holdings was $25/share. In 2004 Sears bought K-Mart, and the stock was $40. I said don’t go near it, as all the signs were bad and the merger was ill-conceived. Despite revenue declines, consistent losses, a revolving door at the executive offices and no sign of any plan to transform the battered, outdated retail giant against growing on-line competition investors believed in CEO Ed Lampert and bid the stock up to $77 in early 2011. (I consistently pointed out the telltale signs of trouble and recommended selling the stock.)
By the end of 2012 it was clear Sears was irrelevant to holiday shoppers, and the stock was trading again at $40. Now, SHLD is $25 – where it was 12 years ago when Mr. Lampert started his machinations. Again, only a market timer could have made money in this company. For long-term investors, the signs were all there that this was not a place to put your money if you want to have capital growth for retirement.
There will be plenty who will call Wal-Mart a “value” stock and recommend investors “buy on weakness.” But Wal-Mart is no value. It is becoming obsolete, irrelevant – increasingly looking like Sears. The likelihood of Wal-Mart falling to $20 (where it was at the beginning of 1998 before it made an 18 month run to $50 more than doubling its value) is far higher than ever trading anywhere near its 2015 highs.