Escaping the Corporate Death Spiral

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

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

At the outset, I have to admit my trepidation about this exercise. First, I am not a corporate historian or strategist and I am sure that there is much that I am glossing over as I make my list of “rebirth” criteria. Second, I am always wary of drawing big lessons from anecdotal evidence, recognizing how easy it is to reach the wrong conclusions. Nevertheless, here are the common factors that I see in these success stories:

  • Acceptance that the old ways don’t work any more: To have a corporate rebirth, a company still has to get through the three step reaction to corporate aging that I noted in my last post and come to an acceptance that the old ways, successful though they might have been in the past, don’t work any more. That acceptance, as I noted, does not come easily or quickly and the longer and more hoary the history of the company, the longer it takes. Thus, while there are many younger investors whose experience with IBM has generally been positive, I remember the late 1980s when a series of CEOs at the company raised denial to an art form and almost pushed the company into irrelevance. Acceptance also requires more than lip service to change and has to be backed up by actions that indicate that the company is indeed willing to jettison big portions of its past.
  • A Change Agent: This may be a cliché but change has to start at the top. In fact, change at IBM really began when Lou Gerstner became CEO of the company in 1993. At Apple, the change agent was obviously Steve Jobs, a man who had been banished from Apple for his lack of focus a decade prior, but returned as CEO in 1997. It would be simplistic to say that the change agent always has to come from outside the company, because there have been companies where insiders who have spent a lifetime in the company have been willing to shake it up. (Bob Goiuzeta at Coca Cola and Jack Welch at GE were company men who still revolutionized their companies.) I think it is safe to say, though, that change agents are usually not shrinking violets and that they are ready to shake up the status quo.
  • A Plan for Change: Pointing out that the existing ways don’t work any more is important but it is futile unless accompanied by a new mission and focus. At IBM, Gerstner changed the mindset of the company (and its employees) early in his tenure, an incredible accomplishment given how deeply entrenched it was in the existing ways. Coming from RJR Nabisco, he brought both a customer-focus and a willingness to let go of IBM’s past mistakes (Anyone remember OS/2?) and this allowed him to create the modern IBM. Steve Jobs shocked Apple employees by entering into a détente with Microsoft, where in return for $150 million in cash and a promise by Microsoft that it would continue producing Office for the Mac, he essentially gave Microsoft a free legal pass to borrow from the Mac OS in updating Windows. He used the breathing room that this agreement gave him to redefine Apple as an entertainment rather than a computer company and the rest as they say is history.
  • Luck: Much as we would like to attribute success to great skill and failure to poor management, it remains true that the X factor in business success is luck. Gerstner was lucky that he made his changes at IBM in the 1990s, a decade of not only robust overall economic growth but especially so for technology companies. Steve Jobs was helped by the ineptitude of his competition, so blinded by their investment in the status quo (music companies to selling us music on CDs and cell phone companies thinking of cell phones as extensions of landline phones) that they either did not react or reacted too slowly to Apple’s innovations.

I am sure that this is not a comprehensive list and that I have missed a few items but I want the list to be tractable because I intend to use it in my investment analysis. Companies that have been value traps can become great investments, if they can find a path to rebirth; an investor who bought IBM shares in 1993 or Apple shares in 1997 would have profited immensely from their reincarnations. So, as an investment exercise, you could prepare a list of the companies where stock prices have stagnated for long periods and check to see which of them have the ingredients in place for rebirth: an acceptance that the old ways don’t work (with tangible evidence in investment, financing and dividend decisions to back it up) and a change agent (new management), a new focus (with actions to back it up). The last factor, luck, is immune from assessment but you can consult your astrological signs or read the tea leaves, if it helps to make the right choices.

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

(click to enlarge)

Of the three companies, I would argue that Microsoft offers the most in terms of possibilities simply because it is getting a new CEO, Cisco is talking the talk (of changing) but is not walking the walk and Merck seems to be stuck in a rut. You are welcome to disagree with me on my conclusions but even if you do, there is no reason why you cannot use the framework to make your own judgments.

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

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About Aswath Damodaran 56 Articles

Affiliation: New York University

Aswath Damodaran is a Professor of Finance at the Stern School of Business at New York University. He teaches the corporate finance and valuation courses in the MBA program as well as occasional short-term classes around the world on both topics.

Professor Damodaran received his MBA and Ph.D degrees from the University of California at Los Angeles. His research interests lie in valuation, portfolio management and applied corporate finance.

He has written four books on equity valuation (Damodaran on Valuation, Investment Valuation, The Dark Side of Valuation, The Little Book of Valuation) and two on corporate finance (Corporate Finance: Theory and Practice, Applied Corporate Finance: A User’s Manual). He also co-edited a book on investment management with Peter Bernstein (Investment Management) and has two books on portfolio management - one on investment philosophies (Investment Philosophies) and one titled Investment Fables. He also has a book, titled Strategic Risk Taking, which is an exploration of how we think about risk and the implications for risk management.

Visit: Aswath Damodaran's Page, Musings on Markets

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