In the past two days, three companies comprising one-tenth of the Dow Jones Industrial Average have been run through a cycle of disappointment, blame-casting and pining for a tough-love savior.
This is the market we inhabit now:
-A corporate titan with a venerated old American brand reports lousy results first thing in the morning.
-Wall Street awakens to the fact the businesses have been stagnant for years, the stocks kept afloat by financial maneuvers and halfhearted cost-cutting programs. The share price is hammered before the opening bell.
-Commentators tut-tut about the decline of stalwart brands in a fast-changing culture, or the squandering by poor CEOs of so much accumulated customer loyalty.
-Before noon, investors start asking whether an activist investor is marshaling his resources and a sense of righteous capitalist outrage to make a run at shaking up these cozy blue-chip companies.
Yesterday it was International Business Machines Corp. (IBM), falling far short on revenue and profit forecasts while paying another company $1.5 billion to take its chip-manufacturing business off its hands.
Today, neither Coca-Cola Co. (KO) nor McDonald’s Corp. (MCD) was able to conceal the steady erosion of customer affinity and sagging revenue, despite (or maybe because of?) decades as incumbent “fun food and drink” brands.
As Josh Brown notes here, all three of these companies have been struggling to hold market share since before the Great Recession. They have leaned on heavy share buybacks and copious dividend growth (Coke and McDonald’s) to keep investors placated amid unfulfilled growth promises.
Big does not mean safe
This being Shareholder Value Nation, big, mature companies are not permitted to ebb in relevance gracefully or hope the cycle of tastes turns back in their favor. So the question is openly asked, “Will an activist emerge?”
Unlike in past cycles, mega-cap companies have not proven beyond the reach of gadflies’ agitation efforts. No company is too big to assail.
Most prominently, Carl Icahn bought less than 1% of Apple Inc. (AAPL) before shouting at CEO Tim Cook to execute a huge stock buyback. Even though Icahn was hardly a credible threat to lead a broad investor mutiny, Cook launched a massive buyback.
Icahn also went after eBay Inc. (EBAY) to spin off PayPal. The company resisted, Icahn stood down, and then eBay management elected to split PayPal off months later.
Hewlett-Packard Corp. (HPQ) – a Dow component until a year or so ago – fended off an attempt by activist Ralph Whitworth a couple of years ago to have it split in two. H-P demurred, but is indeed now planning to crack itself into two pieces.
Note, too, that Bill Ackman of Pershing Square Management, one of his generation’s spotlight activists, teased Wall Street last week in saying fresh cash he’s just raised will be used for “a new commitment” directed at an unnamed, large U.S. company.
As for the three Dow stocks that got themselves into investors’ doghouse this week, here are the arguments by potential activists on what should be done.
Coke already has been in the sights of a public critic who has increasingly struck an aggressive tone advocating for large-scale change at the company.
David Winters, longtime fund manager who runs Coke-shareholding firm Wintergreen Advisors, began assailing the generous executive stock-compensation plan overseen by CEO Muhtar Kent months ago, but has broadened his assault.
Winters responded to Coke’s weak results today by saying they show “failure and disarray at every level, and it is time for new leadership at the company.”
For good measure, he alludes to longtime anchor shareholder Warren Buffet in dismissive terms: “Coke can no longer hide behind a minority shareholder whose unequivocal support for management is harmful in light of Coke’s ongoing poor performance.”
Prior to the report, he posed a dozen questions to Coke management, including demands for details of a plan to revamp its bottling operations and its subpar revenue per employee.
Buffett’s support and the generally docile Coke shareholder base probably insulate the company from an outright shareholder war.
But with its core carbonated-drinks product appearing in secular decline, Coke’s leaders won’t be given the benefit of the doubt much longer.
The world's leading burger chain is in a similar position to Coke, its top soft-drink vendor. Americans have cooled on the brand, finding the experience tired and the food unhealthful. Meantime, growth overseas has stalled, denying the company shelter form its domestic struggles. CEO Don Thompson arguably has little time left to fix things.
Interestingly, Ackamn six years ago attempted to force a major restructuring at McDonald’s. He wanted the company to spin off a portion of its vast network of company-owned stores and sell a slug of them to franchisees. The company refused and the stock recovered nicely on its own for a few years.
But with the stock down 12% in the past 18 months in a strong market, it wouldn’t be surprising to see renewed suggestions for a radical revamp coming from opportunistic investors.
IBM has been among the most aggressive large companies in buying back shares to offset the reality of a shrinking core business. And the fact that it has already been shedding lower-margin divisions – PCs, servers and now semiconductors – leaves Wall Street eyeing even more radical bust-up possibilities.
The most common idea is for IBM to cleave into a vast IT-services business and another focused on software and the remaining hardware operations.
As is often the case with corporate-finance solutions, there would be no magic in making two companies out of one. The market is showing little interest in paying up generously for very mature enterprise-technology businesses, whether they are widely diverse or relatively focused.
Still, split-ups are the current fashion on Wall Street, and in the short term the market tends to reward spinoffs and streamlining moves.
Of course, Coke has endured largely unchanged since the 19th century, McDonald’s has remade itself couple after earlier identity crises across the decades, and IBM has been reinvented numerous times from its start in adding machines through mainframes and PCs, on into the present day.
But in today’s market, companies often aren’t given time to figure out their next act in peace before some angry investor shows up pushing a hastily written script of his own.