Monday, February 8, 2010

Black and White

Framing discussions in "black and white" is part of our DNA in politics, journalism and financial reporting. As Paul Simon writes, "...everything looks worse in black and white." ("Kodachrome")

American companies navigating through the global financial crisis have generally reported solid quarterly comparisons, against depressed prior year periods. The comparisons have been helped generally by one-time items and by cost-cutting, including large layoffs. Investors applaud, the market goes up and everyone feels good, until we suddenly realize that the next set of comparisons will be extremely challenging. This short-term mentality is what has been decried by coalitions of institutional investors, academics, accounting firms, and executives, as for example in The Aspen Principles.

For the most part, I don't see much change in the actions, as opposed to the rhetoric of global American multinationals, which remain focused on the short-term. Talking heads are fearful of American firms adopting "the European model," whatever that means. We do know that it is the polar opposite of the American model, which is driven by profits, even if these profits are ephemeral and not sustainable. Giles Moec, a Deutsche Bank economist, quoted in the New York Times, wrote that "American companies have been faster to adjust their work forces and protect their profit margins than European companies." There's the black-and-white comparison, but reflecting on this, it's really not that simple.

First of all, the reported profits, as we noted, reflect one-time events and are against easy comparisons. Second, these large labor force downsizings are not without their costs, yet investors treat them as if they generate profits at the stroke of a pen. The black and white view says that European companies tolerate higher employment and lower productivity than their American counterparts. American executives from every industry echo this sentiment. The European practice is sometimes referred to as "labor hoarding."

Siemens increased employment at an old factory in the midst of the crisis by adding 500 jobs to a turbine business. However, the factory retrofit and new hires were put into place as part of their "green initiatives," in this case to produce the company's most powerful gas turbines that would also have lower carbon-dioxide emissions than the current products. With oil prices flagging and a weak economy, there probably won't be returns to this investment for some time, but they are still worth making.

Barbara Kux, the Chief Sustainability Officer for Siemens, had this to say: "It's part of sustainability, and it shows you (Siemens) think long-term and are here to stay...It gives you a chance to keep experienced people, to keep their knowledge in-house and to develop a high level of loyalty and trust so they (the workers) feel like part of a family rather than just doing a job." This is not European socialism, it's good business and it's actually emblematic of some of the thinking that is recommended in the Aspen Principles, which is what institutional investors claim they want to see.

In 2006, 6,000 S&P companies in the CompuStat database (1) invested $1.3 trillion into their businesses, (2) returned $1.3 trillion to their shareholders through dividends and share repurchases, and (3) spent $486 billion on mergers and acquisitions. Source: Graham, J.R, Campbell, R.H. and Puri, M. (2009), "Capital Allocation and Delegation of Decision-Making Authority," Fuqua School of Business, Duke University.

We know that pretty much all of the $486 billion will have gone down the rabbit hole and will not yield the promised returns. I suspect that much of the share repurchase activity was of marginal benefit except to the short-term shareholders, especially the hedge funds.

I can think of one very large American company that seems to have used the crisis to think long-term and to change the company for the better, and that is Exxon Mobil. I attended a presentation by Bill George, a director of Exxon Mobil, who said that he felt it was the "best run company in the world." George is a long-time Honeywell executive, and the former CEO of Medtronic. Looking at their ROIC over the cycles, I would tend to agree. Lesson 5 in Bill George's book, "7 Lessons for Leading in a Crisis," is "Never Waste a Good Crisis." He suggests taking aggressive action to improve your company in the long-term. This is exactly what Exxon Mobil did with the acquisition of XTO Energy.

Talking about American or European corporate models is more about politics than about business models, governance and returns to shareholders. We need to see the picture with all the nuances of Kodachrome.

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