News: Analysis & Commentary
What's an Old-Line CEO to Do?
Net-crazed investors sneer, no matter how sturdy the performance
Imagine you're the chief executive of an Old Economy company. You've posted 12 straight years of increased earnings, capped by a 15% rise in 1999. You've engineered a transforming deal that helped double your managed assets, to $50.4 billion. Yet investors are fleeing, driving your company's stock price down 35% in the past year. "It's frustrating," grouses Albert R. Gamper Jr., who is in exactly that predicament. "In the good old-fashioned American system, if you delivered consistent earnings, you were suppose to get recognition from the stock market," says Gamper, the CEO of financial-services company CIT Group Inc. "Yet I look at my Telerate screen and I see our stock in the red, going down every day. That is a real distraction."
A modern-day corporate sob story? You bet, and one that has resonance with increasing numbers of CEOs whose Old Economy stocks are laboring in what has become a stealth bear market. Even the Dow Jones' 320-point gain on Mar. 15--its biggest rally in 17 months--did little to narrow the disparity. The unprecedented flight of capital into high-tech and Internet companies is placing enormous investor pressure on old-line CEOs. They're spinning off divisions, buying back stock, and following the lead of General Electric Co. Chairman John F. Welch Jr. in attempting to make the Internet central to their business models. IBM Chairman Louis V. Gerst-ner Jr. believes the pressure has become so intense that "many CEOs have an air of desperation about them" (page 40).
Yet these moves are virtually to no avail. It's almost as if the stock market, in its infatuation with Net stocks, suffers from attention-deficit disorder. While Old Economy titans Coca-Cola and Bank of America have each lost more than $50 billion in market value since May 1 of last year, tech superstars Cisco soared by $293.3 billion and Oracle by $198.1 billion. The top 10 gainers--all tech luminaries--saw their market caps gain a phenomenal $1.5 trillion in that time. The top 10 losers--old corporate favorites--lost an equally unbelievable $284.3 billion. "High-technology and dot-com companies are getting much bigger sums of money much sooner in their economic life cycles than any other companies in history," says Darrell K. Rigby, a partner at consultants Bain & Co. "Investors are looking for big gains, not solid returns."
The angst over the value split is being felt by a generation of chief executives raised to deliver "shareholder value" to investors. Many are turning in the financial results that ordinarily would lift their stock price, not to mention the value of their stock options. Instead, they have found themselves yesterday's news, ignored by investors seeking extraordinary returns. That's made for plenty of unhappy CEOs among Corporate America's oldest and best-known brand names. "They're envious because they want the valuations the technology companies have, angry because they're working hard and not getting a lot of credit, and fearful because they can now be cheaply bought by some of the dot-coms in their industries," says James A. Champy, chairman of Perot Systems Corp.'s consulting practice.
Many Old Economy execs are straining to understand--and fit into--a world in which the market capitalization of software maker Oracle Corp. now exceeds the combined value of the Big Three carmakers, and that of Yahoo! Inc. eclipses that of Procter & Gamble Co. Is the consumer-goods powerhouse, which lost 31% of its market value after a Mar. 7 earnings warning, really worth $36 billion less because its annual profits will be 5% short of earlier forecasts? Perhaps not, but the loss marks the split between the hot and the cold, a drop "symbolic of the growing divergence between Old and New economies," says Edward E. Yardeni, chief global economist for Deutsche Bank Securities Inc.
The stock market's bifurcation may have further consequences. Many stable, mainline companies with underwater stock options already have found themselves vulnerable to talent raids by New Economy outfits. Instead of options, boards are being forced to offer more cash and restricted stock--both of which affect the bottom line. Execs also are starting to demand that now worthless options be repriced to give them some value, but if directors comply, they could face a shareholder revolt.
More important, though, lower valuations could make the companies vulnerable to takeovers. "If these New Economy companies nibble around the edges, they could make some great acquisitions with their high-valued stocks," says Lawrence M. Schloss, chairman of Donaldson, Lufkin & Jenrette Inc.'s merchant-bank unit. He notes that Amazon.com Inc. could use its stock to buy, rather than build, warehouses. Or it could buy an air-freight company to deliver its products to customers. In the aftermath of the proposed America Online-Time Warner merger, such a deal isn't farfetched. Amazon's $22.4 billion market value dwarfs that of FedEx Corp., whose market cap fell more than $7 billion in the past year, to $9.3 billion. Never mind that Amazon has yet to post a profit, or that its $1.6 billion in sales is less than 10% of FedEx's revenues.
The value split could also usher in an era of leveraged buyouts not seen since the 1980s. "Buyout firms are knocking on the doors of companies again," says Schloss. "CEOs are getting tired of being undervalued even though they're putting up good numbers. Their boards are frustrated as well."
Making matters worse, even when old-line companies seem to "get it," they often fail to gain much recognition from the Street. Consider Eastman Chemical Co., the former spin-off of film giant Kodak. Last year, Eastman became the first chemical maker to introduce e-commerce sales in the U.S. and Canada and will rack up more than $100 million in online revenues this year. It has forged strategic partnerships with seven Internet startups. Yet its shares are down 25% over the past year. "Most of the chemical analysts who follow us don't get it, and none of them has seen a real impact on the bottom line from our e-commerce ventures," says CEO Earnest W. Deavenport Jr. His advice? "You have to be diligent in telling your story, and you have to believe that long term, the stock market is rational."
At CIT Group, Gamper agrees. "You have to recognize that there are some fundamental changes taking place in how business is being conducted. You can't miss that opportunity. And the upside is terrific." But if you're old-line, will anyone notice?By John A. Byrne, with Debra Sparks, in New YorkReturn to top