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The Evanescence of Strategy

Every strategy has a sell-by date, and the costs of ignoring that reality are steep.  Recently General Electric took the radical step of terminating CEO and Chairman John Flannery after 13 months on the job (prior to this action GE had had a total of 11 CEOs and 10 Chairmen in its 126-year history) and replacing him with the company’s first outside CEO, Lawrence Culp.  The break with history was certainly necessary, as General Electric had seen its market capitalization decline by $100 billion in the past year, and $500 billion in the past 18 years.

GE Stock Performance
Value Destruction at GE

GE rose to prominence by constructing a set of self-reinforcing advantages that were largely industry agnostic. Under the leadership of Jack Welch the potential cacophony of multiple lines of business became a sublime orchestra, with GE Capital as the engine that powered the whole.  But the global financial crisis changed the outlook for massive financial businesses, and Welch’s successor, Jeff Immelt, spent much of his tenure untangling the byzantine, and formerly massively profitable, conglomerate.

What happened?

Strategy, a high-level plan to achieve one or more goals under conditions of uncertainty, is the answer to a question.  That question: what set of actions, utilizing what resources, will produce the best outcome.  A company’s strategy is its theory of self, its reason for being.  Unfortunately, few organizations, or the people leading them, can adjust to the cognitive dissonance of an ever-changing answer and all that that implies.

Since at least the Jack Welch era General Electric’s strategy was to compete only in sectors in which it could be a dominant player and rely on what was seen as an advantage in leadership training and internal capital allocation to drive efficiencies that would beat the market.  The strategy worked both long and well (the company first had to attain a market capitalization above $500 billion in order to lose that value), but over time challenges that were long apparent took on increasing importance.

  • Pace of Change.  As the pace of change across industries has ramped up, being a major player in disparate industries became a tax on leadership attention, making it impossible to focus or marshal the resources necessary to make sound strategic adjustments.
  • Leadership Training.  It may have been the case once upon a time that GE had an inherent advantage in leadership training, but with the workforce investing heavily in education and training, this one-time advantage has been negated.
  • Capital Allocation.  Jack Welch took the helm at General Electric after a period of flat equity returns, when many U.S. companies were bloated and inefficient.  In 1981, perhaps a case could have been made that GE could more efficiently allocate capital within the company than the capital markets were able to.  Increased competition, new classes of investor (private equity, activist, etc.), and heightened shareholder expectations have changed that state of affairs.

There is a strong case to be made that complexity killed GE, but the wonder is the extreme longevity that an outmoded strategy enjoyed.  Much like the wooly mammoths (or, for a separate example, the dodo) that lived as recently as four thousand years ago on a small island off the cost of Siberia, General Electric had been a living anachronism for years.  With new leadership, GE is making a break from its past and speeding the dissolution of its current, anachronistic form.

About the Author:

David Johnson is founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition.  Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. 

David can be contacted at: david@abraxasgp.com.

Interim Managers: Value Creation Catalysts

There is a tendency among the leadership ranks of most organizations to espouse the virtues of disruption, but only when that disruption is focused on somebody else.  When incumbent leadership is unable or unwilling to drive necessary change, creditors and other stakeholders are showing an increasing willingness to press for interim managers to supplement the senior management team and drive the change necessary to save what is often a faltering organization.

Recent news regarding two troubled organizations highlights the value interim managers can bring, especially in periods of distress:

Holly Etlin - AlixPartners

Holly Etlin, Interim CFO of RadioShack

  • RadioShack.  The struggling electronics retailer announced recently that CFO John Feray would resign, after only seven months on the job.  Mr. Ferary will be replaced by Holly Etlin of Alixpartners, would will assume the CFO role on an interim basis.  According to Michael Pachter of Wedbush Securities, Ms. Etlin’s appointment is a negative to shareholders, as she will “represent the creditors”.  Mr. Pachter’s comment is actually a strong endorsement: given the fiduciary duty of officers of a company operating in the zone of insolvency, Holly Etlin should be working for the benefit of creditors, not the shareholders who are almost certainly out of the money.

Kevyn Orr - Detroit Emergency Manager

Kevyn Orr, Emergency Manager of Detroit

  • Detroit.  In his nearly 18 months as emergency manager of Detroit, Kevyn Orr has presided over the largest municipal bankruptcy in U.S. history ($18 billion) and pushed that contentious process toward what looks to be a remarkably successful resolution.  The Michigan law which allows for emergency managers dictates a term of 18 months, but in light of his successes many in Detroit are arguing for Orr’s continued involvement, if only to provide continuity throughout the bankruptcy and immediate post-bankruptcy period.

Experienced interim managers, such as Ms. Etlin and Mr. Orr, are professional change agents, responsible for both catalyzing and driving the change necessary for organizations to raise their level of performance.  In periods of turmoil, these change agents can be the difference between success or failure for struggling organizations.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.

 

Business Model Expiration Dates

Buddha - Lose what you cling to

For most companies, worries about the transience of advantage can seem hopelessly theoretical.  The goal for the majority of companies and their leadership teams is to achieve market dominance, not worry about the staying power of that dominance.  And for those lucky companies currently enjoying their time in the sun, time spent pondering the end of their hard-won market position can seem morbidly pessimistic.

Recent developments suggest that leadership teams from the scrappiest startup to the Fortune 100 would be better served by stepping back and considering the roots of advantage, how it has been attained in their industry/niche, and how market trends will impact the staying power of that advantage.

  • Media company Gannett (GCI) recently attracted the interest of investor Carl Icahn due to the company’s plan to spin-off its low-growth print operations.
  • Ecommerce startup Fab, which rode to a $1 billion valuation on the strength of its flash sales model, has recently stumbled, with multiple rounds of layoffs, as the company struggles to navigate a path to profitability.
  • Consumer Products giant Procter & Gamble (PG), driven by a tectonic shift in consumer shopping behavior, has announced a plan to divest as many as 100 brands.  There is some evidence from the company’s prior efforts at divesting brands that this approach is flawed, and may in fact only delay a more substantive shift in the company’s business model.
  • Energy company Kinder Morgan, which popularized the use of a tax-advantaged structure known as a Master Limited Partnership, recently announced a $70 billion plan to simplify the company, citing investor concerns around complexity and a high cost of capital.
  • Tech company Microsoft (MSFT), announced that it will cut up to 18,000 jobs in 2014 as it seeks to integrate its recent acquisition of Nokia and implement new CEO Satya Nadella’s revamp of both the company’s culture and market positioning.

Each of these companies are coming to terms with the need to fundamentally reimagine their business models as shifting market dynamics render prior competitive advantages moot.

The lesson, if there is one, is that there is no end in the struggle for market dominance, but only a continuous journey.  It is a lesson that all leadership teams should reflect on from time to time.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.

The Change Agents We Need

The leader of men in warfare can show himself to his followers only through a mask, a mask that he must make for himself, but a mask made in such form as will mark him to men of his time and place as the leader they want and need.

― John Keegan

The middle market has seen considerable change in recent years, and these changes have led to an evolving shift in how capital providers view distressed situations among their portfolio companies. Increasingly, capital providers (including banks, commercial finance companies, subordinated debt lenders, private equity firms and fundless sponsors) are seeking out versatile professionals able to serve as Chief Restructuring Officers in order to manage a distress situation from the inside, and steer a troubled company to an optimal outcome.  In many middle market companies a CRO will often find him/herself to be the lone advisor on-site, and as such these professionals must embrace the role of change agent.

The emerging generation of CROs will need to possess the following traits:

1) Focus on Substance over Form.  Too often distressed situations devolve as a result of an overly restrictive view of form success will take.  An experienced CRO will recognize that a sale of the company, refinancing, or balance sheet restructuring are all likely to generate superior value to a liquidation, and as a result will pursue a flexible strategy to position stakeholders for the highest value outcomes while not excluding the possibility of lower-value (but still viable) solutions.

2) Strong Communication Skills.  A distressed situation is always a tenuous balancing act, with multiple constituencies angling for position.  Skilled CROs understand the need for clear and consistent communication to all stakeholders, both within the company and without.  Inevitably certain constituencies will receive more or less information, but the messaging should be clear and the focus should be on executing toward an identified goal.

3) Comfort with both Strategy and Tactics.  In the middle market the day of the armchair CRO is coming to an end.  Small and midsize companies experiencing distress can no longer afford to have turnaround advisors dictate broad strategy while the company internally struggles with execution issues.  Today’s distressed situations call for advisors able and willing to first develop a viable strategy and then take a central tactical role (i.e. leading the charge) in executing that strategy.

The role of Chief Restructuring Officer is becoming increasingly central in driving distressed situations to a successful conclusion.  However, changes in the capital provider universe as well as an increase in the general tempo of distressed situations has given rise to a need for a more versatile, independent type of CRO than those who previously served the market.  Increasingly stakeholders must look not only for a CRO, but for a CRO with the right mix of skills, in order to steer a distressed company to a successful outcome.

Fisker Automotive: A Beautiful Mess

This article originally appeared in Business Insider

How can anybody learn anything from an artwork when the piece of art only reflects the vanity of the artist and not reality?

― Lou Reed

Fisker Automotive recently filed for chapter 11 bankruptcy protection and announced plans to sell itself to recently formed holding company Hybrid Technology, following that company’s purchase of a defaulted Fisker loan from the U.S. Energy Department.  Of the startup automakers granted loans by the Energy Department, Fisker Automotive was approved for the largest amount ($529 million).  Tesla Automotive has repaid the $465 million in loans it received.  Though it received approval for a $529 million loan, Fisker received only $192 million (the company repaid only $53 million of that total).

Co-founded by Ashton Martin designer Henrik Fisker, Fisker Automotive set out to create something beautiful and lucrative.  By all accounts the company was wildly successful at the former, and shockingly unsuccessful at the latter. Fisker Atlantic

The Fisker Atlantic

Privco Chief Executive Sam Hamadeh summed up the challenges of an aesthetically driven company with too much capital and too little discipline when he noted the Fisker was at one point spending $900,000 per vehicle produced, and then selling those vehicles for $70,000.

Hamadeh went on to note:

Fisker Automotive may well go down as the most tragic venture capital-backed debacle in recent history,” Hamadeh said in a statement. “The sheer scale of investment capital and government loan money — over $1.3 billion in all — was squandered so rapidly and with so little to show for it that the wreckage is breathtaking. Bankruptcy will be the end of Fisker, but for the taxpayers, venture capital firms, individual investors, and Fisker’s suppliers, it will all be too little too late.

The writing has been on the wall for some time regarding Fisker.  The company laid off 75% of its staff in April as it sought to preserve its dwindling cash and assess its options.  At the time of its announcement, Fisker, which had raised an estimated $1.3 billion from investors, had cash on hand of less than $30 million.

In the end, the company failed to produce the most beautiful of all outcomes for investors: a return.

Municipal Distress

This article originally appeared in Business Insider

Eventually we all have to accept full and total responsibility for our actions, everything we have done, and have not done.

― Hubert Selby Jr., Requiem for a Dream

A noteworthy facet of the evolving municipal distress story in the U.S. has been the slow moving, inexorable nature of the challenge.  Sadly, when a crisis of the magnitude that we are facing develops along these lines it is difficult to appreciate the true scope of the challenge.  This is doubly so when the inevitable change that is coming will upset so many entrenched interests.  And of course the opaque nature of municipal finance has not helped matters.

Stepping back to review the lessons learned in recent years, a few themes become evident:

1)      The Story We Told Ourselves Was Flawed

We may very well look back on the smug claims that “local governments have taxing authority and so can always raise more revenue” and “XYZ bond issue is backed by a dedicated revenue stream, which makes it safer” as we now look at Wall Street’s over-reliance on structured finance to mitigate risk, and the simple yet profoundly wrong thesis that was spread in the middle of the last decade that real estate prices could never go down nationwide.  The simple fact is that for a great many municipalities, and for a troubling number of states and territories as well, the cost of honoring liabilities is severely restricting the ability of local governments to govern effectively (i.e. provide services).

2)      Municipal Risk Has Been Mispriced

The dirty secret of the municipal finance world is that risk has been massively underpriced for too long.  But at the right yield investors will take on the risk of lending to a local government that has gone through a restructuring, and it may not be very long before forward-thinking creditors start to wonder if those local governments who acknowledged their problems and acted accordingly might not in fact offer a superior risk profile, having addressed their issues.

Highlighting the fact, which we have often repeated, that governments do not exist solely to service their debts, Moody’s has indicated that prior recovery rate assumptions for distressed municipal issues were flawed, and is therefore lowering its recovery rate assumptions for these issues going forward.

3)      The Market is Forgiving

When the conversation around municipal distress first attracted wide attention in 2011, many commentators argued that local governments would do everything in their power to avoid a chapter 9 bankruptcy filing or related restructuring in order to stay in the good graces of the capital markets.  It appears that the markets are actually far more understanding than the commentators, with Vallejo, CA, which filed for chapter 9 bankruptcy protection in 2008 having recently sold $19 million in water-revenue bonds.

4)      Delaying the Inevitable Will Only Force More Pain

  • Puerto Rico is facing a financial catastrophe, and the longer it seeks to paper over its challenges with additional borrowings from enabling lenders, the more distract the ultimate remedy will have to be.
  • The approval of the Jefferson County, AL plan of adjustment highlights the scope of losses that are possible going forward.  The revised plan will impose a 47 percent haircut on the holders of $3.1 billion in sewer bonds.
  • Vallejo, CA is facing the prospect of a slow slide to another bankruptcy filing due to an overly aggressive set of assumptions underlying its first emergence.

Conclusion

We are still in the early stages of a seismic shift in the municipal finance sector.  Liabilities have grown to such a point that they will not be paid in full.  This is a painful reality for all stakeholders, but that pain makes it no less true.  Hopefully the lessons of our first tentative steps toward comprehensive municipal restructuring will enable us all to act with clearer eyes and firmer convictions as we seek to position local governments to meet the needs of citizens in the years to come.

Blockbuster Stores’ Stunning Reversal

This post originally appeared in Business Insider

Video rental chain Blockbuster, owned by Dish Network, announced yesterday that it will shutter its 300 remaining U.S. stores.  This closure puts an end to what must rank as one of the most precipitous falls from dominance to irrelevance that has been seen in some time.

In 2004, as it prepared for a spin-off from owner Viacom, Blockbuster was a juggernaut with 9,000 locations.  By 2010 competition from Netflix and others had forced it into bankruptcy (and an ugly, challenging bankruptcy at that).  Now, less than 10 years from the date of its spin-off, the company that defined the U.S. video rental market in the 90s will be gone, with the name living on in a few assorted Dish offerings only.

There are few better illustrations of just how fleeting strategic advantage truly is in a dynamic market.  Blockbuster’s day in the sun was long, but the company was blinded by its success and failed to see the ways in which Netflix and other competitors cut at the very heart of its value proposition.  By the time Blockbuster management recognized their error, it was too late.

And now a brand that rose to prominence by giving consumers more control over their viewing options has been put to rest, killed in part by a failure to see that the video rental store itself was at best an intermediate step toward our current on-demand offerings.  Blockbuster had the resources and the brand to make the leap, but not the vision.  There is a lesson in Blockbuster’s failing for us all.

New Paradigm of Government Distress

This article originally appeared in Business Insider

July 7, 2011

A Slow-Moving Disaster

The state of Illinois is broke, and if it were a company it would at this moment be in the midst of a chapter 11 bankruptcy process.  A recent Bloomberg Businessweek article highlights just how bad things are in the Land of Lincoln:

  • The state is $4 billion behind on bills to 8,000 businesses, charities and state agencies.  Of that number, 114 are owed over $1 million.
  • This mountain of overdue bills exceeds the entire annual budget of the state of Delaware and is more than 10 percent of Illinois’ general budget for the upcoming year.
  • Banks are refusing to lend against these receivables, a sure sign that a state default is no longer a fringe idea.
  • Tax increases raised $7 billion for the state, which was insufficient to cover a $13 billion deficit.  The partisan fight over more borrowing continues.

State budget cuts are getting progressively deeper, and municipalities, faced with an end to federal stimulus money, the financial struggles of states, and declining property tax assessments, are being pressed to find new and ingenious methods to keep expenses down.

Painful Changes Needed

Sadly, cost reduction is not an area of expertise in most governments.  In the turnaround and restructuring community a shakeout is viewed as inevitable.  At the most basic level a restructuring of state and municipal debt as well as pension and healthcare obligations is essential.  Shared services and joint purchasing proposals will need to be moved from the drawing board to implementation.  We can expect vicious fighting between bondholders, government employees (current and former), voters and the unlucky politicians caught in the middle.

The policy implications of an age of local government financial distress must be considered as well.  California’s Proposition 13 was enacted in opposition to rising property taxes at a time (1978) when only half of the Baby Boomer generation was in the midst of their childbearing years.  We are a very different society with different demographic and social trends now, and more property tax fights might be expected, with long-term impacts on the resources placed at the disposal of local governments.

Meredith Whitney Was Right

When Meredith Whitney mad her bearish call predicting a wave of municipal defaults, scorn was heaped upon her.  In a follow up research report looking at the state finances, Whitney reiterated her bearish call, pointing out that the health of state finances is even more precarious than is generally acknowledged.  While many fixed income investors have argued technical points of her analysis, I believe that by taking a step back it is clear that Whitney is making the directionally correct call and those opposing her analyses are propounding a type of exceptionalism that has traditionally led to significant losses for investors.

True believers are difficult people.  Often the very traits that allow them to be ahead of the curve on issues make them poor proponents of those issues to the broader public.  This is exactly the problem with Whitney.  She is media savvy and, since her Citigroup call, seems to be hooked on making big predictions.  As another Business Insider piece pointed out, she could learn a great deal from economist Nouriel Roubini, whose firm also has a bearish view on the U.S. municipal bond market, but has been politic enough to couch their prediction in the soothing tones of economist-speak.

A New Paradigm

We are living in an exciting time, during which the role of state and local governments will be reshaped, with luck for the better.  The old paradigm had something for everyone: nearly risk-free returns for creditors, job security for government employees, pension and healthcare benefits that were both very generous (for employees) and underfunded (for taxpayers).  It was an imperfect system but it worked for a long time.  That time is now at an end.  Stakeholders can fight all they want (and they will), but change has come, and we expect that this change will be contentious but ultimately for the best.

The Demise of a Bad Deal

This post originally appeared in Business Insider

Victory has a thousand fathers, but defeat is an orphan.

– John F. Kennedy

Things seemed so simple in 2007. Energy company TXU looked like a sure-thing. Demand for energy was climbing. The company’s robust profitability suggested an ability to service a substantial debt burden. Throw in some operational efficiencies and TXU had the appearance of a golden opportunity for some of the biggest PE firms in the U.S. to ride increasing energy demands to riches.

It has not worked out quite that way. Following its purchase in 2007 in a $48 billion buyout, the company, now renamed Energy Future Holdings had its profitability crushed by the unset of large scale fracking and the accompanying collapse in natural gas prices. Arguably good management and savvy financial engineering are the only reasons that the day of reckoning has been put off as long as it has. Natural gas hedges minimized the pain in the early years after the buyout. And on the balance sheet side there have been several distressed exchanges and refinancings in specific tranches of the company’s $43.6 billion debt structure. But there is only so much that good management and creative financial engineering can do when faced with an investment thesis that has been proven false, and market expectations are that a bankruptcy filing is imminent.

Losses happen in investing, but it is interesting to see in this case the maneuverings of savvy investors on all sides.
• PE firms KKR and TPG Capital contributed $3.5 billion in equity to the original deal
• Goldman Sachs Capital Partners contributed $1.5 billion in equity
• $3.3 billion of equity was contributed by clients of KKR, TPG and Goldman, as well as Lehman Brothers, Citigroup and Morgan Stanley
• Investor Apollo Management Group, Oaktree Capital Group and Centerbridge Partners have taken considerable stakes in various tranches of the company’s debt, positioning themselves for an eventual ownership stake following a restructuring

Recent news suggests that that $8.3 billion equity commitment may, post-restructuring, shrink to an ownership stake of less than 3 percent. The pain is not limited to the equity in this deal, though. Moody’s recently reported that due to the sheer size and complexity of Energy Future Holdings’ restructuring, it would likely result in lowered recoveries across the capital structure.

With $270 million in interest payments due November 1, one of the largest non-financial bankruptcies in U.S. history is likely about to be filed. A successful chapter 11 reorganization will allow a way forward for the over-indebted company, but will be a black eye for investors floored by the punch they did not see coming.

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. He can be reached at 312-505-7238 or at david@acm-partners.com.

Eike Batista

This article originally appeared in Business Insider

How flattering to the pride of man to think that the stars on their courses watch over him, and typify, by their movements and aspects, the joys or the sorrows that await him! He, in less proportion to the universe than the all-but invisible insects that feed in myriads on a summer’s leaf are to this great globe itself, fondly imagines that eternal worlds were chiefly created to prognosticate his fate.

–          Extraordinary Popular Delusions and the Madness of Crowds

Eike Battista is not having a good year.  In fact, it might be fair to say that the Brazilian entrepreneur is having perhaps one of the most horrendous years of wealth destruction on record.  In little more than a year Batista’s fortune has plummeted by over $30 billion, his support among Brazilian politicians has evaporated, and his creditors have gone from enthusiastically backing his endeavors to nervously eyeing their collateral.

For those unfamiliar with the new poster boy for emerging markets euphoria gone horribly wrong, look no further than the recent Bloomberg Businessweek article by authors Juan Pablo Spinetto, Peter Millard, and Ken Wells.  Their reporting details all the usual elements in these situations, with a few interesting wrinkles:

  • The Batista empire benefited from a compelling story that investors desperately wanted to believe.  With a network of companies focused on natural resources and based in Brazil, Batista had a need for capital at exactly the point in time when institutional investors were looking for investment opportunities emerging markets.
  • OGX, an energy exploration and production company founded by Batista in 2007, bid aggressively (in some cases offering bids double that of its competitors) for offshore oil leases.
  • Batitsa had the dangerous combination of being a famously hands-off manager who was nevertheless relentlessly optimistic about his ventures.  Over time his direct reports came to avoid bringing him bad news, which may have only speeded the decline of Batista’s empire.

The focus of Eike Batista these days is on preserving some value, as he struggles to restructure the debt of his various companies.  News that mining company MMX had reached an agreement to sell a controlling stake in a Brazilian iron-ore port sent the stock up 8 percent for the day, though investors have still suffered a 76 percent decline in 2013.  This marks only the latest in a series of transactions aimed at preserving something of the Batista empire, though the heavy debt burden of these companies suggests that preserving any equity value may be a lost cause (see articles here and here).

About the Author

David Johnson (@TurnaroundDavid) is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services.  He can be reached at 312-505-7238 or at david@acm-partners.com.