Raw Capitalism Bleeds Industry to Feed Dot-coms
February 27, 2000
by Irwin Stelzer
SUNDAY TIMES (London)
February 20, 2000
AT THEIR request, I met last week a group of executives from a company that, by any of the standards of the past, would be considered successful. It has good cash flow; satisfactory though not spectacular returns on equity; millions of satisfied customers and good relations with the communities it serves. It should have been a relaxed, even jolly dinner.
But it was not. The company's shares are languishing and the institutions and hedge funds that hold them are screaming for action - and not just any action. With the share price low, acquisitions are out of the question. This is no dot-com company that can use high-flying shares as the currency with which to make a few strategic acquisitions, as was the case with AOL when it went after Time Warner.
What the institutional investors are demanding is a share buyback, which would return to them and to other shareholders some of the capital now being used - or in the view of the fund managers, wasted - in the business. The market is telling them, say these investors, that the capital now entombed in this company can better be deployed elsewhere, perhaps in some of the internet companies creating instant wealth for their shareholders.
My dinner partners were not cheered to know that they are not alone in their agony. Other companies, many of them quite successful, are under similar pressure to undertake what can only be described as partial liquidations.
Just a few days after our rather sad dinner, BP Amoco announced that high prices for crude oil, rigourous cost cutting and increased sales had driven its fourth-quarter 1999 earnings to record levels.
But despite this performance, Sir John Browne, its chief executive, also announced that the company intended to buy back up to 10% of its shares. Despite record results, despite crude-oil prices high enough to warrant considering stepped-up investment in exploration and development, despite a management team that is widely respected in the City and on Wall Street, BP Amoco is under pressure to withdraw capital from its business and give it back to the shareholders, so that they may use it elsewhere.
This is the practical consequence of what is going on in stock markets around the world. We are seeing a collapse in the prices of the shares of good, old-fashioned "real" companies, to use a term increasingly employed by managers who see their shares collapse despite high earnings, while shares of money-losing dot-coms soar. The Financial Times summed it up best: "The spread between the more favoured and less favoured stocks in the FTSE 100 is the widest for 35 years and about four times what it was in 1985."
But whether the paper is correct in concluding that the flight from traditional companies to high-technology companies is "almost certainly" an overreaction is subject to some doubt.
What we are seeing is a huge change in investors' appraisals of the future. There is no doubt that the world's economies will continue to need companies that produce cars, steel, energy and the other stuff of life in this 21st century. Nor is there any question that the earnings of these companies, or at least those among them that are well managed, will continue to grow.
But these companies are competing for capital with others that investors think will experience explosive growth in earnings. There may or may not be the "new paradigm" that has put the American economy on a path of uninterrupted growth, but there certainly is a new paradigm in the stock market. Simply stated, it is that a history of success, and the near-certain prospect of modest success in the future, matter a lot less than the less certain prospect of spectacular success.
To get some idea of the magnitude of the growth that investors are looking for, consider the new hot area: consultants offering web services to businesses.
Companies such as Luminent, iXL Enterprises, Razorfish, Sapient and others are what Business Week describes as "the foot soldiers of the net". They design websites and help companies to develop e-commerce strategies.
Wall Street loves them. By the end of the year, about two dozen of these companies will have floated on the market. Some sell at 30 times sales - not earnings, which few have - and they have market values of up to $ 5billion.
International Data Corporation, a Massachusetts technology-research firm, told Business Week it expected the industry's sales to rise from the current $ 7.8billion to 10 times that, $ 78billion - and not in the long term, but by 2003. Little wonder that the shares of these net consultants have more than doubled in the past year.
There was a day, not so long ago, when lethargic corporate managers, incapable of growing earnings at what by today's standards are modest rates, were challenged by so-called "predators" - people such as Sir James Goldsmith and the disciples of Mike Milken and his junk bonds. Some succumbed. Others cleaned up their acts, brought down costs and sold businesses they could not manage properly.
Now the challenge to managers is different. It matters little whether they are competent, whether they have cut costs to the bone, or whether they are growing earnings in line with what reasonably can be expected from firms in their industries. The capital markets are telling them to shrink their companies and give the capital back to shareholders so that they can redeploy it in companies likely to grow at dot-com rates.
This is unpleasant, and indeed confusing, for the managers of traditional companies. And it will undoubtedly prove to be a mistake for some, but only some, of the investors who may be seeing sure things where there is, in reality, a high risk of failure. But market capitalism was never designed to be a walk in the park for managers or for investors. It was designed to be a stalk in the jungle.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.