Short-term gains or long-term change?

Dell, once a darling of the markets, is planning to get delisted and go private. The transaction is being spearheaded by none other than the founder Michael Dell, who has arranged financing from a private equity fund and put his own money at stake to buy-out public shareholders. Clearly the company is not in the pink of health lately and needs to transform itself in the age of mobility, but is the stock market missing something that Michael Dell knows?

Industry trends

Successful companies too, falter once in a while — due to change in industry trends — and need to transform themselves to stay relevant, especially so in the field of technology. The case of Dell is just one of many such among tech giants which have experienced the same in the past. Many have transformed themselves successfully and continue to thrive — such as IBM, Apple, Microsoft. Some where the rot was too deep and the surgeries too late, have failed — Kodak. I am the sure the list can be extrapolated to non-tech industries as well — both globally and within India.

The good news is that in the technology sector, unlike others, there is a new wave of change that happens every few years. So, even if a company misses one wave, if it is able to latch on to the next; it could survive and thrive successfully. However, the key with surfing successfully from one wave to the next, as articulated by Prof Vijay Govindarajan of Tuck School of Business at Dartmouth in his famous three-box approach, is: a) Managing the present (short term) but identifying and accepting the need for change; b) selectively abandoning the past; c) Thinking about and investing in high probability bets for the future (long term). Of course, to do all this, the company needs to have a certain degree of split personality.

Striking dichotomy

Here-in lays the dichotomy between the world of business and that of stock markets. While market analysts focus on Q-on-Q performance (that is, the short term), businesses need to think about the long term as well for their fundamental survival, and doing good on the former may not imply the latter. Long term is uncertain and requires investing in calculated bets, which may not pay off over the short term.

In fact, it is very often the case that such bets may dampen short-term performance for quite a while. But usually if the bets are made rationally (that is, keeping in mind the probabilities of success and failure, worst case scenario, core competence, and so on), even if few of the bets are right, the long-term rewards more than compensate for short-term losses in money and time.

Sometimes, there are large changes that occur in the industry that require large-scale transformation by companies, for example, global sourcing, e-commerce, mobility, and so on. These are akin to changing the course of the ship midway — which are especially risky — the larger the ship. Sometimes slowing-down the throttle over the short term to do a manoeuvre for the long term is the best way for a safe journey — lest one may end up like the Titanic.

A business that is obsessed with consistent quarterly performance either becomes too afraid to take the risks required for the long term or is afraid to slow down for course correction. Both are ingredients to perish with consistency.

Lead indicators

Unfortunately, markets and analysts seem to be more focussed on financial numbers for the current/next quarter/year that are mere lag indicators of seeds sown and risks taken in the past. This results in early write-off and late appreciation of good companies, when they are navigating waves in the ocean of commerce.

What is critical are the lead indicators — that is, what is the company doing to ensure that it thrives over the long term — for example, what are the changes being undertaken internally? What are the trends that the company is betting on? How many new initiatives are ongoing? How much has the company invested in new products/services/markets/channels? How many of these have displayed initial success? What is the probability of break-through success (ROI) over the next five yrs/10 yrs?

The lack of patience to observe the lead indicators and wait for them to pay-off in financial terms, results in stock prices of once successful companies falling off a cliff from time to time. This often leads to listed companies focusing most of their energies in dressing up the quarterly performance, while making half-hearted attempts to transform themselves until it is too late.

Of late, promoters/private equity investors across the world, who seem to have a relatively more long-term mindset, are taking advantage of this situation by taking companies private. The company can be bought at a lower price from existing shareholders, thanks to the street’s disenchantment with their recent lacklustre performance. It is also easier to focus on making the transformation work, away from the limelight (and grilling) of quarterly analyst conferences.

Lessons from History

History has proven that really great companies have had the ability to navigate change and come back to surpass their past glory. Investors who stuck by these companies were rewarded handsomely for their patience. Examples of such companies include IBM — which made a transition from hardware to software under Lou Gerstner — and Apple — which made a transition from a marginal player in PCs to a leader in music, smart phones under Steve Jobs.

There are many examples in our own backyard. For example, Bajaj — that made the transition from scooters to bikes; or ICICI — which made a transition from project finance to retail banking; Wipro – that went from vegetable oils to software; or more recently, GSK Consumer — that injected new energy into its ageing Horlicks brand.

Can one extend a similar argument to the case of Infosys which was once the darling of the markets but has been reporting below industry performance over the last couple of years? Going by the strong DNA of the company, the fact that it seems to be aware of its problems and that it is doing something about it (example, Infosys’ 3.0 strategy) makes it hard to write off a possible bounce back to the top.

A potential signal which indicates that a company is dead-serious about transforming itself is when there is leadership change, especially if it involves a passive promoter/founder taking on a more active role, as with Michael Dell in his current avatar or Steve Jobs when he came back to Apple for the second stint. A couple of Indian companies where founders have recently taken more active roles are Geometric and Nucleus Software. Is it a sign of bigger things to come at these firms? Let me leave you with that thought.

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