A faltering firm may boast a good track record, but if it’s in a troubled industry, that may not be enough to save it. Cris Sholto Heaton looks at which firms are doomed to fail
What do Polaroid, Northern Rock and Ford have in common? Not much, you might think – but they’re all examples of once highly-successful companies that fell by the wayside after their industry changed dramatically.
Polaroid’s instant cameras were once such an icon of American life that the firm was part of the Nifty 50 – the large-cap, high-growth stocks seen as vital buy-and-hold shares in the 1960s and 1970s. But the advent of digital cameras dealt a death blow to its business and it filed for bankruptcy in 2001.
Northern Rock borrowed heavily in the money markets to expand its lending – a model that proved highly profitable during the credit boom. But the model looked less clever when the market freeze forced it to go cap in hand to the UK government for a bail-out.
Most dramatically of all, Ford redefined the whole manufacturing process when founder Henry Ford introduced specialisation of tasks and moving assembly lines into his factories. But failure to change its products when customers’ tastes changed saw the company shed market share and suffered huge losses in the face of Asian rivals.
Firms such as these are dangerously tempting for investors. When the business begins faltering, its track record of success makes it easy to believe it won’t fail. Management is experienced, the brand is well-known and, worst of all, as markets begin to fret about the future, its shares plummet, resulting in low p/e ratings and high dividend yields. This makes them highly attractive to contrarians – they look like classic turnaround plays. But there’s a big difference between a firm that’s going through a bad patch and one whose business model is broken.
Avoid banks and old media
So which industries today look as if they may be headed into oblivion? One candidate is newspapers, whose circulation and advertising revenue is falling as readers turn to the internet. This has hammered shares in groups such as Johnston Press and Trinity Mirror, to the point where they offer tempting dividend yields of 7%-8%. But things could easily get worse. There’s little sign that newspapers will cease shedding readers in the near future.
What good news there is coming out of the newspaper groups’ numbers comes from rising digital revenues – but these remain relatively tiny, so there is a long way to go before they can replace the lost print revenues. In the tough world of the internet, it seems rash to bet that firms whose track record is based on print and who initially misunderstood the value of the web for their businesses will succeed in outcompeting more tech-savvy rivals.
Other victims of the internet include high-street retailers of music, books, electricals, and anything else that can be easily and cheaply bought online – they probably still haven’t seen the worst of the web’s impact on their businesses yet. The online world also threatens traditional channel-based TV providers, such as ITV. Widespread on-demand downloading of TV shows and films could do far more damage than digital channels and audience fragmentation has already done.
Offline, the capital-light, leverage-heavy banking model, which has already seen the demise of Northern Rock and Bear Stearns, probably hasn’t claimed all its victims yet. As discussed in our cover story last week, existing shareholders in many banks could see most of their equity wiped out by the need to raise new capital.
So what should you buy instead?
On the other hand, there are at least two out-of-favour industries where the grave-dancing looks premature. Neither are being undercut by new technology and both have solid financials, giving them the ability to spend where needed to reshape their business. The first is big pharma. Competition from generic manufacturers, patent expiry on blockbuster drugs, a shortage of new products despite high research and development spending, and legal and regulatory problems have helped depress pharma shares to the point where many are trading near ten-year lows.
But unlike the industries above, pharma’s reason for existence has not gone away. We need new and better treatments for a vast range of conditions – and there will be even more demand for this as the world gets both older and richer. Even if much drug development shifts to smaller firms, big groups will still be needed to fund the drugs through their clinical trials and get them to consumers through their global distribution and marketing networks. In fact, the idea of outsourcing some development work to other firms – and to a growing extent, cheaper countries – makes excellent sense.
Similarly, fears over the future of the oil majors look overdone. Yes, vast amounts of the world’s conventional oil reserves are locked in countries with nationalistic governments with a preference for using state-owned oil firms. But this doesn’t make the majors obsolete. While Saudi Aramco may be able to go it alone, most other national oil firms still need the supermajors’ expertise to bring large, difficult projects into production.
Investment in unconventional sources, such as the Canadian oil sands, technology such as coal-to-liquids and renewable energy sources keep their longer-term options open. For investors seeking high yields and out-of-favour stocks, pills and petrol looks a better bet than media and merchant banking.