If a Martian or other extraterrestrial suddenly landed on Earth after studying the pre-1980 basics of the American capital markets, he/she/it would probably scratch its pyramid-shaped head, trying to figure out why a stock would rise immediately after a company suffers a shake-up and takes a huge write-off on its balance sheet. ‘How odd,’ it would say in Rille 42 dialect.
Behind the confusion is the fact that such write-offs occur when a company declares a loss on certain assets, reducing that quarter’s earnings and often producing a quarterly loss. For example, Quaker Oats recently sold off its Snapple unit for $300 mn. Yet, only a few years ago it paid $1.7 bn for the tea bottler, so Quaker takes a charge of about $1.4 bn when it goes through with the sale.
Today, of course, write-offs are done on a regular basis; and often, although not always, the company’s stock does experience a significant rise as a reflection of investors’ confidence in the future restructured company.
But the rise is not automatic. Nowadays, investors tend to be more leery of big write-offs than in the past. Among other reasons, they suspect a lot of items not related to the restructuring are thrown into the restructuring package. Also, massive write-offs are so ubiquitous now that investors have had time to realize that they don’t always work. The challenge for the IRO is to convince the market that the ‘big bath’ will truly make the company more profitable and competitive in the future.
Bleeding Red
‘Our function is several fold when advising a client announcing a write-off,’ says Ed Nebb of the New York-based investor relations firm Morgen Walke. ‘Above all, we want to make sure the company clearly articulates the strategic basis for restructuring.’
According to Nebb, a company restructures for at least one of three reasons: It has a business that is bleeding red ink or has no real growth potential, and which it wants to get out of; it wants to focus its financial and managerial resources on its core business; or it wants to eliminate confusion on Wall Street – it may have several lines of business and difficulty attracting analysts. So the company tries to project the image that in one fell swoop it will juggle its balance sheet, clean away all the garbage through restructuring, and become more focused on the business it knows best – hopefully also its most profitable activity.
Sadly, it doesn’t necessarily work. In some cases, the stock soars immediately after the restructuring announcement, but drops sharply when investors start to believe the plan is not working or is being implemented incorrectly.
In other cases, such as that of WMX Inc, a company’s stock plunges immediately after its restructuring announcement. The reason? Investors don’t believe the plan will do the hoped-for job.
Big Hit
IROs are critical to the process of selling the restructuring story to investors, helping to frame the statement and then assuring it gets to the targeted group as quickly and as fully as possible.
At least as critical a role, according to the experts, is reporting to management exactly what the market is looking for. This assures that the announcement of restructuring is not counterproductive. Taking a big hit and not fully satisfying the demands of important investors can lead to disaster, as in the case of WMX, where the CEO was subsequently fired.
Assuming the restructuring makes sense and addresses investor concerns, chances are much greater it will give a substantial lift to the stock price. Moreover, the hit from the restructuring can make future results seem much better by comparison.
IBM is a clear example of this. Big Blue reported a 54 percent increase in profit for the first quarter of 1997 compared to the first quarter of 1996. But that huge jump reflected a $435 mn write-off in the comparable quarter of 1996, largely as the result of IBM’s purchase of two software makers. So excluding the effects of the write-off, IBM’s profits were actually flat. Earnings growth was boosted in other ways: it really earned less, so its results were actually boosted by a lower tax rate. Moreover, EPS was then boosted by an 8 percent reduction in shares as a result of IBM’s aggressive stock buy-back program.
The day before the earnings announcement, IBM’s stock rose strongly, up $2.375 to close at $142.375, a 1.6 percent rise. In contrast, last January IBM’s stock fell 6 percent the day after it released fourth-quarter results, despite better-than-expected earnings. Clearly, controlling the spin on earnings announcements is a difficult game.
Nuclear Al Strikes
In other cases, the ‘big bath’ works like a dream. Often, its success depends heavily on the market’s confidence in a new CEO. That was the case of Sunbeam, when Albert ‘Chainsaw’ Dunlap became CEO last July. Immediately on the announcement of his arrival, Sunbeam’s stock shot up 52 percent, to $19 from $12.50.
Because the market had been expecting a grand and drastic restructuring, Sunbeam’s stock didn’t rise dramatically on November 12 when details of the plan were announced – the stock then was selling at $25-26. The company announced a charge of $300 mn to streamline itself, which included the cost of 6,000 lay offs and the write-down of facilities such as factories that were no longer going to be used. But the company explained to investors that the moves would cut annual costs by $225 mn for years to come.
By late April, after Sunbeam released fantastic first-quarter results, the stock was fetching more than $33. That’s a rise of more than 250 percent from when Dunlap took over, less than a year earlier.
‘When you’re going through a restructuring, you have to do it quickly,’ advises John DeSimone, until recently head of IR at Sunbeam. ‘From the IR standpoint, you have to communicate as much as you can to the investment community as clearly as you can.’
DeSimone says Sunbeam had a teleconference on the day of the restructuring. ‘Release the restructuring plan immediately after it is completed,’ he says. ‘You want to let the investment community know all about it. We wanted to get that information out as quickly as possible.’
DeSimone readily admits that he’s in a relatively easy position. ‘I am fortunate,’ he says, ‘that I have a CEO who is very willing to talk to the investment community. I have no trouble at all setting up a lot of meetings, doing a lot of one-on-ones, and making sure that the investment community is well aware of our entire plan. I don’t have to do that alone – I probably have the most investor relations-oriented CEO in the world in Al Dunlap.’
Muted Response
A restructuring program that met with a lot less success was that of Allergan, the Irvine, California-based producer of ophthalmic products and pharmaceuticals. Allergan announced a restructuring early in June 1996, taking a $75 mn charge-off and reducing its workforce by 450, or about 7.5 percent of its 6,000 workers. It also implied that it had fired its chief operating officer.
Initially, the market’s response was muted. The stock price barely moved, hovering around $38. But within a few days, it began a long, continuous upward trend. It reached a peak of almost $42 by early August. Subsequently, the trend was reversed and the stock started dropping. By mid-March it had lost 12 points, selling at $30. And by late April, it was selling at around $27, a whopping 35 percent decline from its peak.
It’s easy to understand Allergen’s prolonged fall. Last April, the company reported a 23 percent drop in quarterly earnings, to $17.8 mn from $23.1 mn the year before. Even more distressing to investors, sales also declined. In sharp contrast to Sunbeam, investors lost faith in the restructuring when their hopes were dashed.
Shedding Business
Stanhome Inc, with worldwide sales of about $844 mn, got off to a good start in late April after announcing a restructuring that created a $35 mn charge against earnings. It announced it was going to focus on its Enesco Giftware group, its biggest unit that designs and markets branded gifts and collectibles, and shed its non-giftware units. Giving the announcement credibility was the simultaneous announcement that Stanhome had agreed to sell its Hamilton direct marketing business. Hamilton, which reported sales of $145 mn last year and an operating loss of $6.7 mn, was the company’s biggest unit aside from its gift division. Stanhome also indicated that it planned to sell its Direct Selling Group with the help of Goldman Sachs.
Above all, Stanhome made sure its new strategy was crystal clear by issuing a three-page press release : ‘Our vision is of a focused company that is the worldwide leader in the gifts and collectibles industry,’ said G William Seawright, Stanhome’s president and CEO. ‘Giftware has been and remains an attractive, high-margin business.’
The market reaction was overwhelmingly favorable. On April 23, the day the restructuring was announced, Stanhome’s stock soared by $6, to $31 a share – a jump of 24 percent from the previous day’s close.
At times, a restructuring is used to take the bite out of other bad news, hoping to give disenchanted stockholders some shreds to hold onto. That was the case with EDS, the huge computer-management company that was spun out of General Motors. In late April, EDS reported an 11 percent fall in earnings, causing its stock to fall $9.375 to $32.625, a 22 percent plunge in one day. To ease the blow, EDS said it would eliminate 7,000-9,000 of its 98,000 positions. But it failed to say how big a hit it would take for the restructuring.
So, as our little Martian can see, at times there’s logic to the restructuring message. It will only succeed if there is; and if it is presented fully and quickly to the investment community.
