Financial Myths: Look Before You Leap — Part III

Michael McTague |

Investors have a talent for caution: 2016 proved a slow year for mergers and acquisitions; 2017’s promise of profit spurs a brisker pace. So, private equity seekers generally look before taking the plunge. Even so, the first two entries covered various successful and unsuccessful financial leaps. Apollo (APOL), parent of University of Phoenix, remains in permanent detention, despite its new private equity relationship. Major League Soccer’s hopes are much higher than its goal total. This issue looks at a few other possible swan dives.

Manufacturing in China – Reshoring

We saw the dangers of enthusiasm in Part I. High profit and low cost persist as easier to claim than to achieve. The temptation to produce in China because of low cost proves quite seductive. Many companies the Myth Buster and his colleagues work with point immediately to Apple (AAPL). Made in China, the iPhone and its components are inexpensive. But, the price and profit level are high because of technological and design superiority. It would still be profitable if made in the US.

The Apple model does not work for many. Companies in low-margin businesses that face stiff competition where product superiority remains difficult to demonstrate love low wages. However, many are changing their minds about making products outside the US – and were doing so before the 2016 election. The low wages are tied to the higher cost of transportation, difficulties of communicating across the world and enforcing quality standards from a distance.

According to reshorenow.org and USA Today, the following companies have already returned manufacturing to the US: GE (GE) Appliance Park; Walmart (WMT), which launched its own made-in-America plan; Ford (F); Boeing (BA); Caterpillar (CAT), General Motors (GM); Mars; Hubbardton Forge. Expect the list to grow.

Puerto Rico’s Debt

Puerto Rico’s financial plight reveals many leaps: the territory leaped into debt, promising to repay. Investors leaped into the bonds. The island recently leaped into bankruptcy. No resolution has been reached. The Myth Buster has suggested in previous entries that this debt crisis resembles Greece’s and may be resolved with the help of Washington. So far, the federal government is staring at the pool hundreds of feet below and holding its breath. Taking shape as the largest US municipal bankruptcy, it certainly shows the need for valid bond ratings and for looking first.



Avon Calling – for Profit!

We continue to watch this long-standing company struggle to regain profitability. In the first installment on this myth, we considered the possible effects of Avon’s (AVP) new relationship with Cerberus Capital, which seeks a turn around. The plan calls for raising commissions, eliminating noncore products and expanding into health and supplements. Avon says it realized about $120 million in cost savings last year and is on track to achieve its turnaround goals. Can the leaner current staff handle the changes? According to CNBC, revenue fell 7% in Europe and the company’s shares dropped 14%. The last six months have been disappointing for Avon. They missed their profit projections.

However, the good news is that they are beginning to offer medical products. This apparently unrelated product line may boost future revenue by allowing their sales representatives to become more relevant to their clients. This looks like a good strategic move, expanding the product base beyond cosmetics, a very tough line where profits are concerned. It also suggests that the Avon-Cerberus link follows Scenario B described in the April Myth Buster: Cerberus adding needed capital, cutting costs and adding products to improve revenue. Investors will take note that a wider product base is good news. Even so, the cosmetics industry proves skittish as can be seen from Procter & Gamble’s (PG) drawback. Despite Cerberus’s financial clout, do not look for the famous hockey stick shift in profits.

Avoid Tunnel Vision

The Myth Buster finds considerable merit in using the personal selling skills Avon holds to roll out a new type of product. Here is a good lesson for all investors: focus on the big picture. If you see Avon as a cosmetics company that sells door to door, you fall into a trap of thinking that all cosmetics sellers are heading downward. Before its emerging turnaround, Avon looked even worse because of its slow shift to online selling. But a new product line means a new future vision.

Investors can more easily develop tunnel vision about technology. High technology rules but low technology retains its merits: for example, the backup system for a major financial institution often turns out to be a warehouse with a never-used hand-operated generator! Selling door to door (Avon) may work – if you are good at it and if the products are priced right and save the customer time. So, while the hedge fund may salivate over assets and revenue, the product expansion may prove a profitable shift Avon would never have done on its own.

This series opened a number of interesting lines of inquiry. So many managers and organizations leap before looking. Even those who look sometimes leap anyhow – and come to regret it. Better to think first. Greek debt may well prove to be sound – plenty of risk, but a good deal of return. Avon may turn a healthy profit and add even more products. Unfortunately, investing in soccer ranks alongside buying lottery tickets. In the next installment, we will take up a new myth and explore its challenges.

Be sure to read Look Before You Leap Part 1 and Part 2.

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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
GE General Electric Co 23.19 -0.17 -0.73 57,967,981 Trade
WMT Wal-Mart Stores Inc. 85.98 0.24 0.28 5,829,063 Trade
AAPL Apple Inc. 160.47 0.59 0.37 18,870,689 Trade
GM General Motors Company 45.02 -0.74 -1.62 14,054,673 Trade
F Ford Motor Company 12.27 0.15 1.24 54,211,427 Trade
BA Boeing Company (The) 258.62 -1.13 -0.44 2,508,378 Trade
CAT Caterpillar Inc. 130.54 -0.93 -0.71 2,371,757 Trade

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