In the first two installments, we saw that slow fizzles and wobbles are more common than hard falls. New technology submerges the competition, but IT stands apart from other industries. Wrangling over assets, delays in selling inventory and slow profit drains are what investors can expect, rather than the assumed total corporate belly flop. CNN and The New York Times suffer from poor business decisions but no hard falls. Toyota (TM) survived a flood of bad news on brakes; so did GM (GM) .
It would also be reasonable to expect Fannie Mae and Freddie Mac to fall to the center of the earth based on their performance over the last decade. Despite losing $30 billion net income in 2010-2011, Fannie Mae’s market capitalization is actually rising. Investors know that
Fannie Mae and Freddie Mac have a federal tax spigot that is easily turned on.
Too Big To Fail?
The two miserable mortgage cousins demonstrate the American belief in “Too Big To Fail.” They are not alone. Previous Myth Buster entries pointed out that the major US banks grew in recent years – during and immediately following the recession. Maybe a better expression would be “Too Big Not To Get Even Bigger.”
Another excellent candidate for a major flop is organized labor. Membership reached the basement in 2013: 11.3%, down from 20.1% of the workforce in 1983 according to the Bureau of Labor Statistics. That was a big slide from 28.3% in 1954. Here too we see a fizzle rather than a hard fall. Major unions have grown among government employees while shrinking among the for-profit and manufacturing sectors, the industries that breathed life into the movement.
Too Big Should Fail?
All of these are American examples. The story changes outside the US. A hard fall is underway for Rongsheng Heavy Industries, China’s largest shipbuilder. Near bankruptcy, employment has fallen from 30,000 to a few hundred. The company was accused of inflating order books and now owes 230 billion yuan to 14 banks. Unable to complete major projects, they are having delivery problems. European-based Airbus, which is doing well, has also suffered painful delays in delivering aircraft. The Rongsheng predicament shows that China’s emerging economy does not believe in safety nets for business. They seem closer to the idea, “Too Big Should Fail.”
One would expect a few major bank failures in the drooping euro zone. But, total failures don’t happen. Streetwise investors will note that failing stress tests – a big issue in Europe – does not signal hard falls. Even Greece, dangling in Depression-like straits for years, remains a better target for a bailout – OK, many bailouts – than bankruptcy.
The implications are interesting. The US proves more averse to hard falls. Giants shrink and sag but stay in business. China offers no safety nets, no reserves to keep the failing company afloat when the business climate sours. Europe weighs in strongly on the US model of bailouts and now Quantitative Easing (QE).
Lessons for Wary Investors
We did not discover many hard falls in the US or Europe, but a few lessons can be drawn from our investigation. Technology change pulls the rug out from under industry leaders. The iPhone sinks the cell phone and its makers – Motorola, Nokia (NOK) and others. Apple (AAPL) surpasses Hewlett-Packard (HPQ) , which is really a massive roll-up of IT leaders from years past. Lenovo crushes Dell as IBM (IBM) , which sold its personal computer division to Lenovo, struggles for new profit. The obvious lesson is the cruelty of technology change.
However, we can find another investor lesson. HP, Microsoft (MSFT) and others are not in the center of the social media, mobile device explosion. Even so, they make significant products and provide real value. While technology changes, excellent products and services continue to serve a purpose. Servers and desktop personal computers, for example, are not changing with the rapidity and severity of mobile devices. So, HP chugs along even though it loses the high-end of popular, current technology. So, no hard fall.
Oil prices have tumbled thanks to greater supply and modest demand. The oil leaders are not falling hard. In fact, they are even stronger than before. Low oil prices have slashed efforts by Ford (F) and others to increase fuel efficiency. The gas-guzzling Escalade, for example, is doing quite well. The hard flops are in alternative energy. Windmills are vestigial reminders of the search for cheap energy.
A third investor lesson is to look for real value. Companies may sag but they stay around because they deliver real value. Radio Shack flopped because it did not offer anything impressive. Caesar’s (CZR) staked out a reasonable presence in gambling. Along came the real gambling Goliath, the US government. The rapid expansion of Macau as a gambling center shows that others are mimicking the US government.
“The Bigger They Come, The Harder They Fall” proved a challenging myth. While we found few clear examples except in China, the myth revealed why companies fail and why others shrink and shake but keep on going. The myth is often applied to boxing. The Mayweather – Pacquiao welterweight title fight, which took place during our investigation of this myth, offers more trouble for the myth. Mayweather earned $180 million; Pacquiao $100 million. By contrast, the heavyweight champ, Vladimir Klitschko, who just won his eighteenth straight title defense, has earned $100 million in his entire career. And diminutive Pacquiao (5’ 6 ½”, 148 pounds) may run for President of the Philippines. Next month, the Myth Buster will tackle another intriguing truism.
Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.
Edit: A previous version of this article referenced Ginnie Mae instead of Freddie Mac.
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