MARKET PERSPECTIVE

By J Mulraj

May 25- June 1, 2024

Destroying valuations of great companies

There are examples aplenty of great companies, which took years to build, being destroyed in a few weeks by poor management decisions, and excesses of shareholder capitalism.

One of these was Lucent Technologies. Lucent, which means ‘giving out light’, was the earlier Bell Labs, the font of innovation at AT&T, America’s dominant fixed line (there were no mobiles then) carrier, before a court ordered it to be split up into seven Baby Bells. After the birth of the baby Bells, Lucent, which remained with AT&T, made a $3 b. IPO in 1996. As a company, it got almost the entire talent pool from Bell Labs working for it. It’s management, however, succumbed to investor pressures of showing improved quarterly performance, and started fudging accounts to do so. Management compounded the folly by sacrificing projects that would deliver great returns over the long term (for which Bell Labs was famous) in order to improve its short term, quarterly, results. These poor management decisions destroyed Lucent, which went from being a profitable and innovative company, ‘giving out light’, to becoming a loss making company, giving out fudged results. Within a decade, things got so bad that  Lucent had to merge with French telecom leader, Alcatel.

Another case study of poor management decisions is, surprisingly, Apple! The brilliant founder of Apple, Steve Jobs, was fired from the company by its Board, in 1987, over differences with CEO John Sculley, brought in by the Board. Jobs, famous for his innovative design skills, started his own company. Without his talent, Apple started declining, and the Board brought back Steve Jobs in 1997. (The earlier Board’s mistake in not recognizing Job’s talents, including leadership skills, cost Apple 8 years of development.) Apple became the first company in the world to hit a $3 trillion market cap, followed by Microsoft. It is thanks to the sagacity of the later board in bringing Jobs back, and the subsequent appointment of Tim Cook, that Apple is, today, one of the most valuable companies in the world. But the previous Board almost destroyed a great company by firing Jobs.

A third, ongoing, example of using a wrecking ball on a successful company is Tesla. In 2018, Tesla’s Board signed a pay package agreement with CEO Elon Musk, under which, provided he achieved certain milestones (which most considered were too difficult to meet), he would be entitled to receive 304 million shares at $23/share. Musk achieved the milestones, and was contractually entitled to get the stock under the agreement which 73% of shareholders had accepted.

But one shareholder filed a suit in Delaware, where Tesla was headquartered, to void the agreement and, surprisingly, won! Musk was denied the reward for working hard to deliver value. The market cap of Tesla rose from $ 59 b, when the agreement was signed, to $ 561 billion now! Musk’s payout under the agreement, would be around $50 b., just 10% of the value he added, and under an agreement with the Board.

Here comes the bizarre part! The lawyer for the shareholder applied to the court to make Tesla pay his fee, which he, unbelievably, claimed as $6 billion! This was on the grounds that due to his efforts, Tesla had saved $ 50b. Even more bizarrely, he wanted the $6 b fee to be paid in Tesla stock!

Tesla has appealed against the Delaware court judgement, and has applied to move its headquarters from (hostile) Delaware to (friendly) Texas. An EGM of shareholders has been called on June 13, to have shareholders vote on the pay package. Should this not be approved, Musk may well decide to leave Tesla management. That would be a folly of monumental proportion, and an example of sheer lunacy.

Why is it lunacy? Well, Elon Musk launched an AI startup, called Xai, (explainable AI) a year ago. It just raised $6 b. at a valuation of $24 b. In one year! It took Google 6 years to reach that valuation. Are shareholders of Tesla so myopic as to vote against granting Musk what he is entitled, by agreement, to, and risk losing as CEO the person who has created visionary companies?

This is an example of a woke culture seeking to punish those who achieve and reward those who feel ‘entitled’ without building businesses that create value. One hopes that shareholders re-approve the pay package and save an innovative company leading the American EV battle. Musk’s time and effort should be spent on fighting the Chinese competition, not on frivolous litigation.

Another example, surprisingly, is 3M, which has hitherto been one of the most admired and innovative companies. As per this article  3M concealed the fact that PFAS, or perfluorooctanesulfonic acid chemicals, also known as forever chemicals, which it used in some of its products, had entered the blood stream of many users. It could be harmful.

So several great companies have been destroyed (like Lucent) or nearly destroyed but fortuitously rescued (Apple) or at risk of being destroyed (Tesla and 3M) because of management decisions, or shareholder pressure for quarterly performance, or woke culture or other reasons.

Similarly, countries.

The current US administration has succeeded in messing up almost every policy, including immigration (unchecked open borders), energy (from energy independence to dependence after Biden discouraged shale exploration), its budget (another day older and deeper in debt), and foreign policy (overuse of sanctions have stiffened the resolve of other countries to pursue de-dollarisation) and others.

The coming elections can become disruptive especially after the recent judgement of guilty in Donald Trump’s hush money NY case. More so if, on July 11 he is jailed.

Perhaps more dangerous is the approval, given by Biden, for Ukraine to use American weapons to attack Russia. Putin warns that this would be considered a red line, the crossing of which could escalate to, (egad!) a nuclear war! That’s sheer insanity.

The BSE Sensex dropped 449 points to close the week at 73961.

S&P Global has, for the first time in a decade, upgraded India’s sovereign outlook to positive. The rating remains unchanged at BBB- but S&P states that it could be upgraded if cautious fiscal and monetary policies reduce India’s debt and interest burden. S&P should explain why it’s US rating is AA- when the policies of its Government do nothing to reduce its debt (the world’s highest) and interest levels. It’s interest bill will exceed $1 trillion, and will be the largest item of expenditure, when the next President delivers his State of the Onion address, oops, Union.

Indian election results will be declared in the coming week, on June 4. This can lead to volatility if the BJP and allies tally falls short of expectations, which seems doubtful. Geopolitics in Russia, or in Mid East, can cause a crash, though.

Picture Source: https://images.app.goo.gl/8R3ADP3jRi2TTBEQA

For comments please write to jmulraj@asiaconverge.com