Friday, April 30, 2010

Corporate Life Cycles and Investor Relations, Part 2

In my last post I wrote about the commonality between the product life cycle chart and corporate life cycles and some of the implications this has for investor relations. To recap, where you are in terms of your corporate life cycle is a large determinant in whether you get Growth, GARP, Value or Deep Value investors. As each of these different styles of investors is willing to pay differing amounts for your future earnings, the valuation you get in the stock market will in no small degree be influenced by where investors view you in your life cycle. To carry this one step further, in this post we will look at how companies seek to avoid the point at which they transition into a mature, and then declining company and how successful this is in avoiding a declining P/E ratio.

In product development, when a product threatens to become mature, the marketing people move in and try to rejuvenate and refresh the brand by introducing new product features and formulations or market applications. The idea is to boost sales volume and market penetration. Nobody wants to get to the point where a product is mature, verging on stale, and headed for inevitable decline. In graphical terms, what they do looks like this:

Companies do the same thing. A great example of a company continually reinventing itself via new products and markets is Apple. First Apple was a computer company. Then they introduced the iPod and iTunes. This was followed by the iPhone, Apps and now, the iPad. Apple has been incredibly successful in this approach, helped by great design and engineering, creating a tightly integrated suite of products that customers love. And the stock market has richly rewarded them for this. As of this writing, Apple stock is trading at a P/E ratio of 23.8, placing it in very exclusive territory for companies with over $100 billion in market cap.

Companies do not do this with just new products, however. Companies attempt to extend their progress up the growth curve through acquisitions, entering new markets, entering new territories, going global, reengineering their work processes, expense initiatives and a raft of other things too numerous to mention. In doing this they hope to extend their growth and the premium investors will pay for their future earnings. The problem with all of this, from an investor’s viewpoint, is that the new products, programs and initiatives don’t have a track record. Therefore, the certainty with which future earnings from these programs can be predicted is less than it is for existing operations and the willingness of investors to pay up for the incremental earnings is less. Unless and until a company can establish a track record for successful entry into new products or markets or initiatives, investors will discount the future earnings at a greater rate than the old familiar type of earnings. Investors just don’t like uncertainty. So revenues may go up; earnings may in fact also go up, but P/Es will fall until a company can demonstrate that it has as one of its core competencies the ability to extend its growth with new initiatives.

Again, if we look at Apple, the first Ipod was introduced on October 23, 2001. Following the announcement of the new product, one that turned out to be revolutionary, Apple’s stock price didn’t do much for the next couple of years. Investors had a wait and see attitude.

This, of course, drives corporate management nuts. They have invested millions of dollars in a new initiative through design and engineering, consulting fees and countless meetings and studies. They are embarking on a bold new strategy to push their company forward for the next millennium. And yet, in their view, the market doesn’t get it.

Investor relations professionals should learn to recognize this type of fact pattern and be ready to explain to management why the stock didn’t jump when the CEO’s latest initiative was announced. Much heartburn can be avoided if companies take a realistic approach to how the market values new corporate actions. There is no real way around this – companies have to prove themselves to investors on new initiatives to a far greater extent than for existing operations. But as witnessed by Apple, it can be done.

Monday, April 12, 2010

Corporate Life Cycles and Investor Relations

I’ve written before on some of the relationships between marketing and investor relations and I’m at it again today. In marketing there is a well-known graph known as the Product Lifecycle Curve, which I’ve set out below.

The graph points out how products are first brought to market and purchased by early adopters, then go through a phase (if they are lucky) of rapid takeoff and growth. Once the product has achieved wide spread acceptance, the growth cycle slows down, and after a period of maturity, decline inevitably sets in. The speed at which all of this occurs depends in large part on the nature of the industry and the aggressiveness of competitors. Tech gadgets, for example, have much shorter product life cycles than say, breakfast cereals.

The interesting thing about the product lifecycle is that it has applicability to a number of other things, corporate lifecycles included. Stop thinking about products and substitute corporate development and the graph doesn’t change. Where this is of interest to investor relations professionals is in the type of investors each phase of the cycle attracts. Set out below is the same graph with investor segments sketched in.

One of the interesting things about the graph is that as you move on the life cycle line from left to right, the price/earnings ratio that investors are willing to pay for a stock declines. This is because investors perceive that the rate at which future earnings will accrue to the company is slowing and they are therefore willing to pay less for that future stream of lessened earnings.

Companies often struggle with this, particularly at the inflection points between stages. Company executives will say, “We’re a growth company – look at our record. The market is undervaluing us.” Investors, on the other hand, will look forward and say, “Nope, you’re a mature company. Your big gains are over and we’re not going to pay a premium for a company that is going to grow at the rate of the market.” Many an antagonistic relationship has been fostered based on this differing view of the world.

There’s more that can be said about this (and I will in later posts), but if I don’t run out now and buy an iPad, I will lose my status as an early adopter…