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Company directors often show a worrying surfeit of ambition. The London market is littered with the wreckage of companies whose management saw a storm coming and thought it could be navigated safely.
Consider, for example, Yell Group. The publisher of telephone directories spent more than £3bn on acquisitions since its flotation in 2003. The aim was to broaden its reach and remain relevant to customers moving their business online. But Yell’s market value excluding debt stood at £85.5m on Friday, with the shares down 99 per cent since flotation.
HMV tells a similar story. Purchases of bookshops and a live events organiser failed to stem the decline in its core business of CD retailing. Fire sales followed to pay down debt. Acquisitions costing around £75m have over the past decade produced 98 per cent value destruction for shareholders, leaving the company with a market value on Friday of £17.5m.
A survival instinct is natural in chief executives but it can mean danger to investors. There can be no doubt that the shareholders of Yell and HMV would be better off if their directors had abandoned hope of reinvention and began a managed decline.
The same can be said of hundreds of companies that fought decades-long battles to stay relevant in the face of obsolescence, such as Marconi and Radio Rentals. By contrast, successful transformations of embattled companies are rare. So why would any investor want to put money on a company battling its own existential crisis?
Of course, such arguments involve considerable hindsight. Neither chief executives nor investors have shown much ability in identifying whether they were facing a downturn that is largely cyclical or structural. And, if it proves to be the former, bargains can be had.
Results from Home Retail Group this week may demonstrate the point. Its Argos chain has been facing unrelenting pressure. Annual earnings for the catalogue retailer fell 57 per cent as like-for-like sales and profit margins hit multiyear lows. An independent consultant was drafted in to review the group’s future, though analysts expect no conclusions before autumn.
Argos has been a victim of a slump in video games and electronics purchases moving online. This has left the company trading at little more than the value of its net cash balances and debtor book, which Société Générale puts at 71p per share. With Home Retail closing at 81.3p on Friday, the retail business could be seen as being nearly worthless.
Yet there is hope. Chief executive Terry Duddy has confidence that Home Retail can use its market-leading position for toys in combination with a reinvention plan that allows shoppers to pick up what they order on the same day.
There is no reason yet to believe that Home Retail will be worth more to investors dead than alive. His confidence could be misplaced but, if Mr Duddy is proved right, the shares will re-rate.
A tougher case can be made for Man Group, another company whose results this week showed signs of existential crisis. The hedge fund has suffered £1bn of outflows in three months and its shares are mired at an 11-year low.
Man’s problem is AHL, a trend-tracking fund that has underperformed the FTSE 100 in nine of the past 12 quarters. Chief executive Peter Clarke seeks no blame for this, and rightly so. The fund is, after all, powered by a black box that makes its trades with minimal human intervention. So, by the same logic, he should feel no guilt if it were decided that AHL had passed its period of usefulness.
Two years ago, Man Group opted to take the reinvention route with the purchase of GLG Partners at a cost of £1.1bn. Buying a more conventional fund manager was intended to transform Man by reducing its reliance on AHL’s performance. But Man’s market value as of Friday was £1.6bn, with shares down 60 per cent since the acquisition was announced. The plan has not worked; at least not yet.
According to UBS analysts, winding down AHL would put Man on a break-up valuation of 100p apiece. Man closed on Friday at 88.8p so, at least on paper, abandoning all hope could be in shareholders’ interests. It should surprise no one that management disagrees.