Wednesday, December 10, 2014

Why Do Companies Go Bust?

Why do companies go bust?

Some weird tidbits in the news lately and things coming across my desk made me think about why some companies go bust while others carry on.

What got me thinking about this was that the folks at Sirius XM decided, for some reason, to send me a refund check for $23.49.   I had tried their service using one of their come-on three month pricing schemes, and when it expired, I called to cancel.   Like any good negative-option failing company (see, AOL) they claimed not to have received my cancellation, and then charged me for two more weeks, and then threatened legal action if I did not pay up.  Nice folks, eh?

So now they send a refund check, like somehow that makes it all right and I'm going to stick my hand on the hot stove again.   Think again.   These are the last gasps of a dying company and a dying technology.  As I wrote before, the kids today stream media through their smart phones.  The idea of paying $18 a month so they can listen to music in one car seems pretty idiotic to them - when that $18 pays a good-sized chunk of their cell phone bill.

And since the infrastructure for cell phones is nearly ubiquitous today, there is little reason to rely on satellites (which are expensive to launch) for something as pedestrian as radio.  A similar company tried this idea with telephones (Iridium) and went bankrupt.  The company carries on today, relieved of its huge debt burden through bankruptcy.  Sirius/XM I think will likely go a similar route - going bankrupt to relieve itself of debt, and then reorganizing as a low-cost company and offering the same services for a lot less money.  If you want this service, you might as well wait - it will get cheaper over time.

The problems with Sirius/XM extend to regular radio as well - which is dead or dying, thanks to smart phones.  The local radio stations here, it seems, change formats on a weekly basis - flailing and floundering and trying to figure out "what works" and never quite getting it right.   People stopped listening, as they can now stream through their smart phones - without a barrage of annoying ads.   

And people just listen to less music these days, I think, as our country gets older and older.   Styles change, technology changes, the legal climate changes.  And this means a lot of companies will go under.   And that's OK, too.  Trying to keep industries alive, long after they are obsolete, is never a good idea, particularly when you use taxpayer's money to do it.

I Fought the Law, and the Law Won

Legal changes can wreak havoc with a company, if they are not prepared for them.   Changes in the law, or court decisions, can shut down a company overnight.  Other changes in the legal climate can slowly kill off a company over time.  I wrote before about Aereo and how it went from Internet Start-Up to bankrupt, overnight, thanks to a Supreme Court decision, which in retrospect, was pretty  predictable. 

Uber, which I wrote about before, has the same problem, only in multiple jurisdictions.   They are running what amounts to a taxicab company, and saying that since it is an "app" it doesn't need to be licensed.   But an increasing number of municipalities are saying otherwise, and powerful interests (taxicab medallion holders) are pushing back.   It is only a matter of time before more and more of their market is curtailed by thousands of individual legal actions - which will be far harder to fight than a single court case.

Lawsuit liability is another area where a company can be bankrupted, sometimes overnight.   Companies selling asbestos come to mind.  Many of these companies went bust and then reorganized, leaving shareholders with nothing.

General aviation is another area where the legal climate drove many folks bankrupt, and others out of the market.  Small airplanes are so expensive that they generally are not "junked" like old cars are.   Many flying today are from the 1940's through 1970's and have been rebuilt and overhauled and modified numerous times.   They generally don't go out of service until they crash.   At that point, the family of the pilot sues the manufacturer, claiming that a factory defect from sixty years ago caused the plane to crash.   These suits are, of course, nonsense.   But the major General Aviation manufacturers all withdrew from the market as a result.  Until Congress passed a statute of repose that shielded these companies from open-ended liability, the business was basically dead, at least in the United States.

Anti-Trust is another example where the legal climate can change to the point where a company can go bust - or at least be chopped up into smaller pieces as was the case for Standard Oil.   In more recent times, however, it seems that these suits are little more than a nuisance.   IBM was hounded for decades with an anti-trust suit (which was well-founded) but by the time the case was settled, IBM was no longer  a major player in the computer industry.

A similar suit is pending against Apple for anti-competitive practices with its iPods.   Again, streaming on smart phones is the new way people listen to music.  The suit is slated to go to trial shortly - and most of the jurors probably won't even know what an iPod is.

Technological Obsolesce

Which brings us to technology.   Hardly anyone uses an iPod anymore.  But the iPod itself obsoleted the portable CD player, which in turn obsoleted the Sony Walkman.   Technology becomes obsolete in short order, and once high-flying companies often find themselves falling rapidly when "the next big thing" takes over.   Blackberry arguably invented the smart phone market -  combining the ill-fated "personal assistant" with a cellular telephone.   Today, they struggle to survive, and their epitaph has been written again and again.

And this cycle seems to be getting shorter and shorter.   No longer can a company expect to be able to sell a product for decades or even years.  Often 24 months is the length of the design cycle, before "the next big thing" kicks in.

Bookstores used to be ubiquitous.   Every mall had one, and of course, the major bookstore chains took off in the late 1970's and early 1980's.   Today, one chain remains, teetering on the brink of bankruptcy.   People now shop online for books, or download them to their pads or Kindles.   Many others just stopped reading altogether (it is a dying fad) just as many folks listen to a lot less music these days.

The trolly companies and passenger railroads went broke - and were bought up by the government - when people stopped using these services.   While we like to be romantic about these older forms of transport (and some folks think our tax dollars should be spent to bring them back) the reality is, people preferred their cars - and airplanes - over these slower and less convenient forms of transport.  The great ocean-going liners were similarly displaced by new technology and new patterns of consumption.  The jet age killed the great liners - and the railroads.  People voted with their feet - and their pocketbooks.

The Elements of Style

And part of this is due to Styles and Patterns of Consumption.   A website or an online game can be wildly popular one moment and then forgotten the next.   For about 18 months, the media could talk about nothing else but Groupon, and how this "hot new company" was going to take over the Internet.   Not long thereafter, the company stock price plummets, and the CEO is ousted, as the fad evaporates nearly overnight.

Sears, J.C. Penny, and Radio Shack are struggling (and arguably in their dying throes) as they were once mall staples and malls are going bust.   Fewer and fewer people "shop" in malls anymore.   Many prefer strip malls.   Many more go to Wal-Mart, particularly as the middle-class (once the core demographic for the shopping mall) evaporates.   Many more still shop in wholesale clubs or online.   People are less interested in buying things in designer stores - carrying home the shopping bags of "name" department stores, but rather getting certain brand-name goods at the lowest possible prices.
Companies wax and wane in popularity - as do their products.   And some of this has to do with style more than substance.   Twenty years ago, you'd be hard pressed to find a "coffee shop" in any town or even fairly large city.   Then suddenly, the coffee  craze ignited and you can't walk a block without stumbling into a Starbucks.

Thirty years ago, we all had big stereos in our living rooms - and paid dearly for them at the local stereo store.   Today the store is out of business.  People have "surround sound" systems or listen to iPhones through beats headphones - which itself we were told was a billion-dollar "empire."   I wonder what ever happened to that?  I mean, that was like almost ten months ago, right?  Did Apple overpay for headphones?    Isn't that a pretty competitive business?

Abercrombie made news recently when its iconic CEO (worst.facelift.ever!) stepped down - as sales slump in its mall-based stores.   I hate to admit it, but Mark has two Abercrombie shirts and a hat - all bought at garage sales for about ten cents each.   From $70 trendy mall costume to garage sale fodder.   Now appearing on a homeless person near you!   That's how styles are - this is not some weird or unusual thing.   Seen anyone in a Benneton sweater lately?   Of course not.


The malls fell from fashion due to changes in shopping habits.  Hanging out in the mall was no longer seen as cool or novel, but rather a dreaded experience.  (And one other reason not talked about - people just don't walk anymore.  They'd rather drive right up to the door of a store than walk through a mall).  But more importantly, other retailers offered lower prices and a more pleasant experience.   Competition killed the malls - companies offering better goods at lower prices.

There will be a lot of books written about why GM and Chrysler went bankrupt.  But a more interesting question is why did they stay in business as long as they did?   By the late 1970's, Japanese cars were already developing a reputation for quality and, at the time, low cost.   By the 1980's. Japanese cars were more expensive than their American counterparts, and yet sales increased even further.  Customers got tired of buying mediocre cars that fell apart before the loan was paid off.   And since they now had a choice in the matter, they took their business elsewhere.

The same is true for nearly every other industry - even industries that are monopolies.   When someone exercises monopoly power, people often seek other technical solutions - even if they are less efficient.   The wood-burning faithful don't spend half their lives cutting and stacking firewood because it is cheaper, but rather because they dislike paying money to a monopoly energy provider

So What Does This All Mean?

Investing in the future is a difficult task at best.   It seems that eventually, over time, nearly every company goes bust.   And companies that never pay a dividend will never pay back their shareholders, over time.   As Nevil Shute Norway noted in his book Slide Rule, the original investors of his company Airspeed, were paid back their original investment (but not with any interest or dividends) when the company was finally sold to DeHavilland.

As an investor, you might very well ask yourself, "what was the point of all that?"   I mean, after all, you invest in a company, it operates for a couple of decades, and all you get out of the deal is your money back and nothing else.

Granted, some folks made money, when the bought the stock at a low price and then later resold it at a higher one.   Many more, of course, did the opposite - buying high and selling low.   The actions of these speculators, of course, is just background noise and distracts most folks from the underlying signal - what is actually going on with the company or industry in question, and what the overall story arc is going to be.

There are some companies, of course, that do stick around a while.   Maybe they eventually go bankrupt, but over the years, they pay dividends.   Even if a shareholder loses his entire investment after 20 years, chances are, he made a similar amount of money in dividends.  Of course, the tax savings from his capital loss don't necessarily offset the tax burden from his dividend income.  It gets complicated and ugly.

Today we are seeing a lot of the same sort of things going on as in years past.   Apple is talked about as a "Trillion dollar company" and one of the largest in the world - based on "Market Cap" which is misleading.   Yet, time and time again, we have seen in the past how Apple briefly flares into the spotlight with a hot product - and then fizzles into the background.   The Apple II computer was briefly popular and then wiped out by the IBM style PC.   The Macintosh was never really a serious player, being very costly to buy.   The iPod enjoyed its day in the sun for about a decade, but ironically it was another Apple product - the iPhone, which made it obsolete.

The question remains whether the iPhone will be obsoleted by yet another product, down the road.  Already the smart phone market is voting Android over Apple by a factor of 2:1 - and rising.   Yet for some reason, no one identifies the market for smart phones with Google.  To be sure, there is a style factor with Apple, as people like to show off their expensive phones (the gleaming Apple logo tells others you can "afford" to pay extra for an Apple product).

But there may be trouble already on the horizon for Apple.  Sales of the iPad have tapered off in recent months.   Analysts offer a number of reasons why.  First, everyone who wanted one, has one.  Second, you can buy a Droid pad for as little as $99 - or about 1/5th the cost of an Apple pad.   Third, since most pads are not tied to a phone contract, there is no incentive to "upgrade" to a new pad at the expiration of every phone contract, as many phone users do (not realizing that their phone upgrade is not "free" but rather folded into the cost of the monthly phone service).  Fourth, since you can't put your pad in your back pocket, it doesn't break as easily as an iPhone.

In order for Apple to continue to succeed, it has to be able to sell its phones for more than double the current market value for non-Apple smart phones (which have similar, and in some cases, superior features), or like when the iPod faded, come up with the "next big thing" to sell when the existing product sales start to dwindle.   As noted in a recent article about iPods, the cost of an iPod today is actually less than it was back when they first came out.  Once a product becomes a commodity, the best you can hope to command is commodity prices.

And over time, I think the same thing will happen to iPhones as well.   These are commodity items, and no longer able to command monopoly prices.  Unless Apple can come up with another 'must have' product, they won't be able to generate the kinds of profits necessary to keep the share price where it is right now.  As I have noted in the past, Apple's business model is premised on each product being a home-run out-of-the-ballpark hit.   Apple's competitors need only make a base run hit or at least not strike out, in order to survive and prosper.

For other companies, which are selling even more ethereal things than cell phones, the problem is even greater.   Website-based companies like Facebook, Groupon, Linkedin, Twitter, and the like, are all based on the idea that the site is popular and that people will continue to find the site in style and not migrate to another site which may be more in style or trendy.   Again, recent trends in Facebook users are somewhat alarming in this regard, as the site is losing teen and 20-something users and gaining over-55 users.  In terms of trendiness, this does not bode well.  Facebook is going from "hip" to "hip replacement surgery".

For the small investor, this all seems very confusing.   After all, the media talks all the time about Facebook and Apple.   In fact, they seem to talk about nothing else.   And if you go online to most financial websites, what do you see?  Share price and not much else.   Things like earnings and dividends are not deemed to be sexy, and if you see stock data for a company, usually these things are not displayed on the main page - but on subsidiary pages or "research" pages you have to load separately.  The stock analysts talk about nothing but share price - and whether it will go up or down.   The underlying picture is often obscured by a lot of happy talk.

Yes, it is possible to make a lot of money in stocks by speculating.   It is theoretically possible to make a lot of money gambling in a casino, too.  In reality, of course, if you sit in a casino long enough, the law of probability states that you will eventually gamble away all of your money.   And I believe the same holds true for stock speculating as well.   You can gamble on a share price going up, (or even on it going down, with options trading).   But unless you have some inside information (which is illegal) stock-picking, with the idea of making money on variations in share price, is mostly gambling.

This is not to say that buying individual stocks is always a bad idea.   When I started out investing in stocks, I was like most people, watching the television and worshiping at the altar of the almighty share price.   I listened to the financial networks and the financial pages and bought stocks based on their comments and advice.   But a small voice in the back of my head kept saying, "Gee, everyone else is getting this same advice - how can this be a good way to invest?"

And since then, I've learned to listen to that small voice.

As it turned out, stock picks were the exact wrong way to go.    When a company was mentioned in the news, the plebes like me would go out and buy it.   The next day, the stock would rise, and we would all congratulate ourselves on being smart investors.   Hey we must know what we're doing, right?  After all, the credit card company just told us how financially solvent we were by offering us a $10,000 increase in our credit line (at a low, low 18%, right?).

But over the long-term, many of those stock picks turned out to be anything but winners.  Why was this?  Because I didn't understand the fundamentals of the underlying business - but was buying based on share price and hype.

Let me give you an example.   Cemex is the Mexican cement company, and about a decade ago, I bought this stock after hearing a "stock analyst" on television (I think it was Fox News, no less) saying he thought the stock was "going places".   Apparently the toilet was one of those places.

The stock did take off - after all, when millions of plebes buy, the price goes up.  The law of supply and demand takes hold.   But then a funny thing happened - the stock tanked.  Why was this?   Well, as it turns out, the cement business is a commodity business.   Every local town and city has a cement plant, and the competition to make cement is pretty fierce.   You can't corner the market in cement, and Cemex found this out the hard way.

Of course they are still in business and you see their trucks around sometimes, but in retrospect, there was no real "there" there - just a regular commodity business, subject to competition (and the economy) and no real reason to justify a jump in share prices.  Today, the company has a negative EPS - which means it is losing money.  From media darling to dumpster, all in about five years.

I learned from that mistake, and stopped listening for "stock tips" and instead looked for companies that were in it for the long haul.   Instead of looking for "the next big thing!" in terms of some stock that was supposed to "take off!" I looked instead for regular, dividend-paying stocks from companies that had a good track record, a sound business plan, and a decent product that looked like it might stay around for more than 18 months.

And over the years, this portfolio has done well.   With the dividends accumulating every year, I buy another stock, further diversifying the portfolio, so I am not dependent on one stock making it big - or going in the tank.   Do the stocks go down?   Well they sure did in February of 2009 - even as they paid dividends all the way down.   But these profitable companies were the first to recover and prosper.

Of course, this is not to say that dividend stocks are the only thing to invest in.   Invest in a number of things, and over time, you'll make money.   Invest only in one, trendy, thing, and over time, you will likely go bankrupt, unless you are one of the lucky few who picks the right "thing" and also knows when to sell out in time.

But with so many factors working against them, it is amazing that any company these days stays in business for very long.   Because over the long haul, it seems, every company goes bust, eventually, as the times change, styles change, the legal environment changes, and competition levels the marketplace.

Stocks are not forever, as many folks like to say.   But then again, they should last longer than a year or two.   Short-term trading is not investing.   It's just gambling.