Break Up the Washington Post Corporation

If I told you that a company had the following business units, what would you say? 

• an education and test preparation business
• a set of local television stations
• an internet company that helps churches engage in outreach and raise money
• a company that makes components for industrial furnaces
• a home healthcare and hospice provider

Most analysts would say that this company has a scattered strategy.   The company: the Washington Post Co. - or whatever it will be called now that Jeff Bezos has bought the flagship newspaper for $250 million.   With the newspaper gone, the Washington Post Co. will soon face pressure for more strategic change.  Investors will argue that this unrelated diversification strategy makes no sense.  Investors can diversify risk much more effectively and less expensively on their own.  They don't need the executives at the Washington Post Co. to do that diversification for them.  

Most people are focused on the Bezos' acquisition right now.  They are examining the future of the newspaper.  Can Bezos transform it?  Soon, though, many eyes will turn to the company that remains.  Expect investors to push for more change.   They will, rightfully, demand a clear strategy moving forward.  The key question: What does the Washington Post Co. want to be moving forward?

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Is the Sum of the Parts Worth More Than the Whole at Sony?

In May, hedge fund investor Dan Loeb proposed a break-up of Sony, the Japanese electronics and entertainment giant that has struggled over the past decade.   Actually, he's not proposing a complete break-up, but rather an initial public offering whereby Sony would sell a 20% stake in its music and movies business to outside investors.  Loeb argues that the sum of the parts is greater than the whole.  Sony has an entertainment division that produces movies (Skyfall, Spiderman) and represents recording artists (Adele, Springsteen).  The entertainment division has been more profitable than the electronics division in recent years.  Investors recognize that Sony has been subsidizing losses in areas such as its television business with profits from its entertainment division.   Sony also still owns a majority stake in a firm called Sony Financial Holdings, which operates in the banking and insurance business.  Here's an excerpt from a Bloomberg article about Loeb's push for a partial break-up at Sony:

The value of Sony’s entertainment division -- which makes the “Spider-Man” movies through its Culver City, California-based Sony Pictures and also represents music artists including Grammy winner Adele -- isn’t being realized in the company’s current structure, said Michael Souers, an equity analyst at Standard & Poor’s.  “It’s totally being weighed down by the struggling consumer electronics unit and the fact that it’s had to subsidize that unit,” Souers said in a phone interview from New York. A partial spinoff “would make sense for them. And from a managerial perspective, they could focus a little bit more on turning around the electronics business.” A sum-of-the-parts analysis by Christian Dinwoodie, a Tokyo-based analyst at CLSA, values Sony at 2,400 yen a share, 28 percent higher than its price May 14, before Loeb’s proposal lifted the stock. Spinning off part of the entertainment business would give Sony an infusion of capital and allow it to transfer some debt to the new entity, Dinwoodie wrote in a May 14 report. 

In late June, Sony CEO Kazuo Hirai announced the board of directors would be conducting a thorough review of the Loeb proposal.   The board has yet to make a decision on the Loeb proposal, to my knowledge.  Will Loeb succeed in his efforts?   It will be a tough slog, given that activist investors from foreign countries have not fared well historically in Japan.  Having said that, Sony did sell a stake in its financial services business several years ago; there is precedent for a refocusing of the company's strategy.  

Sony should consider Loeb's proposal seriously.   Years ago, many firms pursued strategies that combined media content with hardware/electronics businesses.  Most of those companies failed to realize the purported synergies.   Focused firms outperformed many of the integrated players (think Apple outmaneuvering Sony, not by owning media content, but by negotiating to secure access to content for iTunes).   One of the problems with integration in the entertainment business is the conflicts of interest that arise.  If you tailor content to your devices or vice versa, you run the risk of losing certain customers and partners. CEO Kazuo Hirai will have to explain clearly how he will make synergies materialize between the two arms of Sony, if he wishes to allay the concerns of investors.   If he holds onto both businesses, he has to explain why the entertainment business isn't going to continue subsidizing unprofitable elements of the electronics business. 

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Iger's Long Term Strategy at Disney

As you know by now, Disney acquired Lucas Films last week. With that, Disney now owns the Star Wars and Indiana Jones franchises. I'm not surprised by the move. In fact, you can see a pattern emerging to Bob Iger's strategy at Disney, which is quite in contrast to the strategy during the second half of Eisner's tenure at the company. In Eisner's later years, he moved away from simply focusing on the characters as the central driver of synergy among Disney's businesses. He acquired ABC and Miramax, and he owned a baseball and hockey team for some time - among other moves. Now we see Iger refocusing on characters as the heart of Disney's corporate strategy. We see three major moves (Pixar, Marvel, and now Lucas) during his tenure that all involve expanding the universe of characters which Disney can leverage across its many businesses. I think the focus on characters makes a great deal of sense. Here's why...

When thinking about the characters at Disney, we should note those resources are quite valuable because they are highly durable and inimitable. Moreover, Disney can appropriate the value associated with those resources (as Buffett says, "the mouse has no agent"). How then can one think about leveraging such a valuable resource across multiple businesses? A strategist needs to think about how specialized vs. fungible/general the resource is. A highly fungible resource/capability would be something like “brand management expertise” or “innovation” or “risk management.” A highly specialized capability might be patented product formulas or engineering expertise in a very narrow discipline. Fungible capabilities can be easily transferred across lines of business. However, they are often too general/not unique enough to convey a substantial competitive advantage. On the other hand, highly specialized capabilities tend to provide powerful competitive advantage in a particular business, but they lose value very quickly when a firm tries to transfer them to a wide array of businesses. In other words, there are only so many areas in which you can grow based on a highly specialized set of capabilities.

In the 1980s, Disney’s core capabilities revolved around animated character development and deployment. Those tended to be highly specialized capabilities; Disney was able to leverage those capabilities to enter the hotel and cable television business, but ultimately, growth was constrained by the specialized nature of that capability. To move into even more diverse businesses, Disney had to be able to make the case that it had a broader/more general/more fungible capability such as “managing creativity.” That's the argument that Eisner used to move into a variety of businesses that did not have to do with characters (ABC, Miramax, etc.) There are two challenges associated with defining a firm’s capabilities so broadly. First, it is more difficult to make the case that the firm is truly unique and superior to all rivals in that set of capabilities. Second, it becomes rather difficult to discriminate among various options for diversification, i.e., how many businesses have something to do with managing creativity vs. developing and deploying unique characters?

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The Washington Post Enters the Healthcare Business?

Reuters reports this morning that the Washington Post has acquired Celtic Healthcare, a home healthcare and hospice services provider here on the east coast of the United States.   I have to admit to being puzzled by the move.  I'm curious to learn more about the rationale for this acquisition.   As many of my readers know, the Washington Post has moved away from a reliance on the newspaper business given the disruption that has taken place in that industry.   For a number of years, the company generated strong growth from its other major line of business - the Kaplan education unit.  However, that unit has been plagued by the controversies surrounding for-profit educational institutions in the past couple years.   Therefore, perhaps the Washington Post is looking for another new line of business from which it can generate the growth that is lacking in the core newspaper business.    The question, though, is how investors will react to what looks like a strategy of unrelated diversification.  Why would the Washington Post be better at operating a healthcare company that a firm focused in that industry?  

Reuters offers a brief statement by Donald Graham, CEO of the Washington Post, explaining the deal:  "Our acquisition of Celtic Healthcare is part of the Post Company's ongoing strategy of investing in companies with demonstrated earnings potential and strong management teams."  While that may be true, strong earnings and great management talent alone do not justify an acquisition in an unrelated business (in most circumstances).  The question is what value can the Washington Post add to this business.

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Diversified Firms in Emerging Markets

Harvard Professor Tarun Khanna has conducted extensive research on large business groups (conglomerates) in emerging markets.  He has found that the so-called conglomerate discount doesn't exist in many emerging markets.  Why?  Khanna argues that institutional voids exist in these countries.   Capital, labor, and product markets are not very efficient.  Therefore, large organizations and their management teams fill these "voids" in those countries.  In other words, the conglomerate serves a useful function, because it does what the efficient labor, product, and capital markets do in more developed countries. 

On the other hand, in more advanced economies like the United States, unrelated diversification makes much less sense.  Investors, for instance, can diversify risk quite inexpensively on their own; they don't need a CEO to diversify into many unrelated units to reduce risk.   That type of strategic move proves far more expensive than simply having the investor buy an index fund to achieve risk diversification.  

A new paper by Venkat Kuppuswamy, George Serafeim, and Belén Villalonga examines this concept in more detail.  They look at capital, product, and labor market efficiency in 38 countries over a 15 year period.   They find that the value of corporate diversification does indeed fall as capital and labor markets get more efficient.   However, they did not find a significant effect for product market factors.   In sum, corporate strategy should look different as we move across the globe, and not just because of cultural differences.  Fundamental differences in the institutional environment call for different approaches to corporate strategy as we move from more advanced economies to emerging markets. 

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GE: Changing the Vaunted Leadership Development Model

GE appears to be making a significant shift in its leadership development philosophy.  According to the Wall Street Journal,

The conglomerate that once groomed jack-of-all-trades generalists is now betting on deep industry experts instead. The shift is a change in philosophy at a corporation that for decades had made a rigorously applied but generic management tool kit central to its identity. Like all companies, GE wants some of both traits in its leaders, but the balance has tipped toward expertise. For years, GE wanted its top managers to be experts in managing. Now, it's increasingly looking for them to be deep experts in their fields. Rather than purposely relocate its senior leaders every few years to expose them to more of the company, GE now is leaving them in their business units longer than it used to, in hopes their deeper understanding of products and customers will help them win sales.

Susan Peters, head of leadership development at GE, explains the need for the change: "The world is so complex. We need people who are pretty deep." Interestingly, this shift in philosophy has occurred as the firm continues to face critiques of its corporate strategy. As this article on Forbes.com suggests, GE may be trading at a conglomerate discount because of its complex unrelated diversification strategy.   For years, GE remained an exception to the rule when it came to unrelated diversification.  Its whole was worth more than the sum of the parts, in contrast to many conglomerates that have since broken up.

When a firm pursues a conglomerate strategy, it strives to achieve governance economies.  Governance economies emerge when a firm shares management systems, processes, and talent across a variety of businesses.  Most related diversified firms, such as Disney, strive for scope economies - i.e. synergies through the sharing of intellectual property, manufacturing plants, distribution channels, and the like.   A conglomerate often does not have these types of synergies, so governance economies become critical to justifying the fact that so many seemingly unrelated businesses are being kept together.   However, if GE isn't sharing management talent across the businesses as much any longer, then it seems as though governance economies will shrink.  Of course, the units will still share many excellent systems and processes.  Those processes can be a key source of governance economies.  Will that be enough to convince investors that the parts are worth more together than apart?  That will be the key question moving forward. 

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Another Break-up at Tyco

The recent burst of break-up activity among diversified companies continues.   Tyco has announced its intention to break up into three separate firms:  security, fire- protection and flow-control.    The split follows a 2007 break-up in the wake of the Kozlowski scandals.  At that time, Covidien and TE Connectivity became independent companies.  With this announcement, the Kozlowski empire has been dismantled completely.   I'm not surprised by the move.  The firm had become more focused after the 2007 spin-offs, but it still remained a company with limited synergies among these business units.   In an era of lower economic growth, firms cannot justify these diversification strategies as easily.  They have to show the economic value of diversification.  If not, they must try to create shareholder value by freeing the units to operate as independent, focused companies.  In the past, economic growth masked some of these sins of diversification at many firms.

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