Four dying SV companies

On Sunday, Chris O’Brien of the Merc wrote about four dying Silicon Valley icons. For some reason, it wasn’t posted to the website Sunday or Monday, but it’s there now. He aptly summarizes the problems of three of these companies, and I recommend anyone interested in innovation (or the Valley) to read the analysis.

In my reading, two of the companies are (effectively) single-product companies where their product is no longer compelling and increasingly no longer competitive. AMD once was threatening Intel on the performance front, and now they are asset stripping in hopes of raising enough cash to stay alive. Palm created the pen-based PDA and for a while was a leader in smartphones, but their Treo remakes have long since run out of steam and their last Hail Mary wasted precious time and money.

The other two companies are diversified systems companies which were built around the idea of integration and economies of scope. Their stories diverge somewhat, in that Sun Microsystems was the dominant firm in a category that’s been dying since the end of the dot-com era, while Yahoo is #2 in a category that’s still very much alive.

Still, there are important parallels. Sun has been cutting its way to greatness for years, and is still floundering in search of a strategy that will somehow make up for its loss of a raison d’être in a world of commodity Linux boxes. (Thank you, Intel).

Yahoo has only recent begun to emulate Sun by cutting its way to greatness — with cuts of 7% in February (announced in January) and 10% earlier this month announced back in October. Even their cutting is not being done well: pre-announcing them makes it like a water torture, and they are also cutting staff from its winners and not just deadweight.

However, Yahoo has been floundering for as long as Sun — ever since it hired Terry Semel back in 2001. Semel was cast off in 2007, but his successor hasn’t done any better.

O’Brien puts Yahoo in a separate category, because he thinks they will do a deal in Microsoft in 2009 that will pull them out of a tailspin. But I think Yahoo’s problems are systemic, and even if they make nice with Microsoft, that won’t substitute for a lack of a winning strategy.

So will Yahoo die in 2009? No, but neither will Sun: it has enough inertia (through enterprise sales contracts) to keep limping along for another decade or more, as did DEC and Unisys and Cray and SGI and all the other computer systems also-rans.

Still, if Yahoo doesn’t get a better CEO and better strategy, all its point successes (like Flickr and mobile) will be for naught.

Yet another stupid acquisition

One of the things that I teach my strategy undergraduates is that most acquisitions destroy value. Related diversifications realize less synergy than claimed, vertical integration locks a firm into a substandard supplier (or customer), any merger has culture, integration, and strategic defocusing problems.

Acquisitions make sense as an exit strategy for little companies: sometimes they even work, but either way they get to cash out. But, as I tell students, most big acquisitions are about the CEO moving up the rankings in the Fortune 500 (or increasing the base for a bonus based on revenues or net income).

There are always nominal reasons for the acquisition, but they are filtered and twisted to support what executives want to do. In the principal-agent problem, the principal (shareholders) gives the agent too much discretion and then shouldn’t be surprised when that delegation is abused.

This morning’s Exhibit 2,423 in the Stupid Acquisitions Hall of Fame comes from AMD. AMD admits that the $5.6 billion it paid 21 months ago for videochip maker ATI is now worth only $3.1 billion. Friday’s write-down of $880 million comes on top of a $1.6 billion write down in January. Despite punditry endorsing the deal two years ago, the company is struggling to service its $5 billion in debt and shares fell to a 16 year low. Value destruction doesn’t get any more clear or convincing than that.

The fundamental problem of acquiring public companies is that you have to pay more than the market price — so the claim is either you know better than the market (never true) or that you will realize synergies that increase the value of the acquired company (almost never true). So the choice is between buying overpriced good companies, or troubled companies not worth buying at any price. Acquiring a troubled company means you acquire their troubles — whether it’s exposure to an industry past its peak (AOL Time Warner, Viacom-Blockbuster) or a company with a justifiably lousy market position (Daimler Chrysler).

There's one other problem with megamergers — small numbers. Cisco makes more acquisition mistakes than any tech company in the world, but since they have more at-bats, they have more successes too. (Evidence suggests their batting average is much better than most). Big mergers are almost no upside and huge downside: think Sprint Nextel, or any of the recent Oracle acquisitions.

The poster child for diversification was once General Electric. Its extreme diversification has always meant a lack of financial transparency, which meant that investors were putting blind faith in management. That faith no longer appears justified: GE has missed projections two quarters in a row, and the stock is back where it was in May 2003 (and October 1998). Normally I don't like to inflict new (expensive) editions of the textbook on students, but I think we need one that drops the praise of GE’s diversification skills — which apparently only worked when management skills were scarce among its competitors.