The U.S. economy easily is the most creative, resilient and powerful in the world. But for publicly traded companies in the industrial sector, times are getting tough. Wall Street does not look kindly on corporations that need to invest large amounts of capital in products that take years to pay off. Today, militant investors are demanding quick returns that are starting to hurt the American auto industry.
Mind you, these militants believe they are doing society a service. They see themselves as knights in shining armor who are shaking up sleepy boardrooms and forcing them to deliver better returns to shareholders. Quite conveniently, their philosophy also just happens to make themselves fabulously wealthy.
We saw this earlier this year, when a chap named Harry Wilson got the backing of four big investment firms to demand that General Motors give him a board seat and buy back $5 billion worth of stock. GM managed to stiff-arm his run at the board but caved in on the buyback, earning Mr. Wilson a big payout.
Let me think a minute, how did this turn out for General Motors? Oh yeah, all the stock it bought back is now worth hundreds of millions of dollars less, thanks to the recent market correction.
There’s a lesson here. If you truly want to help shareholders, then give them that money directly in the form of dividends. Otherwise, stock buybacks just help those who want to dump your stock.
Even more disappointing was that GM’s biggest shareholders never said anything about this. Not a peep. The UAW’s VEBA trust fund is the single biggest shareholder in General Motors. You’d think it would especially be opposed to Wall Street militants, but its silence was deafening. Warren Buffett, another major GM shareholder known for his long-term approach to investing, didn’t have much to say either. I guess if you stand to benefit from short-term gains why rock the boat?
And now the tempo is starting to pick up. JCI, one of the best suppliers in the business, just dumped its interiors and seating business, saying automotive returns are not good enough. FCA’s CEO Sergio Marchionne is pleading with other automakers to merge with him so he can get higher returns. And the automotive merger and acquisition activists are shifting into high gear.
But are automotive returns all that bad? Has anyone ever looked at other industrial sectors to see what kinds of returns they deliver? I have. It turns out that highly respected industrial corporations such as Boeing, Caterpillar and John Deere generate about the same returns as the better car companies. So why is it that auto-related companies are the ones in the crosshairs?
I think part of the problem is perception. Wall Street seems to think that automaker executives are simply not very bright, while the militants are supremely confident they are the smartest people in the room.
Then again, American automotive executives make it easy for the militants. Every year they hand out “guidance” to Wall Street, predicting exactly how much revenue they’ll bring in and how much profit they’ll generate. And then Wall Street holds their feet to the fire, every quarter, no matter what’s going on in the world.
When you have to close the books every three months, it can cause all kinds of problems. Companies about to miss their guidance have been known to delay new car programs, freeze hiring or even lay people off just to make sure they hit their numbers. That makes it hard to compete when European, Japanese, Korean and Chinese automakers don’t face this kind of financial scrutiny.
Earlier this year, Toyota created a new class of stock it calls Model AA. Essentially, it locks shareholders into holding their Model AA certificates for at least five years. Toyota says it needs a financial instrument that will allow it to fund long-term investments that won’t pay off for years. My bet is this is how Toyota will fund hydrogen fuel-cell development.
How will U.S.-based automakers compete against that? The simple answer is they can’t. As long as their system demands quick payoffs and higher margins, they will run their companies to placate the militants, not to delight their customers. And that’s how they will be slowly shuffled to the sidelines as their business migrates overseas.