Why Companies Stumble
Failure is more likely to result from corporate overreaching than from complacency.
In his best-selling chronicles of business excellence, Built to Last (1994) and Good to Great (2001), author and business consultant Jim Collins explained how successful companies get that way and what they do to stay on top. As you might expect, the passage of time hasn't been kind to all the companies on which Collins heaped well-deserved (at least at the time) praise. Motorola and Ford, for example, weren't quite as "built to last" as expected. Fannie Mae and Circuit City went from paragons to disasters. Now Collins has published another thoroughly engaging book, How the Mighty Fall ($24), turning his attention this time to why once-great companies decline.
Big isn't always great. Investors can gain a lot of insight from Collins's new book. He finds, for example, that failure is much more likely to result from corporate overreaching than from complacency. In confusing "big" with "great," companies put themselves on the road to ruin by overdiversifying, moving into businesses in which they cannot be leaders and growing beyond their management's capacity to execute effectively.
Even as managements overreach, they allow the strategic and operating discipline that often characterizes corporate success to erode. Denial becomes a problem, too. Executives discount negative results and blame setbacks on external factors. They suffer from "imperious detachment," often signaled by excessive compensation and perks -- characteristics much in evidence among flailing companies during the financial crisis.
To us, Berkshire Hathaway (symbol BRK-B) is the antithesis of Collins's well-described disaster-in-waiting scenario. Under Warren Buffett's direction, Berkshire's performance has been remarkable over the past two years. His disciplined retention of capital looked overly cautious for many years. But when the crisis hit, Berkshire was ready to deploy tens of billions of dollars in some terrific businesses, including Goldman Sachs and General Electric, on highly favorable terms.
Although Berkshire's stock is down 23% since late 2007, we believe the company's value has continued to rise. We value Berkshire's operating businesses -- a widely diversified portfolio that includes insurance giant Geico, various utilities and dozens of other businesses, ranging from Burlington Northern Santa Fe to Dairy Queen -- at over $33 per Class B share. Add to that the estimated value of Berkshire's investment portfolio -- almost $62 per share -- and our value per share totals $95. That's 24% higher than the B shares' post-split price of $77 in mid February.
A cheap but risky bet that is also among our top holdings is Iridium Communications (IRDM), which operates a fleet of satellites in low orbit above the earth. It would be a stretch to call Iridium a great company, but it is one that has reversed what Collins describes as the difficult-to-stop death spiral that many failing companies enter. Identifying such turnarounds can lead to great investment opportunities.
Once ridiculed for clunky phones that didn't work inside buildings, Iridium filed for bankruptcy reorganization in 1999. It has long since recast its business model, however, and is growing rapidly by focusing on commercial and military applications for communications services in areas where wired and terrestrial wireless services don't reach.
Iridium's stock went public again last September, but the shares have fallen because of the company's checkered past and concerns that it may have difficulty funding its next generation of satellites -- concerns that we think are misplaced. With the stock at about $6.60, Iridium's market value of $461 million, less debt, is a mere 2.2 times earnings before interest, taxes, depreciation and amortization. The closest comparable company, London-based Inmarsat, trades at about ten times the same measure.
Columnists Whitney Tilson and John Heins co-edit Value Investor Insight and SuperInvestor Insight. Funds co-managed by Tilson are short the shares of Fannie Mae.