Breaking Up L Brands

CNBC reported this week that hedge fund Barington Capital has called for a break-up of L Brands, the parent company of Victoria's Secret as well as Bath and Body Works. James Mitarotonda of Barington Capital called upon the company to address the poor performance of the Victoria's Secret business.   He noted, "We believe that the declining performance of Victoria's Secret is primarily due to merchandising missteps and the failure to maintain a compelling brand image that resonates with its target consumers."   Mitarotonda pointed out that, in contrast, Bath and Body Works has performed exceptionally well in recent years.  Therefore, he would like L Brands to split into two separate firms.  He argued that investors are not placing "appropriate value" on Bath and Body Works because of the struggles at the Victoria's Secret business.   The proposal comes on the heels of news earlier this week that Target plans to unveil several lines of lingerie and sleepwear to compete with Victoria's Secret.  The once-mighty retailer appears to be receiving pressure on multiple fronts.  

I find the development quite interesting given that one of my MBA student teams performed a strategic analysis of L Brands last semester. They offered a highly critical examination of the Victoria's Secret strategy, arguing the brand requires a significant overhaul.  They pointed that management had  lost touch with key consumer trends.   Their analysis, frankly, is as thorough and insight as the critique put forth by Barington Capital.  I'm a proud professor!  

One should note that the proposed break-up, in and of itself, won't fix these branding and merchandising issues at Victoria's Secrete.  Simply breaking up without addressing the competitive positioning problems will not magically unlock value in the long run.   Moreover, the key question that needs to be asked about the strategy is whether there are substantial synergies between the two chains.  If there are, then breaking up will actually destroy some value.   On the other hand, if limited economies of scope exist, then a strong case can be made for addressing the Barington Capital proposal.   From afar, I don't see a compelling case for synergies that require these two firms to stay together.   Simply sharing corporate services is not a strong enough rationale for keeping the two units in one corporation.   The firm's products are rather distinct.  They don't share many suppliers.  They do share customers, but do the two companies use a wealth of common customer data to enhance each business?    It's hard to know from the outside.   Without some signficant revenue enhancement or cost reduction from collaboration between the two units, the case for a break-up appears compelling.  It will be interesting to see management's response, given that they have not been shy about divestitures in the past.  

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. 

Breaking up is the thing to do: Does Kraft's split make sense?

Kraft announced this morning that it will be splitting into two independent companies.  According to the firm's press release, it will divide into "a high-growth global snacks business with estimated revenue of approximately $32 billion and a high-margin North American grocery business with estimated revenue of approximately $16 billion."   While some investors applauded the move, others expressed some surprise given that Kraft recently acquired Cadbury.  At the time, Kraft made a strong argument for the synergies between Cadbury's chocolate and gum business and the Kraft food businesses.  


I'm still trying to sort through the logic and details of the split, but I am a bit puzzled by a few details that have emerged.  According to the company, the high-growth global snacks business will include brands such as "Oreo and LU biscuits, Cadbury and Milka chocolates, Trident gum, Jacobs coffee,and Tang powdered beverages."  The high-margin North American foods business will include brands such as "Kraft macaroni and cheese, Oscar Mayer meats, Philadelphia cream cheese, Maxwell House coffee, Capri Sun beverages, Jell-O desserts and Miracle Whip salad dressing."  Now, wait a second.  We're going to have coffee brands in each new firm.  We're going to have other beverage brands (Capri and Tang) in each new firm.  How can one argue that the break-up is about keeping the most synergistic businesses together if you are putting identical products in different companies?   

To me, the logic appears to be: keep the high growth stuff in one entity and the low growth stuff in the other entity, rather than focusing on the actual synergies among the businesses.   The press release is very explicit about that motivation.  The move seems designed to try to drive the stock price through a focus on attracting different types of investors to each entity, and through trying to garner as high a price multiple as possible for the global snacks business.   I think this may be somewhat short-sighted though.  At the end of the day, brands should be together in one firm if there are true economies of scope (i.e. synergies).  Price multiples should not be driving competitive strategy.    I'll be interested in hearing more about how and why different brands have been put into each entity.  Perhaps there's more to the story. 

McGraw-Hill - Breaking up is hard to do

The Wall Street Journal reports that Jana Partners (a hedge fund) and the Ontario Teachers' Pension Plan have increased their equity stake in McGraw-Hill and may be pushing the company to break up in the near future.  I found the news quite interesting, because it's been apparent for quite some time that the whole was not worth more than the sum of the parts.  Last year, a team of my first-year MBA students performed a strategic analysis of McGraw-Hill for their course project.  They concluded that McGraw-Hill's businesses did not fit together.  The company operates a financial services unit, which includes the S&P credit rating agency.  It also operates a large, but struggling, education unit (which sells textbooks, for example), and it has several television stations in its portfolio.   McGraw-Hill divested Business Week last year.   The synergies among these varied units are rather limited.  

Of course, investors have known this for some time, as has the management team.  Even a team of first-year MBAs could see rather easily that one had a hard time justifying this strategy given the limited economies of scope.  Yet, the company has remained intact.   It shows how difficult it can be for management to break up a company... particularly one that has a long and storied history of family ownership and leadership.   Chairman and Chief Executive Harold McGraw III's great-grandfather founded the company in 1888.  I'm sure that the family legacy makes it difficult to ponder breaking up the firm.  One reason for that may be that a break-up might put the company in play.   Firms may swoop in to try to acquire the various parts, and the firm may have a hard time remaining independent and family-controlled.