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 One-Stop Shopping a Good Thing?

When many firms pursue diversification strategies, they argue that they can provide one-stop shopping for clients.  This logic implies that one-stop shopping adds value for the customer, and that the multiple business units inside the corporation are more valuable together than apart.  For many firms, cross-selling becomes a key initiative, to try to provide that one-stop shopping experience (Wells Fargo, anyone?).   Does one-stop shopping make sense though?  Do customers actually want to purchase a series of related services from one supplier?   Would you like to have all your financial relationships with one firm, or would you prefer to purchase your insurance at one firm, secure a mortgage at another, and invest in bonds at yet another company?

Olivier Chatain and Denisa Mindruta have written a paper on this topic. The paper is titled, “Estimating Value Creation From Revealed Preferences: Application to Value-based Strategies."  The authors presumed initially that one-stop shopping created value for clients.  After all, the firm provided customers more convenience, and it could apply learning from one aspect of a customer relationship to the provision of other products and services.   Synergies seemed readily available.  The research, however, demonstrated that significant drawbacks may exist to a one-stop shopping strategy.   I'm not shocked; I've always been skeptical of such strategies.   I think firms overvalue synergies routinely.   Moreover, I'm not sure customers actually want to put all their eggs in one basket.   They also get annoyed at times when firms are constantly engaging in cross-selling tactics.  

Chatain and Mindruta studied law firms in this research.   Chatain explains the findings:

What we think is that — especially for the law firms we were looking into — … even though you may know a client well, each time [you provide a new service to him], it’s almost like [starting] a different subject. You really have to start over and learn a lot about the client.

An alternative explanation [for our results] is that some clients are very worried about having one supplier of service serving multiple areas. So even though you might be the best expert for me, if you’re already my best expert for two or three other subjects in law, I may want to deal with someone else because I might be afraid if I get all the information from the same supplier, I might be missing out on some important themes.

I might have a preference of diversity in terms of input, which was something that is apparently more important than the savings you can realize by bundling all these products together.

Should Disney Sell ESPN?

The Wall Street Journal reported this morning on Disney's quarterly earnings announcement, noting that the news disappointed investors.  "Declining income at ESPN continued to overshadow quarterly results at Walt Disney Co., with the sports powerhouse posting lower advertising and subscription revenue that dragged company earnings below Wall Street expectations."  These results continue a multi-year slide in subscriber numbers at ESPN, as many American consumers "cut the cord" - ending their cable television subscriptions.   Some people estimate that ESPN has lost more than 10 million subscribers in the past several years.  

This news raises a key question for me:  Should Disney sell ESPN?   That question may shock some people, as ESPN has been a substantial contributor to Disney's total net income since it was acquired as part of the Disney acquisition of Capital Cities/ABC two decades ago.   However, Disney's corporate strategy has evolved considerably since that time.   During the second half of Michael Eisner's tenure as CEO, Disney diversified well beyond the businesses that leveraged the animation studio as a central asset (acquiring ABC, owning baseball and hockey teams, etc).  However, during Bob Iger's tenure, characters have become the driving force of the corporate strategy once again.   The three major acquisitions during Iger's tenure have focused on expanding the character portfolio, so that Disney can leverage those characters across multiple platforms (i.e. Pixar, Marvel, and Lucas Films).  In many ways, Iger has returned Disney to its roots.   Below you will see famous chart created by Walt Disney himself to describe synergies at the company.   One has to ask:  How does ESPN fit into this chart?   Absent major synergies, and facing a long term disruption to ESPN's business model, might Disney be better off divesting the business unit?   Alternatively, Disney has to take a hard look at reinventing the business model at ESPN, rather than tweaking the strategy.   A reinvention seems necessary given the long term trends regarding cord cutters.   

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.

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.